Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update December 2023
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Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update December 2023 (pdf)
Risk Management Update
The risk management model (chart right) seeks to reduce exposure to fixed-income sectors most sensitive to equity drawdowns. The risk management model improved during the month and entered December recommending an increase in exposure to areas most sensitive to equity markets: U.S. High Yield, Emerging Markets, U.S. Investment Grade, and Floating Rate Notes. At the time, we noted that many of our shorter-term measures of sentiment and overbought conditions had moved to levels denoting excess risk for the near term. Those models and indicators have not yet pulled back, indicating that the market is still consolidating in advance of the next trend, whether it is a resumption of the upside or a reversal lower. We will redeploy the remaining cash holding as sentiment eases or longer-term breadth thrust measures confirm the near-term signals.s.
Figure 1: Smart Sector® Fixed Income Risk Management Model
Figure 2: : % of MSCI Markets Above 50-Day Moving Average: Bullish for Equity Exposure
The improvement in the model was purely driven by better technicals—five of the seven price-based measures are now bullish, including breadth rising to its highest level since July (chart left). Investor sentiment is now excessively optimistic, so we will keep an eye on these measures.
Fixed Income Market Update
After being down for six months in a row, the Bloomberg Barclays U.S. Aggregate Bond Total Return Index rebounded and gained 4.5% in November. Breadth improved sharply—all nine fixed-income sectors we track had positive returns in November—U.S. Long-Term Treasurys rebounded nearly 10%.
After 10-year yields topped 5.00% and became good values, yields have sharply reversed on slowing growth, cooling inflation, and a Fed that is viewed as finished hiking rates. Historically, bonds have performed well after the last rate hike and the Fed has maintained a tightening bias. Additionally, our Bond Enhancement Model flashed a buy signal. As a result, we increased our recommended bond duration. Long-term support can be found from 5.00% to 5.25%. Intermediate-term resistance is around 4.00%.
Investors have moved back into riskier assets—Investment Grade Corporate (chart below), High-Yield, Mortgage-Backed Securities, and Emerging Market bonds all rallied sharply during the month.
Entering December, the fixed income allocation strategy shifted to risk-on leadership. The model is relatively overweight: U.S. High-Yield, Long-Term Treasurys, Short-Term TIPS, U.S. Investment Grade Corporates, International Investment Grade, and Emerging Market Bonds. The model is relatively underweight in U.S. Mortgage-Backed Securities and U.S. Investment-Grade Corporations. All allocations are relative to the cash-adjusted benchmark, Core U.S. Aggregate Bonds.
Figure 3: Investment Grade Corporate Performance Relative to the Float Adjusted U.S. Aggregate
The U.S. Investment-Grade corporate bond allocation held steady. While bond volatility and the U.S. dollar are bearish for the sector, four of the six indicators are bullish, including a price trend indicator that flashed positive during the month (chart right).
Figure 4: Short-Term Price Trend: Bullish for U.S. Investment Grade Corporate
Figure 5: Strong Emerging Market Equity Momentum: Bullish for Emerging Market Bonds
Emerging Market bonds rallied by over 6% in November. The model’s allocation increased, and the sector was upgraded to overweight. Four of five indicators are now bullish for the sector. A weakening U.S. Dollar and positive momentum in Emerging Market equities (chart left) were confirmed by improving technicals.
U.S. Floating Rate Notes’ allocation remains minor. Floating rate notes typically outperform when rates are rising. With the sharp drop in rates in November, the sector underperformed significantly. All five indicators are now bearish for the sector, including short-term momentum (chart right).
Figure 6: Weakening Momentum is Bearish for U.S. Floating Rate Notes
Figure 7: Weakening Relative Strength: Bearish for International Investment Grade
International Investment Grade bonds’ allocation dropped sharply. Narrowing global option-adjusted spreads joined U.S. swaps at neutral. Two price-based measures, including relative strength trends (chart left), flashed bearish, along with equity volatility.
Summary
Entering December, the fixed income allocation strategy shifted to risk-on leadership. The model is relatively overweight: U.S. High-Yield, Long-Term Treasurys, Short-Term TIPS, U.S. Investment Grade Corporates, International Investment Grade, and Emerging Market Bonds. The model is relatively underweight in U.S. Mortgage-Backed Securities and U.S. Investment-Grade Corporations. All allocations are relative to the cash-adjusted benchmark, Barclays U.S. Aggregate Bond Index.
NDR Strategists contributing to this publication: Brian Sanborn, CFA, Ed Clissold, CFA, Rob Anderson, CFA, Thanh Nguyen, CFA, Tim Hayes, CMT, Joe Kalish
For more information, please contact:
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Day Hagan/Ned Davis Research
Smart Sector® Fixed Income ETF
Symbol: SSFI
Strategy Description
The Smart Sector® Fixed Income strategy combines two Ned Davis Research quantitative investment strategies: The NDR Fixed Income Allocation and the NDR Catastrophic Stop.
The Process Is Based On The Weight Of The Evidence
The fund begins by overweighting and underweighting fixed-income sectors based on Ned Davis Research’s proprietary fixed-income models.
Each of the models utilizes sector-specific, weight-of-the-evidence composites of fundamental, economic, technical, and behavioral indicators to determine each area's probability of outperforming the other categories.
Sectors are weighted accordingly relative to an equal-weighted benchmark.
When Market Risks Become Extraordinarily High - Reduce Your Portfolio Risk
The model remains fully invested unless the Ned Davis Research Catastrophic Sell Stop (CSS) model is triggered, whereupon the areas which underperform during periods of market stress (high yield, Emerging Markets, U.S. Investment Grade, and Floating Rate Notes) may be trimmed by up to 50%.
The NDR Catastrophic Sell Stop model combines time-tested, objective indicators designed to identify periods of high risk for the broad financial markets. The model uses price-based, breadth, deviation from trend, fundamental, economic, interest rate, behavioral and volatility-based indicator composites.
When Market Risks Return To Normal — Put Your Money Back To Work
When the NDR CSS model moves back to bullish levels, indicating lower risk, the strategy will reverse toward being fully invested.
Ned Davis Research Disclaimers
The data and analysis contained within are provided "as is" and without warranty of any kind, either express or implied. The information is based on data believed to be reliable, but it is not guaranteed. NDR DISCLAIMS ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY, SUITABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. All performance measures do not reflect tax consequences, execution, commissions, and other trading costs, and as such investors should consult their tax advisors before making investment decisions, as well as realize that the past performance and results of the model are not a guarantee of future results. The Smart Sector® Strategy is not intended to be the primary basis for investment decisions and the usage of the model does not address the suitability of any particular in Fixed Income vestment for any particular investor.
Using any graph, chart, formula, model, or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such devices. NDR believes no individual graph, chart, formula, model, or other device should be used as the sole basis for any investment decision and suggests that all market participants consider differing viewpoints and use a weight of the evidence approach that fits their investment needs.
Disclosures
Past performance does not guarantee future results. No current or prospective client should assume future performance of any specific investment or strategy will be profitable or equal to past performance levels. All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals and economic conditions may materially alter the performance of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. Historical performance results for investment indexes and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. There can be no assurances that a portfolio will match or outperform any particular benchmark.
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References to “NDR” throughout refer to Ned Davis Research, Inc. Clients engaging in this strategy will be advised by Day Hagan and will not have a contractual relationship with NDR. Day Hagan purchases signals from NDR, and Day Hagan is responsible for executing transactions on behalf of its clients and has discretion in how to implement the strategy.
NDR is a registered as an investment adviser with the Securities and Exchange Commission (SEC). NDR serves as the Signal Provider in connection with this strategy. The information provided here has not been approved or verified by the SEC or by any state or other authority. Additional information about NDR also is available on the SEC's website at https://www.adviserinfo.sec.gov/. This material is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or to participate in any trading strategy. NDR’s strategies, including the model discussed in this publication, are intended to be used only by sophisticated investment professionals.
There may be a potential tax implication with a rebalancing strategy. Re-balancing involves selling some positions and buying others, and this activity results in realized gains and losses for the positions that are sold. The performance calculations do not reflect the impact that paying taxes would have, and for taxable accounts, any taxable gains would reduce the performance on an after-tax basis. This reduction could be material to the overall performance of an actual trading account. NDR does not provide legal, tax or accounting advice. Please consult your tax advisor in connection with this material, before implementing such a strategy, and prior to any withdrawals that you make from your portfolio.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends or avoid losses.
© 2023 Ned Davis Research, Inc. | © 2023 Day Hagan Asset Management, LLC
© Copyright Ned Davis Research, Inc. All Rights Reserved | These materials are historical and intended to be used only as examples, and do not necessarily reflect current views or advice of NDR or its representatives.
