Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update February 2024
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Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update February 2024 (pdf)
Risk Management Update
The risk management model (Figure 1) seeks to reduce exposure to fixed-income sectors most sensitive to equity drawdowns. The risk management model weakened during the month but entered February recommending full model exposure to areas most sensitive to equity markets: U.S. High Yield, Emerging Markets, U.S. Investment Grade, and Floating Rate Notes.
Figure 1: Smart Sector® Fixed Income Risk Management Model
The bullish reading from the model is driven by strong internals. Five of the seven price-based measures—including relative strength, trend, and breadth—remain bullish. However, external measures are more mixed. While option-adjusted spreads and high-yield and emerging market breadth are bullish, the short-term trend in global trade—as measured by the Baltic Dry Index—became bearish during the month (Figure 2). Furthermore, investor sentiment remains excessively optimistic, which is bearish for stocks. For now, the weight of the evidence recommends a fully invested allocation to fixed-income sectors according to the model.
Figure 2: Weakening Short-Term Trend in the Baltic Dry Index: Bearish for Equity Exposure
Fixed Income Market Update
After the strong performance by the Bloomberg Barclays U.S. Aggregate Bond Total Return Index in November and December, the index dropped modestly in January (-0.275%). Breadth weakened—five of the nine fixed-income sectors we track had negative returns in January, with long-term Treasurys’ performance the weakest.
In January, central bankers and economic data pushed back on market expectations of early rate cuts. In the U.S., better-than-expected data on retail sales, consumer sentiment, and unemployment claims, and comments from several Fed officials ran counter to a March rate cut that was nearly fully priced in before the Martin Luther King, Jr. holiday. As a result, markets unwound their Powell pivot rally.
As expected, at the late January meeting, the FOMC left the fed funds target range at 5.25% to 5.50%. Fed Chair Powell said March was not their base case for a rate cut. We affirmed our Q2 call, most likely in May, for the first cut. Ten-year Treasury yields have always fallen during the three months before the first rate cut going back to 1970. With the 10-year yield near 4.00%, yields may test their December lows, at a minimum, and our message has been to buy backups in yield (Figure 3).
Entering February, the fixed income allocation strategy continued to favor risk-on leadership but did rebalance. The model remained overweight (versus the AGG benchmark), U.S. Treasuries (allocated across short-, intermediate-, and long-duration), High Yield, and Emerging Market Bonds. The portfolio is market weight TIPS and Mortgage-Backed Securities and underweight U.S. Floating Rate Notes, U.S. Investment Grade, International Investment Grade, and International Bonds.
Figure 3: 10-Year Treasury Yield
U.S. High-Yield bonds’ allocation rose sharply and is now the largest overweight. All six indicators remain bullish for the sector. On a fundamental basis, the trend in small-cap equities and investor sentiment, as measured by both the VIX and option-adjusted spreads, is bullish. This is confirmed by bullish technicals, including breadth and trend (Figure 4).
Figure 4: Short-Term Trend is Bullish for U.S. High Yield Bonds
The U.S. investment-grade corporate bond allocation dropped and is slightly underweight. Four of six indicators remain bullish, but two indicators changed during the month—the bullish trend in the U.S. dollar was offset by rising credit default swaps (Figure 5).
Figure 5: Rising Credit Default Swaps is Bearish for U.S. Investment Grade Corporate Bonds
U.S. Long-Term Treasurys’ allocation improved and is overweight. The portfolio holdings in Treasurys are allocated among short-, intermediate-, and long-duration holdings. Price-based measures are now mixed. The trend remains bullish, while momentum moved neutral during the month. Rising inflation expectations triggered a negative signal for the sector during the month, but it has since reversed back to a bullish reading (Figure 6).
Figure 6: Rising Inflation Expectations is Bearish for U.S. Long Term Treasurys
While U.S. Floating Rate Notes’ allocation increased, U.S. Treasury Inflation-Protected Securities (TIPS) allocation dropped sharply—both remain underweight. Commodity price trends and high-yield option-adjusted spreads remain headwinds for TIPS. These bearish measures are being confirmed by TIPS’ weak technicals, including the relative strength index (Figure 7).
Figure 7: Weak Relative Strength Index is Bearish for TIPS
Summary
Entering February, the fixed income allocation strategy continued to favor risk-on leadership but did rebalance. The model remained overweight (versus the AGG benchmark), U.S. Treasuries (allocated across short-, intermediate-, and long-duration), High Yield, and Emerging Market Bonds. The portfolio is market weight TIPS and Mortgage-Backed Securities and underweight U.S. Floating Rate Notes, U.S. Investment Grade, International Investment Grade, and International Bonds.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk, as well as where to place that capital.
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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Office Phone: (941) 330-1702
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.
Day Hagan Asset Management is registered as an investment adviser with the United States Securities and Exchange Commission. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Day Hagan Asset Management claims compliance with the Global Investment Performance Standards (GIPS®). GIPS is a registered trademark of CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein. Day Hagan Asset Management has been independently verified for the periods June 30, 2008 through December 31, 2020. The U.S. dollar is the currency used to express performance. Calculation Methodology: Pure gross of fees returns are calculated gross of management and custodial fees. Net of fees returns are calculated by reducing the gross number by an average investment management fee of .85% and gross of custodian (trust) fees. Net of fees returns for wrap accounts are calculated net of management fees, transaction costs and all administrative fees charged directly to the client by the broker-dealer. To receive a GIPS composite report, contact Linda Brown at (941) 330-1702 or email at linda.brown@dayhagan.com.
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.
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© 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.
