Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update January 2024
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Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update January 2024 (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 remained steady during the month and entered January 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
Figure 2: Rising Relative Strength is 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. For now, the weight of the evidence recommends a fully invested allocation to fixed income sectors according to the model.
Fixed Income Market Update
After the strong performance by the Bloomberg Barclays U.S. Aggregate Bond Total Return Index in November, the index rebounded further and gained 3.8% in December. Breadth was strong—all nine fixed-income sectors we track had positive returns in December.
Ten-year Treasury yields have always fallen in the 2-3 months before the first rate cut going back to 1970 (chart below). The market is tracking and is currently expecting a rate cut in March. After the cut, yields tend to stabilize. Over the easing cycle, 10-year Treasury yields generally declined, with a median drop of 67 basis points.
Spreads between Baa and Aaa tend to widen modestly heading into the first rate cut. Similarly, excess returns declined heading into a rate cut. Higher-quality sectors generally performed well during an easing cycle. Credit spreads between Baa and Aaa changed little in past easing cycles.
Although the TIPS market has a shorter history, it shows a clear pattern of falling going into the first rate cut. And except for the Long-Term Capital Management incident, real yields kept falling in the months after the first cut. Real yields have fallen significantly over the entire easing cycle (around 100 basis points or more) except for 1998 when they rose modestly after liquidity concerns dissipated.
Entering January, 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.
Figure 3: Treasury Yields Fall Into The First Rate Cut
U.S. Investment Grade Corporate bonds’ allocation remained steady at an overweight position. Four of the six indicators are bullish. Two indicators changed during the month—widening option-adjusted spreads was offset by lower bond volatility (chart right).
Figure 4: Lower Bond Volatility is Bullish for U.S. Investment Grade Corporate
Figure 5: Relative Strength is Bullish for Emerging Market Bonds
Emerging Market bonds rallied by over 4% in December. The model’s allocation to the sector was steady, and it remains a significant overweight. Four of five indicators remain bullish for the sector including Emerging Market relative strength (chart left).
U.S. Floating Rate Notes’ allocation remained steady as the largest underweight position. Floating rate notes typically outperform when rates are rising. With the further drop in rates in December, the sector continued to underperform. All five indicators remain bearish for the sector including short-term trend (chart right).
Figure 6: Short-Term Trend is Bearish for U.S. Floating Rate Notes
Figure 7: Strong U.S. Equity Market Trend is Bearish for U.S. Long-Term Treasurys
U.S. Long-Term Treasurys’ allocation remained steady at slightly overweight. The sector’s performance rebounded for the second month in a row in December, which was picked up by the two price-based measures—trend and momentum. However, the stronger trend in U.S. equities became a headwind for the sector during the month (chart left).
Summary
Entering January, 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.
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 and 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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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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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.
