Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update July 2023
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Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update July 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 from last month and entered July, 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: NDR Volume Demand Outpacing NDR Volume Supply: Bullish for Equity Exposure
The model improvement was driven by two internal (price-based) measures that moved bullish during the month—stronger global stock market breadth and stock volume demand outpacing supply (chart left). While external influences such as trade and market sentiment moved bearish during the month, it was partly offset by a bullish reading from high-yield and emerging market bond breadth. For now, the weight of the evidence recommends a fully invested allocation to fixed-income sectors according to the model.
Fixed Income Market Update
The Bloomberg Barclays U.S. Aggregate Bond Total Return Index declined less than 0.5% in June. Returns have been negative for seven of the past 12 months. Breadth improved—seven of the nine fixed-income sectors we track had positive returns in June—but the weak performance by mortgage-backed securities (MBS) dragged down the Aggregate.
Fixed-income markets are likely to chop around in the second half of 2023. Short-term yields are being pushed up by continued tightening by central banks in the developed markets. Longer-term yields are being pulled down by slower growth and cooling inflation expected later this year. After pausing their tightening cycles earlier this year, the Reserve Bank of Australia and the Bank of Canada resumed their rate hikes, as inflation remained sticky. The Fed paused in June but indicated two more hikes are coming later this year. The European Central Bank and the Bank of England never stopped hiking.
Technically, the March peaks are significant in this battle (chart below). We would be surprised to see 10-year Treasurys hold above 4.00% for very long, confirmed by German 10-year yields above 2.75%. These levels should provide an upward cap to global yields. The lower end of the range will be defined as 3.25% and 2.00%, respectively.
Entering July, the fixed income allocation strategy had very small changes in sector allocations. The model is overweight U.S. Short-Term bonds, U.S. Mortgage Backed, U.S. Long-Term Treasury, and Emerging Market Bonds. We have moved to underweight Floating Rate Note, U.S. Corporate, TIPS, and U.S. High Yield. (Note: We were underweight High Yield and TIPS last month.) International Investment Grade Corporate Bonds are neutral.
Figure 3: Yields on Key 10-Year Governments
Floating rate notes typically outperform during a rising rate environment—yields have recently been in a trading range. Four of five indicators remained steady in June. The only measure to change was the short-term price momentum indicator, which moved bearish this past month (chart right). With U.S. 10-year note yields approaching 4% and potential resistance levels, we have reduced exposure.
Figure 4: U.S. Floating Rate Notes’ Short-Term Momentum Improving: Bullish for the Sector
Figure 5: Short-Term Relative Strength Trend: Bullish for International Investment Grade Bonds.
International Investment Grade bonds’ allocation was also steady and remained neutral. No indicators changed this month. External influences such as high-yield returns vs. inflation and U.S. swaps remained neutral for the sector. The three internal (price-based) measures stayed the same, including the bullish readings from relative strength trends (chart left) and the bearish reading from the equity risk VIX.
Emerging Market (EM) bonds’ allocation was steady in June and remains at a slightly overweight position. Three of the five indicators remained steady. Two price-based signals moved bullish during the month of June—EM equity momentum and EM bond trends (chart right).
Figure 6: Short-Term Trend: Bullish for Emerging Market Bonds
Figure 7: Narrowing Option-Adjusted Spreads: Bearish for Treasury Inflation-Protected Securities
U.S. Treasury Inflation-Protected Securities (TIPS) allocation was steady in June and remains the largest underweight position. TIPS typically outperform when inflation is high. Since we have passed the peak in inflation, the sector has been under pressure. All six indicators are now bearish for the sector, including narrowing high-yield option-adjusted spreads, which moved to an unfavorable level for TIPs (chart left).
Summary
Entering July, the fixed income allocation strategy had very small changes in sector allocations. The model is overweight U.S. Short-Term bonds, U.S. Mortgage Backed, U.S. Long-Term Treasury, and Emerging Market Bonds. We have moved to underweight Floating Rate Note, U.S. Corporate, TIPS, and U.S. High Yield. (Note: We were underweight High Yield and TIPS last month.) International Investment Grade Corporate Bonds are neutral.
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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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) are trimmed by 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 immediately moves back to 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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