Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update June 2023
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Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update June 2023 (pdf)
Risk Management Update
The risk management model (chart at right) seeks to reduce exposure to fixed income sectors most sensitive to equity drawdowns (U.S. High Yield, Emerging Markets, U.S. Investment Grade, and Floating Rate Notes) during periods of market stress.
The model (chart at right) deteriorated from last month but entered June with a risk-on recommendation.
Figure 1: Smart Sector® Fixed Income Risk Management Model
Figure 2: Percentage of MSCI ACWI Markets Above Their 50-Day Moving Averages Dropped Below50% Threshold
The model deterioration was mostly driven by weaker breadth—global stock market breadth (chart at left) and breadth for High Yield and Emerging Market bonds both declined during the month. Additionally, stock volume supply continues to outpace demand, option-adjusted spreads remain wide, sentiment shows excessive optimism, and the Baltic Dry Index reflects weakening economic activity. Some of these indicators will need to improve if the market rally is going to continue deep into the second-half of the year. 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 about 1% in May. Returns have been positive for five of the past 12 months. Breadth has been weak—six of the nine fixed income sectors we track had negative returns in May.
While 10-year yields have been in a trading range since last Fall (chart below, top clip), in the month of May, yields had a significant backup. There were several factors that contributed to the rise, including the debt ceiling, Fed speakers, and supply (bottom clip). The rise in the 10-year yield was a contributing factor to whipsawing fixed income sector leadership.
The bond market is oversold and near short-term support levels. But rising European yields could continue to put upward pressure on Treasurys. Turmoil in the banking sector, tighter credit, and a potential recession later in the year or early next year could lead to a yield breakdown.
Entering June, the fixed income allocation strategy is overweight International Investment Grade, U.S. Mortgage Backed, Emerging Market Debt, and U.S. Long-Term Treasury. We are neutral on Short-Term Bonds. We are underweight Floating Rate Notes, U.S. Corporates, U.S. High Yield, and TIPS.
Figure 3: Corporate Bond Supply
Floating Rate Notes’ allocation is slightly underweight. Floating rate notes typically outperform during a rising rate environment—yields have recently been in a trading range. Four of five indicators improved this past month, as improving spreads was confirmed by bullish short-term trend and momentum (chart right).
Figure 4: U.S. Floating Rate Notes’ Short-Term Momentum Improving: Bullish for the Sector
Figure 5: Rising Relative Strength: Bullish for International Investment Grade
International Investment Grade bonds’ allocation improved from a significant underweight to an overweight position. While external indicators such as high-yield returns vs. inflation and U.S. swaps remained neutral for the sector, two of the three technical measures flipped from bearish to bullish for the sector, including international investment grade bond relative strength trends (chart left).
Emerging Market bonds’ allocation is slightly overweight based on the June model updates. Due to its size, China has a significant influence on Emerging Markets (EM). While China’s economic recovery remains intact, momentum is fading. As a result, EM equities (chart right) and EM currencies weakened during the month, both of which are negative for EM bonds. We will reduce exposure if the models continue to deteriorate.
Figure 6: Weak Emerging Market Equity Momentum: Bearish for Emerging Market Bonds
Figure 7: Weakening Relative Strength Index: Bearish for U.S. TIPS
U.S. Treasury Inflation Protected Securities’ (TIPS) allocation also dropped sharply for June, moving it from a slight overweight to the largest underweight position. TIPS tend to outperform when inflation is high. We have passed the peak in inflation—inflation expectations have dropped which is bearish for TIPS. This has been confirmed by two relative strength trend indicators (chart left), both of which moved bearish during the month.
Summary
Entering June, the fixed income allocation strategy is overweight International Investment Grade, U.S. Mortgage Backed, Emerging Market Debt, and U.S. Long-Term Treasury. We are neutral on Short-Term Bonds. We are underweight Floating Rate Notes, U.S. Corporates, U.S. High Yield, and TIPS.
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:
Day Hagan Asset Management
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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) 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.
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.
© 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.
