Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update May 2023
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Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update May 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 May recommending full model exposure to U.S. Treasury, U.S. Mortgage-Backed Securities, U.S. Corporates, International Investment Grade Bonds, and U.S. Short-Term Bonds.
Figure 1: Smart Sector® Fixed Income Risk Management Model
Figure 2: Improving MSCI ACWI Breadth: Bullish for Equity Expsoure
The model improvement was mostly driven by stronger technicals—stock/bond relative strength, global stock market breadth (chart left), and stock market short-term trend all improved to bullish levels during the month. In terms of external influences, the breadth for High Yield and Emerging Market bonds and global trade (as measured by the Baltic Dry Index) remains bullish, while high-yield option-adjusted spreads remain bearish.
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 a 3% gain in March, the performance of the Bloomberg Barclays U.S. Aggregate Bond Total Return Index moderated—the index gained less than 1% in April. Returns have been positive for six of the past 12 months. Breadth has been strong—all nine fixed-income sectors we track had positive returns in April.
We expect the Fed to raise the Fed funds target range another 25 basis points on Wednesday to 5.00% to 5.25%. We think it will be the last rate hike of this tightening cycle. The Fed, however, will want to preserve its optionality—just in case the economic data doesn’t come in as expected before the next meeting in mid-June. Quantitative tightening will continue to roll on.
Although this has been the most aggressive Fed tightening cycle in history, we never started out in such a deep hole in terms of the real Fed funds rate. The Fed hopes inflation comes down to allow the real Fed funds rate to rise above 1.5% and prays that nothing else breaks. Looking at history, typically, yields fall, and the yield curve steepens after the end of the tightening cycle (chart below). This will have implications for fixed-income sector leadership.
Figure 3: 10 Year Treasury Yield Around End of Fed Tightening Cycle.
U.S. Investment Grade Corporate bond allocation remained at neutral levels. Implied volatility and credit default swaps both moved bullish during the month. This was confirmed by technicals, as the short-term moving average crossed above the long-term moving average, a bullish signal for the sector (chart right).
Figure 4: U.S. Investment Grade Corporate Technical Cross: Bullish for the Sector
Figure 5: : Lower VIX is Bullish for U.S. High Yield Bonds
High Yield bonds’ allocation was reduced in April, moving it to underweight. Indicators are mixed. The bullish breadth and absolute trend are offset by a weaker small-cap equity trend and moving average crossover measures. One indicator improved to bullish last month—lower short-term market volatility, which indicates investors’ appetite for riskier assets (chart left).
Floating Rate Notes’ remains the largest underweight position. Floating rate notes typically outperform during a rising rate environment—yields have recently been in a trading range. Eighty percent of the model’s indicators remain bearish. The only improvement this past month was from the relative strength slope indicator, which moved bullish for the sector (chart right).
Figure 6: Rising U.S. Floating Rate Notes’ Relative Strength is Bullish for the Sector.
Figure 7: International Investment Grade Relative Strength Weakening: Bearish for the Sector.
International Investment Grade bond’s allocation dropped from an overweight position to a slightly underweight position. While external indicators such as high-yield returns vs. inflation and U.S. swaps remained neutral for the sector, all three technical measures flipped from bullish to bearish for the sector, including international investment grade bond relative strength trends (chart left).
Summary
Unlike the stock market, investors shifted allocations to riskier fixed-income sectors during April. Entering May, we have full exposure to U.S. Treasury, U.S. Mortgage-Backed Securities, U.S. Corporates, International Investment Grade Bonds, and U.S. Short-Term 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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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.
