Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update May 2024
A downloadable PDF copy of the Article:
Day Hagan/Ned Davis Research Smart Sector® Fixed Income Strategy Update May 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 model deteriorated during the month but entered May 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, two external measures deteriorated. High-yield and Emerging Market bond breadth weakened to neutral, while the Baltic Dry Index (a measure of global trade) flashed bearish during the month (Figure 2). For now, the weight of the evidence recommends a fully invested allocation to fixed-income sectors according to the model.
Figure 2: Weakening Baltic Dry Index is Bearish for Equity Exposure
Fixed Income Market Update
The Bloomberg Barclays U.S. Aggregate Bond Total Return Index weakened in April with a return of about ‑2.5%. Breadth deteriorated sharply—seven of nine fixed-income sectors we track posted negative returns for the month. U.S. Long-Term Treasurys were the weakest at -6.4%, driving down the aggregate.
Due to sticky inflation and a robust jobs market, the FOMC kept the Fed funds target range at 5.25% to 5.50% for this month’s sixth consecutive meeting. The Fed noted the “lack of further progress toward the Committee’s 2% inflation objective.” We believe that means fewer rate cuts this year than was expected in March.
The big debate in the market and the press is whether policy is restrictive. If you’re the Fed and you look at the real policy rate, the answer is yes. Real rates from the TIPS market are at or near their October cycle highs, leading to a higher cost of capital. In fact, the last time we saw real rates this high was during the GFC (Figure 3).
Entering May, the fixed income strategy’s positioning is overweight Long-term Treasurys, U.S. High Yield, and International Investment Grade. U.S. Investment Grade Corporates are neutral. Floating Rate Notes, Emerging Market Bond, TIPS, and Mortgage-Backed Securities are underweighted relative to the benchmark.
Figure 3: Treasury Inflation Protected Securities (TIPS)
The U.S. Floating Rate Notes model improved with the recent uptick in rates. However, many of the indicators are now at levels that have historically coincided with overbought conditions. During the month, market volatility (as measured by the VIX) moved neutral for U.S. Floating Rate Notes (Figure 4). Technicals improved—the sector had new bullish signals from momentum and slope indicators. The sector is on watch for a potential increase in exposure.
Figure 4: U.S. Floating Rate Notes FRN RS vs. VIX (inv.) Extremes
The International Investment Grade bond allocation improved sharply and was upgraded to overweight. Externals improved. Stock market volatility (as measured by the VIX) flashed bullish for the sector while widening spreads moved to neutral. Price-based measures are bullish—the short-term trend (Figure 5) improved to bullish during the month and joined a relative strength slope indicator.
Figure 5: Improving Trend is Bullish for International Investment Grade
U.S. Mortgage-Backed Securities’ allocation dropped sharply to underweight. On a fundamental basis, a bullish 10-year yield indicator was more than offset by bearish option-adjusted spreads and inflation expectations’ extreme spreads (Figure 6), which moved negatively for the sector during the month. Technicals are confirming, as trend and relative strength measures remained bearish.
Figure 6: Narrowing Inflation Expectations Extremes Spread is Bearish for Mortgage Backed Securities
The allocation to U.S. Treasurys is now overweight. On a fundamental basis, last month’s weaker equity trend was relatively positive for bonds. Notably, last month’s bearish inflation expectations are reversing and several technical measures appear oversold (Figure 7).
Figure 7: U.S. Long Term Treasury Inflation Expectations
Summary
Entering May, the fixed income allocation strategy’s positioning is overweight Long-term Treasurys, U.S. High Yield, and International Investment Grade. U.S. Investment Grade Corporates are neutral. Floating Rate Notes, Emerging Market Bond, TIPS, and Mortgage-Backed Securities are underweighted relative to the benchmark.
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.
For more information, please contact:
Day Hagan Asset Management
1000 S. Tamiami Trl
Sarasota, FL 34236
Toll Free: (800) 594-7930
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.
© 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.
