Day Hagan/Ned Davis Research Smart Sector® International Strategy Update January 2024
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Day Hagan/Ned Davis Research Smart Sector® International Strategy Update January 2024 (pdf)
Catastrophic Stop Update
The NDR Catastrophic Stop Sell model combines time-tested, objective indicators designed to identify high risk periods for the equity market. The model (chart right) remained steady during the month and entered January with a fully invested equity allocation recommendation.
Figure 1: Smart Sector® Catastrophic Stop Sell Model
Figure 2: Rising Relative Strength is Bullish for Equity Exposure
The bullish reading from the model is driven by strong externals and internals. Five of the seven price-based measures remain bullish, including relative strength (chart left). With a strong market rally off the October lows, investor sentiment remains excessively optimistic, so we will keep an eye on this measure. For now, the weight of the evidence recommends a fully invested equity allocation according to the model.
Global Market Update
The ACWI ex. U.S. Total Return Index jumped over 500 basis points (bps) in December. The index last increased by more than 500 bps for two consecutive months at the end of 2020. Among the strongest-performing markets were Peru, Sweden, Australia, Colombia, and Mexico, while the largest underperformers included Turkey, Egypt, China, the Czech Republic, and Greece.
The global economy grew modestly in November, as the S&P Global Purchasing Managers’ Index (PMI) global composite (services and manufacturing) indicated moderate global growth. It was the first increase in the PMI in six months, indicating some stabilization in the economy and putting the PMI further away from severe recession.
Forward-looking indicators reflect slower global growth in 2024 but no recession. Overall new orders moved out of contraction territory for the first time in three months, but the future outlook index was little changed. While well above its cycle low in 2022, this index is still below its long-term average, indicating modest growth expectations.
Both the manufacturing and services indexes saw modest improvement, something not seen in tandem since February. But manufacturing continued to contract, while services are growing at a fraction of the pace from earlier this year.
Due to easing global supply chain pressures and waning pandemic-related imbalances, global price growth has eased significantly from its peak in 2022. Both the global composite input and output price indexes are at or close to their lowest levels since late 2020. However, the composite price indexes are still above pre-pandemic levels as progress in bringing down inflation has slowed this year.
Among major countries and regions, growth trends in the U.S. and China remained mildly positive, while the economic decline in Europe eased somewhat. The global powerhouses remain emerging economies outside China, led by India and the Middle East.
Entering January, the non-U.S. equity Core model overweighted Canada, Australia, and Germany while underweighting the U.K., China, France, and Switzerland. The Explore model favored Mexico, the Netherlands, South Africa, Poland, and Turkey.
Figure 3: Global Purchasing Manager Composite Index Indicating Modest Growth
Core Allocations
Canada remains an overweight allocation relative to the benchmark as the region’s trend continues to move higher with strengthening long-term breadth.
Relative to other economies, Canada’s leading economic indicators have been improving (chart right). Bank of Canada officials have noted that interest rates are likely high enough to tame inflation.
Figure 4: OECD Composite Leading Indicators (CLI) for Canada Improving Relative to Other Economies
Figure 5: MSCI Australia Price Return Index (in local currency)
Australia’s weighting increased, moving the market to overweight status. The MSCI Australia Index (local currency) entered the year at an all-time high (chart left). Short-, intermediate-, and long-term trend indicators have turned bullish on the market.
Net employment increased by 61,500 in November, significantly outpacing expectations. Australia has one of the strongest Citigroup Economic Surprise Index readings entering the year, as it is beating consensus.
The U.K. remained underweight for this month. Economic trends are lackluster, as real GDP growth was flat in the third quarter, with data since then suggesting continued stagnation or just modest gains in economic activity. Official hard data for October, including monthly GDP, retail sales, and industrial production, broadly declined, suggesting a poor start to the fourth quarter. Earnings revisions have moved in line with economic data, as they are now bearish on the outlook.
The market recognizes these risks as equities remain in a downtrend (chart right) with weak breadth. None of the region’s technical indicators are bullish.
Figure 6: MSCI U.K. Relative Strength Remains in a Downtrend
Figure 7: Europe ex. U.K. Forward Earnings Growth Rolling Over
France and Switzerland have the largest underweight positions for January. The Europe ex. U.K. region has suffered macro and fundamental deterioration. The outlook has deteriorated as inflation remains elevated and the European Central Bank’s (ECB) most aggressive tightening cycle on record works its way into the economy.
The Now-Casting Index of Economic Activity, with a reading of 80.8, is well below its long-term average of 100. Moreover, the EuroCOIN, which aims to estimate quarterly GDP, declined 0.8% in November. Forward earnings growth expectations have rolled over (chart left), as they now reflect the weakening economy.
Explore Opportunities
Among the top-ranked Explore markets are Mexico, Netherlands, South Africa, Poland, and Turkey.
Mexico, Netherlands, Turkey, and Poland have favorable price trends as their 50-day moving averages trade above their 200-day counterparts.
Turkey is one standard deviation oversold long-term, while the Netherlands and South Africa are almost one standard deviation oversold near-term. Such oversold conditions may provide a near-term bounce opportunity.
Poland, Mexico, and Turkey have low market capitalization-to-GDP ratios, which typically indicate a favorable valuation.
South Africa and Turkey trade below their average cyclically adjusted price-to-earnings ratios. South Africa (chart below) is more than one standard deviation below its historical tendency.
South Africa and Turkey have double-digit one-year forward earnings growth estimates.
Turkey has over 80% of stocks with positive earnings revisions from analysts.
The Netherlands has one of the strongest year-over-year earnings growth readings within Europe.
Figure 8: South Africa
Summary
The Catastrophic Stop model improved from last month, as it recommends a fully invested allocation.
Entering January, the non-U.S. equity Core model overweighted Canada, Australia, and Germany while underweighting the U.K., China, France, and Switzerland. The Explore model favored Mexico, the Netherlands, South Africa, Poland, and Turkey.
The models combine macro, fundamental, technical, and sentiment indicators to determine opportunities and identify risks in an objective, weight-of-the-evidence approach.
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® International ETF
Symbol: SSXU
Strategy Description
The Smart Sector® International strategy combines three Ned Davis Research quantitative investment strategies: The Core International, Explore International, and the NDR Catastrophic Stop
The Process Is Based On The Weight Of The Evidence
Core Allocation
The fund begins by overweighting and underweighting the largest non-U.S. equity markets based on Ned Davis Research’s proprietary models.
Each of the models utilizes market-specific, weight-of-the-evidence composites of fundamental, economic, technical, and behavioral indicators to determine each area’s probability of outperforming the ACWI ex. U.S. Markets are weighted accordingly relative to benchmark weightings.
Explore Allocation
To select smaller markets, the fund uses a multi-factor technical ranking system to choose the top markets. The markets with the highest rankings split the non-Core model allocation equally.
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 equity-invested position may be trimmed up to 50%.
The NDR Catastrophic Sell Stop model combines time-tested, objective indicators designed to identify periods of high risk for the global equity market. 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 investment 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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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.
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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.
