Day Hagan/Ned Davis Research Smart Sector® International Strategy Update July 2023
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Day Hagan/Ned Davis Research Smart Sector® International Strategy Update July 2023 (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) improved from last month and entered July with a fully invested equity allocation recommendation.
Figure 1: Smart Sector Catastrophic Stop Sell Model image.
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. Some of these indicators will need to improve if the stock market rally is going to continue deep into the second half of the year.
Global Market Update
The ACWI ex. U.S. Total Return Index increased over 450 basis points in June. It was the index’s largest monthly gain since January. Among the strongest-performing markets were Turkey, Peru, Poland, Italy, and Brazil, while the largest underperformers included the Czech Republic, Finland, Malaysia, Qatar, and Indonesia.
Global economic growth continued to accelerate in May, based on the S&P Global Purchasing Managers’ Index (PMI) readings. The combined services and manufacturing global PMI rose to its highest level since November 2021. It was the sixth straight monthly increase, the longest winning streak since October 2009, when the global economy was just getting out of the Global Financial Crisis recession.
On an aggregate basis, the global economy appears to be in excellent shape, but it masks narrow leadership and sector-level divergences. Services continue to be the only growth driver, as manufacturing shrank for a third-straight month. The last such divergence between the services and manufacturing PMIs occurred in early 2009 (chart at bottom). Such gaps typically have not been indicative of an ominous economic future. Rather, they tend to happen either well into or towards the end of global slowdowns/recessions. This is because the more stable services sector often gains traction faster after economic bottoms.
Even so, the ability to maintain accelerating momentum will be more challenging in late 2023/early 2024. Businesses and households will continue to face tighter credit conditions in the U.S. and Europe as the impact of the past year’s tight monetary policy continues to slowly work its way into the global economy. Stubbornly high inflation, particularly in the developed world, indicates that central banks will remain hawkish for longer. Meanwhile, China’s growth will likely ease as pent-up demand is satisfied.
Entering July, the non-U.S. equity Core model overweighted Canada and Australia, marketweighted Japan and China, and underweighted the U.K., France, Switzerland, and Germany. The Explore model favored Mexico, South Korea, Poland, Taiwan, and India.
Figure 3: Global PMI vs. Central Bank Breadth
Core Allocations
Japan’s allocation is neutral relative to the benchmark but remains our largest absolute holding. In May, the composite (services and manufacturing) PMI reached its highest level in almost ten years (chart at right), and inflation swap rates rose, suggesting robust economic growth. The Japan Ministry of Finance’s Business Outlook Survey demonstrated an improved outlook from large corporations. Japan’s cyclically adjusted price-to-earnings ratio has been trading near its cheapest levels since the early 1980s.
The technicals have aligned with the externals (macroeconomic, fundamental, and sentiment data), as trend, momentum, and breadth indicators are bullish on the market. Furthermore, this year non-residents of Japan have had their largest net purchases of Japanese equities from over the last ten years.
Figure 4: Japan Composite (Manufacturing & Services) PMI
Figure 5: MSCI Australia Price Return Index (in local currency)
Australia shifted to overweight status this month. Trend, momentum, and breadth measures are bullish on the market, which is less than 5% from its all-time high (chart at left). Relative valuations within the market remain attractive as Australia’s earnings yield is almost 300 bps above the 10-year government bond yield. Australia’s inflation slowed this past month as it dropped to 5.6% for May. Australia’s central bank responded by leaving its official cash rate unchanged.
Germany maintained its underweight position. The weakening trend and breadth have been driven by declining ETF asset levels and falling economic sentiment. The Ifo German business climate survey data missed expectations to a level consistent with recession risk. At the same time, inflation remains way above the European Central Bank’s (ECB) 2% target. But Germany has among the highest unit labor cost growth (chart at right). This is important in determining inflation since it incorporates productivity.
Figure 6: Germany: Unit Labor Costs (Seasonally Adjusted)
Figure 7: MSCI U.K. Relative Strength Trading Significantly Below Trend
The U.K. dropped to the largest underweight allocation this month. Only two of its indicators are bullish. Sentiment has gotten pessimistic, which may drive a near-term bounce. However, economic measures are weak, and the price-based indicators have deteriorated. The U.K.’s relative strength to the world has fallen to its lowest level below trend since 2021 (chart at left).
Explore Opportunities
Among the top-ranked Explore markets are Mexico, South Korea, Poland, Taiwan, and India:
The South Korea, Poland, Taiwan, and India regions have improving year-over-year trends in positive earnings revisions. Mexico’s percentage of positive earnings revisions now stands at a solid 78.9%.
Poland (chart at bottom), South Korea, Taiwan, India, and Mexico have favorable price trends as their 50-day moving averages trade above their counterparts.
Over the last 21 days, South Korea and Poland have reached levels that are more than one standard deviation oversold, which historically has provided a near-term bounce opportunity. Taiwan and Mexico are nearly -0.8 standard deviations oversold.
Poland, Mexico, India, and South Korea have low market capitalization-to-GDP ratios, which typically indicate favorable valuation. Taiwan’s Forward P/E is just 15.5x, and Price/Cash Flow is 9.5x. Mexico’s F/PE is 11.6x, and Poland is trading at just 7.6x forward earnings expectations.
Figure 8: MSCI Poland Index (in Local Currency) vs. Moving Averages
Summary
The Catastrophic Stop model improved from last month, as it continues to recommend a fully invested allocation.
Entering July, the non-U.S. equity Core model overweighted Canada and Australia, marketweighted Japan and China, and underweighted the U.K., France, Switzerland, and Germany. The Explore model favored Mexico, South Korea, Poland, Taiwan, and India.
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:
Day Hagan Asset Management
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Office Phone: (941) 330-1702
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 is trimmed 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 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 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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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.
