Day Hagan/Ned Davis Research Smart Sector® International Strategy Update October 2023
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Day Hagan/Ned Davis Research Smart Sector® International Strategy Update October 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) deteriorated from last month but entered October with a fully invested equity allocation recommendation.
Figure 1: Smart Sector Catastrophic Stop Sell Model image.
Figure 2: Volume Supply Exceeding Demand: Bearish for Equity Exposure
The model’s overall reading is driven primarily by bullish external influences such as trade, market sentiment, and high-yield spreads. However, price-based measures have weakened during the month—three additional indicators flashed a sell signal including supply vs. demand (chart left). For now, the weight-of-the-evidence recommends a fully invested allocation to non-U.S. equity markets according to the model.
Global Market Update
The ACWI ex. U.S. Total Return Index declined by over 310 basis points (bps) in September. The index dropped more than 300 bps for two consecutive months for the first time since last August and September. Among the strongest-performing markets were Egypt, the United Arab Emirates, Turkey, Norway, and the Philippines, while the largest underperformers included Poland, Ireland, Greece, Thailand, and Peru.
The global economy saw momentum ease for a third straight month in August, according to the S&P Global Purchasing Managers’ Index (PMI) data. The global composite (services and manufacturing) PMI fell for a third straight month to its weakest reading since January. Despite the moderating expansion, there isn’t sufficient evidence to suggest that the global economy is entering a severe recession (chart bottom), which historically has been associated with the worst equity bear markets.
However, the risk of sustained moderate global slowdown is a real possibility amid diverging trends among the world’s economies. Europe, which was a major source of rising momentum in the first half of the year, has seen activity ease markedly in recent months and is even flirting with the prospect of recession. Trends in China and the U.S. remain positive, but not as much as the first half of the year, while Japan and several large emerging markets, such as India, continue to report robust activity.
Services growth has slowed significantly since peaking in May, while the manufacturing sector, which has been in the doldrums for a year, appears to be stabilizing. Although it was the 12th straight month of contraction, it was the first time in six months that manufacturing activity shrank at a slower pace, indicating some stabilization in the sector. Both output and new orders contracted at their slowest pace in three months, while employment grew at its fastest pace in six months. The global bullwhip, which assesses the balance of new orders relative to inventories, moved up to its best level since March, with a rising share of economies contributing to the improvement.
Entering October, the non-U.S. equity Core model overweighted Japan, was marketweight China, Canada, and Australia, and underweight the U.K., France, Switzerland, and Germany. The Explore model favored Brazil, India, Italy, Peru, and Poland.
Figure 3: NDR Global Recession Probability Model Indicating Low Recession Risk
Core Allocations
Australia’s allocation was reduced and is now marketweight for October. On a local currency basis, the MSCI Australia Index is less than 10% from its all-time high. The Reserve Bank of Australia recently kept its core interest rate steady, as it noted that its forecast is for “CPI inflation to continue to decline and to be back within the 2–3 percent target range in late 2025.” The market’s cyclically adjusted P/E ratio is giving a favorable reward-to-risk ratio (chart right) and relative valuations remain attractive.
Figure 4: MSCI Australia 10-Year Real Annualized Price Returns Based
on Price/Average 10-Year Earnings
Figure 5: China’s Improving PMI Bodes Well for Japan
Japan possesses the largest overweight allocation for October. Although external measures reflect headwinds, there are some areas showing an improving environment. Business confidence improved as the Tankan survey beat expectations. China PMI, which tends to be a leading indicator of Japan’s economy, rose this past month (chart left). Inflation swaps are confirming an optimistic economic outlook. The technical indicators reflect an improving outlook as trend and price momentum metrics are bullish.
The U.K. remained below benchmark allocation. Only one of its indicators is bullish. Price-based indicators have deteriorated, which coincides with weaker economic data. Most aggregate measures of the economy point to stagnation, or even modest contraction, in the near-term. On a relative basis, leading economic indicators and economic sentiment (chart right) are both negative on the economy. Expensive relative valuations and an unattractive equity risk premium both indicate that the market still has downside risks.
Figure 6: U.K. Relative Purchasing Mangers Index (PMI) Reflects Weak Outlook
Figure 7: Europe ex. U.K. Relative OECD Composite Leading Indicators (CLI) Weakening
France maintained its underweight position. The continuation of high inflation and tighter monetary policy has taken its toll on the European economy. Economic conditions in Europe have gone from bad to worse. The eurozone composite PMI fell to 46.7 in August, the deepest contraction in nearly three years. The services sector contracted for the first time this year, while manufacturing continues to shrink markedly. The weak technical indicators confirm the headwinds depicted by the macro (chart left), valuation, and sentiment measures.
Explore Opportunities
Among the top ranked Explore markets are Brazil, India, Italy, Poland, and Peru:
All have favorable price trends as their 50-day moving averages trade above their 200-day counterparts.
Within the last 21 days, Peru and Poland are more than one standard deviation oversold, which historically has provided a near-term bounce opportunity.
Brazil, India, Italy, Poland, and Peru have low market capitalization-to-GDP ratios, which typically indicates a favorable valuation.
Brazil’s and India’s composite PMIs resides in the expansionary zone.
Brazil is one of the few economies with a Composite Leading Indicator in expansionary territory.
India has a double-digit one-year forward earnings growth estimate (chart bottom).
Italy and India have over 80% of stocks with positive earnings revisions from analysts.
Figure 8: MSCI India Trailing Earnings and % of Companies with Positive Earnings Revisions
Summary
The Catastrophic Stop model declined from last month, but it continues to recommend a fully invested allocation.
Entering October, the non-U.S. equity Core model overweighted Japan, was marketweight China, Canada, and Australia, and underweight the U.K., France, Switzerland, and Germany. The Explore model favored Brazil, India, Italy, Peru, and Poland.
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 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.
