Day Hagan/Ned Davis Research Smart Sector® Strategy Update March 2023
A downloadable PDF copy of the Article:
Day Hagan/Ned Davis Research Smart Sector® Strategy Update March 2023 (pdf)
Catastrophic Stop Update
The NDR Catastrophic Sell Stop model combines time-tested, objective indicators designed to identify high risk periods for the equity market. The model (chart right) improved in March and remained with a fully invested equity allocation recommendation.
Figure 1: Smart Sector® Catastrophic Stop Sell Model
Figure 2: U.S. Stock/Bond Relative Strength Favors Equity Exposure
Stronger breadth and relative strength drove the model improvement. On February 2, a breadth thrust signal (10-day advances vs. 10-day declines) flashed bullish and the stock/bond relative strength’s short-term moving average rose above its long-term moving average (chart left). In terms of external influences, improvement in short-term stock market sentiment was offset by deterioration in high yield and Emerging Market bond breadth.
If stock volume demand outpaces supply and global shipping rates improve, then it could indicate the rally could be sustained. Conversely, if the stock market weakens in the near-term and investors return to fears of a recession, the stock market rally could be short-lived.
U.S. Market Update
After a 6% rally in the S&P 500 Total Return Index in January, the market declined in February, losing 2.5% for the month. The correction was mostly attributed to higher interest rates as Treasury yields rose across the curve, but it was also in line with a normal correction from excessive investor optimism levels. Additionally, some longer-term breadth measures never confirmed the short-term breadth thrust signals that flashed bullish earlier in the month.
As a result, ten of the 11 S&P 500 sectors registered negative returns in the month of February. Only Technology eked out a modest gain. Rate-sensitive sectors like Communications Services, Real Estate, and Utilities had some of the weakest returns during the month (chart below).
From the March 2009 secular low to the January 2022 high, the stock market gained 609%. When short-term rates were near 0% and long-term rates were averaging 2.3%, investors had to look to the stock market for returns. However, with today's T-bill yields at 4.9% and 10-year Treasury yields at 3.9%, there are now alternatives. As a result, the stock market P/E should likely be 20x earnings—currently, the trailing P/E is 21.3, implying the S&P 500 is 3% overvalued. Earnings in 2023 will need to carry the market higher.
Entering March, the sector model continued to overweight Value areas such as Energy, Materials, and Financials and added more Growth-oriented Consumer Discretionary to its overweights. Interest-rate sensitive sectors such as Consumer Staples, Real Estate, Communication Services, and Utilities were recommended underweights, as well as cyclically oriented Industrials and defensive Health Care.
Figure 3: S&P 500 GICS Sector Monthly Performance (01/31/2023-02/28/2023)
The Financials sector saw steady improvement in our model from August to February. In March, the allocation declined modestly, but it remains significantly overweight, as investors continue to anticipate the end of the tightening cycle. Economic surprises, bank loan growth, and an attractive valuation have all supported strong technicals. This past month, a deterioration in the 10-2 yield curve was offset by improving business credit conditions (chart right).
Figure 4: Improving Business Credit Conditions is Bullish for Financials.
Figure 5: Declining 30-Year Treasury Yield is Bullish for Consumer Discretionary.
Consumer Discretionary’s allocation rose in March to a slight overweight. The majority of price-based measures remained bullish. While consumer credit conditions, housing starts, consumer spending, and earnings surprises remained negative for the sector, there was one bullish development—the 30-year Treasury yield declined (chart left).
Real Estate’s allocation was cut by more than half in March, moving the sector from a slight overweight to an underweight. On a fundamental basis, improving business credit conditions and economic surprises were offset by higher mortgage rates which dampened home purchases (chart right). As a result, technicals weakened and now the majority of the sector’s price-based indicators are bearish.
Figure 6: Weakening MBA Purchase Index is Bearish for Real Estate.
Figure 7: Short-Term Overbought/Oversold Measure is Bearish for Communication Services
Allocation to the Communication Services sector declined in March, moving it to a slight underweight. The sector was down over 450 basis points in February, primarily driven by about a 9% drop in Alphabet. On a fundamental basis, the 10-2 yield curve, earnings revision breadth, sales growth trend, and internet vs. retail sales remain bearish for the sector. Technicals are mixed but a short-term overbought/oversold measure turned bearish for the sector in February (chart left).
Health Care’s allocation rose significantly in March but remained underweight. On a fundamental basis, health care new construction, personal expenditures, and earnings revision breadth (chart right) all moved bullish for the sector. Technicals remain mostly bearish—improving relative price momentum was offset by weakening 100-day breadth.
Figure 8: Improving Earnings Revision Breadth is Bullish for the Health Care Sector.
Figure 9: S&P 500 Consumer Staples’ Relative Breadth is Bearish
Industrials’ allocation improved in March and is now a slight underweight. On a fundamental basis, the message is mixed. However, valuations improved with the median cash flow yield moving bullish (chart left). Price-based measures are also mixed, but a short-term relative price momentum indicator moved bullish in February.
Summary
The sector allocation strategy continues to be positioned in early-cycle areas of the market. Value sectors like Energy, Materials, and Financials remain overweight, and Consumer Discretionary rose to a slight overweight allocation. Interest-rate sensitive sectors such as Consumer Staples, Real Estate, Communications Services, and Utilities are underweight, along with cyclically oriented Industrials and defensive Health Care. The sector model uses sector-specific 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
We welcome the opportunity to provide more color on what we are seeing and answer your questions. Please email or call us anytime to set up a webinar or discuss the strategy and portfolio.
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® With Catastrophic Stop ETF
Symbol: SSUS
Strategy Description
The Smart Sector® with Catastrophic Stop strategy combines two Ned Davis Research quantitative investment strategies: The NDR Sector Allocation and the NDR Catastrophic Stop.
The Process Is Based On The Weight Of The Evidence
The fund begins by overweighting and underweighting the S&P 500 sectors based on Ned Davis Research’s proprietary sector models.
Each of the sector models utilize sector-specific, weight-of-the-evidence composites of fundamental, economic, technical, and behavioral indicators to determine each sector’s probability of outperforming the S&P 500.
Sectors are weighted relative to benchmark weightings.
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 broad U.S. 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 Sector Allocation 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 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.
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. 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 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. Rebalancing 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.
