Day Hagan/Ned Davis Research Smart Sector® Strategy Update May 2023
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Day Hagan/Ned Davis Research Smart Sector® Strategy Update May 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 at right) improved from last month and entered May with a fully invested equity allocation recommendation.
Figure 1: Smart Sector® Catastrophic Stop Sell Model
Figure 2: Improving MSCI ACWI Breadth: Bullish for Equity Exposure
The model improvement was mostly driven by stronger technicals—stock/bond relative strength, global stock market breadth (chart at left), and stock market short-term trend all improved to bullish levels during the month. In terms of external influences, breadth for High Yield and Emerging Market bonds and global trade (as measured by the Baltic Dry Index) remain bullish, while high-yield option-adjusted spreads remain bearish.
If stock volume demand outpaces supply and spreads narrow, 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
The S&P 500 rallied for a second month in a row and was up about 1.6% on a total return basis for the month. Breadth remained strong—eight of the 11 S&P 500 sectors registered positive returns in the month of April. Leadership was overwhelmingly defensive with Consumer Staples, Health Care, and Utilities all outperforming the S&P 500 in April. As a result, the S&P 500 SHUT Index outperformed the Broad Cyclical Sector Index (chart below), which is in line with historical tendencies after the last rate hike.
The Wall Street adage “sell in May and go away” comes from the tendency for seasonal weakness to begin in May. For sectors, the seasonal pattern has meant a shift in leadership towards defensive sectors over cyclical sectors starting in May (top clip). Since 1972, the four best months for defensive sector leadership have all occurred over the May through October period (bottom clip).
This year, the seasonally weak stretch overlaps with several other headwinds for the market, including the late innings in the Fed and economic cycles, debt ceiling discussions, and a high level of complacency as measured by the VIX Index. NDR frequently highlights seasonal trends, but we do not include them in our models. However, we find it noteworthy when our models align with seasonality and historical studies.
The sector model has gotten in line with the cautious outlook in April, shifting more defensive during the month. Entering May, the sector model is overweight defensive sectors such as Health Care, Utilities, and Energy. Information Technology dropped to marketweight. All other sectors are underweighted with significant drops in allocation to Real Estate and Financials.
Figure 3: S&P 500 SHUT Index (Equal-Weighted) vs. Broad Cyclical Sector Index Seasonality
The Health Care sector’s allocation rose significantly in April and is the largest overweight. The sector was up nearly 3% in April, primarily driven by Big Pharma stocks such as Eli Lilly (+15.3%), Merck (+8.5%), and Johnson & Johnson (+5.6%). On a fundamental basis, health care construction and relative spreads moved bullish during the month. This was confirmed by improving technicals—all six indicators are bullish, including absolute short-term price trend (chart right), relative price trend, relative drawdown, and breadth.
Figure 4: Improving Short-Term Price Tend Bullish for the Health Care Sector
Figure 5: Improving Capacity Utiization is Bullish for Utilities
Allocation to the Utilities sector rose in April, moving it from a slight overweight to a significant overweight position. On a fundamental basis, capacity utilization (chart left) and the copper/gold ratio (a measure of slowing economic growth) moved bullish for the sector. Two more technical measures moved bullish for the sector—relative price trend and relative reversals.
The Financials sector’s allocation declined sharply in April and dropped back to underweight. Regional Banks was hit hardest in the aftermath of the recent bank failures, but underperformance within the sector was widespread (chart right). On a fundamental basis, the 10-2 yield curve, business credit conditions, U.S. Financial investment grade spreads, bank loan growth, and valuation remained bullish for the sector. However, over the past month, economic surprises dropped and moved bearish for the sector. This was confirmed by weakening technicals. The improvement in a relative overbought/oversold indicator was more than offset by weakening relative price trend and the sector’s 21-day volatility.
Figure 6: S&P 500 Financials Relative Performance TYD
Figure 7: Weakening Business Credit Conditions is Bearish for the Real Estate Sector
Interest-rate sensitive Real Estate saw a sharp decline in allocation in April, moving it from an overweight to a significant underweight. The sector saw deterioration in industrial production for construction supplies, business credit conditions (chart left), as well as a drop in mortage applications on still-elevated mortgage rates. While relative price deviation from trend remains bullish, the sector became short-term overbought, and joined three other bearish technical measures during the month.
Summary
The sector allocation strategy’s message is overwhelmingly defensive with overweights to Health Care, Utilities, and Energy. Cyclical sectors such as Financials, Industrials, Consumer Discretionary, and Materials are all at underweight. 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.
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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 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.
