It’s all about perspective.

Often, we review our models and indicators based on “relative levels.” Our goal is to compare and contrast current readings to readings that were registered during notable past declines. In this way, we can determine whether an indicator is, for example, “as oversold as it was in 2009 at the end of the second worst financial crisis in U.S. history,” versus the indicator being only “as oversold as during the international market turmoil in 2011.”

By thinking about our models and indicators in this relative context, we can better determine how much “bad news” may be priced into the stock market. If an indicator is at levels similar to what we saw in March 2009, then you might agree with us that the indicator is showing extreme pessimism priced into the market. If an indicator’s current level is similar to what was seen at the February 2018 low, then there is pessimism priced in, but not as much as at the 2009 low.

The difference between the two time periods above is that if the indicator is consistent with 2018 levels, then it’s probably OK to add equity exposure, as long as the world’s banking and financial systems are in good shape. But if the world’s financial and economic backdrops are deteriorating, it would be better, from a technical perspective, to wait for more pessimism to build up in the market before declaring a buying opportunity.

Below is a table indicating current model and indicator levels vs. where they were during:

  • 2009: The end of arguably the second-worst financial crisis in U.S. history. These levels represent excessive pessimism and extremely oversold conditions.

  • 2011: International market turmoil, EU upheavals due to sovereign debt crisis in Italy and Spain, International Banking Crisis, U.S. credit rating downgraded (S&P 500 down 6.7% on August 8, 2011).

  • 2015/16: Chinese stock market freefalls with currency devaluation, Greek debt default, U.S. taper tantrum (fear of rising U.S. interest rates), Brexit vote, August 24/25 decline

  • Feb/2018: Massive complacency and excessive optimism led to the largest percentage VIX spike in history, systematic selling, hawkish Fed rhetoric, wage inflation fears, concerns around higher interest rates

NOTE: “Current Level” represents recent extreme levels seen within the two months, selected at my discretion. Historical Levels were selected to identify extreme levels reached at or around the time periods identified. The goal is to see how current indicator readings stack up relative to past readings at major lows.


Current Level

2009 Level

2011 Level

2015/2016 Level

Feb/2018 Level

NDR Daily Trading Sentiment Composite
(Consistent with shorter-term lows)

23 (Lower = more pessimism)





NDR Crowd Sentiment Poll
(Consistent with short-term lows)

55 (Lower = more pessimism)





Smart Money Confidence
(Consistent with short-term lows)

75 (Higher is better)





McClellan Summation
(Consistent with short-term lows)

-501 (Lower = more pessimism)





Equity Hedging Index
(Consistent with intermediate-term lows)

78.3 (Higher = more hedged)





As you can see in the table above, many of the indicators we track are once again at levels consistent with a short-term bottom. However, even though most of the indicators are at levels suggesting that some selling and allocation repositioning has occurred, widespread capitulation has not yet taken place. Capitulation usually occurs before the stage is set for another major bull market advance.

Below is the Sentimentrader Equity Hedging Index, which evaluates cash positions, put option positions, inverse ETF flows, futures (short) positioning, and credit default swaps (CDS) purchases. These are all ways in which professional investment managers reduce risk in their portfolios. As you can see, investors appear to be well hedged, which has historically provided some support for equities.

Equity Hedging Index Chart, dated from November 23, 2006 to November 23, 2018.

The Ned Davis Research Trading Sentiment Composite also utilizes various measures of investor sentiment (surveys, put/call ratios, etc.) to define the levels of pessimism that are currently priced into equities. The composite shows that investors are as pessimistic as they were in February 2018, but not quite as pessimistic as they were in 2009, 2011, and 2015/2016.

S&P 500 vs. NDR Daily Trading Sentiment Composite Chart, daily data from 2006-01-03 to 2018-11-23.

Our view is that the weight-of-the-evidence message from most of our models and indicators is that the market is oversold at current levels, accompanied by a high degree of pessimism. This typically leads to a relief rally.

However, most indicators don’t evidence levels that would be consistent with a longer-term market washout that has left valuations low and cash balances (purchasing power) high.

As written last month: From where I’m sitting right now, only one thing will keep this market moving higher: stable economic growth—and it needs to be global in scope. To be clear, we need to see economic improvement from China and the EU, especially Germany. (Even though Venezuela, Argentina, Brazil and Italy are getting lots of press.)

And I think this is where investors see problems, especially when looking at the prospects for international growth relative to the U.S.

Ned Davis Research’s (NDR) Global Recession Probability Model shows the global economy may already be in a recession. Since we featured it last month, it has moved even higher into “High Recession Risk” territory. It is based on leading indicators for 35 countries and includes measures of money supply, yield curve, building permits, consumer and business sentiment, stock prices, manufacturing and production. For regions including China, Japan and the EU, economic models are right on the cusp of moving into zones that signal potential economic slowdowns. (Note: We’re watching PMI numbers closely for signs of confirmation. Although most PMIs remain above 50 and indicate expansion, over the last month, there has been widespread deterioration in the readings.)

Global Recession Probability Model Chart, monthly data 1970-03-31 to 2018-11-30.

Conversely, when looking at NDR’s Economic Timing Model for the U.S. (chart on next page), activity seems to be holding up. The model is based on 27 economic measures, and at its current reading of +22, strong U.S. economic growth is indicated. In fact, looking back to 1948, when the model has been at levels of +16.5 or better, the U.S. economy (based on the Coincident Index) has gained at a 3.86% average annualized rate.

Our view is that as long as the U.S. economy holds firm, downside risks will be limited to what we view as “normal” market declines. Typically, since 1900, there is an average of just over 3 “dips” (declines of 5% or more) each year. Typically, once the market declines 5%, the average maximum drawdown from high to low is about 11% (daily closing basis—source NDR). Most U.S. indexes have hit those average drawdown levels.

NDR Economic Timing Model vs. S&P 500 Chart, monthly data 1952-01-31 to 2018-10-31.

Economic growth must continue. And anything affecting growth, including tariffs, Fed funds rate hikes, quantitative tightening, and even political partisanship around potential government shutdowns (what is wrong with these people!) are likely to have an outsized market impact given that economic growth is what this market requires for the next leg higher.

Summary: The pieces are in place for a near-term bottom. For us to become more constructive, we’ll need to see broader participation on the upside. We haven’t seen it yet.


Donald L. Hagan, CFA
Day Hagan Asset Management

—Written 11.26.2018.    

PDF Copy of Article: Day Hagan Research Update November 26, 2018 (pdf)

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