Day Hagan Smart Sector® Fixed Income Strategy Update October 2024
A downloadable PDF copy of the Article:
Day Hagan Smart Sector® Fixed Income Strategy Update October 2024 (pdf)
Risk Management Update
The Catastrophic Stop model combines time-tested, objective indicators designed to identify high-risk periods for the financial markets. The model (Figure 1) improved toward the end of September and entered October with a fully invested fixed-income recommendation.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
Fixed Income Sector
US 1-3 Month T-bill
US 3-7 Year Treasury
US 10-20 Year Treasury
TIPS (short-term)
US Mortgage-Backed
US Floating Rate
US Corporate
US High Yield
International Corporate Bond
Emerging Market Bond
Outlook (relative to benchmark)
Neutral
Neutral
Neutral
Underweight
Neutral
Underweight
Overweight
Neutral
Neutral
Neutral
Fixed Income Commentary
The Bloomberg Barclays U.S. Aggregate Bond Total Return Index was up 1.34% in September. Breadth remained bullish—all nine fixed-income sectors we track posted positive monthly returns. Emerging Market Bonds and U.S. Long-Term Treasurys had the strongest returns during the month. The easing cycle has begun!
The Fed began big, reducing the Fed funds target range by 50 basis points (bp) to 4.75% to 5.00% in September. This was the first reduction since the pandemic. There has only been one non-recessionary easing cycle since 1970 that started with 50 bp: 1984.
Below are the historical tendencies for what it means for fixed-income sectors:
After the first cut, ten-year Treasury yields tend to stabilize. With an inverse relationship to yields, bond prices also stabilize (chart below). Over the easing cycle, 10-year Treasury yields generally declined, with a median drop of 67 bp.
The yield curve tends to steepen for another month after the first cut. The yield curve was flat-to-steeper in all prior easing cycles.
In terms of credit, higher-quality sectors generally performed well during an easing cycle. Credit spreads between Baa and Aaa were little changed in past easing cycles.
Although the TIPS market has a shorter history, real yields kept falling in the months after the first cut.
Real yields have fallen significantly over the entire easing cycle (around 100 bp or more) except for 1998, when they rose modestly after liquidity concerns dissipated. Entering October, the fixed income allocation strategy did not rebalance. U.S. Investment Grade Corporate bonds remain above the benchmark weight. U.S. Floating Rate Notes and U.S. Treasury Inflation-Protected Securities remain below benchmark weight.
Figure 2: After first rate cuts, yields tend to stabilize unless there is a recession. We are currently in the “soft landing” camp.
Sector Commentary
U.S. Treasuries:
Recent Fed Funds projections indicate that investors anticipate another 50-basis-point decrease this year, followed by a 100-basis-point decrease in 2025 and another 50-basis-point decrease in 2026. This is likely to result in a rapid decline in yields on short-term investments (bullish for prices). Additionally, the treasury yield curve, which had been inverted for a considerable period, now shows a return to an upward slope, signaling the normalization of the yield curve as interest rates decrease. While the unemployment rate remains relatively low at 4.1%, there are indications of a slowdown in the labor market, with hiring rates notably sluggish. The Fed’s decision to reduce rates is intended to address this hiring slowdown. Reinvestment risk is on the rise, with yields on short-term investments, such as Treasury bills, typically following the trajectory of the fed funds rate. Although the recent decline in intermediate- and long-term Treasury yields has made the risk/reward balance less favorable, a potential increase in yields could present an opportunity to incorporate more duration into the portfolio. Lastly, intermediate-term investment-grade corporate bonds continue to appear appealing, with average yields ranging from 4.25% to 5% (we are overweight).
Figure 3: Bonds have typically done well during periods of strong economic growth and low inflation.
U.S. TIPS: We remain underweight TIPS as inflationary pressures continue to moderate. The inflation timing model indicates moderate disinflation levels. In other words, inflation continues to head lower but at a slower pace. Every indicator in the TIPS model is bearish, with measures of lower commodity price trends, relative strength weakness, and lower inflation pressures negative for this credit sector.
Figure 4: Commodities are trending lower. Bullish for bonds, bearish for TIPS.
U.S. Mortgage-Backed Securities: The composite model was unchanged and remains neutral. Measures of trend, overbought/oversold, and long-term yield trends are supportive. As noted last month, during periods of low interest rates and strong housing markets, MBBs have performed well, providing higher yields than Treasury bonds while benefiting from the housing sector’s robustness. In contrast, MBBs not guaranteed by GSEs can suffer from increased defaults on underlying mortgages during economic downturns or if the housing market collapses. The decline in U.S. 10-year yields is currently supportive, as inflation expectations continue to move away from the extremes registered last year. The U.S. housing market showed signs of cooling in August 2024, with slower home sales and price growth. This trend, driven by affordability issues and higher mortgage rates earlier in the year, reduced the demand for new mortgages and, by extension, MBS. However, the potential for lower rates improved the outlook for future mortgage origination, providing some support for MBS prices. We are neutral.
Figure 5: Mortgage-backed securities are considered somewhat defensive relative to High-Yield bonds. When the credit spreads of high-yield bonds widen, investors tend to gravitate toward defense. With OAS declining, this is less positive for MBS.
U.S. Floating Rate: The model is negative, and measures of trend, momentum, and option-adjusted credit spreads are negative. We are currently underweight, but if the model’s indicators start to pick up on a reversal from oversold extremes, we will increase exposure accordingly.
Figure 6: Momentum for U.S. Floating Rate Securities is still rated negative but may be finding support. We are looking for technical confirmation before adding exposure. Outside of a geopolitical upheaval, we do not anticipate an inflation spike.
U.S. IG Corporates: The composite model remains modestly bullish, with measures of credit default swaps, trend, and mean reversion supportive. However, we note some deterioration in the model due to rising implied bond volatility and the U.S. dollar’s recent weakness. At the beginning of October, the average yield of the Bloomberg U.S. Corporate Index was 4.7%, near the top of its 15-year range. We remain modestly overweight.
Figure 7: Increasing bond volatility is a headwind for IG Corporates. Outside of the increased volatility and U.S. dollar weakness, the model is generally bullish for this credit sector. Note that the dollar indicator below appears to be basing.
U.S. High Yield: The composite model improved, with measures of breadth, volatility, and credit spreads supportive. The recent relative strength in small-cap stock returns is also positive. We are neutral but will add exposure if the economic outlook improves after the election.
Figure 8: Small-cap equity performance often leads to high-yield fixed-income outperformance.
International IG Corporate Bonds: The composite model remains negative, with measures of international bond volatility, trend, and global inflation expectations still relatively elevated. According to the OECD, global economic growth projections continue to run around 3.2% for 2024 and 2025. They believe the growth will be supported by easing inflation, improving real incomes, and accommodative monetary policies. While this may eventually be the case, our indicators don’t support an overweight allocation at this time.
Figure 9: Rising bond volatility is negative for international corporate bonds.
Emerging Market Bonds: The composite model remained unchanged with this month’s update. Emerging market momentum, trend, and relative strength indicators are supportive. The lone negative is the commodity market’s longer-term downtrend, which is still intact (based on the MACD indicator shown below). If our models confirm commodity strength, we may look to add exposure.
Figure 10: Commodities appear to be basing. If the short-term MA moves above the longer-term MA, it would provide a bullish message.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk and where to place that capital.
For more information, please contact us at:
Day Hagan Asset Management
1000 S. Tamiami Trl
Sarasota, FL 34236
Toll Free: (800) 594-7930
Office Phone: (941) 330-1702
Website: https://dayhagan.com or https://dhfunds.com
© 2024 Day Hagan Asset Management
Charts courtesy Ned Davis Research (NDR). © Copyright 2024 NDR, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo.
Day Hagan/Ned Davis Research
Smart Sector® Fixed Income ETF
Symbol: SSFI
Disclosures
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. Day Hagan 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 Fixed Income vestment 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. Day Hagan 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.
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.
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. Day Hagan 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.
© 2024 Day Hagan Asset Management
