Day Hagan Smart Sector® International Strategy Update August 2024
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Day Hagan Smart Sector® International Strategy Update August 2024 (pdf)
Catastrophic Stop Update
The Catastrophic Stop model combines time-tested, objective indicators designed to identify high-risk periods for the equity market. The model (Figure 1) held steady during July and entered August with a fully invested equity allocation recommendation.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
Entering August, our investment models continue to collectively convey a cautiously optimistic outlook for global equity markets, taking into account various economic factors and market dynamics. For instance, the Global Recession Probability Model assigns a low probability of a broad-based significant global slowdown but is moving toward more neutral levels. An increase above 30 would be concerning. The model is based on the Composite Leading Indicators for 35 countries and includes measures of money supply, yield curve, building permits, consumer and business sentiment, share prices, and manufacturing.
Figure 2: Global Recession Probability Model indicates risks rising but not yet crossing important thresholds.
In July, global equity performance varied, with developed markets slightly higher, the EAFE showing good gains, and emerging markets weaker. U.S. large caps struggled, especially the Nasdaq, due to tech stocks’ earnings generally not meeting elevated expectations. The weakness spilled over into other global tech companies. U.S. small caps gained after the July 11th CPI inflation print as the probability of U.S. rate cuts increased, and investors placed better odds on renewed economic growth.
Global economic (GDP) growth is expected to be modest for the remainder of 2024. The IMF forecasts global GDP growth at 3.1% for 2024, the OECD at 3.1% with a slight increase to 3.2% in 2025, and the World Bank at 2.6% for 2024, stabilizing after three years of economic disruption. Positive economic growth, even if it is “modest,” has historically been supportive of equities.
Japan’s equity markets slumped as the Yen strengthened, while European equities rose modestly. Fixed income broadly gained as key rates generally declined. Commodity prices declined as oil fell. The U.S. dollar index edged lower overall, with notable weakness against the Japanese Yen as the Bank of Japan opted to increase their policy rate and cut bond purchases by up to 50% (see more in the “Japan” commentary below). The US dollar was stronger vs. several emerging market currencies, negatively impacting those markets and leading to weaker performance in local currency terms, particularly in markets like Brazil, Mexico, and Indonesia.
In the U.S., growth accelerated to 2.8% annualized (advanced GDP estimate), but weaker disposable income figures and a cooling labor market suggest the pickup may be short-lived. U.S. Core PCE inflation remained unchanged at 2.6% y/y, with the market fully pricing in the first 25bps rate cut in September.
Across the ocean, the Euro-zone Composite PMI fell to 50.1 in July, consistent with flat growth in Q3, below expectations. Nonetheless, Global PMIs are relatively upbeat, with the Global PMI Composite (including manufacturing and services) still in expansion territory at 52.9.
China's monetary authorities cut rates due to a loss of activity momentum and deflationary risks. The possibility of rate cuts buoyed investor sentiment and contributed to a short-lived market rally.
Despite the complexity, the environment for global equity markets in July 2024 was characterized by cautious optimism.
Figure 3: Global Purchasing Manager Index still in expansion territory.
Major central banks, particularly in Europe, are likely to reduce rates, which could benefit equity markets. The historical trend of positive stock performance during the U.S. presidential election years also provides a supportive backdrop for equities.
Core: Developed Market Positions (approximately 65% of equity holdings)
Country
Australia
Canada
China
France
Germany
Japan
Switzerland
United Kingdom
Outlook
Neutral
Neutral
Overweight
Underweight
Neutral
Underweight
Underweight
Overweight
Explore: Emerging Market Positions (approximately 35% of equity holdings)
India
Taiwan
Turkey
Sweden
Netherlands
Core: Developed Market Commentary
Approximately 65% of the strategy is allocated across eight of the largest markets in the ACWI ex-U.S. Index. The fund overweights and underweights the largest non-U.S. equity markets based on macro, fundamental, behavioral, and technical indicators. Weightings are determined using the Black-Litterman framework, which seeks to reduce volatility and enhance returns.
Australia: Australian stocks were bolstered by softer-than-expected inflation figures, increasing the likelihood of a rate cut by the Reserve Bank of Australia (possibly in November rather than previous expectations around April of 2025). The Australia Services PMI Business Activity Index fell to 50.8 in July, marking the weakest expansion in six months, with a decline in new orders due to reduced client demand and a significant drop in new international business. Despite this, service providers continued to increase staffing, albeit at the slowest rate since December 2022. Higher minimum wage led to increased pay pressures and a sharp rise in input prices, resulting in the fastest inflation rate since November 2023. The 12-month outlook for activity hit its lowest level since the initial COVID-19 wave in 2020, reflecting low optimism levels. The Australia Manufacturing PMI edged up to 47.5 in July, indicating a sixth consecutive month of deterioration in manufacturing sector conditions, driven by a reduction in new orders and a solid contraction in output, employment, purchasing activity, and inventory levels. Despite supply constraints and rising costs, there was some cautious optimism for improved economic conditions in the future. A weaker Australian dollar supported equities. The Composite model is mixed, with trend indicators reversing from oversold conditions now bullish. Interest rate differentials are negative, while volatility, relative earnings, and gold trends are neutral. We are neutral.
Figure 4: Trend indicators are reversing from very oversold levels.
Canada: Canada is responding to concerns about slowing growth in North American economies, particularly in the US labor market and manufacturing activity. The heavyweight Canadian financial sector is under pressure due to worries about declining credit demand. Energy producers are also experiencing sharp losses due to global concerns about reduced fuel demand. The S&P Global Canada Manufacturing PMI fell to 47.8 in July 2024, indicating the sharpest contraction in operating conditions since December. Output and new orders both decreased significantly due to challenging market conditions and heightened uncertainty related to inflation and geopolitical tensions. Supply chain delays exacerbated the situation, leading firms to reduce their purchasing activity. Despite these challenges, employment growth has been maintained at a marginal level, reflecting dwindling hopes for future output. Input price inflation remained solid, forcing manufacturers to raise their charges only slightly. Despite concerns regarding high costs and interest rates, the overall outlook remains positive, indicating a need for continued vigilance. The Composite model is mixed, with measures of trend, relative currency strength, and aggregate valuations negative. Positive support is found with improved momentum, better leading economic indicators, and a lower relative earnings yield. We remain neutral.
Figure 5: Earnings revisions are positive.
China: During a recent Politburo meeting, China's leaders pledged to enhance support measures to stabilize market confidence. Emphasizing the need to boost consumption for growth targets, the focus shifted from infrastructure projects. In Q2 of 2024, the Chinese economy grew by a seasonally adjusted 0.7%, the softest since Q2 of 2023, due to domestic headwinds such as extreme weather, weak consumption, high local government debts, and property weakness. Simultaneously, tensions between the US and its allies intensified. Premier Li Qiang indicated a gradual recovery approach, stating that strong measures should be avoided for now. The People's Bank of China promised to maintain a supportive monetary policy stance. However, the central bank hesitated to further trim lending rates, fearing more capital outflows and yuan pressure. The Caixin China General Manufacturing PMI fell to 49.8 in July 2024 from 51.8 in June, the first decline in factory activity since last October, primarily due to subdued demand conditions and reductions in client budgets. Employment remained relatively stable, while output grew the least in nine months. Selling prices declined, input cost inflation eased, and sentiment improved from the previous month. The Composite model remains bullish, with measures of relative momentum, relative strength, PMI trends (even though slightly lower in this most recent reading), and currency strength positive. Emerging market bond credit spreads are widening a bit, which we are monitoring closely. We remain overweight.
Figure 6: EM High-yield credit spreads ticked higher, but levels are still relatively low. This indicates investors aren’t yet anticipating a significant financial disruption.
Figure 6a: China’s Forward P/E is nearing historically low levels.
France: In Q2 2024, the French economy expanded by 0.3% q/q, in line with Q1 figures but surpassing market expectations. Domestic demand and net trade were positive contributors to growth, with household consumption remaining stable. Government spending rose by 0.3%, and fixed investment increased by 0.1%. Notably, exports remained solid, while imports were flat. Yearly growth reached 1.1%, lower than Q1 figures. The France Manufacturing PMI fell to 44 in July 2024, marking the 18th consecutive month of decline and the steepest contraction since January. Employment also decreased, and input costs rose, leading to increased selling prices. Meanwhile, the France Services PMI increased to 50.7 in July 2024, showing expansion in business activity, though demand for services declined. Both input and output prices remain a challenge for the French economy as inflation rates accelerated. The Composite model is negative, with trend, breadth, aggregate valuations, and ETF asset outflows bearish. There has been some slight improvement in leading economic indicators and valuation, however, we remain underweight at this juncture.
Figure 7: French 10-year rates have rolled over, but relative to Germany, they are still elevated, which is a headwind.
Germany: In the second quarter of 2024, the German economy shrank by 0.1% year-on-year. This marks the fifth consecutive quarter of no growth. The HCOB Germany Manufacturing PMI was revised higher to 43.2 in July 2024 from a preliminary of 42.6, indicating a sharp drop in the manufacturing sector for 25 consecutive months. Output, new orders, and employment all declined at accelerated rates while prices across the German manufacturing sector moved closer to stabilization. The HCOB Germany Services PMI dropped to 52 in July 2024, indicating a slowdown in the German service sector and a decrease in new work from non-domestic customers. Additionally, the annual inflation rate in Germany unexpectedly edged up to 2.3% in July 2024 from 2.2% in June, with price growth accelerating for food and services. The CPI edged up 0.3% from the previous month, the most in three months. The Composite model is mixed, with trend indicators, aggregate valuations, and asset outflows negative. A relatively high dividend yield, some improvement in manufacturing (though still at low levels), and the U.S. dollar stalling are bullish. We remain neutral.
Figure 8: Investors have been exiting Europe-related ETFs.
Japan: In July, the Bank of Japan (BoJ) adjusted its monetary policy by raising the cap on long-term interest rates from 0.5% to 1%, allowing for more flexibility in market operations. The central bank aims to keep the real yield on 10-year Japanese government bonds (JGBs) around zero percent. Most recently, Japan moved towards normalizing economic policy, raising the policy rate to .25% and cutting bond purchases by fifty percent. Japan’s GDP is expected to grow by 1.6% for the fiscal year 2024 and 1.3% for the following fiscal year, although the International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) forecast slower growth rates. Inflation has been a key driver of the BoJ’s policy decisions, with recent data influencing its actions. Positive indicators, including robust business conditions and a low unemployment rate of 2.4% in December 2023, support the BoJ’s outlook on the Japanese economy’s resilience. The yen has responded by reversing from a 38-year low. The Composite model level is 50%-right on the neutral line. Japan’s PMIs and increasing yen strength are negative for this export-based economy, though sentiment is at extremely pessimistic levels, and valuations are relatively attractive. We are slightly underweight given the BoJ is in a tightening mode.
Figure 9: Japan’s Economic Surprise Index indicates that expectations are still too optimistic.
Switzerland: The Swiss Franc strengthened to 0.86 against the USD, benefiting from dollar weakness due to concerns about the US economy after a disappointing jobs report. Speculation arose that the Fed may need to cut interest rates three times this year. Switzerland's annual inflation rate remained at 1.3% in July 2024, in line with expectations, reinforcing expectations of a third consecutive rate cut by the Swiss National Bank in September. Swiss consumer prices fell 0.2% in July 2024. The Swiss procure.ch and Credit Suisse Manufacturing PMI dropped to 43.5 in July, marking the 19th consecutive month of contraction, with declines in production, order book, purchasing volume, purchasing prices, and employment. Swiss investors’ sentiment index declined to 9.4 in June 2024, indicating a moderately optimistic outlook, with expectations of lower short-term rates in Switzerland, the Eurozone, and the US. The Composite model is negative, with breadth deteriorating. We are underweight the benchmark.
Figure 10: Breadth is deteriorating around Euro Area equity markets.
United Kingdom: The Bank of England cut interest rates by 25bps to 5% on 8/1, meeting investor expectations. Future rate cuts totaling 35bps are anticipated, with the next likely in November. Governor Bailey cautioned against drastic cuts due to lingering inflationary pressures. UK's Consumer Price Index rose 0.1% in June, in line with predictions. Q1 2024 saw a 0.7% economic expansion, ending a previous year-long recession. Service sector growth was 0.8%, led by scientific research and legal activities. UK Manufacturing PMI for July 2024 was revised up to 52.1, indicating the strongest expansion since 2022. Manufacturing output saw notable growth, as did new export orders. The Services PMI for July 2024 edged higher to 52.4, marking the ninth consecutive period of expansion. Higher demand drove firms to increase staffing despite budget constraints. Business confidence rebounded, driven by expectations of improved conditions after the UK election. The Composite model is bullish, but the increase in option-adjusted credit spreads is concerning, though still at low levels. If more technical indicators confirm the weakness, we will reduce exposure. We are overweight.
Figure 11: Two months ago, we first featured the sentiment chart below. We noted that a reversal from lower levels, confirmed by short-term trend indicators, would be positive.
Emerging Market Positions
AApproximately 35% of the strategy is allocated across five markets from a pool of more than 20 smaller markets. Selection is based on a multi-factor technical ranking system using trend and mean reversion indicators.
Current Holdings:
India
Taiwan
Italy
Sweden
Netherlands
Explore: Emerging Market Commentary
Each of the five emerging markets is supported by favorable price trends, with 50-day moving averages trading above the 200-day moving averages. All also show rising 200-day moving averages.
Expected one-year earnings growth: India (+11.6%), Taiwan (+22.6%), Italy (+2.9%), Sweden (+6.2%), Netherlands (+14.3%). (All data based on MSCI constituent holdings.)
The percentage of positive earnings revisions for each country supports positive earnings expectations: India (+87.2%), Taiwan (+79.9%), Italy (+65.3%), Sweden (+76.2%), and the Netherlands (+84.9%).
The Forward P/Es for Italy (8.3x), Sweden (15.5x), Taiwan (17.3x), and the Netherlands (16.8x) compare favorably to the U.S. at 20.7x.
India, Italy, the Netherlands, and Sweden have low market capitalization-to-GDP ratios, which typically indicate a favorable valuation.
Taiwan and the Netherlands are over two standard deviations oversold. Such oversold conditions may provide a near-term bounce opportunity. (Japan is the only country more oversold, based on this measure.)
Manufacturing PMIs indicate improving economic activity in India (PMI 58.1) and Taiwan (PMI 52.9). Overall, emerging markets are supported by a 50.7 composite PMI level.
All five countries are supported by increasing forward earnings estimates.
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
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Smart Sector® International ETF
Symbol: SSXU
Strategy Description
The Smart Sector® International strategy combines three quantitative investment strategies: Core International, Explore International, and 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 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, for example. 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 Catastrophic model is triggered, whereupon the equity-invested position may be trimmed by up to 50%.
The Catastrophic 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 Catastrophic Stop model moves back to bullish levels, indicating lower risk, the strategy will reverse toward being fully invested.
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.
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