Day Hagan Smart Sector® International Strategy Update July 2024
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Day Hagan Smart Sector® International Strategy Update July 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 June and entered July with a fully invested equity allocation recommendation.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
As we step into July, our investment models 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. 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
In June, global equity markets were mixed, with European stocks declining due to France’s unexpected snap election announcement. Specifically, the French CAC 40 Index was down by approximately 6% on the news day, casting a shadow over the rest of the EU markets. Global investors are becoming increasingly alarmed about the prospects of a shift toward more conservative governments, which could lead to a revival of austerity measures and the potential tamping down of fiscal stimulus. While we believe fiscal restraint will ultimately be beneficial in the long term, investors have become accustomed to the money spigots supporting demand for financial assets and providing a floor in the event of a significant downturn.
These concerns were likely heightened by the most recent PMI reports out of the Euro Area. The Eurozone Manufacturing PMI declined to 45.6% in June, to a six-month low. This is the 15th consecutive month below 50% (below 50 = contraction). Measures evaluating employment, new orders, and export orders were weak as input costs increased and selling prices decreased. Nonetheless, manufacturing concerns were partially offset by the Eurozone Services PMI (services are a larger contributor to economic activity), which also declined in June. Still, at 52.6%, it remains in expansion territory. It was the fifth consecutive monthly reading above 50. Global PMIs are also upbeat, with the Global PMI Composite (including manufacturing and services) now 53.7. Individually, global manufacturing and services have both improved (chart below).
Figure 3: Global Purchasing Manager Index ticked higher
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
Underweight
Neutral
Overweight
Neutral
Neutral
Underweight
Neutral
Neutral
Explore: Emerging Market Positions (approximately 35% of equity holdings)
India
Taiwan
Turkey
Sweden
Peru
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: Entering July, Australia’s composite model is virtually unchanged. Indicators calling interest rate differentials and relative volatility are positive. Shorter-term technical measures of trend and mean reversion probabilities are less supportive. Based on recent declines in the country’s manufacturing and services PMIs, economic activity has slowed. The overall composite PMI is 50.6, down from 53.2 in May. Business and consumer confidence measures are also toward the low end of the historical ranges. With valuations neutral (Price/Cash Flow is 12x, slightly above the 20-year average), the net result is an underweight position.
Figure 4: Economic surprises over the past three months have generally been to the downside.
Canada: In a surprising upset, Conservative candidate Don Stewart narrowly defeated Liberal Leslie Church by 590 votes, ending the Liberal party’s 30-year hold on the Toronto seat. Conservative leader Pierre Poilievre called for a snap election in response to the victory, characterizing it as a “shocking upset” on social media. The win was significant for the Conservative party, as they had not secured a seat in Toronto since 2011. On June 5, the Bank of Canada cut rates by 25 bps to 4.75% in response to lower inflation indications and slowing economic activity (GDP growth is less than 1%). However, after having done so, the inflation report on June 25 surprised to the upside, with the m/m CPI hitting 0.6% vs. expectations of 0.3%. The Core CPI m/m was 0.6%. Investors put their future rate cut hopes on hold. Our composite model is neutral, with measures of trend and relative currency rates now negative. Valuations (forward P/E = 13.9x) and some leading economic indicators are supportive. The net result is a neutral rating.
Figure 5: Valuations are slightly below average based on Forward P/E.
China: China’s composite model declined slightly with this month’s update but remains bullish. The lower reading resulted from High-Yield Credit Spreads ticking higher, albeit from low levels (chart below). Notably, S&P recently affirmed China’s credit rating at A+/A-1, with a stable outlook. While real estate is still a challenge, China is creating a fund designed to rescue financial companies impacted by the property slump and lowering mortgage rates and down payment requirements for home buyers. Earnings expectations and valuations show positive earnings revisions increasing and valuations relatively low (forward P/E just 9.4x). Q1 GDP growth increased to 5.3% y/y (beating expectations), with fixed investment increasing by 4.5%, the most in a year. Continued policy easing is paramount, and the Bank of China’s efforts to weaken the CNY are emblematic of their focus. The annual inflation rate is just 0.3%. We are overweight.
Figure 6: EM High-yield credit spreads ticked higher, but levels are still relatively low. This indicates investors aren’t anticipating a significant financial disruption.
France: Given the election results described earlier, France needs clarity around its budget strategy. Markets don’t do well with uncertainty. With the first round of voting this past weekend showing a shift toward conservative government, we are monitoring the French/German 10-year yield spread for signs that the election results are more impactful than expected. (Following the European Parliament elections, the spread widened to its highest levels since 2011.) Currently, valuation measures, relative leading economic indicators, and long-term trends are supportive. Conversely, short-term trend indicators have declined, and investors have been exiting the region based on ETF flow data through June 27. Manufacturing (45.3) and Service (48.8) PMIs declined in June. With the Paris Olympics ending on August 11, we may see a boost in economic activity in Q3. We are now neutral the region until the model improves.
Figure 7: Higher rates are a headwind for France.
Germany: Germany’s economy has slowed down primarily due to a decline in the manufacturing sector. The ECB’s rate cut on June 6 (25 bps to 4.25%) is positive. Nevertheless, the Gross Domestic Product (GDP) only expanded by 0.2% in the first quarter of 2024, and manufacturing activity has shown signs of decline. Germany’s consumer price index (CPI) showed a year-on-year inflation rate of 2.4% in May 2024, a slight increase from 2.2% in the previous months, driven by rising service prices. The ZEW Economic Sentiment Index, which measures investor confidence, rose slightly to 47.5 points in June 2024, indicating a cautiously optimistic outlook among investors. The employment situation continues to show a slight upward trend. In May 2024, approximately 45.9 million people were employed in Germany, marking a marginal increase from the previous month, following a similar trend observed in April 2024. These indicators suggest that while Germany is experiencing modest inflation and a stable employment market, the manufacturing sector’s weaknesses hinder overall economic growth. The model has picked up on the shift and has declined to neutral levels.
Figure 8: Business sentiment in Germany is in decline.
Japan: The main story in Japan is the yen closing at its lowest level in 38 years, following a BoJ meeting in which it was revealed that members voted 8-1 to curtail bond buying (JGBs). Nonetheless, Japanese officials have signaled their intentions to support the yen, as inflation (including Core inflation) has been slowly increasing—so far, to no avail. The latest policy moves by the Bank of Japan (BOJ) also involved loosening its yield curve control (YCC) policy. This decision was made during their monetary policy meeting on June 14, 2024. The BOJ aims to expand the monetary base until the inflation rate exceeds its target. This move is intended to limit borrowing costs and stimulate the economy, a core component of Japan’s ultra-easy monetary policy strategy. The weight of the evidence concludes that we remain underweight.
Figure 9: Japan’s Economic Surprise Index indicates that expectations are still too optimistic.
Switzerland: With the July update, the composite model declined to neutral due primarily to asset outflows from the region. This also caused a short-term trend indicator to register a sell. Outside of those changes, technical measures show a rising percentage of companies above their 50-day MAs, better dividend yields, a relatively better trend in nominal 10-year yields, and positive earnings revisions. As described last month, with Q1 annual Real GDP growth of just 0.6%, weak consumer confidence, and declining business confidence, Switzerland has a growth challenge. Inflation is manageable at 1.4%, and government debt/GDP is just 38.3% (the U.S. is 122%), which is better than surrounding regions. We note a positive surprise interest rate cut by the SNB on June 21, taking the key policy rate down by 25 bps to 1.25%. We remain neutral.
Figure 10: Positive earnings revisions remain supportive.
United Kingdom: The U.K. Composite model is unchanged for July, though two indicators shifted: Sentiment turned positive, while option-adjusted spreads flipped back to negative. Both series of indicators target shorter-term horizons. The Bank of England (BoE) recently decided to maintain the Bank Rate at 5.25%. This decision was made during the Monetary Policy Committee (MPC) meeting on June 19, 2024. Seven of the nine committee members voted to keep the rate unchanged, while two preferred a reduction of 0.25 percentage points. The MPC emphasized the need for the current restrictive monetary policy to continue for an extended period to bring inflation back to the 2% target in the medium term. With other countries lowering rates, this puts the U.K. at a disadvantage. As described last month, the U.K. is in wait-and-see mode until the election on July 4. We are neutral.
Figure 11: Last month, we featured the sentiment chart below. We noted that a reversal from lower levels, confirmed by short-term trend indicators, would be positive. We have the sentiment reversal, but other short-term indicators have yet to confirm.
Emerging Market Positions
Approximately 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
Turkey
Sweden
Peru
Explore: Emerging Market Commentary
Each of the five emerging markets has favorable price trends as their 50-day moving averages trade above their 200-day moving averages.
Expected one-year earnings growth: India (+11.5%), Taiwan (+21.7%), Turkey (+24.0%), Sweden (+6.4%), Peru (+21.6%). The U.S. is +13.0%. (All data based on MSCI constituent holdings.)
The percentage of positive earnings revisions for each country supports positive earnings expectations: India (+73.5%), Taiwan (+74.8%), Turkey (+82.8%), Sweden (+80.3%), and Peru (+88.9%).
The Forward P/Es for Turkey (5.3x), Sweden (16.1x), and Peru (11.9x) compare favorably to the rest of the world at 18.6x, and the U.S. at 21.4x.
India, Turkey, Sweden, and Peru have low market capitalization-to-GDP ratios, which typically indicate a favorable valuation.
Sweden, Turkey, and Peru are over one standard deviation oversold. Such oversold conditions may provide a near-term bounce opportunity.
All five countries are supported by increasing forward earnings estimates.
Manufacturing PMIs indicate improving economic activity: India (Manufacturing PMI 58.3, Services PMI 60.4), Taiwan (Manufacturing PMI, 53.2 Services N.A).
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
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Day Hagan/Ned Davis Research
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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