Day Hagan Smart Sector® International Strategy Update June 2024
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Day Hagan Smart Sector® International Strategy Update June 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) improved during the month and entered June with a fully invested equity allocation recommendation.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
According to the S&P Global Purchasing Managers’ Index (PMI), the global economy showed continued signs of accelerating momentum in April. The global composite rose for the sixth straight month to its highest level since June 2023. Accelerating economic momentum, as represented by the three-month change of the global composite PMI, has historically been consistent with strong global equity market gains.
Successive gains in the PMI usually don’t last much longer than six months, suggesting that the composite could take a short breather soon. Moreover, leading indicators in the report, such as new orders and future output, eased modestly. Nonetheless, both remain in firm growth territory. Also, the global PMI is still below its long-term average, indicating more room for upside in the intermediate term, as there are few signs that the economy is overheated.
Both the global manufacturing and services sectors expanded as the latter saw growth accelerate. Manufacturing expanded for a third month, albeit at a slower pace, suggesting a lackluster recovery. Economic breadth remained strong as most economies continued to expand.
Price pressures eased in April after a surge led by the U.S. in the prior month. Despite the moderation, both input and output price indexes have remained in a tight range above pre-pandemic levels since mid-2023.
The global equity uptrend has gotten back on track after a healthy correction that relieved excessive optimism and produced oversold conditions. The VIX has been receding from another higher low within the bull market intact since 2022, as the limited upturn in fear has given way to a renewed increase in confidence.
Core: Developed Market Positions (approximately 65% of equity holdings)
Country
Australia
Canada
China
France
Germany
Japan
Switzerland
United Kingdom
Outlook
Underweight
Neutral
Overweight
Overweigh
Neutral
Underweight
Neutral
Underweight
Explore: Emerging Market Positions (approximately 35% of equity holdings)
Chile
South Korea
Mexico
Poland
South Africa
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: Like the U.S., Australia is having trouble taming the last leg of inflation. Recent data shows the inflation rate at 3.6%, with GDP growth of 1.5%. Moreover, Retail Sales show the consumer is retrenching. Services are currently driving the economy, as manufacturing PMIs remain below 50%. Bullish indicators include trend measures, relative volatility, and the country’s positive interest rate differential. Negative indicators include short-term momentum and breadth. Valuations are neutral. The net result is an underweight position.
Figure 2: Australia’s manufacturing output has slowed. Expectations are for services-related consumption to improve.
Canada: Given Canada’s weak economic growth (Q1 annualized GDP was 1.7% vs. expectations of 2.8%), high unemployment rate (6.1%), and trend inflation rate (a manageable 2.7% annualized, down from the peak of 7.2% in 2022), the Bank of Canada is likely to cut policy rates this week (meeting on June 5). Moreover, leading economic indicators, relative valuations, and yield curve trends show that the corporate operating environment is improving. The reason the overall model remains neutral is that the majority of price-related indicators have yet to turn around. As they do, we will increase exposure accordingly. We remain neutral.
Figure 3: Canada’s Leading Indicators are showing signs of improvement.
China: China has 0.3% annual inflation and 5.3% annualized GDP growth, supported by positive manufacturing and service PMIs. Following several rounds of fiscal stimulus, China is absorbing the liquidity as the PBOC decides its next move. China’s model shows uniformly positive internal and external indicators, including momentum, relative strength, trend, volatility, economic growth, FX trends, and emerging market debt spreads relatively narrow (indicating a normally functioning fixed-income market). We are overweight.
Figure 4: EM High-yield credit spreads narrowing. This indicates investors aren’t anticipating a major financial disruption.
France: Measures of trend, valuation, asset inflows, and leading economic indicators are positive. Perhaps most importantly, investor flows continue to move into the region. France’s inflation rate is now 2.2%, with a core inflation rate of 1.9%. GDP growth is below trend at 1.1% through March but has been ticking higher. Consumer confidence is also improving, leading to more consumer spending. PMIs are mixed, with manufacturing improving and services flat.
Figure 5: France’s composite of leading indicators slowly working higher.
Germany: Q1 Real GDP was -0.2% annualized, though recent PMIs are showing improvement with services at 53.9. And while manufacturing PMI is just 45.4, that is an uptick from the previous reading of 42.5. Additionally, the ZEW Economic Sentiment Index is the highest since early 2022. The Euro region continues to slowly emerge from a weak economic growth environment, and the ECB has guided for a rate cut in the near term, potentially this week. Leading economic indicators are just starting to improve, relative valuations are low, and being one of the first Developed Markets to start lowering rates would be an advantage. Business confidence and economic sentiment indexes (especially services) are also still low but stabilizing. Lastly, short-term technical models are bullish on the British Pound and the Euro.
Figure 6: Investor demand is starting to pick up, with inflows into Europe lifting off of 10-year lows.
Japan: Japan’s models remained mixed this month, with the Internal and External Composites hovering near high-neutral levels. Positive inputs include trend, breadth, and sentiment reversing from excessive optimism levels back to neutral. Negative inputs show new lows expanding (relative to new highs), relative price strength weakness, and aggregate measures of ROE, earnings yields, and long-term earnings growth at below-average levels. Real GDP growth has turned negative (down -2.0% in Q1 vs. -1.5% expected) while the inflation rate held at 2.5% annualized. Private consumption is weak, and business spending has stalled. PMIs, consumer and business confidence surveys, and the Tankan survey indicate that the BoJ’s exit from NIRP (negative interest rate policy) is currently a headwind for the region. The weight of the evidence concludes that we remain underweight.
Figure 7: Forward earnings growth expectations are plummeting.
Switzerland: 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%), both of which are better than surrounding regions. The model is currently at high-neutral levels, with trends improving, rates stabilizing, and positive earnings revisions bullish. Asset inflows are also picking up. We increased exposure this month.
Figure 8: Positive earnings revisions are supportive.
United Kingdom: The U.K. is in wait-and-see mode until the election, and it is unlikely the BoE will enact any policy changes over the next five weeks. Recent economic data suggest there are some green shoots; manufacturing data is improving, business confidence has turned slightly positive, and inflation is 2.3% (though Core is a bit higher at 3.9%, it has been retreating). Energy costs have also declined following massive increases during the second half of 2022. Energy inflation has declined from a peak of 59.9% in October 2022 to -16.7% in April. The Composite Model is mixed with trend, earnings revisions, FX rates, valuations, and credit spreads supportive. Weak PMIs and negative sentiment are detractors. We remain underweight.
Figure 9: Sentiment has turned pessimistic. A reversal from lower levels, confirmed by short-term trend indicators, would be positive.
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:
Chile
South Korea
Mexico
Poland
South Africa
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 counterparts.
Chile, Mexico, and South Africa are more than one standard deviation oversold. South Korea and Poland are more than -0.5 standard deviation oversold. Such oversold conditions may provide a near-term bounce opportunity.
Chile, Poland, South Korea, South Africa, and Mexico have low market capitalization-to-GDP ratios, which typically indicate a favorable valuation.
The Forward P/Es for Chile (10.4x), South Korea (9.9x), Mexico (10.9x), Poland (9.5x), and South Africa (9.4x) compare favorably to the rest of the world at 18.4x, and the U.S. at 20.9x.
Chile, South Korea, South Africa, and Mexico are at relative price levels historically associated with bullish mean reversion tendencies.
All five countries are supported by increasing forward earnings estimates.
Expected one-year earnings growth: Chile +5.9%, South Korea +54.7%, Mexico +22.3%, and South Africa +24.8%.
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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