Day Hagan Smart Sector® International Strategy Update November 2024
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Day Hagan Smart Sector® International Strategy Update November 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) declined toward the end of October but entered November with a fully invested equity allocation recommendation. If our models shift to bearish levels (below 40% for two consecutive days), we will raise cash.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
The model’s decrease was due primarily to the ACWI Breadth and Baltic Dry Index Factors turning negative, indicating that equity participation is narrowing and economic activity is moderating. Based on the changes, the Catastrophic Stop model has moved closer to neutral, setting it up to generate a sell signal more quickly if conditions warrant.
Figure 2: The ACWI Breadth Factor indicates that global equity participation has waned. Historically, the strongest uptrends have been supported by a broader range of stocks.
Figure 3: The Baltic Dry Index Factor has reversed to a sell signal (chart below). The Baltic Dry Index tracks rates for shipping dry bulk commodities and is often considered a leading indicator of economic activity. It measures 23 different shipping routes.
In recent months, global economic conditions have prompted significant shifts in monetary policy and corporate strategies, with central banks like the Federal Reserve adjusting interest rates to support growth amid uncertainty. In September, the Federal Reserve cut rates by 50 basis points, signaling a commitment to fostering economic activity. This decision influenced investor expectations, particularly as rising bond yields reflected concerns over tighter financial conditions. Long-term U.S. Treasury yields have approached multi-year highs, increasing borrowing costs for consumers and corporations alike. This is especially pertinent for high-growth technology stocks, which are sensitive to interest rate fluctuations due to their reliance on future earnings projections.
The Q3 earnings season has revealed a mixed picture for corporate performance, particularly within the technology sector. Major companies, including Microsoft and Meta Platforms, posted better-than-expected profits; however, their stock prices declined due to investor apprehension about future growth and spending plans. Concurrently, firms in the consumer goods and retail sectors reported increased cost pressures alongside softer demand, indicating a potential shift in market preferences from growth-focused to more value-oriented investments if inflation remains persistent.
As of October, consumer spending continues to be robust, buoyed by strong employment figures and rising wages. Yet, the resumption of student loan payments poses a new challenge for disposable income, especially among younger demographics, which could impact retail sales as the holiday season approaches. Geopolitical tensions are another critical factor affecting market dynamics. Events in the Middle East, such as Israel’s airstrikes, have influenced oil prices and general investor sentiment, contributing to broader market volatility. Investors have historically flocked to the U.S. dollar during uncertain times, further adding to its strength. This appreciation impacts the competitiveness of American exports and negatively impacts earnings for multinational corporations that generate substantial revenue from international markets. Companies heavily reliant on overseas operations may face currency-related pressures, particularly in light of ongoing global geopolitical uncertainties.
In contrast, China is grappling with significant economic challenges, particularly in its real estate sector, which remains a cornerstone of its GDP. October’s data indicated continuing liquidity issues among developers, with property sales still sluggish despite government attempts to stimulate growth through targeted measures, including tax incentives and infrastructure spending. While these efforts aim to restore investor confidence, caution lingers due to underlying structural issues within the economy. Trade tensions between the U.S. and China continue to strain key sectors, particularly technology and industrial manufacturing. The recent tightening of export controls by the U.S. on high-tech components has prompted Chinese companies to invest in domestic alternatives to lessen foreign dependency. This shift toward self-sufficiency, while a strategic move, is expected to take time.
These developments could significantly impact both domestic and foreign companies engaged in semiconductors, tech manufacturing, and advanced materials. Along with the challenges posed by inflation and geopolitical instability, consumer confidence in China appears tepid, contributing to underwhelming retail sales figures. The combination of economic pressures and trade disputes raises questions about the sustainability of consumer spending and overall economic growth in the region.
As these complexities unfold, Central Banks continue to navigate the delicate balance between securing economic growth while addressing inflationary concerns. Overall, monetary policy shifts have been, on balance, stimulative, girding corporate performance. As the U.S. prepares for its presidential elections, political considerations further complicate the financial landscape, with potential policy shifts influencing trade relations and economic performance. This combination of factors and the resulting increased volatility create an environment in which staying in tune with the quantitative, unemotional message of our models becomes even more important.
Figure 4: Global Purchasing Manager Index is still in expansion territory but has moved even lower. It would be concerning if the Services PMI (light blue) dropped below 50, joining the weak manufacturing PMI reading.
Core: Developed Market Positions (approximately 65% of equity holdings)
Country
Australia
Canada
China
France
Germany
Japan
Switzerland
United Kingdom
Outlook
Neutral
Overweight
Overweight
Underweight
Underweight
Underweight
Neutral
Neutral
Explore: Emerging Market Positions (approximately 35% of equity holdings)
India
Taiwan
Thailand
Philippines
Malaysia
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: The Reserve Bank of Australia (RBA) held its cash rate steady at 4.35% in September, marking the seventh consecutive meeting without change and aligning with market expectations. The bank remains concerned about persistent inflation, emphasizing that the trimmed mean indicates high momentum, while headline inflation is not expected to reach the 2-3% target until 2026. The board stressed vigilance regarding potential upside inflation risks and indicated that policy would remain restrictive for the foreseeable future. Household consumption is projected to improve in the second half of 2024, although the rebound may be slower than anticipated, potentially leading to subdued output growth and a weakening labor market. A mixed quarterly inflation report has dampened expectations for an immediate rate cut, putting additional pressure on equities. In October, the Judo Bank Australia Manufacturing PMI fell to 46.6 from 46.7, indicating deteriorating sector health for the ninth consecutive month and the fastest decline since May 2020. Conversely, the Services PMI Business Activity Index rose to 50.6 from 50.5, reflecting modest expansion driven by stronger domestic demand, even as export business declined. Employment in services increased at the fastest rate in five months, signaling improved business confidence as the final quarter commenced. For November, the composite model declined to neutral, primarily due to short-term trend deterioration. Measures of currency, volatility and longer-term trend remain positive. We have reduced exposure to a neutral allocation relative to the ACWX benchmark.
Figure 5: Australia’s composite model declined due to short-term technical deterioration.
Canada: In October, the Bank of Canada cut its key interest rate by 50 basis points to 3.75%, in line with expectations, and signaled further reductions if economic conditions warrant. This decision marked an acceleration in rate cuts following three consecutive 25 basis point decreases, responding to a notable slowdown in Canadian inflation, which fell to 1.6% in September—below the 2% target for the first time in three years. The bank reported a decline in per capita consumption and a softening labor market, with the unemployment rate exceeding 6.5% for the first time in over two years, reinforcing the need for lower borrowing costs. The latest Monetary Policy Report indicates that policymakers foresee inflation stabilizing near target levels, with balanced risks. Economic growth projections show GDP expanding by 1.2% this year and a sharper increase of 2.1% in 2025. Meanwhile, strong U.S. economic growth has tempered expectations for dovish actions from the Federal Reserve. As a significant player in the energy sector, fluctuations in oil prices continue to impact the Canadian market. Notably, lower oil prices in October affected both energy stock performance and overall market confidence. The top stocks on the TSX, Royal Bank of Canada and Shopify, saw impressive year-to-date gains of 54.6% and 69.7%, respectively. Quantitative measures calling leading economic indicator trends, relative earnings yields, relative currency strength, and yield curve trends are positive. Price trends and momentum measures are also positive. Canada’s composite model declined but remains at levels supporting an overweight allocation.
Figure 6: Canada’s Composite of Leading Economic Indicators is showing positive relative strength vs. the rest of the world.
China: In October, the People’s Bank of China cut key lending rates as part of efforts to bolster a weakening economy. The one-year loan prime rate (LPR) was reduced by 25 basis points (bps) to 3.1%, while the five-year rate, used mainly for property mortgages, also saw a 25-bps cut to 3.6%. Previously, these rates were last adjusted in July. Traders are focused on the upcoming National People’s Congress from November 4-8, with speculation around a planned stimulus package exceeding 10 trillion yuan to revive economic conditions. Despite various monetary strategies to foster growth, a lack of definitive fiscal initiatives has left markets underwhelmed. Measures of momentum, trend, relative currency strength, and Emerging Market High Yield option-adjusted spreads are supportive. We remain overweight.
Figure 7: Manufacturing has been slow to recover, as evidenced by most global PMI readings. China’s level has recently moved back above 50, from 49.3 the previous month. Output levels were the highest in four months, with new orders improving. However, the PMI for the overall Emerging Markets category is rolling over (see chart).
France: The European Central Bank (ECB) cut its benchmark interest rates by 25 basis points in October, following similar reductions in September and June. The new rates for the deposit facility, main refinancing operations, and marginal lending facility are 3.25%, 3.40%, and 3.65%, respectively. This decision reflects an updated assessment of inflation, which has shown significant disinflation, with Eurozone inflation dipping below the ECB’s 2% target for the first time in over three years. Although inflation is projected to rise temporarily, it is expected to align with the target by 2025, while wage pressures are easing. Meanwhile, the CAC 40 index reached eleven-week lows amid heightened hawkish expectations for the ECB and mixed corporate earnings. After an unexpected increase in Euro Area inflation to 2%, surpassing forecasts, investors anticipate a cautious approach from the ECB. Additionally, the S&P Global France Manufacturing PMI fell to 44.5 in October, marking the 21st consecutive month of contraction with persistent declines in output and new orders. The HCOB France Services PMI also decreased sharply to 48.3, indicating significant hurdles in service demand, particularly for export orders, leading to workforce reductions in response to the slowdown. The Composite model remains mixed, with measures of trend, breadth, valuation, and asset flows negative. Given the neutral Composite model and France’s struggle to stimulate its economy, we remain slightly underweight.
Figure 8: Investors continue to sell.
Germany: In October 2024, Germany’s seasonally adjusted unemployment rate rose to 6.1%, the highest since February 2021, up from 6% in recent months, reflecting a 27,000 increase in the unemployed population to 2.856 million, exceeding expectations of a 15,000 rise. At the same time, annual inflation accelerated to 2%, the highest in three months, surpassing forecasts of 1.8%. The HCOB Flash Manufacturing PMI improved to 42.6 from September’s low of 40.6, though it still indicates significant contraction in the sector. Reports suggest weak consumer spending and declining demand from the auto industry contributed to a steep drop in factory gate prices—the most significant in over 15 years. Conversely, the HCOB Services PMI rose to 51.4, indicating growth in the services sector for the eighth-straight month, despite a fall in new business inflows. The Ifo Business Climate indicator increased for the first time in five months to 86.5. This uptick suggests improved business expectations, despite underlying skepticism. On a positive note, SAP, Germany’s largest company by market cap, reported double-digit revenue growth, with cloud revenue surging 27% to €4.4 billion, driven by a 36% increase in its Cloud ERP Suite. Operating profit climbed 28% to €2.2 billion. The composite model remains negative due to the PMI weakness, while measures of trend, valuation, and ETF outflows were also negative. We are underweight.
Figure 9: Germany’s Manufacturing PMI remains at contraction levels.
Japan: The Bank of Japan (BoJ) maintained its key short-term interest rate at approximately 0.25% during October’s meeting, the highest level since 2008. This unanimous decision aligns with market expectations, signaling the central bank’s cautious approach to further rate hikes after increases in March and July. The BoJ emphasized the need to monitor financial markets amid hawkish sentiments from some board members while reiterating its view that Japan’s economy is on a moderate recovery path. Private consumption is rising, bolstered by improving corporate profits, yet exports and industrial production remain stagnant, with inflation hovering between 2.5% and 3.0%, primarily due to higher service prices. However, policy uncertainty emerges following the ruling Liberal Democratic Party’s loss of its parliamentary majority. The opposition leader has urged the BoJ to refrain from drastic policy changes, highlighting concerns over stagnant real wage growth. In October, the au Jibun Bank Japan Manufacturing PMI fell to 49.0, marking four consecutive months of contraction and the strongest decline since March, driven by reduced output and new orders. Meanwhile, the au Jibun Bank Japan Services PMI dropped to 49.3, indicating the steepest decline in service sector activity since February 2022, attributed to weakened domestic and international demand. From a model perspective, internal and external indicators remained negative on balance. Measures of trend, relative strength, valuation, and sentiment were negative. We are underweight.
Figure 10: Japan’s Economic Surprise Index remained weak throughout October. This indicates that investors are still too optimistic regarding economic expectations.
Switzerland: Nestlé, Switzerland’s largest company, has seen a notable decline of nearly 18% this year. In contrast, the next five largest firms—Novartis, Roche, ABB, UBS, and Zurich—showed positive performance with stock increases of 9.94%, 12.75%, 56.78%, 22.08%, and 16.94%, respectively. Interestingly, smaller-cap stocks in the region have performed relatively well compared to the U.S. In October, notable performers included Lonza Group AG, which rose on the back of strong quarterly earnings in the biotech sector, and Holcim Ltd, whose shares climbed, benefiting from increased infrastructure projects. ABB Ltd also experienced an increase due to robust demand in industrial automation. On the downside, Credit Suisse Group AG faced a significant drop amid restructuring challenges, while Nestlé saw an extended decline attributed to rising input costs and slowing growth concerns. Givaudan SA’s stock fell due to supply chain issues. In September 2024, the Swiss National Bank reduced its key policy rate by 25 basis points to 1%, the third consecutive cut, signaling ongoing efforts to stabilize prices amid fluctuating global economic conditions impacting investor sentiment and the CH20 index. The composite model is mixed, with measures of trend, interest rates, and ETF outflows negative. There are some green shoots, with earnings estimates improving and valuations less of a headwind. We are neutral.
Figure 11: The Swiss Franc and U.S. Dollar are at parity.
United Kingdom: The British pound weakened to its lowest point since mid-August, following the Labour government’s first budget announcement. On October 30, as the budget was revealed, sterling fluctuated but ultimately depreciated as traders evaluated its implications. Key highlights include an annual borrowing increase of £28 billion during the parliamentary term, £297 billion in bond sales for this fiscal year—marking the second-largest total on record—and proposed tax hikes totaling £40 billion aimed at funding public services and addressing a £22 billion fiscal deficit from the previous administration. The Office for Budget Responsibility adjusted its GDP growth forecast for this year to 1.1%, while projecting 2% for 2025. Inflation is anticipated to average 2.5% in 2024, rising slightly to 2.6% in 2025. The Bank of England is expected to reduce borrowing costs by another 25 basis points next week, with market bets shifting from five cuts by 2025 to three. Meanwhile, the S&P Global Flash UK Manufacturing PMI decreased to 50.3 in October, reflecting a slowdown in growth and new orders, while the S&P Global UK Services PMI fell to 51.8, indicating the slowest expansion in services activity since June. The Composite model is neutral, however measures of positive earnings revisions, valuations, sentiment, and narrowing credit spreads are supportive.
Figure 12: Sentiment is reversing from levels denoting excessive optimism. A move below 40 and a reversal back above that level would be bullish.
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 multifactor technical ranking system using trend and mean reversion indicators.
Current Holdings:
India
Taiwan
Thailand
Philippines
Malaysia
Explore: Emerging Market Commentary
Each of the five emerging markets are supported by favorable price trends, with 50-day moving averages trading above the 200-day moving averages. All show rising 50-, 100-, and 200-day moving averages. We note that 99.3% of ACWI regions are supported by rising 200-day moving averages.
Expected one-year earnings growth: India (+14.1%), Taiwan (+19.8%), Thailand (+12.2%), Philippines (+10.3%), and Malaysia (+7.8%). (All data based on MSCI constituent holdings.)
Forward P/Es are as follows: India (22.9x), Taiwan (17.1x), Thailand (16.6x), Philippines (11.9x), and Malaysia (13.8x).
All five countries are supported by increasing forward earnings estimates.
Four of the five countries have low market capitalization-to-GDP ratios (below 1.0), typically indicating a favorable valuation. Taiwan is more expensive at 1.86x.
The Philippines and Malaysia equity markets are significantly oversold on a short-term (21-day) basis. Such oversold conditions may provide a near-term bounce opportunity.
Regarding the additions of Thailand, the Philippines, and Malaysia to the portfolio, below are the most recent central bank actions for each country:
Thailand: In October 2024, the Bank of Thailand made a significant move by lowering its key interest rate by 25 basis points to 2.25%, marking the first cut since early 2020 and aligning with long-standing government advice. This decision comes in response to a sluggish economy, with inflation remaining below the target range of 1% to 3%. Most committee members agreed that the rate reduction would help alleviate some of the debt burden without compromising the efforts to reduce the household debt-to-income ratio. The Thai economy is projected to grow by approximately 2.7% in 2024 and 2.9% in 2025, supported by a rebound in tourism, increased private consumption, and improved export activity in electronic products.
Philippines: Meanwhile, the Central Bank of the Philippines lowered its benchmark interest rate by 25 basis points to 6%, marking the second consecutive cut in response to manageable price pressures. BSP Governor Eli Remolona noted that recent data revealed a sharp decline in the annual inflation rate, dipping to 1.9% in September from 3.3% the previous month, which was below market expectations. This figure represents the lowest inflation rate since May 2020. The central bank adjusted its inflation forecast for 2024 down to 3.1% but raised expectations for 2025 and 2026 to 3.3% and 3.7%, respectively, reflecting ongoing adjustments in economic conditions.
Malaysia: In Malaysia, the central bank chose to maintain its key interest rate at 3% for the eighth consecutive meeting in September 2024, matching market expectations. Policymakers expressed growing optimism regarding the nation’s economic growth, inflation, and currency stability. They indicated that the current monetary policy remains supportive of economic conditions and aligns with their inflation and growth assessments. Economic growth is anticipated to reach the upper end of the 4-5% projection for 2024, driven by robust domestic expenditure and increased export activity. Average headline and core inflation are expected to stay within projected ranges, unlikely to exceed 3%, although the inflation outlook will depend on domestic policy implementation following recent reforms, including diesel subsidy removals.
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.
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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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