Day Hagan Smart Sector® International Strategy Update October 2024
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Day Hagan Smart Sector® International Strategy Update October 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 toward the end of September and entered October with a fully invested equity allocation recommendation.
Figure 1: Catastrophic Stop Model vs. S&P 500 Total Return Index
The model’s increase was due to the Short-term Trend, U.S. Stock/Bond Relative Strength, High Yield OAS, and Baltic Dry Index Factors reversing to positive levels.
Figure 2: The Short-term Trend Factor continues to oscillate around neutral levels. A decisive move in either direction would quickly be reflected in the overall model.
Figure 3: The U.S. Stock/Bond Relative Strength Factor is back on a buy signal.
Figure 4: High-yield OAS reversed to bullish levels. This indicates that the financial markets are behaving relatively normally.
Figure 5: The Baltic Dry Index Factor is also now positive (chart above).
Entering September, our investment models continue to convey a cautiously optimistic collective outlook for global equity markets. For instance, the Global Recession Probability Model now assigns a 57.28% probability of a broad-based significant global slowdown. Above 70, the probability jumps to 87.83%. 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 6: The Global Recession Probability Model crossed into the neutral zone from bullish. A move above 70 would denote “High Recession Risk.”
During September, global equity markets were influenced by a mixed bag of economic, monetary, and geopolitical factors. For example, the Australian equity market gained momentum, driven by strong performance in the resource sector due to a surge in iron ore prices, boosted by China’s stimulus measures. However, domestic economic indicators showed slowing growth, with inflation easing to 2.7%. Canadian equities benefited from the Bank of Canada’s 0.25% interest rate cut, which brought the rate to 4.25%. This reduction, alongside the global shift towards monetary easing, helped the market recover despite ongoing concerns about consumer demand and inflation. China’s stock market surged nearly 20% during September, largely due to a significant stimulus package aimed at reviving the property sector and encouraging bank lending. However, the broader Chinese economy continued to grapple with weak consumer demand and challenges in the housing and manufacturing sectors.
France’s equity markets saw modest performance, influenced by weak consumer confidence and slowing economic growth in the Eurozone. The country also faced political uncertainty after leadership changes, but expectations of further European Central Bank (ECB) rate cuts helped support equity valuations. German equities were pressured by concerns about regional elections and weaker industrial output. The country’s economic data showed slow consumer spending and industrial production, with the ECB’s rate cut of 0.25% providing limited relief for investors. Additionally, subdued demand from China affected German exports. The Japanese equity market remained relatively flat, as the Bank of Japan’s continued hawkish stance and the yen’s strength contributed to subdued equity performance, with investors anticipating slower growth in global demand and domestic consumption. Switzerland’s equities underperformed relative to other European markets. The Swiss National Bank cut its interest rate to 1%, but this did not significantly boost market sentiment, as concerns about global demand and weaker economic indicators in the Eurozone weighed on performance. UK equities rose modestly, supported by expectations that the Bank of England would hold off on immediate rate cuts. However, ongoing political uncertainty and mixed economic data kept investors cautious.
Overall, global markets in September were buoyed by central bank rate cuts and China’s aggressive stimulus, though challenges like weak industrial output and geopolitical uncertainties persisted.
Figure 7: 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 manufacturing PMI reading.
Core: Developed Market Positions (approximately 65% of equity holdings)
Country
Australia
Canada
China
France
Germany
Japan
Switzerland
United Kingdom
Outlook
Overweight
Overweight
Overweight
Underweight
Underweight
Underweight
Underweight
Underweight
Explore: Emerging Market Positions (approximately 35% of equity holdings)
India
Taiwan
Poland
Italy
New Zealand
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: In September, business activity in Australia experienced a slowdown, with the Judo Bank Flash Australia Services PMI Business Activity Index dropping to 50.5 from 52.5 in August. This indicates a decreased rate of expansion, the slowest since December 2020. Although new business inflows, particularly in consumer services, contributed to growth, the expansion decelerated due to reduced export demand and more challenging trade conditions. However, service providers increased their hiring, resulting in the highest rate of job creation since May and reducing backlogs for the fifth consecutive month. The Judo Bank Australia Manufacturing PMI fell to 46.7 in September from 48.5 in August, marking the eighth consecutive month of contraction in manufacturing activity and the fastest pace since May 2020. Both new orders and production declined at the quickest pace in 52 months, including external demand, with export orders returning to contraction in September. The Reserve Bank of Australia (RBA) maintained its cash rate at 4.35% during its September meeting, keeping borrowing costs unchanged for the seventh consecutive gathering and aligning with market expectations. However, the central bank expressed concerns about inflation momentum, particularly the trimmed mean, which it considers too high. For October, the composite model improved primarily due to technical indicator improvement. Measures of trend, currency strength, gold prices, and volatility turned positive. We are upgrading to overweight.
Figure 8: Australia’s Economic Surprise Index continues to improve, indicating that economic releases have been outpacing expectations, on average, over the past three months.
Canada: The Bank of Canada lowered its key interest rate by 25 basis points to 4.25% in September 2024, marking the third consecutive cut. This decision was made due to ongoing downward pressure on inflation from excess supply in the Canadian economy. Concerns about undershooting inflation targets and a slowing labor market also influenced the rate cut. As a result, the Canadian dollar weakened, reflecting soft GDP growth and expectations of further rate cuts. The S&P Global Canada Manufacturing PMI rose to 49.5 in August 2024, the softest contraction since March, amid subdued demand and cautious hiring. Input cost inflation reached its highest level since April 2023, leading to increased output charges. However, purchasing activity declined due to concerns over high costs, interest rates, and shipping delays. As reflected by the CFIB’s Business Barometer, business confidence eased to 55 in September 2024, with sectoral confidence varying widely. Overall, the Canadian economy faces challenges, with GDP stagnation and the manufacturing sector experiencing a prolonged decline. Despite some positive indicators, such as elevated wage growth, the outlook remains uncertain, leading to reduced business confidence in certain sectors and regions. 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. While economic growth is clearly decelerating, it is still positive, and the weight of the evidence confirms our current slightly overweight allocation.
Figure 9: Canada’s Composite of Leading Economic Indicators is showing positive relative strength vs. the rest of the world.
China: The driving factor in equity markets at the end of September was in China and not the U.S., as the China Central Bank cut interest rates in their medium loan facility by a full percentage point (from 3% down to 2%), which was the largest cut ever. China’s equity markets spiked higher, taking much of the international complex with it. The offshore yuan eased after the People’s Bank of China announced the key monetary easing measures, including cuts to the reserve requirement ratio (RRR) and the seven-day reverse repo rate. The central bank lowered the RRR by 50 bps, marking the second reduction this year to support China’s economy. Additionally, the PBoC reduced the seven-day reverse repo rate by 20 bps to 1.5%. Profits earned by China’s industrial firms grew by just 0.5% year-on-year in the first eight months of 2024, a sharp slowdown from the previous period. Exports from China increased by 8.7% YoY in August 2024 to a 23-month peak, exceeding forecasts and accelerating from July. Real estate is under pressure in China, with new home sales YoY decreasing to -26.80 percent in August from -19.70 percent in July 2024. We remain overweight.
Figure 10: EM High-yield credit spreads continue to narrow. This indicates that investors aren’t anticipating a significant financial disruption.
Figure 10a: China’s Forward P/E has increased back to the 22-year average, removing some of the margin of safety discussed last month.
France: The recent market declines were influenced by rising tensions in the Middle East and decreased confidence regarding China’s economic stimulus efforts. Stellantis and Renault experienced pressure, particularly with Stellantis anticipating a decrease in electric vehicle production to less than 500,000 units by 2024. In September 2024, the HCOB Eurozone Composite PMI indicated the first contraction in private sector activity since February, standing at 49.6. The S&P Global France Manufacturing PMI also increased to 44.6 in September 2024, marking the 20th consecutive month of contraction, albeit the mildest since May. Notably, there were declines in output and new orders, especially in intermediate and capital goods. Additionally, the HCOB France Services PMI dropped to 49.6 in September 2024 due to reduced visitor and customer numbers following the Paris Olympic Games. This decline also reflected weakened demand in overseas markets as incoming new business volumes shrank. The Composite model increased to neutral, with some improvement in trend indicators. However, valuation measures and ETF asset flows indicate France is still relatively expensive, and investors are still selling holdings. Given the neutral Composite model and France’s struggle to stimulate its economy, we remain slightly underweight.
Figure 11: French 10-year rates have rolled over, but relative to Germany, they are still elevated, which is a headwind.
Germany: In September 2024, the economic conditions in Germany experienced a significant decline. The manufacturing sector saw a sharp drop in the Purchasing Managers’ Index (PMI) to its lowest level in a year, indicating a contraction in manufacturing activities. This decline was attributed to decreased new orders, market uncertainty, and weakness in the auto manufacturing sector. Similarly, the services sector also declined, with business activity and new business inflows decreasing to their lowest levels since March. This was linked to customer uncertainty, weak investment, and declining export business. As a result, job cuts were implemented for a third consecutive month. Inflationary pressures eased, with cost and price increases slowing down. Moreover, growth expectations hit a one-year low, raising concerns about a potential economic downturn. The composite model declined due to the PMI weakness, while measures of trend, valuation, and ETF outflows were also negative. We are underweight.
Figure 12: Germany’s Forward P/E is back to the long-term average.
Japan: After Shigeru Ishiba was elected as the next prime minister, the Japanese yen experienced a significant increase. Ishiba is known for supporting economic stimulus and expansionary fiscal policies. In September, Tokyo’s core inflation rate slowed to 2%, which led to a cautious approach to rate hikes by the Bank of Japan (BoJ). The BoJ decided to maintain its key short-term interest rate at around 0.25%, indicating a reluctance to further increase rates due to hawkish views from some board members, especially after the negative impact of their recent rate hike on the “carry trade.” Private consumption has risen, supported by improving corporate profits and business spending, while exports and industrial production have remained stagnant. The au Jibun Bank Japan Manufacturing PMI declined to 49.6, showing the third consecutive month of contraction in factory activity. However, the au Jibun Bank Japan Services PMI rose to 53.9, driven by sustained demand. The Nikkei 225 Index recently closed above the 39,000 level, reaching its highest point in two months due to positive corporate earnings and solid economic data in the U.S. From a model perspective, internal and external indicators are mixed. We are underweight.
Figure 13: Japan’s Economic Surprise Index weakened in September. Indicates that investors are still too optimistic regarding economic expectations.
Switzerland: In September 2024, the Swiss National Bank lowered its key policy rate by 25 bps to 1%, marking the third consecutive cut and bringing borrowing costs to their lowest since early 2023. This move was in line with market predictions. Anticipations of more dovish policies were reinforced by softer CPI data, leading to expectations of a 50-basis point rate reduction in the upcoming December meeting. The Credit Suisse Manufacturing PMI increased to 49.9 in September 2024, slightly surpassing the previous month’s 49 and beating market projections of 48.2. This indicates that the Swiss manufacturing sector is approaching stabilization, with improvements in new orders. However, GDP growth forecasts for 2024 and 2025 remain subdued at approximately 1% and 1.5%, respectively. The composite model is mixed, with measures of trend, relative valuation, interest rates, and ETF outflows negative. There are some green shoots, with earnings estimates improving and a rising 50-day moving average. We are underweight the benchmark but will add exposure if the model improves.
Figure 14: Assets continue to exit the Eurozone region.
United Kingdom: Bank of England Governor Andrew Bailey indicated the possibility of rapid interest rate cuts in response to positive inflation trends, underscoring the central bank’s commitment to maintaining economic stability amid evolving market conditions. Nevertheless, despite widespread expectations for rate reductions in other major economies, the Bank of England chose to hold its interest rate at 5.0%, citing concerns around renewed inflationary pressures, particularly in the services sector. This stance diverged from actions taken by the U.S. Federal Reserve and the European Central Bank and contributed to weaker equity market performance. While China’s substantial stimulus measures provided a boost to U.K. companies engaged in international trade, overall market gains were tempered by persistent weaknesses in consumer spending and business confidence. The Composite model is neutral, with negative earnings revision, trend, and credit spread indicators. We are slightly underweight.
Figure 15: Earnings revisions have reversed lower. Urges caution.
Emerging Market Positions
ApproximatelApproximately 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
Poland
Italy
New Zealand
Explore: Emerging Market Commentary
Four of the five emerging markets are supported by favorable price trends, with 50-day moving averages trading above the 200-day moving averages. The lone exception is Poland. All show rising 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 (+13.8%), Taiwan (+20.7%), Poland (+8.8%), Italy (+3.5%), and New Zealand (+19.0%). (All data based on MSCI constituent holdings.)
Forward P/Es are as follows: India (24.8x), Taiwan (17.0x), Poland (7.7x), Italy (8.7x), and New Zealand (32.9x).
Four of the five countries are supported by increasing forward earnings estimates (ex-India).
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 1.88x.
All five countries are oversold on a short-term (21-day) basis. Such oversold conditions may provide a near-term bounce opportunity.
From a qualitative perspective, the following external factors also contribute to each country’s positive outlook:
1.) Technology and Semiconductor Demand (Taiwan, India, Italy)
Taiwan: Taiwan is one of the world’s largest producers of semiconductors, with companies like TSMC playing a critical role in global supply chains. The demand for semiconductors in everything from consumer electronics to electric vehicles has strongly supported the Taiwanese stock market.
India: India’s growing tech sector, especially in software services, fintech, and digitalization, has attracted significant investment. Strong IT and digital services sector growth has bolstered India’s equity market.
Italy: Italy has a growing tech and innovation sector, especially in industrial automation and robotics. Though not as tech-heavy as Taiwan, sectors tied to tech demand have helped boost parts of the Italian market.
2.) Domestic Economic Growth and Recovery
India: India has seen strong economic growth, driven by domestic consumption, reforms, and government spending on infrastructure. Structural reforms like GST, production-linked incentives (PLIs), and investment in renewable energy are also attracting foreign investment into Indian markets.
Poland: Poland has benefited from being a key part of the European Union’s value chain, particularly in manufacturing and services. Strong domestic demand and government programs to boost employment and spending have supported Poland’s stock market.
Italy: Italy’s recovery from COVID-19, supported by EU funds, has boosted economic growth. The European Union’s Next Generation EU program has funneled investment into Italy’s infrastructure, renewable energy, and digitalization efforts, which are positively impacting the stock market.
New Zealand: While more dependent on global trade, New Zealand’s economic resilience, underpinned by a strong agricultural sector and tech innovations, has contributed to a positive outlook for its stock market.
3.) Commodities and Energy Prices (New Zealand, Poland, Italy)
New Zealand: As a major exporter of agricultural goods like dairy, meat, and wine, New Zealand’s stock market benefits from favorable global commodity prices. Rising food demand and inflation have been supportive.
Poland and Italy: While both countries are net energy importers, their industrial sectors benefit when commodity prices stabilize or decline. Additionally, Poland’s role as a regional energy hub (with initiatives to diversify energy sources) has helped certain sectors.
4.) Foreign Direct Investment (FDI) and Global Supply Chain Realignment
India and Poland: These countries have benefited from FDI, especially as global companies seek to diversify supply chains away from China ("China plus one" strategy). India’s large market and Poland’s central position in Europe attract significant investment in manufacturing, logistics, and technology sectors, bolstering stock prices.
Taiwan: Taiwan’s strong integration in global technology supply chains, especially in the semiconductor industry, attracts foreign investment and supports its stock market.
Italy: Italy benefits from European foreign investment as part of larger EU industrial and innovation strategies. European funds post-COVID are directed towards creating industrial growth hubs in Southern Europe, benefiting Italian equities.
5.) Central Bank Policies and Currency Stability
New Zealand: The Reserve Bank of New Zealand has maintained a cautious stance, balancing inflation concerns with economic growth. Due to effective monetary policy, currency stability is seen as a positive factor for investor confidence in New Zealand’s stock market.
India: The Reserve Bank of India (RBI) has proactively controlled inflation and maintained adequate liquidity. Domestic and foreign investors view this stability in monetary policy favorably, contributing to positive stock market trends.
Taiwan: The Central Bank of Taiwan has kept a stable policy environment, promoting economic growth while keeping inflation in check. Taiwan’s currency stability is also a positive factor for foreign investors.
Poland: The National Bank of Poland has managed inflationary pressures well while maintaining economic growth and supporting the stock market. Currency strength (the Polish zloty) also helps attract foreign investment.
6.) Inflation and Consumption Trends
India: Moderate inflation and rising disposable incomes in India have driven robust domestic consumption, especially in sectors like consumer goods, financials, and infrastructure. This consumption boom is reflected in the stock market.
Poland: Poland’s inflation has been manageable, with consumer demand supported by government programs and wage growth, driving performance in retail, real estate, and financial sectors.
New Zealand: While inflation is a concern, New Zealand’s resilient domestic economy, especially strong retail and housing sectors, continues to support market optimism
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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