Day Hagan Smart Sector® with Catastrophic Stop Strategy Update May 2025
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Day Hagan Smart Sector® with Catastrophic Stop Strategy Update May 2025 (pdf)
Executive Summary
In last month’s letter, we concluded, “In summary, the market’s trajectory remains largely influenced by trade tensions, mixed economic indicators, and shifting investor sentiment. While some analysts express optimism regarding potential economic boosts from deregulation and tax policies, the current climate of uncertainty poses significant risks for market stability and growth.”
That proved to be the case for April, as the U.S. stock market experienced significant volatility and a broad decline, primarily driven by a combination of policy shifts, economic indicators, and global trade dynamics. The S&P 500 entered correction territory with a decline of over 10% from its February peak, and small-cap stocks approached bear market levels.
Yet, despite the uncertainty, volatility, angst, and pessimism, the S&P 500 was down less than 1%, and the NASDAQ was up for the month. The Catastrophic Stop model remained favorably invested during this historically volatile period and didn’t move to cash at an inopportune time, recognizing that he operating environment for equities remained constructive.
In April, the U.S. stock market faced significant turbulence, driven by trade policy shocks, economic slowdown, and persistent inflation, leading to a mid-month correction in the S&P 500 and a near bear market for small-cap stocks. The primary catalyst was President Donald Trump’s April 2 announcement of sweeping tariffs, including a 10% blanket tariff on all nations (exempting Mexico and Canada) and 145% tariffs on Chinese imports, prompting China’s retaliatory 125% tariffs on U.S. goods. This triggered a sharp sell-off, with the S&P 500 dropping 10% in two days and 17% from its February peak, while global markets followed suit.
A brief reprieve came on April 9 when Trump paused most tariffs for 90 days, sparking a nearly 10% rally from the April 8 low, but uncertainty over U.S.-China trade talks sustained volatility. The economy contracted by 0.3% in Q1 2025, driven by a 41.3% import surge as firms stockpiled goods pre-tariffs, marking the first decline since 2022 and fueling recession fears. Consumer confidence plummeted, with surveys showing heightened concerns over rising prices, though labor markets held steady at 4.2% unemployment and 177,000 new jobs.
Inflation remained sticky at a projected 2.3% PCE for March 2025, above the Federal Reserve’s 2% target, but heading in the right direction. The Fed held rates at 4.25%-4.50% in March, forecasting just two 25-basis-point cuts for 2025, down from three, while lowering growth projections to 1.7% and raising unemployment estimates to 4.4%. However, as the market declined, rate cut hopes soared, and now markets are pricing in around four 25 bps cuts over the next year.
Nonetheless, high borrowing rates pressured small-cap firms reliant on debt, and the Fed’s cautious stance dampened investor hopes for relief, hitting growth sectors. Corporate earnings showed resilience, with S&P 500 Q1 growth at 6.1% and 74% of firms beating estimates, but tariff-related cost pressures threatened margins. Market breadth weakened, with over 95% of S&P 500 stocks in the red on April 21, and high valuations raised correction fears if earnings faltered.
Sector performance varied sharply. Technology and consumer discretionary, including giants like Apple, Amazon, Tesla, and Nvidia, suffered from tariff-driven supply chain disruptions and cost hikes, with Tesla and Nvidia dropping 6.8% and over 4% on April 21. Small-caps, tracked by the Russell 2000, entered bear market territory, down 20%, due to high borrowing costs and tariff sensitivity. Consumer staples was the only sector with positive year-to-date returns by April 4, reflecting its defensive appeal, though rising prices posed risks. Industrials and manufacturing faced supply chain strains but held potential for domestic revival if tariffs spurred local production. Financials and healthcare showed mixed results. Retail struggled with tariff-induced price hikes, particularly in electronics and home goods, though firms like BJ’s Wholesale saw some relief.
Market sentiment turned extremely pessimistic, with the S&P 500’s rapid 22-day correction from its February peak outpacing historical averages. Investor concerns surged, with 36% of Americans worried about the market, up from 24% in September 2024. Geopolitical tensions, including the Russia-Ukraine war and a 45% drop in U.S.-China cargo shipments, added pressure, while Trump’s $4.5 trillion tax cuts and deregulation raised both inflation fears and hopes for corporate gains. Despite the downturn, opportunities emerged as the equity market became deeply oversold and most sectors subsequently rallied. Information Technology, Consumer Staples, Communication Services, Industrials, and Utilities were up for the month. Energy was the worst-performing sector, down 13.73% as oil prices dropped due to fears of a slowing economic backdrop dampening demand, OPEC+ announcing production increases, and tariff concerns.
Turning to our primary equity risk model, the Catastrophic Stop, the model’s level has risen to 63.64% as of Friday, May 2 (where 0 represents the worst conditions and 100 represents the best). Our breadth thrust composite is bullish, and the extreme oversold mean reversion factor also moved to a buy. Despite this, sentiment remains pessimistic (positive from a contrary opinion perspective). Additionally, volume demand has increased, bond breadth has expanded, and our economic activity indicator is currently positive. The net result is that investors should maintain their equity benchmark exposure.
Holdings
Sector
Consumer Discretionary
Consumer Staples
Communication Services
Energy
Financials
Health Care
Industrials
Information Technology
Materials
Real Estate
Utilities
Outlook (relative to benchmark weighting)
Neutral
Neutral
Overweight
Neutral
Underweight
Underweight
Neutral
Neutral
Neutral
Neutral
Overweight
Sector Review
Consumer Discretionary: After a mid-month decline, the Consumer Discretionary composite model improved back to neutral by the end of April. Measures of trend, mean reversion, momentum, new highs, and relative forward P/E are positive. However, overbought/oversold indicators are overbought in the near term, and the rate of change for total consumer credit owned and securitized is negative. We remain neutral.
Commentary: President Trump’s April 2 tariff announcements, imposing a 10% universal tariff and a 145% tariff on Chinese imports, sparked fears of rising costs and reduced consumer spending. This led to a sector sell-off, with companies like Amazon and Tesla, major index constituents, dropping significantly—Amazon due to tariff-related Prime Day disruptions and Tesla by 6.8%. Earnings reports showed mixed results: while 73% of S&P 500 firms beat EPS estimates, consumer discretionary reported negative revenue surprises, contributing to a sector P/E ratio of 27.77, signaling high valuations. Harley-Davidson withdrew its 2025 outlook amid tariff uncertainties, reflecting broader sector concerns. Declining consumer confidence and potential recession risks further pressured the sector, despite some resilience from homebuilding stocks anticipating lower rates.
Figure 1: Consumer Discretionary reversing from oversold levels.
Consumer Staples: The composite model remains neutral. Measures of short-term trend, overbought/oversold, net new highs, financial conditions, food sales, short interest, and the G10 Economic Surprise Index (weaker = investors become more defensive) are positive. Short-term momentum, 45-day relative breadth, and pricing power (the CPI for food) are weaker.
Commentary: The S&P 500 Consumer Staples sector demonstrated resilience amid market volatility, bolstered by its defensive nature. President Trump’s tariffs, including a 10% universal import tax, increased costs for packaged goods firms, squeezing margins for companies like Kraft Heinz, which reported a 2% revenue drop due to higher input prices. Despite this, 71% of sector firms surpassed Q1 EPS forecasts, though earnings growth lagged the S&P 500’s 7.2%, with a P/E ratio of 23.77 signaling fair valuations. Procter & Gamble’s stable demand for household products drove a 3% organic sales increase, reinforcing sector stability. Consumer preference for value-oriented retailers like Dollar General grew, but rising commodity prices challenged food producers. The sector’s defensive appeal attracted investors amid economic uncertainty, though cost inflation remained a key risk.
Figure 2: Approaching overbought levels.
Communication Services: The composite model improved, and we are overweight. The sector is in the process of reversing from major oversold levels, lower rates are positive for the many debt-heavy companies within the sector, trend indicators are directionally higher, and relative valuations have improved.
Commentary: The potential for tariffs disrupted advertising budgets, impacting digital media firms reliant on ad revenue. Alphabet and Meta reported robust Q1 earnings, with Alphabet’s ad revenue up 13% and Meta’s AI-driven ad efficiency boosting sales 20%. However, valuations improved with a sector P/E ratio of 20.66, now in line with the overall market. Telecom firms like AT&T shone, adding 324,000 postpaid phone subscribers, surpassing estimates, and boosting shares with a planned Q2 share repurchase. However, streaming giant Netflix issued cautious Q2 guidance despite beating Q1 earnings, citing tariff-related consumer spending concerns. Regulatory uncertainty under the new administration and softening ad demand posed risks, though AI advancements offered long-term growth potential.
Figure 3: Communication Services sector exiting extreme oversold conditions.
Energy: The composite model deteriorated by the end of April. Relative strength has weakened, volatility is elevated, breadth is narrow, trend indicators are still negative, cash flow growth has stalled, and inventory levels haven’t yet shown signs of reversing from recent lows. We are aware that OPEC+ is likely to increase production, and that is now priced in as it is widely known. If OPEC+ does reduce the expected supply increases (likely surprising investors), the sector is poised to move higher. We will look for our trend indicators to signal that it is time to increase exposure. We are now neutral but looking for an opportunity to increase.
Commentary: A sharp drop in oil prices, with West Texas Intermediate falling 6.6% to $66.95 after OPEC+ announced increased production, pressured revenues for exploration and production firms. ExxonMobil and Chevron, reporting Q1 earnings on May 2, posted a combined 14.2% year-over-year earnings decline, attributed to lower oil prices ($71.38 vs. $76.91 in Q1 2024). Refining margins collapsed, with the Oil & Gas Refining & Marketing sub-industry reporting a significant earnings drop, exacerbating sector weakness. Natural gas producers, like APA, which fell 26%, struggled with oversupply and weak pricing despite earlier LNG export strength. Policy shifts, including Trump’s coal-friendly executive orders, offered limited immediate relief. The sector’s forward P/E ratio of 17.12 suggested overvaluation, contributing to its 14.5% monthly loss. There are still demand opportunities available from AI-driven power demand, and dividend yields are relatively attractive.
Figure 4: Relative strength trends for the Energy sector have tended to persist. A reversal in the indicator below, confirmed by the composite model, would increase the probability of a longer-term uptrend.
Financials: The composite model declined during April, and we are now slightly underweight. From a technical perspective, measures of trend, overbought/oversold, momentum, and volatility are mixed. The generally weaker U.S. dollar, the Citi Economic Surprise Index below 0%, the widening of credit spreads, weaker loan growth, and neutral valuations are headwinds.
Commentary: A wider yield curve bolstered net interest margins for banks, but tariff-driven economic uncertainty tempered gains. FactSet reported Q1 2025 earnings growth of 2.3%, with Consumer Finance leading at 23% growth, driven by Discover Financial Services’ EPS of $3.37, up from $1.10. Capital Markets grew 10%, with Goldman Sachs beating estimates. However, the Insurance industry lagged, declining 11%, with Reinsurance and Property & Casualty dropping 50% and 30%, respectively, due to elevated claim costs. JPMorgan Chase reported a 3% revenue increase, supported by strong loan demand. The sector’s forward P/E ratio of 17.43 reflected moderate valuations. Deregulation optimism under the Trump administration supported sentiment, but tariff-related volatility and potential credit risks offset the optimism. We are closely watching the lower-income segments increasing stress for signs that it is impacting middle and higher-income segments.
Figure 5: The Financials sector is facing a slowing economic regime.
Hmomentum, breadth, health care new construction, and health care personal expenditures are negative. Valuations and earnings breadth trends are positive. Entering May, we are modestly underweight.
Commentary: The Health Care sector faced unique pressures despite its defensive appeal. Tariff-induced cost increases for medical equipment and pharmaceuticals disrupted supply chains, impacting firms like GE HealthCare, which cut 2025 guidance despite strong Q1 sales. FactSet reported Q1 earnings growth of 10.2%, with 75% of companies beating EPS estimates, led by Eli Lilly’s 15% revenue rise from diabetes drug demand. However, UnitedHealth Group’s stock plummeted 20% after reporting elevated Medicare Advantage costs, dragging down insurers with a sector-wide ripple effect. The sector’s P/E ratio of 30.42, well above the 20-year average of 17.48, raised overvaluation concerns. Innovation persisted, with Pfizer advancing a Phase 3 trial for sasanlimab, but regulatory uncertainty under the Trump administration and softening elective procedure demand posed risks, tempering sector optimism.
Figure 6: New construction trends for healthcare facilities have decreased since 2022. Indicates a deterioration in CEO optimism.
IndusIndustrials: The composite model’s level remained neutral at the end of April. Indicators are mixed, with technical measures of price momentum, volatility, and RSI levels positive, along with industrial production and the CRB Index trends. Valuations, oil price trends, and consumer confidence are headwinds.
Commentary: Tariffs increased costs for raw materials like steel, impacting manufacturers such as Caterpillar, which reported a 4% Q1 revenue decline due to higher input prices. FactSet noted the sector as the only one with a year-over-year revenue drop, down 2.1%, with Q1 earnings falling 11%. Boeing’s earnings disappointed, with a 7% revenue miss, driven by supply chain disruptions and reduced 737 deliveries. Aerospace and defense firms like Lockheed Martin saw stable demand, but construction equipment demand weakened amid economic uncertainty.
Figure 7: Short-term momentum measures are starting to appear stretched. We need to see intermediate-term indicators confirm for an overweight rating.
Information Technology: The composite model is neutral as we enter May. The outlook is illustrated by the short-term OBOS indicators turning positive while the intermediate-term remains negative. Valuations are a bit better, short-interest has increased, and earnings revisions are trending higher. Higher inflation expectations are a headwind. We are neutral.
Commentary: President Trump’s implementation of new tariffs, particularly affecting technology imports, intensified supply chain disruptions and increased operational costs for firms heavily reliant on Chinese manufacturing. Apple, for instance, reported a substantial decline in iPhone sales, attributing it to both tariff impacts and waning consumer demand in key markets. Similarly, Nvidia disclosed a $5.5 billion charge related to export restrictions, highlighting the sector’s vulnerability to geopolitical developments. Despite these setbacks, some companies like Microsoft and Meta Platforms managed to exceed earnings expectations, driven by their diversified business models and investments in cloud computing and artificial intelligence. However, the overall sector’s performance was dampened by the underwhelming results from other tech giants, leading to a cautious outlook.
Figure 8: Increasing short interest levels are bullish supports.
Materials: The Materials sector is neutral. Technical indicators are mixed, with measures of short-term trend, relative price momentum, and net new highs positive, while intermediate-term measures are subdued. Earnings remain under pressure, and valuations relative to earnings growth expectations aren’t inexpensive. The sector is also reversing from recent overbought levels.
Commentary: Tariffs escalated costs for raw materials like aluminum and chemicals, impacting producers such as Dow, which reported a Q1 EPS of $0.56, missing estimates by 15% due to higher input costs. FactSet noted a Q1 earnings decline of 8.7%, with revenues down 3.2% year-over-year, reflecting weakened global demand. Freeport-McMoRan’s Q1 copper sales fell 6%, driven by tariff-related trade disruptions, contributing to a sector P/E ratio of 24.11, above its 20-year average of 18.22. Packaging firm Amcor cited reduced demand for consumer goods packaging, reporting a 4% revenue drop. China’s economic stimulus, including relaxed homebuying rules, offered some hope for metals demand, but U.S. manufacturing slowdowns constrained growth. Despite long-term optimism for copper and lithium due to electrification trends, near-term tariff pressures and oversupply risks led to a monthly price decline.
Figure 9: The recent uptick in gold prices is a positive support for the materials sector.
Real Estate: The composite model declined with the May update due to relative breadth deteriorating, weakness in the homebuilding industry, weaker business credit conditions, and the Citigroup Economic Surprise Index below 0%. We remain neutral.
Commentary: With the federal funds rate steady at 4.25%-4.50%, increased borrowing costs for real estate investment trusts (REITs) continue to compress yields. Prologis, a leading industrial REIT, posted a drop in core funds from operations (FFO), citing reduced warehouse demand amid tariff-related trade slowdowns. Simon Property Group outperformed, reporting an FFO increase, fueled by strong retail leasing. Declining commercial property values, particularly in office spaces, pressured firms like Boston Properties, which fell after reporting higher vacancies. Trump’s deregulation promises sparked optimism for streamlined development, but near-term challenges from elevated rates and a 0.3% Q1 GDP contraction led to a 1.34% decline in April.
Figure 10: Tighter business credit conditions are a headwind for real estate.
Utilities: The sector increased slightly in April due to its defensive characteristics. Technical measures of trend, OBOS, and relative breadth are positive and confirm the trend. However, we are monitoring indicators calling OBOS, and while still positive, are nearing levels where the indicators have historically peaked and reversed. If this occurs, we will likely reduce exposure in line with any model deterioration. We do note that the dividend yield remains attractive. We remain overweight relative to the benchmark.
Commentary: Elevated electricity demand fueled by data center growth and supported revenue, but President Trump’s executive orders pausing wind turbine leasing and promoting coal mining disrupted renewable energy projects, impacting firms like NextEra Energy, which reported a Q1 EPS drop. FactSet noted a Q1 earnings growth of 8.5%, with 81% of companies beating estimates, led by Vistra Corp.’s 12% FFO increase from nuclear portfolio strength. However, rising wholesale power prices, up 2.7% year-to-date, and tariff-related equipment cost hikes pressured margins for Dominion Energy, down after reporting higher transmission costs. Deregulation optimism and nuclear investment incentives offered long-term potential, but near-term renewable policy uncertainty and capital expenditure strains contributed to a 0.6% April return.
Figure 11: The 50-day relative breadth oscillator is oversold.
Catastrophic Stop Update
The Catastrophic Stop model combines time-tested, objective indicators designed to identify high-risk periods for the equity market. The model entered May recommending a fully invested equity allocation relative to the benchmark.
Breadth Thrust and Oversold Mean Reversion indicators have recently provided bullish signals, along with supportive measures of Investor Sentiment, A/D line trends, Volume-adjusted Demand, Economic Activity indicators, and improving High-yield Bond Breadth.
The weight of the evidence suggests that the recent decline is not expected to extend into a significant downtrend. Of course, if our model flips negative (below 40% for two consecutive days), signaling more substantial problems, we will raise cash immediately.
The Day Hagan Daily Market Sentiment Composite (below) has recently moved into the neutral zone from levels denoting excessive pessimism. If the composite moves above 70 and reverses, it would be considered a headwind for stocks. Currently, the trend is your friend.
Figure 12: S&P 500 Index vs. Day Hagan Daily Market Sentiment Composite
Lastly, we are pleased to announce that our collaboration with 3Fourteen Research has reached a milestone. We have been working with their strategists and data scientists for over a year to take the lead in modeling our Smart Sector and Global Macro strategies. With the May 1st rebalance, we have fully incorporated their research into our allocations. Their support has been instrumental in enhancing our research, developing essential indicators, and maintaining our existing indicators and investment models. 3Fourteen Research is headed by Warren Pies (Co-founder and Strategist) and Fernando Vidal (Co-founder and Chief Data Scientist), both of whom were instrumental in developing major models and indicators at Ned Davis Research. Warren Pies is a frequent guest on CNBC. Gary Sarkissian (Senior Research Analyst), CFA, also formerly of Ned Davis Research, created and maintained NDR’s U.S. sector ranking model and developed numerous proprietary tools and studies for the firm’s institutional strategy. 3Fourteen provides a team of experienced analysts, data scientists, and developers whose expertise includes machine learning, time series analysis, and application development.
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. Currently, the uptrend remains intact. As has been the case for all of 2024, the broader-based composite models calling U.S. economic growth, international economic growth, inflation trends, liquidity, and equity demand remain constructive. The Catastrophic Stop model is positive, and we are aligned with the message. If our models shift to bearish levels, we will raise cash.
This strategy uses 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:
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With Catastrophic Stop ETF
Symbol: SSUS
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