Day Hagan Smart Value Strategy Update June 2025
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Summary
The DH Smart Value Portfolio continues to invest in companies producing excess returns through positive economic profitability, supported by solid balance sheets (quality), significant cash generation (profitability), and trading with considerable margins of safety (valuation). We believe these factors will continue to provide rational opportunities for the foreseeable future.
Strategy Update
During May, U.S. equity markets were buffeted by a complex array of economic, policy, and global factors. Most importantly, trade policy uncertainty had a profound impact, with the steep tariffs announced by the White House in April, followed by a partial delay, creating significant volatility. The S&P 500 gained 6.15% in May but ended the month nearly flat for the year-to-date period at 0.51%. The Russell 1000 Value index was up 3.5% in May, while fixed income, based on the Core U.S. Aggregate Bond Index, was down 0.6%. Tariffs, including a 10% base rate on imports and higher rates for countries like China (34%) and the EU (20%), disrupted supply chains and heightened inflation fears, weighing on investor confidence. Yet, the markets were able to look past the disruptions and seemingly focus on corporate profitability and better economic results based on recently released reports.
The only sector with a negative return in May was Health Care (down -5.7% and underweighted in our portfolio). Growth-focused sectors like Information Technology, Communication Services, and Consumer Discretionary led the pack (+10.8%, +9.6%, +9.4%, respectively). The Industrial sector was fourth best, up 8.6%, in response to improving economic expectations.
Clearly, inflation pressures persisted, with annualized core inflation for April at 2.8%, above the Federal Reserve’s 2% target. This was viewed by many investors as potentially constraining monetary policy flexibility. However, with commodity prices still soft and economic activity slowing in China, the eurozone, and the U.S., we continue to view inflation as moderating and “heading in the right direction.”
Federal Reserve actions (or lack thereof) also played a critical role, as market expectations for rate cuts in 2025 fell to under 40 basis points from the overly optimistic 125 back in September 2024. The shift reflected concerns about persistent inflation but also resulted from improved economic data. In fact, the Atlanta Fed GDPNow model now estimates 4.6% real GDP growth for the second quarter (data as of June 2). As we’ve detailed in previous updates, as long as economic growth remains positive, most companies can find a way to continue growing profits.
It’s important to keep in mind that several FOMC members have been very active on the speaking circuits, reiterating their commitment to supporting full employment and stable prices. We note that with the effective Fed Funds rate above 4.25% and the Fed’s balance sheet having been reduced by over $2.276 trillion since the peak in April 2022, they may be creating room for potential quantitative easing (QE) should conditions warrant. We think this is an underappreciated factor that may gain traction should economic reports revert back to a “soft landing” scenario. The old market adage “Don’t Fight the Fed” continues to ring true.
Fiscal policy changes, including proposed tax cuts and deregulation under the new U.S. administration, fueled optimism but raised concerns about rising deficits, unsettling markets sensitive to debt sustainability. Sector-specific dynamics saw technology, financials, and industrials thrive, while health care and real estate struggled under high interest rates and tariff-driven cost increases.
Corporate earnings growth was “good enough” to bolster equities, with S&P 500 earnings achieving mid- to high-single-digit growth, driven by sectors such as technology and AI. Strong Q1 2025 performances from companies like NVIDIA, driven by demand for AI chips, supported investor optimism despite concerns related to tariffs. AI and technological innovation fueled outperformance in the technology sector, though worries about slowing capital expenditures by firms like Meta and Microsoft introduced risks.
Valuation concerns lingered, as U.S. equities traded near a 20-year high, capping forward returns unless earnings growth exceeded forecasts. Based on 2026 forecasts, the S&P 500 Forward P/E is still a lofty 20.0x. Sector Forward P/Es based on 2026 estimates range from 13.2x for Energy to 25.6x for Consumer Discretionary (the Real Estate sector’s Forward P/E is 34.4x, but the sector trades more around funds from operations [FFO] than earnings). Operating earnings growth for 2026 is expected to be 13.1%, ranging from 6.4% for Health Care to 19.1% for Energy and 16.1% for the Information Technology sector. Our view is that if earnings growth does approach the 13.1% aggregate forecast, equities can continue higher, even in the face of elevated valuations, absent a major shock.
Interestingly, the S&P/Citigroup Growth Index 2026 P/E forecast is 24.6x versus the S&P/Citigroup Value 2026 P/E of 16.6x. One might conclude that earnings growth expectations are the differentiator; however, the 2026 operating earnings growth forecast for the Growth index is 14.2%, compared to 12.3% for the Value index. For perspective, the median 2025 Forward P/E for the portfolio is 16x.
Global economic fragmentation added uncertainty, as U.S. protectionism triggered retaliatory measures from the EU and others, impacting multinational corporations. U.S. economic growth remained resilient, with a projected 2% GDP for 2025, although a 0.2% contraction in Q1, driven by tariff-related import surges and reduced government spending, tempered optimism. Labor market strength, with unemployment steady at 4.2% and 177,000 jobs added in April, supported consumer spending but contributed to wage-driven inflation pressures.
Market volatility was amplified by policy announcements and social media-driven reactions, with the S&P 500’s April selloff followed by a May recovery highlighting its sensitivity to short-term developments. Investors navigated this environment by focusing on quality stocks with strong balance sheets and capitalizing on AI-driven sector opportunities to manage risks.
The portfolio comprises 38 positions, including major names like Comcast (CMCSA), Alphabet (GOOGL), Meta (META), Amazon (AMZN), Chevron (CVX), PepsiCo (PEP), JPMorgan Chase (JPM), and smaller or sector-specific firms like Lululemon (LULU), Ulta Beauty (ULTA), and Zoom (ZM).
The portfolio is diversified across sectors but leans toward a larger-cap, earnings (cash flow) growth-oriented bias. Tech giants (GOOGL, AMZN, META) and financials (JPM, GS, BK) provide quality exposure to technology and financial services, while consumer staples (PEP, KMI), energy (CTRA, CVX, OGE), and healthcare (MRK) provide some defensive balance. Retail (LULU, ULTA) and discretionary stocks (SBUX) add cyclical exposure. The presence of smaller or niche players, such as Zoom (ZM) and SEI Investments (SEIC), indicates a mix of mid-cap and speculative growth elements.
The portfolio leans toward quality and scale, with many S&P 500 constituents (e.g., AMZN, JPM, CVX) driving stability, but retail and discretionary stocks introduce cyclical sensitivity. Tech-heavy weighting aligns with AI and innovation trends, as seen in May 2025’s market, where tech outperformed (e.g., NVIDIA’s Q1 strength). However, the portfolio’s diversity mitigates some concentration risk compared to a pure tech-focused basket.
We view the following macro sensitivities as keys to the portfolio’s success:
Trade Policy and Tariffs: The tariffs implemented in May 2025 (a 10% base rate, 34% on China, and 20% on the EU) had a significant impact on tech and retail. AMZN and META, reliant on global supply chains, faced cost pressures, while ULTA and LULU saw margin risks from imported goods. Energy firms like CVX benefited from a tariff-driven domestic focus but faced uncertainty in global demand. As tariff uncertainty continues to recede, our holdings are expected to benefit.
Interest Rates and Inflation: With core inflation at 2.8% (on a longer-term downward trajectory) and the Fed’s rate cuts limited to 40 basis points for 2025, high interest rates (U.S. 10-year at 4.40%) have pressured growth stocks like AMZN and ZM, which rely on low rates for valuation expansion. Financials (JPM, GS) benefited from higher yields but faced risks if economic growth slowed. We also view interest rates as elevated, expecting some reversion lower. This, too, would be a tailwind for the portfolio.
Consumer Spending Trends: Cyclical stocks (SBUX, LULU) were sensitive to consumer confidence, which held steady with a 4.2% unemployment rate and 177,000 jobs added in April 2025. However, inflation eroded purchasing power, impacting discretionary spending and pressuring retail stocks. We continue to focus on industry leaders and expect SBUX and LULU to react positively as U.S./China trade policy normalizes.
Energy and Commodity Prices: Energy stocks (CVX, NRG) were influenced by oil price volatility amid geopolitical tensions and tariff-driven trade shifts. A stronger U.S. focus benefited domestic producers, but global fragmentation posed risks. With OPEC+ focused on increasing production levels, we will look for a valuation trough before adding exposure.
Market Sentiment and Tech Momentum: The portfolio’s tech exposure (GOOGL, META) aligned with AI-driven gains but was vulnerable to capex slowdowns (e.g., Meta’s AI spending concerns).
This portfolio balances growth (tech, financials) with stability (staples, energy), but its tech and cyclical tilt makes it sensitive to tariffs, interest rates, and consumer spending shifts. Defensive holdings can mitigate some volatility, but monitoring Fed policy and trade developments remains key.
On May 22, we sold Franklin Resources (BEN) and Masco Corporation (MAS). Franklin Resources failed to meet expectations for enhancing shareholder value through its acquisitions of Putnam Investments in 2023 and Legg Mason in 2020, as these transactions have yet to yield the anticipated synergies or growth. Continued net outflows have exerted pressure on assets under management, diminishing shareholder returns and exposing operational challenges in retaining client assets. Given these factors and the prevailing macroeconomic uncertainties, we exited our position to mitigate downside risk and reallocate capital more effectively.
Masco Corporation (MAS) remains a key player in the home improvement and building products sector, bolstered by strong brands such as Behr Paint, Delta Faucets, and HotSpring Spas. However, persistently high mortgage rates and elevated home prices have significantly dampened housing affordability, curbing home purchases and increasing inventory levels. This has negatively impacted the demand for home improvement products, prompting us to divest our position in Masco as its current valuation does not adequately reflect these macroeconomic challenges.
Turning to equity sectors for a moment, our largest sector allocations are Financials, Information Technology, Communication Services, and Consumer Staples. Our target weightings versus the Russell 1000 Value Index are as follows: Information Technology 17.5% vs. 9.2% benchmark, Healthcare 1.1% vs. 13.1%, Financials 14.4% vs. 23.5%, Consumer Discretionary 6.3% vs. 5.9%, Communication Services 13.8% vs. 4.5%, Industrials 4.6% vs. 15.3%, Consumer Staples 8.0% vs. 8.3%, Energy 5.5% vs. 6.3%, Utilities 4.8% vs. 4.8%, Materials 4.1% vs. 4.2% and Real Estate 6.1% vs. 4.6%.
The Smart Value portfolio strategy utilizes measures of economic profitability, balance sheet sustainability, cash flow generation, valuation, economic trends, monetary liquidity, and market sentiment to make objective and rational decisions about how much capital to put at risk and where to allocate that capital.
Please let us know if you want to discuss the portfolio in more detail or learn more about our approach.
Sincerely,
Donald L. Hagan, CFA®
Regan Teague, CFA®, CFP®
Disclosure: The aforementioned positions may change at any time.
Disclosure: *Note that individuals’ percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. Returns are based on a representative account. The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, any of its affiliates or employees, or any third-party data provider shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. Day Hagan Asset Management accounts that Day Hagan Asset Management or its affiliated companies manage, or their respective shareholders, directors, officers, and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
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