Day Hagan Smart Value Strategy Update October 2024
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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. Using our consistent and differentiated investment approach, the DH Smart Value Portfolio is focused on outperformance, seeking higher total returns with lower volatility.
Strategy Update
During September, the S&P 500 and Nasdaq gained 2.1% and 2.8%, respectively. Developed market equities rose by 1.9% (MSCI EAFE), while emerging market equities rose by 6.7%, driven by a larger-than-expected stimulus from Beijing that caused Chinese equities to increase 23.9% in the month. Global equities (MSCI ACWI index) gained 2.4%, while fixed income (U.S. Treasuries) also rose by approximately 1.4%. Small-caps were up just 0.7%.
In September, the U.S. markets (S&P 500) started the month with a 4.1% decline due to concerns about weaker economic growth triggered by a softer-than-expected August employment report and a contraction in ISM manufacturing. However, equities recovered as the month progressed, with the Fed implementing a larger-than-expected 50bps cut and a softer-than-expected unemployment claims report supporting expectations for additional easing. Moreover, China’s broader-than-expected stimulus announcements provided a late-month boost.
Although U.S. data releases aligned with our expectations of a “soft landing,” European markets were less optimistic. Euro-area flash PMIs (purchasing manager indexes) fell into contraction territory, and inflation in several euro-area economies came in lower than expected. As we’ve noted in past Updates, the worst economic and inflation regime scenarios typically involve weakening economic growth with declining inflation, indicating a contracting economy and a weak pricing environment.
The good news is that our models continue to support a bullish economic growth environment with a neutral inflation-pressure outlook for the U.S.
In Asia, the Bank of Japan stayed on hold, but concerns increased about a hawkish tilt in policies following the election of a new prime minister. The “hold” was welcome news, as the BoJ’s decision to raise rates earlier this year was met with significant selling of U.S. equities and fixed income as the Japanese “carry trade” was partially unwound. Japanese equities (Nikkei), the Stoxx 600, and the FTSE 100 all had negative monthly returns. In China, recent economic activity and inflation reports were offset by a late-month announcement of broader-than-expected rate cuts and an easing of mortgage restrictions, leading to the aforementioned monster rally in Chinese equities.
Ending September, and based on the August U.S. employment report, Fed Funds Futures analysis indicated that investors expected another 100-basis points reduction in policy rates by year-end. November FOMC expectations now lean towards a 25-basis points ease or holding.
The third quarter earnings season is upon us, and current estimates are that the S&P 500’s year-over-year earnings growth is healthy at +7.8%. This is crucial because the overall market’s valuation is historically expensive, with the forward P/E currently standing at 21.4x, compared to the 10-year average of 18.0x. While index valuations remain elevated, we continue to focus on companies generating significant cash at a fair price. For example, the median forward P/E for our portfolio is 15.9x.
FactSet has reported that almost 50% of the companies in the S&P 500 that are set to release their earnings over the next two weeks are from the financial sector. We are particularly interested in the upcoming earnings reports from the financial companies in our portfolio, as we will be monitoring them to see if the positive trends from the last earnings updates remain intact.
Bank of New York Mellon (BK): BNY’s recent financial performance has been impressive, with solid earnings per share growth of 16% year-over-year and a net income of $1,168 million for the quarter ending June 30, 2024, showing a growth of 8.96%. The company also demonstrated resilience through its strong balance sheet and robust regulatory capital and liquidity ratios. BNY’s strategic growth was further evidenced by being awarded a significant mandate by a premier global asset manager and receiving recognition for its wealth advisory platform, Wove, as one of the top three global financial innovations by Global Finance. Additionally, the company’s ability to attract top talent was showcased through its largest-ever intern and analyst classes, along with new leadership appointments. Lastly, two weeks ago, it was announced that the SEC had approved BK for crypto custody beyond ETFs, which provides a first-to-market advantage. The forward P/E is 11.5x, with solid 3-year free cash flow growth and revenue increases.
BlackRock (BLK): The company has shown robust financial performance with a market cap of $138.35 billion and total revenues of $18.69 billion. BlackRock has also demonstrated impressive profitability metrics, including a gross profit margin of 49.32%, an EBITDA margin of 38.76%, and a net profit margin of 32.36%. Moreover, BlackRock is experiencing significant growth, as evidenced by its latest earnings call, which highlighted that the company is growing faster than last year, with double-digit operating income growth and expanding margins. Additionally, BlackRock generated $82 billion of total net inflows in the second quarter, representing 3% annualized organic asset and base fee growth. In terms of leadership in the ETF industry, BlackRock leads inflows, with $150 billion of net inflows in the first half of 2024, more than double the first half of last year. This indicates strong demand for BlackRock’s ETF products and a solid market position. Lastly, BlackRock is committed to innovation and strategic growth areas, such as private markets, technology, whole portfolio mandates, and model portfolios. The company also aims to be a leader in the investment opportunity, which is being shaped by the demand for generative AI and data centers. Free cash flow and revenue growth remain positive.
Goldman Sachs (GS): The company reported strong year-on-year growth in both its Global Banking & Markets and Asset & Wealth Management segments, with net revenues for Q2 2024 reaching $12.73 billion, marking a 17% increase from the second quarter of 2023. Notably, Goldman Sachs boasts a high gross profit margin of 83.64% and a net profit margin of 22.99%, underlining its strong profitability. Furthermore, the firm’s market leadership is evident as it maintains its #1 rank in announced and completed mergers and acquisitions (M&A) and holds the #2 position in equity underwriting. The substantial increase in the investment banking backlog reflects a robust pipeline of future business. In addition, Goldman Sachs has excelled in asset and wealth management, achieving record levels in assets under supervision, totaling $2.93 trillion, and in total wealth management client assets, amounting to $1.5 trillion. The company also surpassed expectations, raising $36 billion in alternatives fundraising year-to-date. Overall, Goldman Sachs’ strong financial performance, market leadership, and robust asset and wealth management underscore its position as a formidable player in the financial industry.
JPMorgan Chase (JPM): JPMorgan Chase delivered an outstanding financial performance in the latest quarter, achieving record revenue and net income. The company reported a net income of $18.1 billion and an impressive Return on Tangible Common Equity (ROTCE) of 28%. With a robust capital position, JPMorgan Chase boasts a Common Equity Tier 1 (CET1) capital ratio of 15.3%. The growth across key segments is equally noteworthy, with investment banking fees soaring by 50% year-over-year and 17% quarter-over-quarter. Market revenue also experienced a significant uptick, rising by 10% year-over-year. The Asset and Wealth Management division also reported remarkable net inflows, with $52 billion in long-term products and $16 billion in liquidity products. The division’s Assets Under Management (AUM) grew by 15% year-over-year to reach $3.7 trillion. Furthermore, JPMorgan Chase is dedicated to delivering value to its shareholders, as evidenced by the Board of Directors’ intention to increase the quarterly common stock dividend by 19%. With a sustainable dividend payout ratio of 24.52% and a dividend yield of 2.18%, the company remains committed to providing attractive returns to its shareholders while maintaining its financial strength and stability.
While we have several financial holdings reporting, the first company to report from our portfolio is actually PepsiCo (PEP), scheduled for October 8. Following is a short review of last quarter’s report:
PepsiCo (PEP): PepsiCo has demonstrated strong international growth, achieving a 7% increase in the year’s first half with expectations to sustain this growth in the second half. The company’s North American beverage business has also shown solid performance, driving profitable growth and witnessing market share gains for key brands such as Gatorade, Propel, and Mountain Dew. Furthermore, PepsiCo has delivered positive financial metrics, including net revenue growth, significant gross and operating margin expansion, and double-digit EPS growth in Q2 2024. With a high degree of confidence, the company anticipates achieving at least 8% core constant currency EPS growth for the full year 2024.
While earnings season and the associated report details are crucial to understanding stock and industry-specific trends, this will be the last batch before the November elections. The policy differences among the candidates are substantial, and we are likely to reorient the portfolio once we have a clear picture of the regulatory, tax, and economic policy environment we’ll be dealing with.
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, rational decisions about how much capital to put at risk and where to put that capital.
Please let us know if you would like to discuss the portfolio in more detail or learn more about our approach.
Sincerely,
Donald L. Hagan, CFA®
Regan Teague, CFA®, CFP®
Rob Herman, MBA
Jeffery Palmer, CIPM
Steve Zimmerman, MBA
Steven Goode, CFA®
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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