Day Hagan Smart Value Strategy Update October 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
U.S. equities pushed higher again in September, with the S&P 500 logging a fifth consecutive monthly gain. Small-caps outpaced, and mega-cap tech names helped drive the rally. On the data front, inflation remained sticky. The PCE price index recorded a 2.7% year-over-year increase in August (the latest published data), and the Core PCE remained near 2.9%. At the September FOMC meeting, the Fed cut rates by 25 basis points, bringing the target rate to ~4.13%. But officials emphasized that inflation remains a constraint and that further cuts depend on labor and price trends. Labor‐market indicators showed signs of softening. Private-sector data (e.g., ADP) suggested job losses in September, and announcements of corporate job cuts reached their highest quarterly total since the start of the pandemic in 2020. Meanwhile, the U.S. services sector slowed—with new orders weakening and employment decelerating. Nonetheless, both the manufacturing and service sectors of the economy still remain in expansion territory, based on the most recent PMI releases.
Given current conditions — sticky inflation, softening labor, likely further rate cuts, but policy caution — we remain cautiously constructive. We don’t expect an extended downtrend at present, but we stand ready to reduce exposures should our risk indicators shift negatively. Our portfolio continues to blend durable cash‐flow leaders and cyclicals where conviction is high.
To date, 2025 has been a challenging year for a few of the portfolio’s holdings. Quality and value factors have underperformed, and our focus on economic profitability has definitely been overshadowed by expensive stocks getting more expensive.
Value and quality stocks have lagged growth and meme stocks for several interconnected reasons. The dominant driver has been the persistence of enthusiasm around technology and artificial intelligence. Mega-cap growth companies, particularly those tied to cloud infrastructure, semiconductors, and AI applications, continue to attract significant investor interest. This has reinforced momentum in growth indices and crowded positioning, even as valuations stretch further above historical averages. Although we have some exposure, the high valuation levels deter us from overweighting those areas.
Meanwhile, value stocks, which are more heavily represented in staples, financials, energy, and industrials, have faced macro headwinds. Moderating energy prices, sluggish global trade, and uncertainty around tariff policy have constrained earnings revisions in cyclical and defensive value sectors. Quality stocks, often defined by stable cash flows, strong balance sheets, and defensive characteristics, have also underperformed. Investors have shifted their focus from defensive sectors, such as consumer staples and utilities, to higher-beta growth opportunities. Moreover, elevated equity risk appetite has meant that investors are willing to pay up for future earnings potential rather than current consistency and positive returns on capital employed.
Obviously, our longer-term track record shows that this is an uncomfortable blip; however, we understand that investors may wonder if something has changed. It hasn’t, as our process and discipline continue to focus on value, strong balance sheets, and solid cash flows.
Over the previous five years, we have provided excess returns relative to our value benchmark. It seems we’re giving some of that back this year. More specifically, LULU and NKE were significant hits (primarily due to tariff-related issues), with stalwarts like CLX, PEP, CMCSA, and MRK also facing unexpected pressure (quality was out of favor). Nonetheless, and most importantly, we fully expect our favored factors, such as quality, to gain ground as some of the market froth dissipates.
Below, we highlight our holding in Lululemon, a stock that we purchased that hasn’t met our expectations. We explain why it was initially purchased, then provide a brief description of what changed that led to the unexpected downside. As you will see, our purchase criteria were sound, and the position worked well until exogenous variables interrupted the progress.
We also want to emphasize that many holdings in the portfolio have delivered very strong results. However, for the purposes of this letter, we found it more valuable to highlight the areas where performance fell short and explain the reasons. Our goal is to show that, while every strategy experiences periods of challenge, our investment approach remains consistent and disciplined. The companies we own today continue to represent a well-diversified portfolio of strong cash flow generators with healthy balance sheets—a combination that has historically driven positive results across full market cycles.
Lululemon:
On October 21, 2024, we purchased LULU.
Our rationale was as follows:
Lululemon is a premier athletic wear company worldwide, based in Vancouver, Canada. It was founded in 1998.
Over the previous 3 years, the company had generated annualized revenue growth of 31.1% and earnings (EBITDA) growth of 37%.
Gross margins were 58.54%, and operating margins were 23.02%.
The stock’s Forward PE and price-to-operating cash flow were historically attractive.
The company had $1.6 billion in cash and no debt, allowing management to increase shareholder yield through share buybacks or the initiation of a dividend.
From an EVA perspective, the company consistently generated strong margins. In addition, the value attributed to expected future growth was well below what management has been able to generate since 2010, which offered an attractive entry point.
The weakness in share price (down 42% YTD) due to concerns around valuations and the consumer had gone too far, based on our work. The price reflected an attractive entry point for a high-quality company that had consistently demonstrated its ability to generate excess returns for shareholders.
The stock was trading around $299 and spiked higher to $423 by January 30, 2025. Then the tariff turmoil began in earnest.
In our April 7th monthly update, we detailed our views around tariffs, writing:
“What Next? The primary focus now shifts to potential retaliatory actions from affected countries. Before the announcement, Chinese state media indicated they would seek to coordinate a collaborative response from China, Japan, and South Korea. This was concerning. Furthermore, and unfortunately, China then reacted by increasing the tariffs on U.S. goods. In response to that response, President Trump’s team again increased tariffs on China by an additional 10%. This ultimately had the effect of igniting Friday’s extensive market decline.
Equity Market Response: Risk off. The S&P 500 had its worst 2-day return since the March 2020 pandemic lows. $5 trillion in market value was lost, potentially affecting consumer confidence and spending plans. From a quantitative standpoint, based on our models and indicators, selling has been widespread, and several measures evaluating “panic selling,” “selling exhaustion,” and “excessive pessimism” are now at levels where declines have historically stalled or reversed, as long as there wasn’t a recession within the next 12 months. And this is where it gets dicey: If the tariff pressures don’t start to alleviate soon, the probability of a global recession will continue to rise. But other countries know that a dislocation of global trade is bad for everybody.
While it has only been five days since “Liberation Day” (the April 2 announcement of the tariffs), several countries are already negotiating to reduce tensions. Vietnam has expressed their intent to eliminate all import tariffs on U.S. goods (LULU, TGT, and NKE spiked on the news, as a large part of their production line resides there—this is a good corollary for what could happen with other regions and equity sectors), the EU proposed lowering car tariffs and increasing purchases of U.S. energy and military equipment (good news), Japan has pledged to import more liquefied natural gas and invest in AI sectors, South Korea has announced intentions to find common ground and not escalate, India has offered to reduce or eliminate tariffs on over half of its imports from the U.S. contingent upon relief from the new tariffs, and of course, as mentioned earlier, Mexico and Canada were spared from the new tariffs (the U.S.’s two largest trading partners, with total trade in 2024 totaling $839.9B and $762.1B, respectively). Taiwan has stated it will not impose reciprocal tariffs and is already negotiating tariff-free agreements with the U.S., similar to the USMCA (U.S.-Mexico-Canada Agreement).”
On June 4, 2025, LULU’s price recovered to $335 and was still profitable based on our initial purchase price. However, LULU reported earnings on June 5, and while beating earnings expectations and meeting lowered revenue expectations, the company reduced guidance due to the tariff uncertainties, and the share price declined significantly. At that point, although our views on the tariffs proved correct, investors continued to sell the name.
Currently, LULU is significantly undervalued. Standard metrics, EVA analysis, and company releases confirm the company’s potential. Although we have experienced a significant loss in the holding, we note that had we not already held it, it would currently be a strong buy based on our analysis. Note: On April 8, near the market low, we added Hershey (HSY) and Zoom (ZM), capitalizing on the tariff-related opportunity while also incorporating names with defensive characteristics in case the downtrend turned out to be more severe than expected.
Every investment strategy has its ups and downs, and this year has simply been one of those tougher stretches. A handful of names—such as LULU, NKE, and TGT—have put pressure on results, even though most of the portfolio continues to perform as expected. It’s important to remember that no approach works in every market environment, but the strength of a strategy is proven over time, not in a single quarter or year. We’ve been through periods like this before, and history shows they are temporary. What remains constant is our disciplined process, our focus on strong, long-term businesses, and our commitment to making thoughtful investment decisions on your behalf. We remain confident that these short-term bumps will give way to renewed momentum, just as they have in the past.
As we turn to sector positioning, the following summaries provide a snapshot of the main drivers—strengths, vulnerabilities, and outlooks—influencing performance across the major sectors.
Technology
Technology remains the primary engine of U.S. equity leadership, driven by artificial intelligence, cloud adoption, and resilient demand for software. Large-cap names continue to attract capital, although sector breadth has improved, driven by the strength of the semiconductor sector. Earnings growth is expected to remain robust, in the mid-teens annually into 2026, supported by hyperscaler spending that exceeds $250 billion. Valuations remain elevated: the sector trades around 30x 2026 forward earnings, with a PEG ratio of nearly 2.8, indicating that growth justifies but doesn’t fully protect stretched multiples. Strengths include high free cash flow margins and strong balance sheets. Weaknesses are tied to cyclical end-markets such as smartphones and PCs, and heavy concentration in a handful of mega-caps. Rising real yields or a stall in Fed easing could pressure multiples. Overall, Technology offers unmatched growth momentum but a limited valuation cushion, favoring companies with durable pricing power and consistent capital returns.
Financials
Financials present a mixed picture. On one hand, banks and insurers benefit from resilient credit conditions and continued deposit stability. On the other hand, the Fed’s September rate cut has flattened the yield curve, compressing net interest margins for lenders. Asset managers continue to enjoy ETF inflows, though fee pressure persists. Consensus calls for mid-single-digit EPS growth into 2026, lagging the broader market. Valuations are reasonable, with the sector trading at around 12 times 2026’s earnings and a PEG ratio of nearly 1.2. Strengths include healthy capital ratios, diversified revenue streams in large banks, and steady insurance profitability. Weaknesses stem from sensitivity to further yield-curve flattening, regulatory capital requirements, and slower deal activity. Relative to growth sectors, Financials offer attractive dividends and value characteristics, but upside may be capped until steeper curves or stronger loan demand emerge. For investors, stability and yield rather than rapid expansion define the opportunity.
Health Care
Healthcare offers a balance of defense and innovation. Pharmaceuticals provide steady cash flows and dividends, while biotechnology and medical technology drive growth through pipeline and procedure volumes. Sector EPS growth is expected to be in the high single digits through 2026, supported by demographics and product innovation. Valuations are moderate, with a forward P/E ratio of around 18x and a PEG ratio of near 1.5, which is below Technology but above Staples. Strengths include resilient demand, non-cyclical revenue, and strong balance sheets. Weaknesses center on policy risks—specifically, drug-pricing legislation remains a headline concern—and slower recovery of elective procedures in certain geographies. Health Care has underperformed in recent months as investors rotated toward cyclicals, but it retains long-term appeal as a quality, lower-volatility sector. For portfolios, Health Care provides both downside protection and exposure to secular growth themes, making it an attractive diversifier despite near-term regulatory headwinds.
Consumer Discretionary
The Consumer Discretionary sector remains supported by a resilient U.S. consumer, although performance has been uneven across industries. E-commerce platforms and premium brands continue to capture share, while autos and housing-related names face affordability headwinds. Consensus calls for double-digit EPS growth into 2026, though estimates have narrowed in recent months. Valuations are rich, with the sector trading near 25x forward 2026 earnings and a PEG ratio around 2.0, reflecting growth optimism but limited margin of safety. Strengths include strong brand equity, loyalty programs, and exposure to higher-income consumers less affected by credit costs. Weaknesses lie in the sensitivity to discretionary spending, rising wage expenses, and tariff risks that could impact global supply chains. Overall, Consumer Discretionary offers compelling growth, particularly in online retail and experiential categories; however, its cyclicality means that results will hinge heavily on labor-market resilience and real income growth in 2026.
Consumer Staples
Consumer Staples continues to provide defensive ballast within equity portfolios. Companies in the food, beverage, and household products sectors maintain steady cash flows and dividends, even as volumes remain under pressure following price hikes. Earnings growth is projected in the low to mid-single digits through 2026, slower than most cyclical sectors. Valuations reflect this stability, with the sector trading near 20 times forward 2026 earnings and a PEG ratio of ~2.5, making Staples relatively more expensive compared to its growth outlook. Strengths include pricing power, strong distribution networks, and consistent free cash flow. Weaknesses involve sluggish volume recovery, ongoing private-label competition, and limited operating leverage. Investor appetite for Staples has faded in 2025 as risk-on sentiment favored growth sectors, but these companies retain long-term appeal for income-oriented strategies. In a more volatile macro environment, Staples’ predictable earnings, defensive quality, and dividends provide an important stabilizer.
Industrials
Industrials sit at the intersection of global trade, capital spending, and infrastructure. The sector has benefited from ongoing reshoring trends and public infrastructure investment, though softness in freight and services has pressured margins. Earnings are expected to grow in the high single digits through 2026, supported by order backlogs and capital expenditure pipelines. Valuations are moderate, with the sector trading at around 19x forward 2026 earnings and a PEG ratio of approximately 1.7. Strengths include diversified exposure across aerospace, machinery, and construction materials, as well as strong balance sheets. Weaknesses stem from cyclicality, exposure to global growth risks (notably China), and higher wage and input costs. Relative to growth-oriented sectors, Industrials provide more cyclical beta, making them beneficiaries if manufacturing rebounds and trade conditions improve. While volatility is higher, Industrials remain well-positioned as beneficiaries of infrastructure spending, energy transition projects, and supply-chain realignment.
Energy
Energy remains under pressure as oil prices soften due to modest global demand and OPEC+ supply discipline. Sector earnings are projected to decline modestly in 2026, following peak profits in 2022–23; however, cash returns via dividends and buybacks are expected to remain strong. Valuations are attractive: the sector trades at a price-to-earnings ratio of nearly 11x forward 2026 earnings, with a PEG ratio below 1.0, reflecting cyclical headwinds but robust free cash flow. Strengths include capital discipline, strong balance sheets, and shareholder-friendly capital return policies. Weaknesses include commodity price volatility, geopolitical risks, and decelerating demand growth as energy transition policies are implemented. While near-term earnings may remain subdued, the sector provides valuable inflation protection and yield. For investors, Energy offers value-oriented exposure and income, but with heightened sensitivity to macro conditions and supply dynamics. Selectivity—favoring low-cost producers and integrated operators—is critical in managing downside risks.
Materials
Materials continue to face mixed fundamentals, as chemical and commodity demand has softened, while infrastructure and electrification themes support select sub-industries. EPS growth is expected to be in the mid-single digits through 2026, with variance across chemicals, specialty materials, and metals. The sector trades at around 17 times forward 2026 earnings, with a PEG ratio of ~1.4, making it reasonably valued relative to its growth prospects. Strengths include pricing power in specialty chemicals, demand tied to agricultural and industrial production, and long-cycle benefits from infrastructure and clean-energy projects. Weaknesses center on the sensitivity to global growth, particularly in relation to China, and margin compression resulting from input costs. Materials tend to perform well during early-cycle recoveries; however, near-term demand softness has limited the upside. For investors, the sector offers selective opportunities in specialty and agriculture-linked names, though broad exposure may remain constrained until global trade flows and industrial activity reaccelerate.
Real Estate
Real Estate remains challenged by higher funding costs and pressure on capitalization rates, despite the Fed’s rate cuts. Earnings growth expectations for 2026 are low single digits, reflecting limited rental growth and cautious development pipelines. The sector trades near 18x forward 2026 earnings and carries a PEG ratio of ~2.0, pricing in stability but modest growth. Strengths include predictable cash flows in net-lease, storage, and residential REITs, plus dividend yields that remain attractive compared with bonds. Weaknesses include refinancing risks, office property overhangs, and higher capital expenditures (capex) requirements for property upgrades. While valuation has improved, Real Estate remains interest-rate sensitive and tends to lag in a risk-on environment. For investors, selective allocation to higher-quality REITs with CPI-linked escalators or defensive subsectors (storage, residential, triple-net leases) makes sense. Broadly, however, sector upside remains capped until financing conditions ease further.
Communication Services
Communication Services continues to benefit from strong digital ad spending and robust streaming engagement. Mega-cap platforms like Alphabet and Meta dominate, leveraging their operations with AI and targeted advertising. Sector EPS growth is expected to be in the low double digits through 2026, outpacing many defensive stocks. Valuations are moderate compared to the technology sector, with the group trading at 21x forward 2026 earnings and a PEG ratio of nearly 1.4. Strengths include global scale, recurring revenue models, and high free cash flow generation. Weaknesses center on regulatory scrutiny, changes in privacy policy, and dependence on advertising cycles. Telecom subsectors provide yield but struggle with slower growth and high capital intensity. Overall, Communication Services offers a mix of growth and defensiveness, with digital platforms providing the strongest upside, while traditional carriers remain value-oriented laggards.
Utilities
Utilities remain a defensive sector, offering yield and stability, but have underperformed during 2025’s risk-on rally. Earnings growth is expected to be in the 3–4% range through 2026, driven by regulated rate bases and investments in grid reliability and renewable energy sources. Valuations are elevated relative to growth, with the sector trading at 19x forward 2026 earnings and a PEG ratio above 3.0. Strengths include predictable cash flows, regulatory support for capital investment, and defensive characteristics during market stress. Weaknesses involve high leverage, interest-rate sensitivity, and limited pricing flexibility. Utilities remain attractive for income-focused investors, but they are less compelling when growth sectors are leading. Selectivity in companies with renewable and distributed-energy exposure provides some upside, but broad sector performance is likely to remain muted until rate volatility subsides or markets shift back toward defensive positions.
Sector Overview/Recap
Across sectors, leadership remains concentrated in growth areas (Technology, Communication Services, Consumer Discretionary), supported by strong earnings expectations into 2026. Valuations are most stretched here, but momentum and secular trends (AI, digital platforms, premium brands) continue to attract flows. Value-oriented sectors (Financials, Energy, Real Estate, Utilities) trade at lower multiples and offer yield, yet face headwinds from flatter curves, softening demand, and rate sensitivity. Defensives (Health Care, Consumer Staples) provide balance but have lagged in risk-on markets. Cyclicals (Industrials, Materials) sit in the middle, dependent on global growth and capital-spending cycles. Overall, the investment landscape favors selective growth exposure, balanced with cash-flow-durable sectors to hedge volatility.
Sector Summary
Figure 1: Sector Summary
The portfolio’s 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 16.5% vs. 10.7% benchmark, Healthcare 4.2% vs. 12.0%, Financials 15.7% vs. 22.2%, Consumer Discretionary 5.7% vs. 7.7%, Communication Services 11.5% vs. 8.0%, Industrials 4.3% vs. 13.1%, Consumer Staples 7.8% vs. 7.5%, Energy 5.4% vs. 5.9%, Utilities 4.6% vs. 4.6%, Materials 3.9% vs. 4.1% and Real Estate 5.8% vs. 4.1%.
Overall, this portfolio aims to strike a balance between growth and stability by combining innovative growth companies with established blue-chip stocks and defensive sectors, making it suitable for investors seeking long-term capital appreciation through prudent diversification across the U.S. economy.
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 allocate and where to invest 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.
For more information, please contact us at:
Day Hagan Asset Management, 1000 S. Tamiami Trail, Sarasota, FL 34236
Toll-Free: (800) 594-7930 | Office Phone: (941) 330-1702
Website: https://dayhagan.com or https://dhfunds.com