DAY HAGAN TACTICAL ALLOCATION STRATEGY AUGUST 2018
Based on the August investment model updates and corresponding position changes, the Day Hagan Tactical Allocation strategy (DHTA) is now 72.0% invested in equity and equity alternatives (an increase of 10.1 percentage points from last month), 14.6% in fixed income (a decrease of 9.3 percentage points) and 13.4% in cash and cash alternatives.*
The equity allocation for the DHTA strategy has returned to a mildly bullish level. With regard to our fixed income holdings, the allocation was reduced and the overall allocation remains well below our fixed income benchmark. This indicates that investors should remain cautious on bonds, and by extension, prepare for higher interest rates over time. If our models were to confirm that fixed income exposure should once again be increased, we will be quick to deploy our capital into attractive opportunities.
With regard to our cash holdings, we’d note that, rather than hold our cash in money market accounts, we have invested the majority in an ultra-short enhanced bond ETF with an indicated yield of 1.76%.
It is important to note that the first decision made in the Tactical Allocation process is the percentage of the portfolio that will be allocated to stocks, bonds and cash, using unemotional, quantitative indicators. Once the overall allocation is defined, the strategy then identifies which global equity ETF opportunities are most attractive—also using quantitative modeling.
The increase in equity exposure resulted from improvements in global market breadth (more international equity indexes are participating in the uptrend), the OECD Composite of Leading Indicators turned positive again (indicating stable economic growth momentum), and equity prices have been evidencing relative strength versus bond prices. Also, sentiment readings which had been warning of potentially excessive optimism retreated enough that the indicator is no longer negative for stocks.
Also supporting equities, though with waning impact, is Central Bank Policy. While currently still a positive underpinning, we’d note that by the end of December, 2019, the combined monetary policies of the Fed, European Central Bank (ECB) and the Bank of Japan are likely to have fully reversed from accommodative to restrictive. We are watching these developments closely.
While the overall message of the models is positive for stocks, we are watching for signs of caution from the following indicators:
The markets are entering a potentially seasonally weak period as defined by Ned Davis Research’s Cycle Composite. Based on a combination of the 1-year cycle, 4-year Presidential cycle, and 10-year Decennial cycle, U.S. equity markets may encounter headwinds beginning during the July-August months, which historically have lasted through early October. While not a major factor in our view, it is worth keeping an eye on it.
The spread between global equity yields and global bonds has narrowed, indicating that the risk premium for stocks may be too low. In other words, investors are not getting “paid” to take on the risk of owning stocks.
Global manufacturing, as defined by PMI surveys (purchasing manager indexes), shows that manufacturing may be peaking, or certainly has slowed. Whether this is the result of corporate management’s reactions to tariffs and potential trade wars or global economic momentum waning is debatable. We’ll be watching closely to see if this indicator reverses should trade tensions abate. This is somewhat offset by the improvement in the OECD Composite of Leading Indicator, mentioned earlier.
From a global regional equity perspective, the following changes were made:
We increased our overall equity exposure by adding to several of our existing positions. Proportional increases were made to our ETF holdings targeting Europe, Hedged Europe, Japan, Large Cap U.S. stocks (including Growth and Dividend Payers), and Canada. (Tickers: HEZU, EWJ, EWU, VIG, IWF, IVV, and EWC.)
Two months ago, we initiated an allocation to Canada (EWC). We added slightly to the position again this month as Canada is supported by the highest regional composite model readings.
We again (slightly) trimmed our portfolio exposure to Emerging Markets (which was already underweight) and U.S. Small Capitalization companies.
The Emerging Markets region allocation (IEMG, AAXJ) was again reduced as price momentum continues to be weak and other-price related indicators continue to portray a backdrop of waning investor demand. Economically, manufacturing trends have turned negative for the region. The only new positive was the continued strength in Crude Oil prices.
As described in last month’s letter, Day Hagan Tactical Allocation Strategy Update July 2018, “We think it is important to note that there are signs that earnings growth rates may peak in the second half of the year, potentially coinciding with the Fed quickening their balance sheet wind-down (i.e., the process of reversing quantitative easing measures). Add to those circumstances the potential for higher interest rates, a “topping out” of global growth, and higher energy prices, and global equity markets may find it hard to make significant gains over and above previous highs. One might certainly be rational in thinking that, at the very least, corporate margins would be under pressure.”
Nonetheless, based on our indicator evidence, none of the aforementioned concerns have begun to “bite” enough to impact corporate returns in a way that would make us turn bearish. At this point, economic growth is positive, and consumers and businesses, based on available survey data, remain optimistic (although investors are showing signs of potential fatigue). Economic and financial liquidity is still positive, and money is available for credit-worthy, and some not-so-credit-worthy, borrowers.
All in all, the weight of the evidence supports a healthy dose of equity exposure, but not an overly aggressive positioning that inordinately, and indiscriminately, takes on risk.
We will be looking for our models and the weight of the evidence to turn more positive before committing additional capital to equities or fixed income. If global equity markets, are not able to breach resistance, we will be quick to follow our models’ direction and lower equity exposure. The bottom line is that broad-based indicator confirmation is the key to success.
If you have any questions or comments, please feel free to call anytime.
Donald L. Hagan, CFA
Arthur Huprich, CMT
PDF Copy of Article: Day Hagan Tactical Allocation Strategy Update August 2018 (PDF)
(Note: *The fixed income and cash allocations reflect holdings within the exchange-traded funds that are utilized. Therefore, individuals may look at their portfolios and see slightly different stock/bond/cash allocations.)
The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Day Hagan Asset Management (DHAM), 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. DHAM, accounts that DHAM 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. DHAM uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. When evaluating the results of prior DHAM recommendations or DHAM performance rankings, one should also consider that DHAM may modify the methods it uses to evaluate investment opportunities from time to time, that model results do not impute or show the compounded adverse effect of transactions costs or management fees or reflect actual investment results, that some model results do not reflect actual historical recommendations, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, the performance of DHAM’s past recommendations and model results are 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.