DAY HAGAN TACTICAL ALLOCATION STRATEGY JUNE 2018
Based on the May investment model updates and corresponding position changes, the Day Hagan Tactical Allocation strategy (DHTA) is now 68.2 percent invested in equity and equity alternatives (a decrease of 7.7 percent from last month), 16.3 percent in fixed income (an increase of 3.9 percent) and 15.5 percent in cash and cash alternatives.*
The equity allocation for the DHTA strategy remains mildly bullish. With regard to our fixed income holdings, although the models mandated a slight increase in exposure this month, the total fixed income allocation remains well below our benchmark weighting. This indicates that investors should remain cautious on bonds, and by extension, prepare for higher interest rates over time.
- 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 decrease in our overall equity exposure resulted from weaker breadth readings based on global equity index trends, indicating that the recent stock rally may be losing steam. In other words, fewer and fewer stocks are participating on the upside. Historically, strong, sustainable up-moves are broad-based.
- The strategy’s global equity sector composition is as follows:
|Financial Services||11.14 percent|
|Consumer Cyclical||9.84 percent|
|Health Care||7.18 percent|
|Consumer Defensive||5.53 percent|
|Basic Materials||4.40 percent|
|Real Estate||2.24 percent|
|Communication Services||2.01 percent|
|Not classified||7.35 percent|
|(Based on Morningstar definitions as of 06.06.2018)|
From a global equity perspective, the following changes were made:
- From a regional equity perspective, the model decreased exposure to Europe ex. U.K. and Emerging Markets.
- For the Europe ex. U.K. region, indicators evaluating the region’s Purchasing Managers Indexes, Leading Economic Indexes, Relative Valuations, and Interest Rate trends are signaling caution even though the technical backdrop remains supportive.
- The Emerging Markets region allocation was reduced as price momentum slowed and commodity prices softened. Additionally, higher interest rates in the U.S., along with a stronger U.S. dollar, have typically been negative for EM. We are monitoring these trends closely.
- Conversely, there was a new allocation to Canada (EWC), though it was less than 2 percent of the overall portfolio.
- Canada’s equity markets are evidencing some green shoots, as breadth is expanding and price momentum is bouncing off lows. The country’s Leading Economic Indicators and Yield Curve are supportive of equity gains. The overall indicator evidence is just starting to show improvement; therefore, this month’s initial investment is small.
- We exchanged our (currency) Hedged Japan ETF (HEWJ) exposure for Japan (non-hedged) ETF (EWJ) exposure due to the U.S. dollar’s inability to break out versus the yen, confirmed by our models. While models for the yen and the dollar have both been improving relative to the rest of the world, the yen’s model readings are simply stronger at this point.
- We adjusted our small-cap exposure lower (IJR), consistent with the overall equity allocation reduction, as well as exchanged some of the small-cap exposure for a U.S.-based dividend appreciation-focused ETF (VIG).
- In summary, while there were several slight adjustments made to the portfolio, the overall change was a 7.7 percent decrease in equity exposure.
There are signs that earnings growth rates may peak in the second half of the year, potentially coinciding with the projected start of the Fed reducing the size of their balance sheet (i.e., beginning 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, the aforementioned items seemingly remain outside of the view of the average investor, and frankly, based on our indicator evidence, none have begun to “bite” enough to negatively impact corporate returns. At this point, economic growth is positive and consumers and businesses, based on available survey data, remain optimistic. Economic and financial liquidity is still bullish, 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.
The Day Hagan Tactical Allocation strategy uses a quantitative, model-based, weight-of-the-evidence approach to determine the levels of investment and, by proxy, the levels of risk that should be taken at any given time.
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 the market doesn’t find support and takes a second leg down, 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 June 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.)
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