DAY HAGAN TACTICAL ALLOCATION STRATEGY MARCH 2018
Based on the March investment model updates and corresponding position changes, the Day Hagan Tactical Allocation strategy (DHTA) is now 66.7 percent invested in equity and equity alternatives (a decrease of 11 percent from last month), 23.3 percent in fixed income (an increase of 11 percent) and 11.0 percent in cash and cash alternatives (no change).*
The allocation for the DHTA strategy is now effectively neutral with regard to equity exposure. Although we increased our fixed income exposure, the overall level remains below our benchmark weighting. We note that the increase in our bond weighting likely represents a shorter-term opportunistic investment, and we are monitoring our bond models closely. The cash allocation remains slightly overweight at this juncture.
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. Currently, the overall equity vs. bond model indicates that risks have increased for stocks and diminished slightly for bonds. This month’s allocation changes, therefore, represent a reduction in portfolio risk.
- Equity market breadth is deteriorating, as several global equity indexes have breached intermediate-term moving average levels.
- With the significant decline in bond prices, bonds are calculated to be more oversold than stocks—even though stocks have also declined.
- From a contrary opinion perspective, longer-term sentiment measures for stocks have begun to reverse from excessively optimistic extremes and haven’t yet reached levels denoting excessive pessimism and lower-risk entry points (some shorter-term sentiment indicators have reached pessimistic levels, but not enough to influence the overall model).
- With global bond yields increasing, the spread between global equity yields and bond yields is narrowing. This is less of an advantage for equities, and places fixed income in a relatively more positive position near-term.
From a global equity perspective, the following changes were made:
- Reduced exposure to Europe
- The internal and external models for the European and U.K. regions declined as Leading Economic Indicators showed early signs of weakness and investor sentiment reversed from excessively optimistic extremes. Price-related indicators are also negative on balance.
- Reduced exposure to Japan
- Japan evidenced breadth deterioration as new highs declined relative to new lows, a sign that fewer stocks are participating in the upside. Meanwhile, earnings yield trends (for the MSCI Japan index) indicate that stock prices are already reflecting good earnings. In other words, for this ratio-based indicator to turn positive, stock prices would need to decline or earnings would need to meaningfully accelerate.
- Reduced exposure to U.S. Large Cap
- The Large Cap earnings yield (Proxy: Russell 1000 Index) is below the Small-Cap earnings yield (Proxy: Russell 2000 Index) to an extent that now favors small-cap stocks.
- Increased exposure to U.S. Small Cap
- Typically, small-cap U.S. companies tend to have higher tax rates than larger-cap companies. While there isn’t an indicator that specifically targets tax rates (or expected tax rates), the analysis does take into account earnings expectations, which reflect these changes. Tax reform clearly is a benefit for smaller-cap companies.
Although portfolio risk levels have been reduced, there is enough indicator evidence to support our remaining equity allocation. In other words, it’s not time to be bearish, but it’s not time to be overly aggressive either.
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. At this point, the competing number of bullish and bearish indicators illustrates that markets remain vulnerable and are likely to continue to meander until economic growth can find a more solid foothold and there is more clarity on the big issues. Our view is that taking oversize positions based on “hope and change” is risky. 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
PDF copy of Article: Day Hagan Tactical Allocation Strategy Update March 2018 (pdf)
Disclosure: (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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