DAY HAGAN TACTICAL ALLOCATION STRATEGY NOVEMBER 2018
Based on the November investment model updates and corresponding position changes, the Day Hagan Tactical Allocation strategy (DHTA) is now 47.8% invested in equity and equity alternatives, representing a decrease of 24.5% from last month. The fixed income and cash allocations are now 35.9% and 16.3%, respectively.
The global equity allocation for the DHTA strategy is now mildly bearish. We remain cautious on the world’s equity markets, currently preferring the U.S. over other global regions.
From a technical (price-related) perspective, several indicators turned negative this month, confirming that global equities have a less attractive risk/reward profile than fixed income and cash at this juncture:
Short-term global equity upside momentum is waning (momentum had previously been a driving factor, and momentum typically fades during market downtrends—we’re looking for signs the selling is drying up).
Sentiment is in the process of shifting from optimistic to pessimistic (but may have more to go as measures have not yet definitively bottomed and/or reversed from extremes that would indicate a higher probability buy opportunity).
Signs abound that investors are moving more toward risk-off areas of the market (sector rotation from “high-expectation” to “rational-expectation” areas of the market tend to occur during major selloffs).
All of these changes are representative of spreading selling pressure and a return to “risk-off.” To be clear: these are shorter-term indicators by nature and may shift mid-month. If so, we will respond quickly by adding back the exposure.
From a macro perspective, the following indicators are also urging caution:
Global earnings yields relative to global bond yields, based on historical relationships, are not providing enough risk premium to justify greater exposure to the added risk of owning stocks over bonds/cash.
Global manufacturing PMIs continue to deteriorate, signaling that global trade is responding to the pressure of tariffs, EU uncertainty and other geopolitical factors.
Indicators that are still positive for stocks include:
Some signs that stocks are oversold at current levels (though oversold conditions can extend further into oversold territory).
Central Bank monetary policy is still rated as being generally accommodative, though their support is also winding down.
We would also note
The overall stock/bond/cash model equity allocation is at levels consistent with the recommended weightings during the 2015/2016 declines. In other words, our models are detecting similar magnitudes of risk.
While U.S. stocks have been experiencing bouts of intermittent weakness, international stocks, by and large, have been much weaker. Will the U.S. succumb to the contagion of international markets, or have international equity markets already seen the worst and will they soon start to outperform the U.S., and by default, also keep the U.S. market from experiencing further weakness?
We’ll let the indicators point us in the right direction. Currently, they have us removing some of the equity risk from our portfolios until the indicator evidence improves.
With regard to our global equity regional allocations:
The U.S. composite model has the highest readings of our global regions and continues to evidence positive relative scores.
Most of the U.S. technical indicators remain supportive, but the external indicator composite now has more negative indicators than positive.
The positive external (macro) indicators include Leading Economic Indicators and the Relative Valuation Trends composite. Both argue that the U.S. is the “cleanest dirty shirt in the laundry basket,” since the evaluation is relative to other global markets. Again, we are waiting for the indicator evidence to support either adding exposure or getting more defensive.
The regions with the second- and third-highest composite model readings are the U.K. and Emerging Markets, respectively. However, both model composites are below 50% bullish, urging caution.
The U.K. is starting to see some price improvement and positive trend action that we consider potential near-term green shoots, but are not yet enough to warrant an outsize allocation. Furthermore, Leading Economic Indicators, PMIs, and Equity Risk Premiums for the region are still negative. All of the action is still subject to Brexit risks, which are coming into focus along with the March 29, 2019 official exit date—which, in the grand scheme of things, isn’t that far off (there’s a very important vote toward the end of December 2018 that will likely move markets).
Like the U.K., Emerging Markets are also seeing the faintest signs of potential equity price stabilization, but only in the very shortest-duration indicators we track. Longer-term measures have not yet confirmed that it is time to market weight or overweight the region. As we’ve discussed in prior letters, an appreciating U.S. dollar and higher interest rates are headwinds for Emerging Markets. Until the dollar and U.S. rates stabilize, the prospects for the regions are less attractive.
Lastly, a few words of wisdom that I picked up from my time at Ned Davis Research: “Go with the flow until it reaches an extreme and reverses.” This means don’t fight the trend (tape) until there are tangible signs that the selling is drying up and buyers are gaining traction. As of Friday’s close, that wasn’t the case. So, while there are plenty of indicators saying “get ready,” we’ll wait for model confirmation before adding positions. Just as importantly, if our overall broad market equity models turn more negative, we’ll be quick to get more defensive.
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 November 5, 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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