DAY HAGAN TACTICAL ALLOCATION STRATEGY OCTOBER 2018
Based on the October investment model updates and corresponding position changes, the Day Hagan Tactical Allocation strategy (DHTA) is now 72.3% invested in equity and equity alternatives, 15.5% in fixed income and 12.2% in cash and cash alternatives*. This reflects very minor changes to the overall allocations.
The equity allocation for the DHTA strategy remains mildly bullish. With regard to our fixed income holdings, 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.
Concerning 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 1.91%.
With regard to overweighting stocks vs. bonds, our models have correctly been focusing on equities, particularly in the U.S. Most internal (price-related) factors continue to indicate that equities remain the preferred asset class of the two. Relative momentum, overbought/oversold, and seasonality indicators favor stocks over bonds.
However, when looking at external factors, there are a few caution signs. We note that sentiment for stocks is approaching overly optimistic levels, while for fixed income, pessimism is excessive. Additionally, global equity yields are now at levels that have been historically competitive with global equity earnings’ yields. Lastly, global PMIs (leading measures of economic activity) have rolled over and indicate that global economic activity is moderating.
The weight of the evidence still leans toward equities, but the aforementioned developments have us poised to take additional action when mandated by our unemotional model readings.
Our models continue to overweight U.S.-based equities over international equities. The U.S. Composite model now has the highest rating of the global regions covered.
Most of the U.S. composite model’s positive positioning is due to continued relative strength and positive price-related trends versus the rest of the world.
Even with the recent mild pullback in the U.S. markets and particularly tech-related stocks, the U.S.-focused internal model has held its ground, with momentum, breadth and OBOS measures still positive.
Looking at the operating environment for companies, we note that measures of economic growth are positive, but valuations, sentiment, and the narrow yield curve (10yr-2yr) are signaling caution.
Net/net, overweighting exposure to the U.S. is currently warranted.
From a global regional equity perspective, there has been slight improvement in the external models for Europe and Europe ex-UK, while Emerging Markets declined back to August’s levels.
As discussed in last month’s letter, from a macro perspective, the world is changing from the central bank supported, declining interest rate, easy-money, improving economic growth, low-valuation environment we saw at the beginning of the bull market ten years ago, to what could be argued is now at the opposite end of that spectrum.
While we continue to maintain our exposure to equities, we are well aware of the growing risks and will be quick to adjust our portfolios as our models and indicators direct.
Below is a representative list of what’s different and/or changing versus 10 years ago:
There are also positive developments (among others):
Clearly, this isn’t an exhaustive list. Nonetheless, based on our indicator evidence, none of the above mentioned 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.
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 October 4, 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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