DAY HAGAN TACTICAL ALLOCATION STRATEGY SEPTEMBER 2018

 

Based on the September investment model updates and corresponding position changes, the Day Hagan Tactical Allocation strategy (DHTA) is now 72.7% invested in equity and equity alternatives, 14.7% in fixed income and 12.6% in cash and cash alternatives*. The update reflected very slight 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.

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 1.84%. 

Specifically:

  • 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, we’re monitoring Emerging Markets, which we had been trimming over the past few months and remains significantly underweight the benchmark in our portfolio. The overall model improved slightly with this month’s update, but price-related indicators have yet to signal that it is a good time to increase exposure meaningfully. We’d also add that many EM currencies remain in significant downtrends. The overall EM composite model remains below 50% bullish.

From a macro perspective, the world is changing from the central bank supported, 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 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:

 10 years ago                                                  Current

Central banks supportive                                Central banks reducing/removing/normalizing support

Interest rates moving lower                            Interest rates moving higher

Sentiment pessimistic                                     Sentiment optimistic (contrary indicator at extremes)

U.S. stock market at decade lows                  U.S. stock market at all-time highs

Valuations low                                                 Valuations high

U.S. corporate earnings have upside             U.S. earnings growth rates may be peaking

Weak inflationary pressures                           Inflationary pressures building

Tariff/trade war risk low                                  Tariff/trade war risk high

No Brexit                                                         Yes Brexit

 

There are also positive developments (among others):

 10 years ago                                                  Current

U.S. economic growth weak                           U.S. economic growth good

Unemployment high                                        Unemployment low

U.S. household debt ratios high                     U.S. household debt ratios better

No tax reform                                                  Tax reform/corporate and individual taxes lower (mostly)

Number of regulations increasing                   Regulatory burdens declining

Clearly, this isn’t an exhaustive list. 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.

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.

Sincerely,

Donald L. Hagan, CFA
Arthur Day
Arthur Huprich, CMT

Regan Teague 

PDF Copy of Article: Day Hagan Tactical Allocation Strategy Update September 7, 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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