Day Hagan Tech Talk: Blind Squirrel and Smart Sector Update
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Summary
Wall Street veteran Ralph Acampora has said, “Rotation is the lifeblood of any bull market,” an apt description of the domestic equity market last week.
Finding an Acorn
When the team at Day Hagan discusses the markets, I am known to state, always about myself, “Even a blind squirrel can find an acorn once in a while.”
In last week’s report prior to the “Fed speak,” CPI report, and earnings reports, amongst several topics, I touched on the following:
A) The figures (breadth) need to expand (broader upside participation) this week!
B) Maybe interest rate cuts, or the anticipation of them, will help small caps and the broad market.
Relative to last week:
Weekly gains: Micro Caps +8.3%, Small Caps +6.1%, Mid-Caps +4.4%, Value +3.8%, Russell 1000 (large cap) Equal Weight +3.7%, S&P 500 Equal Weight +2.9%, DJIA +1.5%, S&P 500 +0.87%, NASDAQ +0.25%. In other words, the Non-Index Movers far outperformed.
Weekly losses: NDX 100 -0.30%, Magnificent Seven -1.94%, NYSE FANG+ Index -2.51%. Net-net, many of the Index Movers took a backseat and felt the brunt of extreme rotation.
10 of the 11 S&P macro sector proxies closed higher.
7 of the 11 S&P macro sector proxies outperformed the S&P 500.
YTD leaders (Technology and Comm. Services) underperformed the S&P 500.
NYSE All Issues Advance-Decline Line (A/D Line) and S&P 500 A/D Line reached new high territory. This suggests that if and when sharp downside selling occurs, it will be contained.
Still A Tale of Two Cities
For months, the Index Movers SPX and NDX/NASDAQ/Large Cap Growth/Technology have been rising while almost the entire rest of the domestic equity market went down or traded laterally. Now, however, while I can’t say that all the internal breadth issues have been fully rehabilitated, I can say they are moving in the right direction and some “rehab work” has been done.
Bottom Line: To extend the current trend, and for last week to be more than just a reversion to the mean move due to extreme positioning (Index Movers vs. Non-Index Movers) coupled with algorithm/computer trading, more is needed. Specifically, everything—the Index Movers and Non-Index Movers (“the 493,” broad market) moves in sync together, higher.
As Tavis McCourt of Raymond James stated last week, “We suspect earnings season will be very important in this regard.” This is good food for thought, yet I will add, watch stocks’ reaction to the earnings report just as much as the actual report itself.
Figure 1: S&P 500, S&P 500 Equal Weight Index, Russell 1000 Equal Weight (EQAL, large cap) | If you want to watch how the Index Movers and Non-Index Movers are doing without having to follow all the indices and proxies mentioned on page 1, consider these along with their respective areas of support (green lines—also see Figure 5) and resistance (red lines).
Smart Sector Strategies
U.S. Equity Strategy
Our goal is to stay on the right side of the prevailing trend, introducing risk management when conditions deteriorate. As has been the case for all of 2024, the broader-based composite models calling U.S. economic growth, international economic growth, inflation trends, liquidity, and equity demand remain constructive. The Catastrophic Stop model is currently supportive of the S&P 500’s primary uptrend. If our models shift to bearish levels, we will raise cash.
Figure 2: Russell 2000 proxy with Momentum and Rising 30-week MA – weekly data. | Many times in the past I’ve shared the opinion that on any hints of lower interest rates this proxy would make a run at its 2021 price peaks—red lines. Unless support is broken (green lines) and last week’s breakout isn’t quickly reversed (a failed breakout), I am still of that opinion.
The Sector Allocation Model is another risk management component of the Smart Sector strategy. Entering July, Health Care and Information Technology are above benchmark weight. Consumer Staples, Materials, Real Estate, and Utilities are below benchmark weight.
In the July strategy update, Don Hagan wrote the following (please reach out for all of Don’s observations relative to the 11 S&P macro sector proxies and/or charts of the respective sector proxies):
As we’ve discussed over the past few months, the capping effect continues to evolve. The Technology Select Sector SPDR Fund (XLK) rebalanced the top 3 holdings on June 21. Nvidia’s weighting increased to 20.6% (from under 5%), while Apple was reduced to 4.36% (versus over 24% in the GICS Information Technology sector). In response, we exited the Semiconductor ETF exposure (SMH) we added at the beginning of the month (to true up the NVDA weighting) but continued holding the MAGS ETF to account for the Apple underweighting in XLK.
Health Care: Even with the excitement around weight-loss drugs, the sector’s returns have been average, with YTD results being the fifth worst of the 11 sectors. The sector’s technical indicators are still mixed, but the operating environment is improving. Indicators calling medical CPI, HC company aggregate book values, and aggregate HC company credit spreads are supportive. Additionally, personal expenditures for health care are gradually increasing. With elections ahead, we’re keeping an eye on proclamations around changes to Medicare/Medicaid and regulatory risk….
Information Technology: Internal and external indicators leaning marginally more positively…. Perhaps it’s time for the troops to help the generals… the sector is overbought, but overbought levels can persist. At this point, a decisive reversal has not occurred. Upside positioning is extended, and with investors still very optimistic, earnings must hit all cylinders. NVDA is trading at 25.3x forward sales (not earnings), vs. 13.6x for Microsoft and 8.4x for Apple.
This strategy uses measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk and where to place that capital. Please reach out for more details from a portfolio manager.
International Markets (ex U.S.) Strategy
Entering July, the non-U.S. equity Core model (approximately 65% of equity holdings) overweighted China. The Core model overweights and underweights the largest non-U.S. equity markets based on macro, fundamental, behavioral, and technical indicators. Weightings are determined using the Black-Litterman framework, which seeks to reduce volatility and enhance returns.
The Explore model (approximately 35% of equity holdings), based on a multi-factor technical ranking system using trend and mean reversion indicators, favored India, Taiwan, Turkey, Sweden, and Peru.
In the July strategy update, Don Hagan wrote the following (please reach out for all of Don’s observations relative to a variety of international proxies used in this strategy and/or charts of the respective country proxies):
China: China’s composite model declined slightly with this month’s update but remains bullish. The lower reading resulted from High-Yield Credit Spreads ticking higher, albeit from low levels. Notably, S&P recently affirmed China’s credit rating at A+/A-1, with a stable outlook. While real estate is still a challenge, China is creating a fund designed to rescue financial companies impacted by the property slump and lowering mortgage rates and down payment requirements for home buyers. Earnings expectations and valuations show positive earnings revisions increasing and valuations relatively low (forward P/E just 9.4x). Q1 GDP growth increased to 5.3% y/y (beating expectations), with fixed investment increasing by 4.5%, the most in a year. Continued policy easing is paramount, and the Bank of China’s efforts to weaken the CNY are emblematic of their focus. The annual inflation rate is just 0.3%. We are overweight.
Each of the five emerging markets (India, Taiwan, Turkey, Sweden, and Peru) has favorable price trends as their 50-day moving averages trade above their 200-day moving averages.
Expected one-year earnings growth: India (+11.5%), Taiwan (+21.7%), Turkey (+24.0%), Sweden (+6.4%), Peru (+21.6%). The U.S. is +13.0%. (All data based on MSCI constituent holdings.)
The percentage of positive earnings revisions for each country supports positive earnings expectations: India (+73.5%), Taiwan (+74.8%), Turkey (+82.8%), Sweden (+80.3%), and Peru (+88.9%).
Manufacturing PMIs indicate improving economic activity: India Manufacturing PMI 58.3, Services PMI 60.4; Taiwan Manufacturing PMI 53.2, Services PMI N/A.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk and where to place that capital. Please reach out for more details from a portfolio manager.
Fixed Income Strategy
For July, the strategy’s positioning is overweight U.S. Corporates.
In the July strategy update, Don Hagan wrote the following (please reach out for all of Don’s observations relative to the various fixed income proxies used for this strategy and/or charts of the respective proxies):
Most central banks are becoming less hawkish, and many are already/expect to start lowering interest rates. Figure 3.
Stable economic growth and limited inflationary pressures are positive for equities. Improved equity performance is also favorable for corporate bonds.
U.S. Corporates: Technical cross and mean reversion factors are positive contributors to the model. Implied volatility, option-adjusted spreads, and the strength of the U.S. dollar (improving from negative) are neutral. An increase in Credit Default Swap rates is negative. The net result is an overweight position.
Figure 3: Breadth of Central Bank Rate Changes. | While it is not always a matter of things being “good” or “bad” (above or below the 50% level), many times it’s more prudent to ask, “are things getter better or worse?” This chart indicates things are getting better, a positive for fixed income (and equities).
Figure 4: U.S. Corporate proxy (weekly chart, adjusted for dividends). | Relative strength trend (vs. AGG, top frame) and price trend (lower frame), each with a rising 40-week MA, are bullish.
This strategy utilizes measures of price, valuation, economic trends, monetary liquidity, and market sentiment to make objective, unemotional, rational decisions about how much capital to place at risk and where to place that capital. If you would like to discuss this strategy with a portfolio manager, please reach out.
Additional Chart
Figure 5: S&P 500 with short-term moving averages. | In order to more easily discern initial underlying support, as opposed to Figure 1, please note the support levels shown by the green, orange, and blue lines.
Note: While some may focus on last Thursday’s low of 5584.54 (closing)/5576.53 (intraday) as being critical support, I think those levels are too short-term. If you feel otherwise, please use whatever levels best support your risk management approach and/or positions.
Please let me know if you would like to schedule a call to go over the process and discipline underpinning our Smart Sector with Catastrophic Stop, Smart Sector International, and/or Smart Sector Fixed Income strategies. Disclosures and Fact Sheet information can be found here: https://dhfunds.com/literature.
Day Hagan Asset Management appreciates being part of your business, either through our research efforts or investment strategies. Please let us know how we can further support you.
Art Huprich, CMT®
Chief Market Technician
Day Hagan Asset Management
—Written 7.13-14.2024. Chart source: Stockcharts.com unless otherwise noted.
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