Day Hagan Catastrophic Stop Update December 31, 2024
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The Catastrophic Stop model held steady at 60.7%, the same reading as last week. The Internal Composite is bullish, and the External Composite is neutral.
The model correctly recommended a fully invested position for all of 2024. It was especially helpful during the July 16th to August 5th period, when the S&P 500 stalled due to the Japan carry trade unwind (the BoJ raised policy rates and the yen appreciated), concerns around U.S. economic growth (the Citi Economic Surprise Index was negative), concerns around AI profitability vs. Capex levels, over-optimism, systematic and algo traders being fully invested (on a net and gross basis), the reversal of the short-covering rally that lead into the July peak, gamma shifting from positive to negative (creating a higher vol environment), and election uncertainty.
While the model correctly reflected the increasing risks and declined, it did not cross into sell territory, keeping us on the right side of the prevailing trend.
Figure 1: S&P 500 vs. Catastrophic Stop model.
We highlighted the table below a few times over the course of the year. It details asset class performance during various economic growth and inflation environments (regimes). We noted that as long as economic growth is stable or growing, U.S. equities have historically generated positive returns (on average). This was the case regardless of the inflation backdrop, whether inflation was rising, neutral, or falling. Of course, returns are better if inflation is under control (at or below trend).
This table helps to answer the question, “If U.S. economic growth slows and inflation starts to rise (the ‘Growth Stable, Inflation Rising’ regime), how have equities historically reacted?” The answer is that returns are more muted but still positive. This table also answers the question of why we consistently monitor the economic backdrop for signs of distress (option-adjusted spreads, PMIs, Baltic Dry Index rates, etc.).
Figure 2: U.S. equities enjoyed a “Growth Rising, Inflation Neutral” backdrop in 2024. For 2025, we expect growth to moderate and inflation to remain neutral.
Reviewing major economic and inflation timing models, economic activity is currently improving while inflation is neutral.
Figure 3: Economic growth in the U.S. is supportive of equities.
Figure 4: Inflation pressures are rated neutral.
For 2025, S&P 500 analysts’ expected earnings are expected to increase from $245 to $275, a little over 12% (source: Yardeni). Although the beginning-of-year analysts’ earnings growth expectations are notoriously wrong, the S&P 500 Earnings Model supports the notion that continued earnings growth is likely. Of course, as the indicators and models shift, we will adjust our holdings accordingly.
Figure 5: Earnings are expected to increase by double-digits in 2025. If that’s the case, 2025 should be another up year (as long as interest rates behave). We will closely monitor the tariff and weak manufacturing activity issues, as both could be problematic. Nonetheless, so far, investors are looking past those potential disruptions.
Sectors expected to contribute the most to 2025 earnings include Information Technology, as one might expect; however, the Q4 2024 earnings growth laggards Health Care, Industrials, and Materials, are expected to make a comeback. Currently, the Information Technology and Industrials sector models are neutral, while the Health Care and Materials sector models are negative. Should our models for those sectors improve, we will reallocate accordingly.
Figure 6: Calendar year 2025 earnings growth expectations by sector (as of 12-20-2024).
In light of the tariff debates, the graph below illustrates Goldman’s take on the potential impact of tariffs on U.S. consumer prices. The conclusion is that “even assuming a full pass-through and no substitution, tariffs would raise consumer prices of the most affected good just 1-2% on average (for U.S. consumers).”
Figure 7: If this is the case, tariffs are unlikely to be the culprit behind an extended selloff.
Shorter-term sentiment has reversed from excessively optimistic levels into the pessimism zone. For example, the CNN Fear and Greed Index shows the historical results of buying when the index crosses below 40 and then rises above that level. The gain-per-annum (until the subsequent sell signal) was 16.9% with a Sharpe Ratio over 1. However, drawdowns (DD) can be an issue, even though the max DD is less than the Buy/Hold DD. This is why we focus on the weight of the evidence, utilizing additional indicators to evaluate market risk and the probability of an extended decline.
Figure 8: Sentiment is no longer a headwind, but we must see a reversal before this indicator turns positive.
Figure 9: We also remain cognizant that the Fed and most global central banks are past the point of peak hawkishness, and many are in easing modes. Specific to the U.S., past slow easing cycles have typically gained 24.42% (on average) during Year 1 and another 6.06% during Year 2. Since the September 18th close, the S&P 500 is up just 4.8%, leaving plenty of room for upside based on this one view. By the way, it feels like it's been a lot longer than 3 ½ months since the first rate cut!
Lastly, the Cycle Composite for 2025 shows seasonal supports for the year, though there is some potential weakness indicated for early February and late June.
Figure 10: S&P 500 Cycle Composite for 2025.
Note: Our monthly strategy update will be available next week at DayHagan.com. In it, we review each sector model and the indicators within them.
Bottom Line: Our view remains the same as last week's: “We remain fully invested based on the message of the models. We acknowledge that inflationary pressures have increased slightly, global economic activity is waning (especially in manufacturing), valuations are extended, and geopolitical risks are elevated. But U.S. companies are profitable and growing, and the Fed is past peak hawkishness. Until the models shift negative, we will continue to hold the course. Note that we expect our technical indicators to turn first should the supporting backdrop deteriorate. As of this writing, the weight of the evidence continues to portray an uptrend that remains intact.”
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 positive, and we are aligned with the message. If our models shift to bearish levels, we will raise cash.
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 any of the above or our approach to investing in more detail, please don’t hesitate to schedule a call or webinar. Please call Tyler Hagan at 941-330-1702 to arrange a convenient time.
I hope you have a wonderful week,
Sincerely,
Donald L. Hagan, CFA
Chief Investment Strategist, Partner, Co-Founder
Charts with models and return information use indices for performance testing to extend the model histories, and they should be considered hypothetical. Charts courtesy Ned Davis Research (NDR). © Copyright 2024 NDR, Inc. Further distribution is prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers, refer to www.ndr.com/vendorinfo.
Disclosures
S&P 500 Index – An unmanaged composite of 500 large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks.
S&P 500 Total Return Index – An unmanaged composite of 500 large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. This index assumes reinvestment of dividends.
Sentiment – Market sentiment is the current attitude of investors overall regarding a company, a sector, or the financial market as a whole.
Disclosure: The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Asset Management, any of its affiliates or employees, or any third-party data provider shall not have any liability for any loss sustained by anyone who has relied on the information contained in any Day Hagan Asset Management literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. Day Hagan Asset Management accounts that Day Hagan Asset Management or its affiliated companies manage, or their respective shareholders, directors, officers, and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Day Hagan Asset Management uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of Day Hagan Asset Management’s past recommendations and model results is not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends, or avoid losses.
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