by Scott Martindale
President & CEO, Sabrient Systems LLC
As the New Year gets underway, stocks have continued their impressive march higher. Comparing the start of this year to the start of 2019 reveals some big contrasts. Last January, the market had just started to recover from a nasty 4Q18 selloff of about 20% (a 3-month bear market?), but this time stocks have essentially gone straight up since early October. Last January, we were still in the midst of nasty trade wars with rising tariffs, but now we have a “Phase 1” deal signed with China and the USMCA deal with Mexico and Canada has passed both houses of Congress. At the beginning of last year, the Fed had just softened its hawkish rhetoric on raising rates to being "patient and flexible" and nixing the “autopilot” unwinding of its balance sheet (and in fact we saw three rate cuts), while today the Fed has settled into a neutral stance on rates for the foreseeable future and is expanding its balance sheet once again (to shore up the repo market and finance federal deficit spending (but don’t call it QE, they say!). Last year began in the midst of the longest government shutdown in US history (35 days, 12/22/18–1/25/19), but this year’s budget easily breezed through Congress. And finally, last year began with clear signs of a global slowdown (particularly in manufacturing), ultimately leading to three straight quarters of YOY US earnings contraction (and likely Q4, as well), but today the expectation is that the slowdown has bottomed and there is no recession in sight.
As a result, 2019 started with the S&P 500 displaying a forward P/E ratio of 14.5x, while this year began with a forward P/E of 18.5x – which also happens to be what it was at the start of 2018, when optimism reigned following passage of the tax cuts but before the China trade war got nasty. So, while 2018 endured largely unwarranted P/E contraction that was more reflective of rising interest rates and an impending recession, 2019 enjoyed P/E expansion that essentially accounted for the index’s entire performance (+31% total return). Today, the forward P/E for the S&P 500 is about one full standard deviation above its long-term average, but the price/free cash flow ratio actually is right at its long-term average. Moreover, I think the elevated forward P/E is largely justified in the context of even pricier bond valuations, low interest rates, favorable fiscal policies, the appeal of the US over foreign markets, and supply/demand (given the abundance of global liquidity and the shrinking float of public companies due to buybacks and M&A).
However, I don’t think stocks will be driven much higher by multiple expansion, as investors will want to see rising earnings once again, which will depend upon a revival in corporate capital spending. The analyst consensus according to FactSet is for just under 10% EPS growth this year for the S&P 500, so that might be about all we get in index return without widespread earnings beats and increased guidance, although of course well-selected individual stocks could do much better. Last year was thought to be a great setup for small caps, but alas the trade wars held them back from much of the year, so perhaps this will be the year for small caps. While the S&P 500 forward P/E has already risen to 19.0x as of 1/17, the Russell 2000 small cap index is 17.2x and the S&P 600 is only 16.8x.
Of course, there are still plenty of potential risks out there – such as a China debt meltdown, a US dollar meltdown (due to massive liquidity infusions for the dysfunctional repo market and government deficit spending), a US vote for democratic-socialism and MMT, a military confrontation with Iran, or a reescalation in trade wars – but all seem to be at bay for now.
In this periodic update, I provide a detailed market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings look neutral, while the technical picture also is quite bullish (although grossly overbought and desperately in need of a pullback or consolidation period), and our sector rotation model retains its bullish posture. Notably, the rally has been quite broad-based and there is a lot of idle cash ready to buy any significant dip.
As a reminder, Sabrient now publishes a new Baker’s Dozen on a quarterly basis, and the Q1 2020 portfolio just launched on January 17. You can find my latest slide deck and Baker’s Dozen commentary at http://bakersdozen.sabrient.com/bakers-dozen-marketing-materials, which provide discussion and graphics on process, performance, and market conditions, as well as the introduction of two new process enhancements to our long-standing GARP (growth at a reasonable price) strategy, including: 1) our new Growth Quality Rank (GQR) as an alpha factor, which our testing suggests will reduce volatility and provide better all-weather performance, and 2) “guardrails” against extreme sector tilts away from the benchmark’s allocations to reduce relative volatility. Read on....
by Scott Martindale
President & CEO, Sabrient Systems LLC
As yet another decade comes to a close, the US continues to enjoy the longest economic expansion on record. And as if to put a cherry on top, the economic reports last week hardly could have been more encouraging for the New Year, propelling the S&P 500 index into its third major technical breakout since the recovery from the financial crisis began well over 10 years ago. In particular, the jobs report blew away estimates with 266,000 new jobs, the prior month’s report was revised upward, and the unemployment rate fell to a 50-year low of 3.5%. Importantly, those new jobs included 54,000 manufacturing jobs. Indeed, a growing view is that the manufacturing/industrial segment of the economy has bottomed out along with the corporate earnings recession and capital investment, with an economic upswing in the cards, which has been a key driver for the resurgence in value and cyclical stocks with solid fundamentals.
The good news kept coming, with the Consumer Sentiment report jumping back up to 99.2 (and averaging 97.0 over the past three years, which is the highest sustained level since the Clinton administration’s all-time highs), while wages are up 3.1% year-over-year, and household income is up 4.8% (to the highest levels in 20 years). And with capital rotating out of pricey bonds into riskier assets, it all seems to me to be more indicative of a recovery or expansionary phase of the economic cycle – which could go on for a few more years, given a continuation of current monetary and fiscal policies and a continued de-escalation in trade wars.
To be sure, there have been plenty of major uncertainties hanging over the global economy, including a protracted trade war with China, an unresolved Brexit deal, an unsigned USMCA deal, and so on. And indeed, investors will want to see the December 15 trade deal deadline for new tariffs on China postponed. But suddenly, each of these seems to have a path to resolution, which gave a big boost to stocks today (Thursday). Moreover, a pervasive fear that we are in a “late-cycle” economy on the verge of recession was becoming more of a self-fulfilling prophesy than a fundamental reality, and now there is little doubt that investor sentiment is starting to ignore the fearmongers and move from risk-averse to risk-embracing, which better matches the fundamental outlook for the US economy and stocks, according to Sabrient’s model.
In this periodic update, I provide a detailed market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings have turned bullish, while the longer-term technical picture remains bullish, and our sector rotation model also retains a solidly bullish posture.
The bullish risk-on rotation since 8/27/19 is persisting, in which investors have shifted away from their previous defensive risk-off sentiment and back to a more optimistic risk-on preference that better aligns with the solid fundamental expectations of Wall Street analysts and Corporate America.
We have developed and introduced a new Growth Quality Rank (GQR) as an enhancement to our growth-at-a-reasonable-price (aka GARP) model. It is intended to help provide better “all-weather” performance, even when investor sentiment seems “irrational.” Read on….
by Scott Martindale
President, Sabrient Systems LLC
After an “investor’s paradise” year in 2017 – buoyed by ultra-low levels of volatility, inflation, and interest rates, and fueled even more by the promise of fiscal stimulus (which came to fruition by year end) – 2018 was quite different. First, it endured a long overdue correction in February that reminded investors that volatility is not dead, and the market wasn’t quite the same thereafter, as investors’ attention focused on escalating trade wars and central bank monetary tightening, leading to a defensive risk-off rotation mid-year and ultimately to new lows, a “technical bear market” (in the Nasdaq and Russell 2000), and the worst year for stocks since the 2008 financial crisis. Then, it was confronted with the Brexit negotiations falling apart, Italy on the verge of public debt default, violent “yellow vest” protests in France, key economies like China and Germany reporting contractionary economic data, and bellwether companies like FedEx (FDX) and Apple (AAPL) giving gloomy sales forecasts that reflect poorly on the state of the global economy. The list of obstacles seems endless.
Moreover, US stocks weren’t the only asset class to take a beating last year. International equities fared even worse. Bonds, oil and commodities, most systematic strategies, and even cryptocurrencies all took a hit. A perfect scenario for gold to flourish, right? Wrong, gold did poorly, too. There was simply nowhere to hide. Deutsche Bank noted that 93% of global financial markets had negative returns in 2018, the worst such performance in the 117-year history of its data set. It was a bad year for market beta, as diversification didn’t offer any help.
Not surprisingly, all of this has weighed heavily upon investor sentiment, even though the US economy, corporate earnings, and consumer sentiment have remained quite strong, with no recession in sight and given low inflation and interest rates. So, despite the generally positive fundamental outlook, investors in aggregate chose to take a defensive risk-off posture, ultimately leading to a massive selloff – accentuated by the rise of passive investing and the dominance of algorithmic trading – that did huge technical damage to the chart and crushed investor sentiment.
But fear not. There may be a silver lining to all of this, as it has created a superb buying opportunity, and it may finally spell a return to a more selective stock-picker’s market, with lower correlations and higher performance dispersion. Moreover, my expectation for 2019 is for a de-escalation in the trade war with China, a more accommodative Fed, and for higher stock prices ahead. Forward valuations overall have become exceedingly attractive, especially in the cyclical sectors that typically flourish in a growing economy.
In this periodic update, I provide a market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings remain bullish, while the sector rotation model remains in a defensive posture. Read on…
by Scott Martindale
President, Sabrient Systems LLC
Volatility suddenly returned with a vengeance last week – to both stocks and bonds. In fact, on Wednesday, while the -3.1% single-day selloff in the S&P 500 didn’t quite equal the -4.1% fall on February 3, the normal “flight to safety” into US Treasuries when stocks sell off didn’t occur, which was quite distressing to market participants and pundits alike. But on Thursday, bonds caught a bid while equities continued their fall. Suddenly, talk has become more serious about the potential for slower global growth due to rising interest rates and escalating trade wars.
But has anything really changed from a fundamental standpoint? I would say, absolutely not. Although the risk-off rotation since June 11 continues to hold back Sabrient’s cyclicals-oriented portfolios, our quantitative model still suggests that little has changed with the fundamentally strong outlook characterized by global economic growth, impressive US corporate earnings, modest inflation, low real interest rates, a stable global banking system, and historic fiscal stimulus in the US (including both tax relief and deregulation). Moreover, it appears to me that equities are severely oversold, and now is a good time to be accumulating high-quality stocks with attractive forward valuations from the cyclical sectors and small caps.
When a similar correction happened in February, the main culprits were inflation worries and hawkish rhetoric from the Federal Reserve regarding interest rates. After all, the so-called “Fed Put” has long supported the stock market. But then the Fed commentary became less hawkish and more data-driven, which was helpful given modest inflation data, but the start of the trade war rhetoric kept the market from bouncing back with as much gusto as it had been displaying.
So, what caused the correction this time? Well, to an extent, bipartisan support for heightened regulation and consumer privacy protections hit some of the mega-cap InfoTech stocks that had been leading the market. But in my view, the sudden spikes in fear (and the VIX) and in Treasury yields and the resulting rush to the exit in stocks was due to a combination of the Federal Reserve chairman’s suddenly hawkish rhetoric about interest rates and China’s extreme measures to offset damage from its trade war with the US.
In this periodic update, I provide a market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings remain bullish, while the sector rotation model has switched to a neutral posture due to the recent correction.Read on....
by Scott Martindale
by Scott Martindale