by Scott Martindale
  President & CEO, Sabrient Systems LLC

As expected, last week the FOMC left the fed funds rate as is at 5.25-5.50%. Fed funds futures suggest the odds of a hike at the December meeting have fallen to less than 10%, and the odds of at least three 25-bp rate cuts by the end of 2024 have risen to nearly 80%, with a 25% chance the first cut comes as soon as March. As a result, after moving rapidly to cash for the past few months, stock and bond investors came rushing back with a vengeance. But what really goosed the market were underwhelming economic reports leading to Fed Chair Jerome Powell’s comments suggesting the lag effects on surging interest rates and the strong US dollar are finally manifesting. Investors apparently believed the Fed’s promise of “higher for longer” (making the Fed’s job easier), which spiked Treasury yields (and by extension, mortgage rates) much faster and more severely than the Fed intended.

The S&P 500 had fallen well below all major moving averages, accelerating downward into correction territory, and was down 10% from its 7/31 high. Moreover, the S&P 500 Bullish Percent Index (BPSPX), which rarely drops below 25, had fallen to a highly oversold 23 (anything below 30 is considered oversold), and the CBOE Volatility Index (VIX) had surged above the 20 “panic threshold” to hit 23. Both were contrarian bullish signals. Then stocks began to recover ahead of the FOMC meeting, and after the less-than-hawkish policy announcement, it triggered short covering and an options-driven “gamma squeeze,” with the S&P 500 surging above its 200-day, 50-day, and 20-day moving averages (leaving only the 100-day still above as potential resistance), the BPSPX bullish percent closed the week at 43 (which is still well below the overbought level of 80 last hit on 7/31), and the VIX closed the week below 15.

The recovery rally was broad, and in five short days put the major indexes back to where they were two weeks ago. The best performers were those that sold off the most, essentially erasing the late-October swoon in any instant. As for Treasury yields, the week ended with the 2-year at 4.84% (after hitting 5.24% in mid-October) and the 10-year at 4.57% (after touching 5.0% in mid-October), putting the 2-10 inversion at -27 bps. The 30-year mortgage rate has fallen back below 7.50%. Recall that my “line in the sand” for stocks has been the 2-year staying below 5.0%, and indeed falling below that level last week correlated with the surge in equities.

Looking ahead, investors will be wondering whether last week’s huge relief rally is sustainable, i.e., the start of the much-anticipated Q4 rally. After all, it is well known that some of the most startling bull surges happen during bear markets. Regardless, stock prices are ultimately based on earnings and interest rates, and earnings look quite healthy while interest rates may have topped out, as sentiment indicators are flashing contrarian buy signals (from ultra-low levels). But much still hinges on the Fed, which is taking its cues from inflation and jobs reports. Last week’s FOMC statement suggests a lessening of its hawkishness, but what if the Fed has viewed our post-pandemic, return-to-normalcy, sticky-inflation economic situation—and the need for harsh monetary intervention—all wrong?

Much of the empirical data shows that inflation was already set to moderate without Fed intervention, given: 1) post-lockdown recovery in supply chains, rising labor force participation, and falling excess savings (e.g., the end to relief payments and student debt forbearance); and 2) stabilization/contraction in money supply growth. These dynamics alone inevitably lead to consumer belt-tightening and slower economic growth, not to mention the resumption in the disinflationary secular trends and the growing deflationary impulse from a struggling China.

Notably, the New York Fed’s Global Supply Chain Pressure Index (GSCPI), which measures the number of standard deviations from the historical average value (aka Z-score) and generally presages movements in PPI (and by extension, CPI), was released earlier today for October, and it plummeted to -1.74, which is its lowest level ever. This bodes well for CPI/PPI readings next week and PCE at month end, with a likely resumption in their downtrends. So, although the Fed insists the economy and jobs are strong and resilient so it can focus on taming the scourge of inflation through “higher for longer” interest rates, I remain less concerned about inflation than whether the Fed will pivot quickly enough to avoid inducing an unnecessary recession.

Assuming the Fed follows through on its softer tone and real yields continue to fall (and we manage to avoid World War III), I think this latest rally has given investors renewed legs—likely after a profit-taking pullback from last week’s 5-day moonshot. With over 80% of the S&P 500 having reported, Q3 earnings are handily exceeding EPS expectations (3.7% YoY growth, according to FactSet, driven mostly by a robust profit margin of 12.1%), and optimistic forecasts for 2024-2025 earnings growth are holding up. Meanwhile, a renewed appetite for bonds promises to drive down interest rates.

I like the prospects for high-quality/low-debt technology companies, bonds and bond-proxies (e.g., utilities and consumer staples), oil and uranium stocks, gold miners, and bitcoin in this macro climate. Furthermore, we continue to believe that, rather than the broad-market, passive indexes that display high valuations, investors may be better served by active stock selection Sabrient’s portfolios include the new Q4 2023 Baker’s Dozen (launched on 10/20), Small Cap Growth 40 (just launched on 11/3), and Sabrient Dividend 45 (launched on 9/1, and today offers a 5.5% dividend yield).

In today’s post, I discuss the trend in supply chains and inflation, equity valuations, and Fed monetary policy implications. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which is topped by Technology and Industrials), current positioning of our sector rotation model (which is switching from neutral to a bullish bias, assuming support at the 50-day moving average holds for the S&P 500), and some actionable ETF trading ideas.

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested).

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Federal shutdown averted, at least for another 6 weeks, which may give investors some optimism that cooler heads will prevail in the nasty tug-of-war between the budget hawks and the spendthrifts on the right and left flanks. Nevertheless, I think stocks still may endure some turmoil over the next few weeks before the historically bullish Q4 seasonality kicks in—because, yes, there are still plenty of tailwinds.

From a technical standpoint, at the depths of the September selloff, 85% of stocks were trading below their 50-day moving averages, which is quite rare, and extreme September weakness typically leads to a strong Q4 rally. And from a fundamental standpoint, corporate earnings expectations are looking good for the upcoming Q3 reporting season and beyond, as analysts are calling for earnings growth of 12.2% in 2024 versus 2023, according to FactSet. But that still leaves us with the interest rate problem—for the economy and federal debt, as well as valuation multiples (e.g., P/E) and the equity risk premium—given that my “line in the sand” for the 2-year Treasury yield at the 5% handle has been solidly breached.

But the good news is, we learned last week that the Fed’s preferred inflation metric, core PCE (ex-food & energy), showed its headline year-over-year (YoY) reading fall to 3.9% in August (from 4.3% in July). And more importantly in my view, it showed a month-over-month (MoM) reading of only 0.14%, which is a better indicator of the current trend in consumer prices (rather than comparing to prices 12 months ago), which annualizes to 1.75%—which of course is well below the Fed’s 2% inflation target. Even if we smooth the last 3 MoM reports for core PCE of 0.17% in June, 0.22% in July, and 0.14% in August, the rolling 3-month average annualizes to 2.16%. Either way, it stands in stark contrast to the upward reversal in CPI that previously sent the FOMC and stock and bond investors into a tizzy.

Notably, US home sales have retreated shelter costs have slowed, wage inflation is dropping, and China is unleashing a deflationary impulse by dumping consumer goods and parts on the global market in a fit of desperation to maintain some semblance of GDP growth while its critical real estate market teeters on the verge of implosion.

So, core inflation is in a downtrend while nominal interest rates are rising, which is rapidly driving up real rates, excessively strengthening the dollar, threatening our economy, and contributing to distress among our trading partners and emerging markets—including capital flight, destabilization, and economic migration. Also, First Trust is projecting interest on federal debt to hit 2.5% of GDP by year-end, up sharply from 1.85% last year (which was the highest since 2001 during a steep decline from its 1991 peak of 3.16%).

Therefore, I believe the Fed is going to have to lighten up soon on hawkish rate policy and stagnant/falling money supply. When the Fed decides it’s time to cut rates—both to head off escalating crises in banking and housing and to mitigate growing strains on highly leveraged businesses, consumers, and foreign countries (from an ultra-strong dollar and high interest rates when rolling maturing debt)—it would be expected to ignite a sustained rally in both stocks and bonds.

But even if the AI-leading, Big Tech titans can justify their elevated valuations with extraordinary growth—and according to The Market Ear, they trade at the largest discount to the median stock in the S&P 500 stock in over 6 years on a growth-adjusted basis—investors still may be better served by active strategies that exploit improving market breadth by seeking “under the radar” opportunities poised for explosive growth, rather than the broad passive indexes. So, we believe this is a good time to be invested in Sabrient’s portfolios—including the new Q3 2023 Baker’s Dozen (launched on 7/20), Forward Looking Value 11 (launched on 7/24), Small Cap Growth 39 (launched on 8/7), and Sabrient Dividend 45 (launched on 9/1 and today offers a 5.5% dividend yield).

In today’s post, I discuss inflation, stock-bond relative performance, equity valuations, and Fed monetary policy implications. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which continues to be topped by Technology and Energy), current positioning of our sector rotation model (neutral bias), and some actionable ETF trading ideas. Your feedback is always welcome!

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested).

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The future direction of both stocks and bonds hinges on the trajectory of corporate earnings and interest rates, both of which are largely at the mercy of inflation, Fed monetary policy, and the state of the economy (e.g., recession). So far, 2023 is off to an impressive start, with both stocks and bonds surging higher on speculation that inflation will continue to subside, the Fed will soon pause rate hikes, the economy will endure at most a mild recession, China reopens, and corporate earnings will hold up…not to mention, stocks have risen in the year following a midterm election in every one of the past 20 cycles. The CBOE Volatility Index (VIX) is at a 52-week low.

Moreover, although inflation and interest rates surged much higher than I predicted at the beginning of 2022, my broad storyline around inflation and Fed policy remains intact:  i.e., a softening of its hawkish jawboning, followed by slower rate hikes and some balance sheet runoff (QT), a pause (or neutral pivot) to give the rapid rate hikes a chance to marinate (typically it takes 9-12 months for a rate hike to have its full effect), and then as inflation readings retreat and/or recession sets in, rate cuts commence leading to an extended relief rally and perhaps the start of a new (and lasting) bull market. Investors seem to be trying to get a jump on that rally. Witness the strength in small caps, which tend to outperform during recoveries from bear markets. However, I think it could be a “bull trap” …at least for now.

Although so far consumer spending, corporate earnings, and profitability have held up, I don’t believe we have the climate quite yet for a sustained bull run, which will require an actual Fed pause on rate hikes and more predictable policy (an immediate dovish pivot probably not necessary), better visibility on corporate earnings, and lower market volatility. Until we get greater clarity, I expect more turbulence in the stock market. In my view, the passive, broad-market, mega-cap-dominated indexes that have been so hard for active managers to beat in the past may see further weakness during H1 2023. The S&P 500 might simply gyrate in a trading range, perhaps 3600–4100.

But there is hope for greater clarity as we get closer to H2 2023. If indeed inflation continues to recede, China reopens, the war in Ukraine doesn’t draw in NATO (or turn nuclear), the dollar weakens, and bond yields fall further, then investor interest should broaden beyond value and defensive names to include well-valued growth stocks help to fuel a surge in investor confidence. I believe both stocks and bonds will do well this year, and the classic 60/40 stock/bond allocation model should regain its appeal.

Regardless, even if the major indexes falter, that doesn’t mean all stocks will fall. Indeed, certain sectors (most notably Energy) should continue to thrive, in my view, so long as the global economy doesn’t sink into a deep recession. Quality and value have regained their former luster (and the value factor has greatly outperformed the growth factor over the past year), which means active selection and smart beta strategies that can exploit the performance dispersion among individual stocks seem poised to continue to beat passive indexing in 2023—a climate in which Sabrient’s approach tends to thrive.

For example, our Q4 2021 Baker’s Dozen, which launched on 10/20/21 and terminates on Friday 1/20/23, is outperforming by a wide margin all relevant market benchmarks (including various mid- and small-cap indexes, both cap-weighted and equal-weight) with a gross total return of +9.3% versus -10.2% for the S&P 500 as of 1/13, which implies a +19.5% active return, led by a diverse group encompassing two oil & gas firms, an insurer, a retailer, and a semiconductor equipment company. Later in this post, I show performance for all of Sabrient’s live portfolios—including the Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend (which offers a 4.7% current yield). Each leverages our enhanced model that combines Value, Quality, and Growth factors to provide exposure to both longer-term secular growth trends and shorter-term cyclical growth and value-based opportunities. By the way, the new Q1 2023 Baker’s Dozen launches on 1/20.

Here is a link to a printable version of this post. In this periodic update to start the new year, I provide a comprehensive market commentary, discuss the performance of Sabrient’s live portfolios, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a modestly bullish bias, the technical picture looks short-term overbought but mid-term neutral, and our sector rotation model remains in a neutral posture. Energy continues to sit atop our sector rankings, given its still ultra-low (single digit) forward P/E and expectations for strong earnings growth, given likely upside pricing pressure on oil due to the end of Strategic Petroleum Reserve releases (and flip to purchases), continued sanctions on Russia, and China’s reopening…and assuming we see only a mild recession and a second half recovery. Read on…

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Investors found optimism and “green shoots” in the latest CPI and PPI prints. As a result, both stocks and bonds have rallied hard and interest rates have fallen on the hope that inflation will continue to subside and the Fed will soon ease up on its monetary tightening. Still, there is a lot of cash on the sidelines, many investors have given up on stocks (and the longstanding 60/40 stock/bond allocation model), and many of those who are the buying the rally fear that they might be getting sucked into another deceptive bear market rally. I discuss in today’s post my view that inflation will continue to recede, stocks and bonds both will gain traction, and what might be causing the breakdown of the classic 60/40 allocation model—and whether stocks and bonds might revert back to more “normal” relative behavior.

Like me, you might be hearing highly compelling and reasoned arguments from both bulls and bears about why stocks are destined to either: 1) surge into a new bull market as inflation falls and the Fed pivots to neutral or dovish…or 2) resume the bearish downtrend as a deep recession sets in and corporate margins and earnings fall. Ultimately, whether this rally is short-lived or the start of a new bull market will depend upon the direction of inflation, interest rates, and corporate earnings growth.

The biggest driver of financial market volatility has been uncertainty about the terminal fed funds rate. DataTrek observed that the latest rally off the October lows closely matches the rally off the 12/24/2018 bottom, which was turbocharged when Fed Chair Jerome Powell backed down from his hawkish stance, which of course has not yet happened this time around. Instead, Powell continues to actively talk up interest rates (until they are “sufficiently restrictive”) while trying to scare businesses, consumers, and investors away from spending, with the goals of: 1) demand destruction to push the economy near or into recession and raise unemployment, and 2) perpetuate the bear market in risk assets (to diminish the “wealth effect” on our collective psyche and spending habits). Powell said following the November FOMC meeting that it is “very premature” to talk about a pause in rate hikes.

Indeed, the Fed has been more aggressive in raising interest rates than I anticipated. And although some FOMC members, like Lael Brainard, have started opining that the pace of rate hikes might need to slow, others—most notably Chair Powell—have stuck unflinchingly with the hawkish inflation-fighting jawboning. However, I think it is possible that Powell has tried to maintain consistency in his narrative for two reasons: 1) to reduce the terminal fed funds rate (so he won’t have to cut as much when the time comes for a pivot), and 2) to not unduly impact the midterm election with a policy change. But now that the election has passed and momentum is growing to slow the pace given the lag effect of monetary policy, his tune might start to change.

As the Fed induces demand destruction and a likely recession, earnings will be challenged. I believe interest rates will continue to pull back but will likely remain elevated (even if hikes are paused or ended) unless we enter a deep recession and/or inflation falls off a cliff. Although the money supply growth will remain low, shrinking the Fed balance sheet may prove challenging due to our massive federal budget deficit and a global economy that is dependent upon the liquidity and availability of US dollars (for forex transactions, reserves, and cross-border loans)—not to mention the reality that a rising dollar exacerbates inflationary pressures for our trading partners and anyone with dollar-denominated debt.

Thus, the most important catalyst for achieving both falling inflation and global economic growth is improving supply chains—which include manufacturing, transportation, logistics, energy, and labor. Indeed, compared to prior inflationary periods in history, it seems to me that there is a lot more potential on the supply side of the equation to bring supply and demand into better balance and alleviate inflation, rather than relying primarily on Fed policy to depress the demand side (and perhaps induce a recession). The good news is that disrupted supply chains are rapidly mending, and China has announced plans to relax its zero-tolerance COVID restrictions, which will be helpful. Even better news would be an end to Russia’s war on Ukraine, which would have a significant impact on supply chains.

In any case, it appears likely that better opportunities can be found outside of the passive, cap-weighted market indexes like the S&P 500 and Nasdaq 100, and the time may be ripe for active strategies that can exploit the performance dispersion among individual stocks. Quality and value are back in vogue (and the value factor has greatly outperformed the growth factor this year), which means active selection is poised to beat passive indexing—a climate in which Sabrient's GARP (growth at a reasonable price) approach tends to thrive. Our latest portfolios—including Q4 2022 Baker’s Dozen, Forward Looking Value 10, Small Cap Growth 36, and Dividend 41 (which sports a 4.8% current yield as of 11/15)—leverages our enhanced model-driven selection approach (which combines Quality, Value, and Growth factors) to provide exposure to both: 1) the longer-term secular growth trends and 2) the shorter-term cyclical growth and value-based opportunities.

By the way, if you like to invest through a TAMP or ETF, you might be interested in learning about Sabrient’s new index strategies. I provide more detail below on some indexes that might be the timeliest for today’s market.

Here is a link to a printable version of this post. In this periodic update, I provide a comprehensive market commentary (including constraints on hawkish Fed actions and causes of—and prognosis for—the breakdown of the classic 60/40 portfolio), discuss the performance of Sabrient’s live portfolios, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a modestly bullish bias, the technical picture looks short-term overbought but mid-term bullish, and our sector rotation model has moved from a defensive to neutral posture. Read on...

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The rally to kick off Q4 was most welcome, but it quickly petered out. We must acknowledge that macro conditions are still dicey, and no industry is showing leadership—not even the Energy industry, with oil prices surging and green energy getting a tailwind from the new IRA spending bill. The traditional 60/40 stock/bond portfolio could be in for its worst year ever as interest rates surge while stocks flounder. Only the dollar is strong, as the US dollar index has hit its highest level in 20 years.

On the one hand, some commentators believe that things always look darkest before the dawn, so perhaps a bottom is near, and it is time to begin accumulating good companies. Others say there needs to be one more leg down, to perhaps 3400 on the S&P 500 (and preferably with the VIX touching 40), before the buying opportunity arrives. Either is a near-term bullish perspective, which aligns with my view.

On the other hand, there are those who say that markets don’t clear out such massive distortions quite so quickly. So, after such a long period in which “buy the dip” has always paid off (for many traders, it has been so their entire adult life), things are different now, including no “Fed put” or the shadowy “Plunge Protection Team” to backstop the market. Indeed, they say that given the persistent inflation, central banks can no longer embolden speculators by jumping in quickly to cushion market risk—and so, we should be preparing ourselves for global economic restructuring, broad liquidation, and a long, wealth-destroying bear market. This is not my expectation.

The most important number these days is the CPI, and the September number came in at 8.2%, which was only slightly below August’s 8.3%. Of course, inflation is a lagging indicator, and new Fed monetary policy actions can take several months to show their impact, but the Fed’s hawkish jawboning indicates it has less fear of a “doing too much than too little,” which I disagree with as I discuss in today’s post. Although the Fed’s preferred PCE gauge isn’t released until 10/28, market consensus following the CPI print is now for a 75-bp rate hike on 11/2 followed by another 75-bp hike on 12/14, and then a final 25-50 bps in February before it ultimately pauses with the fed funds rate around 5% or so.

However, because the September CPI print (again, a lagging indicator) shows a flatline with some slowing in inflation, it bolsters my ongoing view that inflation is on the decline, the economy is slowing down fast, and the Fed ultimately will raise less than expected (perhaps even calling for pause to watch and reflect after a 75-bp hike on 11/2) because of the vulnerabilities of a hyper-financialized global economy to rapidly rising rates and an ultra-strong dollar. Even bearish Mike Wilson of Morgan Stanley believes the Fed will need to tone down its hawkish monetary policy as global US dollar liquidity is now in the "danger zone where bad stuff happens.” In effect, a strong dollar creates QT (quantitative tightening) of global monetary policy.

It all hinges on the trajectory of corporate earnings and interest rates, both of which are largely at the mercy of the trajectory of inflation, Fed monetary policy decisions, and the state of the economy (e.g., recession). I believe inflation and bond yields are in volatile topping patterns (including the recent "blow-off top" in the 10-year Treasury yield to over 4.0%). Supply chains are gradually recovering (albeit hindered by Russia’s war) and the Fed is creating demand destruction, recession, and a global investor desire for the safety and income of elevated Treasury yields. Also constraining the Fed’s ability to shrink its balance sheet is a world hungry for dollars (for forex transactions, reserves, and cross-border loans), a massive federal debt load, and the reality that a rising dollar is painful to other currencies by exacerbating inflationary pressures for our trading partners and anyone with dollar-denominated debt service.

The biggest risks of course are catastrophic escalation in the war, or untamed inflation coupled with a rapid withdrawal of liquidity…or the possibility that central banks’ disinflationary tools of yore are no longer effective. But if inflation and nominal yields continue to fall, real yields (nominal minus inflation) should follow, leading to a neutral Fed pivot, improving corporate profitability, rising earnings, and perhaps some multiple expansion on stock valuations (e.g., higher P/Es). I discuss all of this in today’s post.

We continue to suggest staying long but hedged (e.g., with leveraged inverse ETFs and index puts). For long positions, a heightened emphasis on quality is appropriate, with a balance between value/cyclicals/dividend payers and high-quality secular growers. Sabrient’s terminating Q3 2021 Baker’ Dozen shows a +6% active gross total return versus the S&P 500 through 10/14 (even without any Energy exposure), while the latest Q3 2022 Baker’s Dozen that launched on 7/20 already shows a +8% active return of (with 23% Energy exposure). Also, our latest Dividend portfolio is sporting a 5.5% yield.

By the way, if you are a financial advisor who uses a TAMP (like SMArtX or Envestnet, for example) and might be interested in adding one of Sabrient’s new index strategies to your portfolio mix, please reach out to me directly for discussion! We have 17 strategies to consider. I provide more detail below on 3 strategies that might be the most timely today.

Here is a link to a printable version of this post. In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with the top 5 scorers being economically sensitive sectors. In addition, the technical picture shows the S&P 500 may have successfully tested critical support at its reliable 200-week moving average, although our sector rotation model remains in a defensive posture. Read on…

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

So far this year, the Federal Reserve has been removing liquidity from the markets via rate hikes and quantitative tightening, hence the 1H22 crash. But stocks have rallied strongly since the mid-June lows on the growing belief that the Fed will make one more rate hike in September and then pause ahead of the midterm elections – and perhaps even start cutting rates in the New Year. However, many others remain adamant that the Fed is committed to keep raising rates until it is clear that inflation is under control.

I remain of the belief that the hyper-financialization of the US and global economies means that rising rates could cripple debt-addicted businesses and governments (including our own federal government!), and the housing market (which is critical for a healthy consumer) depends upon mortgage rates stabilizing soon. And as the dollar further strengthens (it just went above parity with the Euro!) given the relatively higher interest rates paid by the US, some emerging market economies with dollar-denominated debt may be forced to default. In other words, today’s financial system simply can’t handle much higher rates – which suggests the Fed may already be at or near the elusive “neutral rate” and will ultimately choose to live with elevated inflation.

Earnings season has turned out better than expected, even though profit margins have been challenged by inflationary pressures. Still, at an estimate of about 12.4% (down from a record 12.8% in Q1), profit margins remain well above the 5-year average of 10.8%, according to FactSet. After a long period of low and falling inflation, massive monetary and fiscal stimulus combined with extreme supply chain disruptions (including lockdowns in manufacturing centers, labor shortages, logistics bottlenecks, and elevated energy and labor costs) sent inflation soaring. This cut into profit margins (albeit less than many predicted), as did falling US labor force productivity, which has seen its worst drop so far this year since 1948, according to DataTrek.

But now, inflation is showing signs of retreating due to both demand destruction and mending supply chains (including lower energy, commodity, and shipping costs), as well as a strong dollar. U.S. business inventories are up such that the important inventory/sales ratio is back to near pre-pandemic levels, which is disinflationary. Moreover, productivity-enhancing technologies continue to proliferate along with other disinflationary structural trends, which I believe will reverse the troublesome recent trend in labor productivity and help to contain costs and boost profitability – leading to rising corporate earnings and real wages, which together reflect a healthy and sustainable economy and stock market. All of this is of critical importance because the direction of interest rates and stock prices largely depend upon the direction of inflation and the Fed’s reaction to it.

In addition, positive catalysts like an end to Russia’s war on Ukraine or China’s COVID lockdowns, and/or a Republican sweep in November that brings greater support for domestic oil & gas production, all would be expected to hasten improvement in supply chains and have an immediate impact on inflation. In other words, compared to prior inflationary periods in history, it seems to me that there is a lot more potential on the supply side of the equation to alleviate inflation rather relying primarily on Fed policy to depress the demand side.

So, what comes next? I suggested in my late-June post that there were numerous signs of a market capitulation, and indeed the market has roared back. The big questions are whether we have seen the lows for the year and whether we will see new highs; whether this has been simply a strong bear-market rally or the start of a new bull market. I believe the current pullback is simply a normal reaction to the extremely overbought technical conditions after such a strong (nearly monotonic) rally. It simply ran into a brick wall at the convergence of the May highs and the 200-day moving average, mostly due to buyer exhaustion. In fact, some traders have observed that the S&P 500 historically has never fallen to new lows after retracing more than 50% of its bear-market losses, as it has done. I talk more about this in my full post.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 5 of the top 6 scorers being cyclical sectors. In addition, the technical picture looks short-term bearish but longer term bullish, and our sector rotation model has taken on a neutral posture (at least until the S&P 500 retakes its 200-day moving average). I also offer up a political comment that you might want to ponder. Read on…

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The S&P 500 officially entered a bear market by falling more than -20% from its all-time high in January, with a max peak-to-trough drawdown of nearly -25% (as of 6/17). The Nasdaq Composite was down as much as -35% from its November all-time high. During the selloff, there was no place to hide as all asset classes floundered – even formerly uncorrelated cryptocurrencies went into a death spiral (primarily due to forced unwinding of excessive leverage). But then stocks staged an impressive bounce last week, although it was mostly driven by short covering.

Earlier this year when stocks began their initial descent, laggards and more speculative names sold-off first, but later, as the selling accelerated, the proverbial baby was thrown out with the bathwater as investors either were forced to deleverage (i.e., margin calls) or elected to protect profits (and their principal). Even the high-flying Energy sector sold off on this latest down leg, falling over -25% intraday in just 10 days, as the algorithmic momentum trading programs reversed from leveraged buying of Energy to leveraged selling/shorting.

These are common signs of capitulation. So is historically low consumer and investor sentiment, which I discuss in detail later in this post. But despite the negative headlines and ugly numbers, it mostly has been an orderly selloff, with few signs of panic. The VIX has not reached 40, and in fact it hasn’t eclipsed that level since April 2020 during the pandemic selloff. Moreover, equity valuations have shrunk considerably, with the S&P 500 and S&P 600 small caps falling to forward P/Es of 15.6x and 10.8x, respectively, at the depths of the selloff (6/17). This at least partially reflects an expectation that slowing growth (and the ultra-strong dollar) will lead to lower corporate earnings than the analyst community is currently forecasting. Although street estimates have been gradually falling, consensus still predicts S&P 500 earnings will grow +10.4% in aggregate for CY2022, according to FactSet. Meanwhile, Energy stocks are back on the upswing, and the impressive outperformance this year of the Energy sector has made its proportion of the S&P 500 rise from approximately 2% to 5%...and yet the P/Es of the major Energy ETFs are still in the single digits.

A mild recession is becoming more likely, and in fact it has become desirable to many as a way to hasten a reduction in inflationary pressures. Although volatility will likely persist for the foreseeable future, I think inflation and the 10-year Treasury yield are already in topping patterns. In addition, supply chains and labor markets continue their gradual recovery, the US dollar remains strong, and the Fed is reducing monetary accommodation, leading to demand destruction and slower growth, which would reduce the excess demand that is causing inflation.

Bullish catalysts for equity investors would be a ceasefire or settlement of the Russian/Ukraine conflict and/or China abandoning its zero-tolerance COVID lockdowns, which would be expected to help supply chains and further spur a meaningful decline in inflation – potentially leading to a Fed pivot to dovish (or at least neutral)…and perhaps a melt-up in stocks. Until then, a market surge like we saw last week, rather than the start of a V-shaped recovery, is more likely just a bear market short-covering rally – and an opportunity to raise cash to buy the next drawdown.

Nevertheless, we suggest staying net long but hedged, with a heightened emphasis on quality and a balance between value/cyclicals and high-quality secular growers and dividend payers. Moreover, rather than investing in the major cap-weighted index ETFs, stocks outside of the mega-caps may offer better opportunities due to lower valuations and higher growth rates. Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced model-driven selection approach (which combines Quality, Value, and Growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities. In particular, our Dividend Portfolio – which seeks quality companies selling at a reasonable price with a solid growth forecast, a history of raising dividends, a good coverage ratio, and an aggregate dividend yield approaching 4% or more to target both capital appreciation and steady income – has been holding up well this year. So has our Armageddon Portfolio, which is available as a passive index for ETF licensing.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 5 of the top 6 scorers being cyclical sectors. In addition, the near-term technical picture looks neutral-to-bearish after last week’s impressive bounce, and our sector rotation model remains in a defensive posture.  Read on...

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Needless to say, investors have been piling out of stocks and bonds and into cash. So much for the 60/40 portfolio approach that expects bonds to hold up when stocks sell off. In fact, few assets have escaped unscathed, leaving the US dollar as the undisputed safe haven in uncertain times like these, along with hard assets like real estate, oil, and commodities. Gold was looking great in early-March but has returned to the flatline YTD. Even cryptocurrencies have tumbled, showing that they are still too early in adoption to serve as an effective “store of value”; instead, they are still leveraged, speculative risk assets that have become highly correlated with aggressive growth stocks.

From its record high in early January to Thursday’s intraday low, the S&P 500 (SPY) was down -19.9% (representing more than $7.5 trillion in value). At its lows on Thursday, the Nasdaq 100 (QQQ) was down as much as -29.2% from its November high. Both SPY and QQQ are now struggling to regain critical “round-number” support at 400 and 300, respectively. The CBOE Volatility Index (VIX) further illustrates the bearishness. After hitting 36.6 on May 2, which is two standard deviations above the low-run average of 20 (i.e., Z-score of 2.0), VIX stayed in the 30’s all last week, which reflects a level of panic. This broad retreat from all asset classes has been driven by fear of loss, capital preservation, deleveraging/margin calls among institutional traders, and the appeal of a strong dollar (which hit a 20-year high last week). The move to cash caused bond yields to soar and P/E ratios to crater. Also, there has been a striking preference for dividend-paying stocks over bonds.

It appears I underestimated the potential for market carnage, having expected that the March lows would hold as support and the “taper tantrum” surge in bond yields would soon top out once the 10-year yield rose much above 2%, due to a combination of US dollar strength as the global safe haven, lower comparable rates in most developed markets, moderating inflation, leverage and “financialization” of the global economy, and regulatory or investor mandates for holding “cash or cash equivalents.” There are some signs that surging yields and the stock/bond correlation may be petering out, as last week was characterized by stock/bond divergence. After spiking as high as 3.16% last Monday, the 10-year yield fell back to close Thursday at 2.82% (i.e., bonds attracted capital) while stocks continued to sell off, and then Friday was the opposite, as capital rolled out of bonds into stocks.

Although nominal yields may be finally ready to recede a bit, real yields (net of inflation) are still solidly negative. Although inflation may be peaking, the moderation I have expected has not commenced – at least not yet – as supply chains have been slow to mend given new challenges from escalation in Russian’s war on Ukraine, China’s growth slowdown and prolonged zero-tolerance COVID lockdowns in important manufacturing cities, and various other hindrances. Indeed, the risks to my expectations that I outlined in earlier blog posts and in my Baker’s Dozen slide deck have largely come to pass, as I discuss in this post.

Nevertheless, I still expect a sequence of events over the coming months as follows: more hawkish Fed rhetoric and some tightening actions, modest demand destruction, a temporary economic slowdown, and more stock market volatility … followed by mending supply chains, some catch-up of supply to slowing demand, moderating inflationary pressures, bonds continuing to find buyers (and yields falling), and a dovish turn from the Fed – plus (if necessary) a return of the “Fed put” to support markets. Time will tell. Too bad the Fed can’t turn its printing press into a 3D printer and start printing supply chain parts, semiconductors, oil, commodities, fertilizers, and all the other goods in short supply – that would be far more helpful than the limited tools they have at hand.

Although both consumer and investor sentiment are quite weak (as I discuss below), and there has been no sustained dip-buying since March, history tells us bear markets do not start when everyone is already bearish, so perhaps Friday’s strong rally is the start of something better. Perhaps the near -20% decline in the S&P 500 is all it took to wring out the excesses, with Thursday closing at a forward P/E of 16.8x ahead of Friday’s rally, which is the lowest since April 2020. So, the S&P 500 is trading at a steep 22% discount compared to 21.7x at the start of the year, a 5-year average of 18.6x, and a 20-year post-Internet-bubble average of 15.5x (according to FactSet), Moreover, the Invesco S&P 500 Equal Weight (RSP) is at 15.0x compared to 17.7x at the beginning of the year, and the S&P 600 small cap forward P/E fell to just 11.6x (versus 15.2x at start of the year).

But from an equity risk premium standpoint, which measures the spread between equity earnings yields and long-term bond yields, stock valuations have actually worsened relative to bonds. So, although this may well be a great buying opportunity, especially given the solid earnings growth outlook, the big wildcards for stocks are whether current estimates are too optimistic and whether bond yields continue to recede (or at least hold steady).

Recall Christmas Eve of 2018, when the market capitulated to peak-to-trough selloff of -19.7% – again, just shy of the 20% bear market threshold – before recovering in dazzling fashion. The drivers today are not the same, so it’s not necessarily and indicator of what comes next. Regardless, you should be prepared for continued volatility ahead.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 5 of the top 6 scorers being cyclical sectors, Energy, Basic Materials, Financials, Industrials, and Technology. In addition, the near-term technical picture looks bullish for at least a solid bounce, if not more (although the mid-to-long-term is still murky, subject to news developments), but our sector rotation model switched to a defensive posture last month when technical conditions weakened.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines Quality, Value, and Growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s latest Q2 2022 Baker’s Dozen launched on 4/20/2022 and is off to a good start versus the benchmark, led by three Energy firms, with a diverse mix across market caps and industries. In addition, the live Dividend and Small Cap Growth portfolios have performed quite well relative to their benchmarks. Read on....

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

As the economy has emerged from the pandemic and some sense of normalcy has returned around the world, investors had returned to wrestling with the potential impacts of unwinding 13 years of unprecedented monetary stimulus (QE and ZIRP). But then new uncertainties piled on with the onset of Russian’s invasion of Ukraine, Ukraine’s impressive resistance, and the resulting refugee crisis, not to mention new COVID mutations and some renewed lockdowns – all of which has led to historic inflationary pressures on energy, commodities, and food prices, as well as elevated market volatility.

After a solid post-FOMC rally, the CBOE Volatility Index (VIX) fell from a panicky high near 37 – which is more than two sigma above its long-term average of 20 – to close last week at 20.81. At their lows, the S&P 500 had corrected by -13.1% and the Nasdaq Comp by -21.7% (from their all-time high closing prices last November to their lowest close on Monday 3/14/22). But the price action in the SPDR S&P 500 and Tech-heavy Nasdaq 100 over the past few weeks looks very much like a bottoming process going into the FOMC meeting, culminating in a bullish “W” technical formation that broke out strongly to the upside, with recoveries of +9.2% for the S&P 500 and +12.9% for Nasdaq through last Friday. The rally has seen a resurgence in the more speculative growth stocks that had become severely oversold, as illustrated by the ARK Innovation ETF (ARKK), which has risen nearly 25%.

Except for some gyrations in the immediate aftermath of the FOMC announcement, price essentially went straight up. I believe the rocket fuel came from a combination of the Fed providing greater clarity (and not hiking by 50 bps), China’s soothing words (including assurances to global investors and distancing itself from Russia’s aggression), as well as a general fear of missing out (FOMO) among investors on an oversold rally.

Notably, commodities and crude oil have been strong from the start of the year, with oil at one point (March 7) touching $130/bbl after starting the year at $75 (that’s a 73% spike!). For now, oil seems to have stabilized in a trading range, although the future is uncertain and summer driving season is on the horizon. It seems that President Putin finally acting out his goal of restoring historical Russian lands (similar to the jihadist dream of redrawing an Islamic caliphate) may be shaking up our leftists’ utopian vision of a Great Reset and “stakeholder capitalism” and into realizing (at least for the moment) the pitfalls of rapid decarbonization, denuclearization, the embracing of green/renewable energy before the technologies are ready for the role of primary energy source, and the outsourcing of critical energy supplies (the very lifeblood of a modern economy) to mercurial/adversarial dictators. I talk at length about oil production and supply dynamics in today’s post.

So, have we seen the lows for the year in stocks? Is this merely an oversold bounce and end-of-quarter “window dressing” for mutual funds that will soon reverse, or is it a sustainable recovery? Well, my view is that we may have indeed seen the lows, depending upon how the war develops from here, how aggressive the Fed’s actions (not just its language) actually turn out, and how economic growth and corporate earnings are impacted. But I also think there is too much uncertainty – including a possible recessionary dip for one quarter – for there to be new highs in the broad indexes anytime soon. Instead, I think we are in a trader’s market. Although I think stocks will end the year in positive territory, they are unlikely to reach new highs given the vast new disruptions to supply chains and the less-speculative nature of current investor sentiment – meaning that valuations will depend more on earnings growth rather than multiple expansion. In any case, I believe there are many high-quality stocks to be found outside of the mega-cap Tech darlings offering better opportunities.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 4 of the top 5 scorers being cyclical sectors, Energy, Basic Materials, Financials, and Technology. In addition, the near-term technical picture looks weak, but the mid-to-long-term looks like a bottom is in, and our sector rotation model is back in a bullish posture.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines quality, value, and growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s latest Q1 2022 Baker’s Dozen launched on 1/20/2022 and is off to a good start versus the benchmark, led by an oil & gas firm. In addition, the live Dividend and Small Cap Growth portfolios are performing quite well relative to their benchmarks.  Read on....

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

As earnings season gets going, I believe we will see impressive reports reflecting stunning YOY growth in both top and bottom lines. According to Bloomberg, sell-side analysts' consensus YOY EPS growth estimate for the S&P 500 is north of 63% for Q2, 36% for full-year 2021, and 12% for 2022. But I still consider this to be somewhat conservative, with plenty of upside surprises likely. However, the market’s reaction to each earnings release will be more predicated on forward guidance, as investors are always forward-looking. To me, this is the bigger risk, but I am optimistic. Today’s lofty valuations are pricing in the expectation of both current “beats” and raised guidance, so as the speculative phase of the recovery moves into a more rational expansionary phase, I expect some multiple contraction such that further share price appreciation will depend upon companies “growing into” their valuations rather than through further multiple expansion, i.e., the earnings growth rate (through revenue growth, cost reduction, and rising productivity) will need to outpace the share price growth rate.

Despite the lofty valuations, investors seem to be betting on another blow-out quarter for earnings reports, along with increased forward guidance. On a technical basis, the market seems to be extended, with unfilled “gaps” on the chart. But while small caps, value stocks, cyclical sectors, and equal-weight indexes have pulled back significantly and consolidated gains since early June, the major indexes like S&P 500 and Nasdaq that are dominated by the mega caps haven’t wanted to correct very much. This appears to reinforce the notion that investors today see these juggernaut companies as defensive “safe havens.” So, while “reflation trade” market segments and the broader market in general have taken a 6-week risk-off breather from their torrid run and pulled back, Treasuries have caught a bid and the cap-weighted indexes have hit new highs as the big secular-growth mega-caps have been treated as a place to park money for relatively safe returns.

It also should be noted that the stock market has gone quite a long time without a significant correction, and I think such a correction could be in the cards at some point soon, perhaps to as low as 4,000 on the S&P 500, where there are some unfilled bullish gaps (at 4,020 and 3,973). However, if it happens, I would look at it as a long-term buying opportunity – and perhaps mark official transition to a stock-picker’s market.

The past several years created historic divergences in Value/Growth and Small/Large performance ratios with narrow market leadership. But after a COVID-selloff recovery rally, fueled by a $13.5 trillion increase in US household wealth in 2020 (compared to an $8.0 trillion decrease in 2008 during the Financial Crisis), that pushed abundant cheap capital into speculative market segments, SPACs, altcoins, NFTs, meme stocks, and other high-risk investments (or “mal-investments”), it appears that the divergences are converging, leadership is broadening, and Quality is ready for a comeback. A scary correction might be just the catalyst for the Quality factor to reassert itself. It also should allow for active selection, strategic beta, and equal weighting to thrive once again over the passive, cap-weighted indexes, which also would favor the cyclical sectors (Financial, Industrial, Materials, Energy) and high-quality dividend payers (e.g., “Dividend Aristocrats”). But I wouldn’t dismiss secular-growth Technology names that still sport relatively attractive valuations (Note: the new Q3 2021 Baker’s Dozen includes four such names).

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our sector rankings reflect a solidly bullish bias; the technicals picture has been strong for the cap-weighted major indexes but is looking like it is setting up for a significant (but buyable) correction; and our sector rotation model retains its bullish posture.

As a reminder, Sabrient’s newer portfolios – including Small Cap Growth, Dividend, Forward Looking Value (launched on 7/7/21), and the upcoming Q3 2021 Baker’s Dozen (launches on 7/20/21) – all reflect the process enhancements that we implemented in December 2019 in response to the unprecedented market distortions that created historic Value/Growth and Small/Large performance divergences. With a better balance between cyclical and secular growth and across market caps, most of our newer portfolios once again have shown solid performance relative to the benchmark (with some substantially outperforming) during quite a range of evolving market conditions. (Note: we post my latest presentation slide deck and Baker’s Dozen commentary on our public website.)  Read on….