by Scott Martindale
  President & CEO, Sabrient Systems LLC

Stocks are pulling back a bit to start Q2 but have shown remarkable resilience throughout their nearly 6-month (and nearly straight-up) bull run, with the S&P 500 (SPY) finding consistent support at its 20-day simple moving average on several occasions, while the slightly more volatile Nasdaq 100 (QQQ, beta=1.18) has found solid support at the 40-day moving average. Moreover, the Relative Strength Index (RSI) on SPY has reliably bounced off the neutral line (50) on every test. And it all happened again early last week—at least until Thursday afternoon when Minnesota Fed president Neel Kashkari ventured off Fed chairman Jerome Powell’s carefully crafted script to say they may not cut interest rates at all this year if inflation’s decline continues to stall.

Before that moment, Powell had been keeping his governors in line and saying all the right things about imminent rate cuts in the pipeline (albeit making sure not to provide a firm timetable). And the pervasive Goldilocks outlook has lifted stocks to uncomfortably elevated valuations (current forward P/E for SPY of 21.3x and for QQQ of 26.6x) that suggest a need for and expectation of both solid earnings growth in 2024-25 and falling interest rates (as the discount rate on future earnings streams).

Up until Kashkari’s unexpected remarks, it appeared that once again—and in fact every time since last November, when the indexes look extremely overbought and in need of a significant pullback (as typically happens periodically in any given year) a strong bid arrived like the Lone Ranger to save the day and push stocks higher. It has burned bears and kept swing traders who like to “fade” spikes hesitant. Not surprisingly, the CBOE Volatility Index (VIX) has seen only a couple of brief excursions above the 15 line and has been nowhere near the 20 “fear threshold.”

But after his remarks, the market finished Thursday with a huge, high-volume, “bearish engulfing candle,” and the CBOE Volatility Index (VIX) surged 20% intraday (closing at 16.35), and all those previously reliable support levels gave way—until the very next day. On Friday, they quickly recovered those support levels following the apparently strong March jobs report, finishing with a “bullish harami” pattern (that typically leads to some further upside). As you recall from my March post, I have felt a correction is overdue—and the longer it holds off, the more severe the fall. The question now is whether SPY and QQQ are destined for an upside breakout to new highs and a continuation of the bull run…or for a downside breakdown to test lower levels of support. I believe we may get a bit of a bounce here, but more downside is likely before an eventual resumption in the bull run to new highs.

Regardless, the persistent strength in stocks has been impressive, particularly in the face of the Fed's quantitative tightening actions (balance sheet reduction and “higher for longer” rates)—along with the so-called “bond vigilantes” who protest excessive spending by not buying Treasuries and thus further driving up rates—that have created the highest risk-free real (net of inflation) interest rates since the Financial Crisis and reduced its balance sheet by $1.5 trillion from its April 2022 peak to its lowest level since February 2021.

But (surprise!) gold has been performing even better than either SPY or QQQ (as have cryptocurrencies, aka “digital gold”). Gold’s appeal to investors is likely in anticipation of continued buying by central banks around the world as a hedge against things like growing geopolitical turmoil, our government’s increasingly aggressive “weaponization” of the dollar to punish rogue nations, and rising global debt leading to a credit or currency crisis.

To be sure, solid GDP and employment data, a stall in inflation’s decline, rosy earnings growth forecasts for 2024-2025, tight investment-grade and high-yield credit spreads, low volatility in interest rates, a low VIX, and a sudden recovery in manufacturing activity, with the ISM Manufacturing Index having finally eclipsed the 50 threshold (indicating expansion) after 16 straight months below 50 (contraction), all beg the question of why the Fed would see a need to cut rates. As Powell himself said the other day, we have seen an unusual and unforeseen occurrence in which “productive capacity is going up even more than actual output. The economy actually isn't becoming tighter; it's actually becoming a little looser…” Indeed, the “higher for longer” mantra might seem more appropriate, at least on the surface.

Yet despite the rosy outlook and investor confidence/complacency (and Kashkari’s latest comments), the Fed continues to suggest there will be multiple rate cuts this year, as if it knows of something lurking in the shadows. And that something might be a credit crisis stemming from our hyper-financialized/ultra-leveraged economy—and the growing debt burden across government, small business, and consumers being refinanced at today’s high interest rates. We are all aware of the outright depression in commercial real estate today; perhaps there is a contagion lurking. Or perhaps it’s the scary projection for the federal debt/GDP ratio (rising from 97% of GDP last year to 166% by 2054). Or perhaps it is a brewing currency crisis with the Japanese yen, given its historic weakness that may lead the BOJ to hike rates to stem capital outflows. Or perhaps it’s because they follow the real-time “Truflation” estimate, which indicates a year-over-year inflation rate of 1.82% in contrast to the latest headline CPI print of 3.2% and headline PCE of 2.5%.

I discuss all these topics in today’s post, as well as the relative performance of various equity and asset-class ETFs that suggests a nascent market rotation and broadening may be underway, which is a great climate for active managers. Likewise, Michael Wilson of Morgan Stanley asserts that the stock rally since last fall has been driven more by loose financial conditions, extreme liquidity (leverage), and multiple expansion (rather than earnings growth), but now it's time to be a stock picker rather than a passive index investor.

So, if you are looking outside of the cap-weighted passive indexes (and their elevated valuation multiples) for investment opportunities, let me remind you that Sabrient’s actively selected portfolios include the Baker’s Dozen (a concentrated 13-stock portfolio offering the potential for significant outperformance), Small Cap Growth (an alpha-seeking alternative to the Russell 2000 index), and Dividend (a growth plus income strategy paying a 3.74% current yield). The latest Q1 2024 Baker’s Dozen launched on 1/19/24 and remains in primary market until 4/18/24 (and is already well ahead of SPY).

Click here to continue reading my full commentary in which I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which continue to be led by Technology), current positioning of our sector rotation model (which turned bullish in early November and remains so today), and several top-ranked ETF ideas. Or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested). Please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com.

By the way, Sabrient founder David Brown has a new book coming out soon through Amazon.com in which he describes his approach to quantitative modeling and stock selection for four distinct investing strategies (Growth, Value, Dividend, and Small Cap). It is concise, informative, and a quick read. David has written a number of books through the years, and in this new one he provides valuable insights for investors by unveiling his secrets to identifying high-potential stocks. Please let me know if you’d like to be an early book reviewer!

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The US stock market has gone essentially straight up since late October. While the small-cap Russell 2000 (IWM) surged into year-end 2023, pulled back, and is just now retesting its December high, the mega-cap dominated S&P 500 (SPY) and Nasdaq 100 (QQQ) have both surged almost uninterruptedly to new high after new high. They have both briefly paused a few times to test support at the 20-day moving average but have not come close to testing the 50-day, while the CBOE Volatility Index (VIX) has closed below 16 the entire time. History says this can’t go on much longer.

I think this market rally is getting out over its skis and needs at least a breather if not a significant pullback to cleanse itself of the momentum “algo” traders and FOMO investors and wring out some of this AI-led bullish exuberance. That’s not say we are imminently due for a harsh correction back down to prior support for SPY around 465 (-9%) or to fill the gap on the daily chart from November 13 at 440 (-14%). But it will eventually retest its 200-day moving average, which sits around 450 today but is steadily rising, so perhaps the aforementioned 465 level is good target for a pullback and convergence with the 200-day MA.

Regardless, I believe that short of a Black Swan event (like a terrorist strike on US soil or another credit crisis) that puts us into recession, stocks would recover from any correction to achieve new highs by year-end. As famed economist Ed Yardeni says, “Over the years, we’ve learned that credit crunches, energy crises, and pandemic lockdowns cause recessions. We are looking out for such calamities. But for now, the outlook is for a continuation of the expansion.”

As for bonds, they have been weak so far this year (which pushes up interest rates), primarily because of the “bond vigilantes” who are not happy with the massive issuances of Treasuries and rapidly rising government debt and debt financing costs. So, stocks have been rising even as interest rates rise (and bonds fall), but bonds may soon catch a bid on any kind of talk about fiscal responsibility from our leaders (like Fed chair Powell has intimated).

So, I suspect both stocks and bonds will see more upside this year. In fact, the scene might follow a similar script to last year in which the market was strong overall but endured two significant pullbacks along the way—one in H1 and a lengthier one in H2, perhaps during the summer months or the runup to the election.

Moreover, I don’t believe stocks are in or near a “bubble.” You might be hearing in the media the adage, “If it’s a double, it’s a bubble.” Over the past 16 months since its October 2022 low, the market-leading Nasdaq 100 (QQQ) has returned 72% and the SPY is up 47%. Furthermore, DataTrek showed that, looking back from 1970, whenever the S&P has doubled in any 3-year rolling period (or less), or when the Nasdaq Composite has doubled in any 1-year rolling period, stock prices decline soon after. Well, the rolling 3-year return for the S&P 500 today is at about 30%. And the high-flying Nasdaq 100 is up about 50% over the past year. So, there appears to be no bubble by any of these metrics, and the odds of a harsh correction remain low, particularly in a presidential election year, with the added stimulus of at least a few rate cuts expected during the year.

Meanwhile, while bitcoin and Ethereum prices have surged over the past few weeks to much fanfare, oil has been quietly creeping higher, and gold and silver have suddenly caught a strong bid. As you might recall, I said in my December and January blog posts, “I like the prospects for longer-duration bonds, commodities, oil, gold, and uranium miner stocks this year, as well as physical gold, silver, and cryptocurrency as stores of value.”  I still believe all of these are good holds for 2024. The approval of 11 “spot” ETFs for bitcoin—rather than futures-based or ETNs—was a big win for all cryptocurrencies, and in fact, I hear that major institutions like Bank of America, Wells Fargo, and Charles Schwab (not to mention all the discount brokers) now offer the Bitcoin ETFs—like Grayscale Bitcoin Trust (GBTC) and iShares Bitcoin Trust (IBIT), for example—to their wealth management clients. And they have just begun the process of allocating to those portfolios (perhaps up to the range of 2-5%).

As for inflation, I opined last month that inflation already might be below the 2% target such that the Fed can begin normalizing fed funds rate toward a “neutral rate” of around 3.0% nominal (i.e., 2% target inflation plus 1.0% r-star) versus 5.25–5.50% today. But then the January inflation data showed an uptick. Nonetheless, I think it will prove temporary, and the disinflationary trends will continue to manifest. I discuss this in greater length in today’s post. Also, I still believe a terminal fed funds rate of 3.0% would be appropriate so that borrowers can handle the debt burden while fixed income investors can receive a reasonable real yield (i.e., above the inflation rate) so they don’t have to take on undue risk to achieve meaningful income. As it stands today, I think the real yield is too high—i.e., great for savers but bad for borrowers.

Finally, if you are looking outside of the cap-weighted passive indexes (and their elevated valuation multiples) for investment opportunities, let me remind you that Sabrient’s actively selected portfolios include the Baker’s Dozen (a concentrated 13-stock portfolio offering the potential for significant outperformance), Small Cap Growth (an alpha-seeking alternative to a passive index like the Russell 2000), and Dividend (a growth plus income strategy paying a 3.8% current yield). The new Q1 2024 Baker’s Dozen just launched on 1/19/24.

Click here to continue reading my full commentary in which I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which continues to be led by Technology), current positioning of our sector rotation model (which turned bullish in early November and remains so today), and several top-ranked ETF ideas. Or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested). Please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com.

By the way, Sabrient founder David Brown has a new book coming out soon through Amazon.com in which he describes his approach to quantitative modeling and stock selection for four distinct investing strategies. It is concise, informative, and a quick read. David has written a number of books through the years, and in this new one he provides valuable insights geared mostly to individual investors, although financial advisors may find it valuable as well. I will provide more information as we get closer to launch. In the meantime, as a loyal subscriber, please let me know if you’d like to be an early book reviewer!

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

As an update to some of the topics I discussed in my lengthy early-January post, I wanted to share an update in advance of the FOMC announcement on Wednesday based on several economic reports that were released last week.

The Fed’s preferred inflation metric, Core Personal Consumption Expenditures (PCE, excluding food & energy) for December came in on Friday at 2.93% YoY and 0.17% MoM. However, I prefer to focus on the most recent trend over the past 3 months. Annualizing the Core PCE price index change over the past 3 months (0.14% in Oct, 0.06% in Nov and 0.17% in Dec) computes a 1.52% annualized inflation rate, as shown in the chart below.

So, it appears to me that inflation today is likely below the 2% target such that the Fed can begin normalizing fed funds rate toward the “neutral rate” (neither contractionary nor expansionary), which I believe ultimately will be around 3.0% nominal (i.e., 2% target inflation plus 1.0% r-star) versus 5.25–5.50% today. Moreover, I think the 10-year Treasury will settle at about 4.0–4.50%, assuming we don’t continue flood the Treasury market with new issuances to fund fiscal boondoggles and rising debt service (we’ll get a clue on Wednesday with the Treasury Refunding announcement). The rate levels I am suggesting seem appropriate so that borrowers can handle the debt burden while fixed income investors can receive a reasonable real yield (i.e., above the inflation rate) so they don’t have to take on undue risk to achieve meaningful income.

The Fed believes the composition of PCE more accurately reflects current impacts on consumers than does CPI. This is because it more quickly adapts to consumer choices through its weighting adjustments to individual items (e.g., shifts from pricier brands to discount brands). Also, while CPI narrowly considers only urban expenditures, PCE considers both urban and rural consumers as well as third-party purchases on behalf of a consumer, such as healthcare insurers buying prescription drugs. Furthermore, items are weighted differently—for example, shelter is the largest component of CPI at 32.9% but only 15.9% of PCE, and healthcare is the largest component of PCE at 16.8% but only 7.0% of CPI. So, while Core PCE shows a 1.52% 3-month annualized inflation rate, Core CPI is 3.33%.

So, let's talk more about shelter cost. I have often discussed the lag in shelter cost metrics distorting both PCE and CPI, particularly as new leases gradually roll over throughout the course of a year while existing lease rates persist. So, let me introduce another metric published by the BLS that provides more current insights into the trend in shelter cost, namely the New Tenant Rent Index (NTR).

The NTR data peaked in Q2 2022 while CPI Shelter didn’t peak until Q2 2023. And NTR has fallen precipitously since then, showing a substantial -8.75% quarter-over-quarter decline in Q4 2023 versus Q3 2023. But because such QoQ comparisons can be quite volatile with this metric, I’m not going to annualize that number. Instead, let’s stick with the year-over-year or 4-quarter comparison, which shows a more modest (but still significant) decline of -4.74% versus Q4 2022. Although CPI Shelter index is still elevated, it is also falling (as shown in the chart), now showing a YoY rate of 6.15% for December.

Furthermore, the BLS also publishes an All Tenant Regressed Rent Index (ATRR), which is not restricted only to new leases, so it moves more slowly and with less volatility. ATRR also has been in a steady decline since peaking in Q4 2022 at 7.84%, and it has been steadily falling over the past 4 quarters to its latest Q4 2023 reading of 5.27% YoY, which again reflects rapidly falling rental prices and is in-line with CPI Shelter.

This suggests to me that falling shelter costs will soon be more impactful to PCE and CPI readings. The FOMC is surely aware of this.

As for other economic reports last week, we saw the BEA’s advance (first) estimate of Q4 GDP growth surprised to the upside at a 3.3% annual rate, largely driven by personal consumption. Also, the December reading for M2SL money supply shows it has stayed basically flat since last March, while velocity of money (M2V) continues to ramp up. This suggests that more transactions are occurring in the economy for each dollar in circulation, which has offset the negative impact of stagnant money supply, thus supporting GDP, corporate earnings, and stock prices—although lack of M2 growth creates other strains on liquidity. I discuss this further in today’s post below.

Click here to continue reading my full commentary. And please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com.

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

To be sure, 2023 was another eventful year (they just keep coming at us, don’t they?), ranging from escalating hot wars to a regional banking crisis, rising interest rates, falling inflation, a dire migration crisis, and an AI-driven frenzy in the so-called “Magnificent Seven” (MAG7) corporate titans— Meta Platforms (META, ne: FB), Apple (AAPL), Nvidia (NVDA), Alphabet (GOOGL), Microsoft (MSFT), Amazon (AMZN), and Tesla (TSLA), aka “FANGMAT,” as I used to call them—which as a group contributed roughly 60% to the S&P 500’s +26.2% gain in 2023. Their hyper-growth means that they now make up roughly 30% of the index. Nvidia (NVDA), whose semiconductors have become essential for AI applications, was the best performer for the full year at +239%.

Small caps finally found some life late in the year, with the Russell 2000 small cap index essentially keeping up with the S&P 500 starting in May and significantly outperforming in December. Bonds also made a big comeback late in the year on Fed-pivot optimism, which allowed the traditional 60/40 stock/bond allocation portfolio to enjoy a healthy return, which I’m sure made a lot of investors and their advisors happy given that 60/40 had been almost left for dead. The CBOE Volatility Index (VIX) has been below 20 for virtually the entirety of 2023 and as low as 11.81 in December, closing the year at 12.45. Also, as a breadth indicator, the percentage of stocks that finished the year above their 200-day moving average hit 75%, which is bullish.

Nevertheless, the Russell 2000 (+16.8%) and the equal-weight version of the S&P 500 (+13.7%) were up much less for the full year than the cap-weighted S&P 500 (+26.2%) and Nasdaq 100 (+54.9%). In fact, 72% of the stocks in the S&P 500 underperformed the overall index for the full year, illustrating that despite the improvement in breadth during the second half of the year, it could not overcome the huge outperformance of a small cohort of dominant companies. This suggests that either the market is set up for a fall in 2024 (as those dominant companies sell off) …or we’ll get a continued broadening into other high-quality companies, including mid- and small caps. I think it will be the latter—but not without some volatility and a significant pullback. Indeed, despite signaling investor confidence and complacency by remaining low for a long stretch, the VIX appears to be ripe for a spike in volatility. I think we could see a significant market correction during H1 (perhaps to as low as 4,500 on the S&P 500) even if, as I expect, real GDP growth slows but remains positive and disinflationary trends continue, supporting real wage growth and real yields—before seeing an H2 rally into (and hopefully following) the November election. And don’t forget there’s a potential tsunami of cash from the $6 trillion held in money market funds, as interest rates fall, much of it may well find its way into stocks.

Not surprisingly, last year ended with some tax-loss harvesting (selling of big losers), and then the new year began last week with some tax-gain harvesting—i.e., selling of big winners to defer tax liability on capital gains into 2024. There also has been some notable rotation of capital last week into 2023’s worst performers that still display strong earnings growth potential and solid prospects for a rebound this year, such as those in the Healthcare, Utilities, and Consumer Staples sectors. Homebuilders remain near all-time highs and should continue to find a tailwind as a more dovish Fed means lower mortgage rates and a possible housing boom. Energy might be interesting as well, particularly LPG shipping (a big winner last year) due to its growing demand in Europe and Asia.

As I discussed in my December commentary, I also like the prospects for longer-duration bonds, commodities, oil, gold, and uranium miner stocks this year, as well as physical gold, silver, and cryptocurrency as stores of value in an uncertain macro climate. Also, while Chinese stocks are near 4-year lows, many other international markets are near multi-year highs (including Europe and Japan), particularly as central banks take a more accommodative stance. Indeed, Sabrient’s SectorCast ETF rankings show high scores for some international-focused ETFs (as discussed later in this post).

While stocks rallied in 2023 (and bonds made a late-year comeback) mainly due to speculation on a Fed pivot toward lower interest rates (which supports valuations), for 2024 investors will want to see more in the way of actual earnings growth and other positive developments for the economy. I expect something of a “normalization” away from extreme valuation differentials and continued improvement in market breadth, whether it’s outperformance by last year’s laggards or a stagnation/pullback among last year’s biggest winners (especially if there are fewer rate cuts than anticipated)—or perhaps a bit of both. Notably, the S&P 500 historically has risen 20 of the last 24 election years (83%); however, a recent Investopedia poll shows that the November election is the biggest worry among investors right now, so it’s possible all the chaos, wailing and gnashing of teeth about Trump’s candidacy will make this election year unique with respect to stocks.

Regardless, I continue to believe that investors will be better served this year by active strategies that can identify and exploit performance dispersion among stocks across the capitalization spectrum—particularly smaller caps and the underappreciated, high-quality/low-valuation growers. Small caps tend to carry debt and be more sensitive to interest rates, so they have the potential to outperform when interest rates fall, but you should focus on stocks with an all-weather product line, a robust growth forecast, a solid balance sheet, and customer loyalty, which makes them more likely to withstand market volatility—which may well include those must-have, AI-oriented Tech stocks. Much like the impact of the Internet in the 1990s, AI/ML, blockchain/distributed ledger technologies (DLTs), and quantum computing appear to be the “it” technologies of the 2020’s that make productivity and efficiency soar. However, as I discuss in today’s post, the power requirements will be immense and rise exponentially. So, perhaps this will add urgency to what might become the technology of the 2030’s—i.e., nuclear fusion.

On that note, let me remind you that Sabrient’s actively selected portfolios include the Baker’s Dozen (a concentrated 13-stock portfolio offering the potential for significant outperformance), Small Cap Growth (an alpha-seeking alternative to a passive index like the Russell 2000), and Dividend (a growth plus income strategy paying a 4.5% current yield).

By the way, several revealing economic reports were released last week, which I discuss in today’s post. One was the December reading on the underappreciated New York Federal Reserve Global Supply Chain Pressure Index (GSCPI), which has fallen precipitously from it pandemic-era high and now is fluctuating around the zero line. This historically suggests falling inflation readings ahead. As for the persistently inverted yield curve, I continue to believe it has more to do with the unprecedented supply chain shocks coupled with massive fiscal and monetary stimulus to maintain demand and the resulting surge in inflation, which as observed by Alpine Macro, “makes the inversion more reflective of different inflation expectations than a signal for an impending recession.”

Also, although M2 money supply fell -4.6% from its all-time high in July 2022 until its low in April 2023, it has essentially flatlined since then and in fact has been largely offset to a great extent by an increase in the velocity of money supply. Also, we have a robust jobs market that has slowed but is far from faltering. And then there is the yield curve inversion that has been gradually flattening from a low of about -108 bps last July to -35 bps today.

I discuss all of this in greater detail in today’s post, including several illustrative tables and charts. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which is topped by Technology), current positioning of our sector rotation model (which turned bullish in early November and remains so), and some actionable ETF trading ideas.

Overall, I expect inflation will resume its decline, even with positive GDP growth, particularly given stagnant money supply growth, mending and diversifying supply chains (encompassing manufacturing, transportation, logistics, energy, and labor), falling or stabilizing home sale prices and new leases, slowing wage inflation, slower consumer spending on both goods and services, and a strong deflationary impulse from China due to its economic malaise and “dumping” of consumer goods to shore up its manufacturing (US imports from China were down 25% in 2023 vs. 2022). This eventually will give the Fed (and indeed, other central banks) license to begin cutting rates—likely by mid-year, both to head off renewed crises in banking and housing and to mitigate growing strains on highly leveraged businesses, consumers, government, and trading partners. Current CBOE fed funds futures suggest a 98% chance of at least 100 bps in rate cuts by year end (target rate of 4.25-4.50%), and 54% chance of at least 150 bps.

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). And please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The New York Fed’s Global Supply Chain Pressure Index (GSCPI) for November was released today, and although it rose more than expected (likely due to disruptions from heightened global hostilities), it still suggests inflation will continue its gradual retreat, with a reading near the long-run average. But let me start by talking about October’s inflation indicators. Last week, the headline reading for Personal Consumption Expenditures (PCE) for October came in at 3.0% YoY, helped quite a bit by the fall in oil and gasoline prices (note: the US is producing an all-time high of 13.2 million barrels/day of crude oil). Core PCE, which is the Federal Reserve's preferred inflation metric, came in at 3.46% year-over-year. However, the month-over-month number for October versus September, which better reflects today's inflation trends and the lag effects of higher interest rates, came in at 0.16%, which annualizes to 1.98%. Keep in mind, the Fed's inflation target is 2.0%. But monthly data can be choppy, so looking at the rolling 3-month average, it annualizes to 2.37%.

Earlier reports had shown October PPI at 1.3% YoY and CPI at 3.2%, with core PPI (excluding food & energy) was 2.4% YoY, and core CPI was 4.0%. All of this was presaged by the GSCPI, which measures the number of standard deviations from the historical average value (aka Z-score) and generally foreshadows movements in inflation metrics. It plummeted from a December 2021 all-time high of +4.31 down to the October reading of -1.74—its lowest level ever. However, that ultra-low October reading has been revised to -0.39 due to “a change in exchange rate weighting methodology,” according to the New York Fed. Nevertheless, the writing was on the wall for last week’s favorable PCE report. The chart below illustrates the correlation between GSCPI, PPI, and CPI.

So, what to expect for November inflation? Well, as shown in the chart, GSCPI for November just came in today at 0.11. Although rising from its ultra-low levels, it still remains at the long-run average, and the chart illustrates that volatility is to be expected. All in all, I think it still bodes well for the next week’s CPI/PPI readings as supply chains continue to heal and diversify (albeit with occasional hiccups like we see today from heightened global hostilities), especially when you also consider that the consumer has become stretched with rising household debt and falling growth in job openings and wages, money supply growth is stagnant, and budget hawks are increasingly flexing their fiscal muscles in Congress. Thus, I believe the probability of a resurgence in either inflation or fiscal expansion is quite low.

Furthermore, although the second estimate for Q3 GDP was ultra-strong (the highest in 2 years), revised up to 5.2% annual rate (from previous 4.9%), the boost came from state and federal government spending, which was revised up to 5.5% from the prior estimate of 4.6% (i.e., more unsustainable deficit spending and issuance of Treasuries paying high coupons, mostly from an 8.2% increase in defense spending), while personal consumption was revised down to 3.6% from 4.0%. This tells me the “robust” GDP number was something of an illusion.

Indeed, looking ahead, the Atlanta Fed’s GDPNow forecasts only 1.3% GDP growth and 1.9% PCE growth for Q4 (as of 12/6). Moreover, the good folks at Real Investment Advice observed that Gross Domestic Income (GDI) for Q3 was reported at only +1.5%, displaying the widest gap below GDP in 50 years. (Note: GDP measures the value of goods and services produced, including consumption expenditures, investments and exports, while GDI measures incomes earned and costs incurred in production of GDP, including wages, profits, and taxes.) Also, last week’s Fed Beige Book showed that two-thirds of Fed districts reported slower economic activity over the prior six weeks, and the ISM Manufacturing Index came in at an anemic 46.7, showing continued contraction for the 15th straight month.

So, this all seems to be more “bad news is good news” when it comes to Fed policy moves, and investors will be eagerly watching Friday’s jobs report followed by next week’s CPI, PPI, and FOMC policy announcement. Stocks have been taking a healthy breather and consolidation in anticipation of it all, but so far, no major pullback. This year seems to be following the playbook of what economist Ed Yardeni has characterized as a series of “rolling recessions” (among sectors) and an “Immaculate Disinflation,” i.e., moderating inflation without a harsh recession or massive layoffs. As an aside, I have opined many times that it is ridiculous that we constantly find ourselves awaiting the edict of this unelected board of “wise elders” to decide our economic fate. Why can’t they take emergency measures only when absolutely necessary to avert economic cataclysm, and then once the crisis has passed, those emergency measures are quickly withdrawn so that the free market can get back to doing its productive, creative, wonderful thing? One can dream.

Regardless, in my view, the Fed is likely done with rate hikes and preparing for its eventual pivot to rate cuts—which I think will come sooner than most expect, likely before the end of H1 2024. Why? Because if inflation maintains its gradual downtrend while the Fed holds its overnight borrowing rate steady, the real (inflation-adjusted) rate keeps rising, i.e., de facto tightening. Indeed, Fed funds futures are projecting 98% chance for no rate change next week, and for 2024, 62% chance for at least one 25-bp rate cut by March, 97% for at least one 25-bp cut by June, and 89% chance of a full 1.0% in total rate cuts by December 2024, which would put the fed funds rate below 4.5%.

Accordingly, after kissing the 5% handle, the 10-year Treasury yield has fallen precipitously to below 4.2%—a level last seen at the end of August. So, I encourage and expect the FOMC to follow the message of the bond market and begin cutting the fed funds rate back towards the neutral rate, which I think is around 2.5-3.0% nominal (i.e., 2% target inflation plus 0.5-1.0% r-star), and hand back control of the economy to the free market. As of now, the Fed is on the verge of crushing the housing market…and by extension the broader economy. In addition, it must ensure money supply resumes a modest growth rate (albeit slowly), not continue to shrink or stagnate.

To be sure, the safe steadiness of bond yields was disrupted this year. After rising much faster than anyone anticipated, interest rates have fallen much faster than expected, especially considering that the Fed hasn’t made any dovish policy changes. Nevertheless, if rates are going to generally meander lower, investors might be expected to lock in sustainable yield with capital appreciation potential through longer-duration securities, including long-term bonds, “bond proxies” like dividend-paying equities (e.g., utilities, staples, and REITs), and growth stocks (like high-quality technology companies).

I also like oil, gold and uranium stocks, as well as gold, silver, and cryptocurrency as stores of value in an uncertain macro climate. Notably, gold is challenging its highs of the past few years as global investors and central banks are both hedging and/or speculating on a weaker dollar, falling real interest rates, rising geopolitical tensions, and potential financial crisis, and the World Gold Council reported robust demand among central banks, which purchased a record 800 tons during the first three quarters of the year. Similarly, Bitcoin is catching a bid on speculation of broader investor access (through spot-price ETFs) and dollar debasement (if debt and deficit spending continue to spiral).

Keep in mind that, when valuations get lofty within a given asset class, volatility and performance/valuation dispersion among stocks often increases while correlations decrease. For stocks, active selection strategies that can exploit the dispersion to identify under-the-radar and undervalued companies primed for explosive growth become more appealing versus passive index investing. Sabrient’s actively selected portfolios include the Q4 2023 Baker’s Dozen (launched on 10/20), Small Cap Growth 40 (launched on 11/3), and Sabrient Dividend 46 (just launched on 11/29, and today offers a 4.7% dividend yield).

In today’s post, I further discuss inflation, the US dollar, Fed monetary policy implications, and relative performance of asset classes. 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 turned bullish in early November and remains so), 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

Given the latest inflation reports last week and this week’s FOMC meeting, I thought I would offer up some perspective today in a short post. Although there are plenty of other issues to worry about, including the historic auto workers’ strike and an impending federal government shutdown, all eyes are focused on the Fed’s reaction to inflation and jobs reports in the form of monetary policy, specifically interest rates and money supply.

The 2-year yield again has been battling the important 5% threshold, which I have called a “line in the sand” for stocks. After challenging the March and July highs above 5% during August, it had appeared to me that it was just another buyable bond selloff, driven by the various reasons I discussed in my 9/1/2023 post. Indeed, yields pulled back substantially to end the month of August, as both bond and stock prices rose. But this month’s renewed weakness in bonds (and the rise in yields) suggests a “buyer’s strike” as investors generally have been moving to cash ahead of this week’s FOMC meeting. At the moment, resistance at the 5-handle seems to have given way, with the rate now at 5.10% as I write (and stocks are weak).

To be sure, last week’s inflation reports gave mixed signals. CPI and PPI both ticked up from their June lows of 3.0% and 0.1%, respectively, to August readings of 3.7% and 1.6%, which appear troubling to the Fed’s ongoing inflation fight. Certainly, the recent surge in oil prices to above $90 has hurt the cause, as has the stubborn shelter cost component, which makes up 42% of CPI. In addition, Mexico’s rise as a “near-shore” manufacturing hub for the US, its extreme wage inflation, and the extraordinary strength of the peso has increased prices of its exports to the US.

On the other hand, rising oil prices are like a tax on consumers, limiting their disposable income to buy other things. Same with the imminent student loan payment restart. Also, core rates (ex-food and energy) for CPI and PPI both fell to 4.3% and 2.2%, respectively. And given the emerging “lag effects” of rising interest rates on rents and owner’s equivalent rent (OER), many economists expect shelter costs to begin to decline very soon. Indeed, by Q4 2024, JPMorgan chief global strategist David Kelly expects both headline and core PCE to fall below the Fed’s 2% target and perhaps hit 1.5%, largely driven by declines in shelter costs, new and used car prices, auto insurance, and car maintenance. 

Below is an updated version of a chart I present from time to time. It compares trends in CPI and PPI versus the New York Fed’s Global Supply Chain Pressure Index (GSCPI), which measures the number of standard deviations from the historical average value. It also shows wage growth, M2 money supply (M2SL), and the S&P 500 (SPY). I know the chart is busy, but it tells a good story.

Read on....

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Stocks and bonds both sold off in August before finishing the month with a flourish, as signs that the jobs market is weakening suggest an end to Fed rate hikes is nigh. The summer correction in equities was entirely expected after the market’s extraordinary display of strength for the first seven months of the year in the face of a relentlessly hawkish Federal Reserve, even as CPI and PPI have fallen precipitously. State Street’s Institutional Investor Risk Appetite Indicator moved dramatically from bearish in May to highly bullish at the end of July, and technical conditions were overbought. And although the depth of the correction took the bulls by surprise, it was quite orderly with the CBOE Volatility Index (VIX) staying tame (i.e., never even approaching the 20 handle). In fact, a 5% pullback in the S&P 500 is not unusual given the robust 20% YTD return it had attained in those seven months. Weakness in bonds, gold, and commodity prices also reversed.

Moreover, IG, BBB, and HY bond spreads have barely moved during this market pullback despite rising real rates, which signals that the correction in stocks is more about valuations in the face of the sudden spike in interest rates (and fears of “higher for longer”) rather than the health of the economy, earnings, or fundamentals. Certainly, the US economy looks much stronger than any of our trading partners (which Fed chair Powell seems none too happy about), with the Atlanta Fed’s GDPNow model estimating a robust 5.6% growth for Q3 (as of 8/31) and the dollar surging in a flight to safety [in fact, the US Dollar Index Fund (UUP) recently hit a 2023 high].

However, keep in mind that the US is not an island unto itself but part of a complex global economy and thus not immune to contagion, so the GDP growth rate will likely come down. Moreover, Powell said in his Jackson Hole speech that the Fed’s job is “complicated by uncertainty about the duration of the lags with which monetary tightening affects economic activity and especially inflation.”

Investors have generally retained their enthusiasm about stocks despite elevated valuations, rising real interest rates (creating a long-lost viable alternative to stocks—and a poor climate for gold), a miniscule equity risk premium, and a Fed seemingly hell-bent on inducing recession in order to crush sticky core inflation. Perhaps stock investors have been emboldened by the unstoppable secular force of artificial intelligence (AI) and its immediate benefits to productivity and profitability (not just “hope”)—as evidenced by Nvidia’s (NVDA) incredible earnings release last week.

I have discussed in recent posts about how the Bull case seems to outweigh the (highly credible) Bear case. However, the key tenets of the Bull case—and avoidance of recession—include a stable China. Since 2015, I have been talking about a key risk to the global economy being the so-called “China Miracle” gradually being exposed as a House of Cards, and perhaps never before has it seemed so close to implosion, as it tests the limits of debt-fueled growth—and a creeping desperation coupled with an inability (or unwillingness) to pivot sharply from its longstanding policies makes it even more dangerous. I talk more about this in today’s post.

Yet despite all the significant challenges and uncertainties, I still believe stocks are in a normal/predictable summer consolidation—particularly after this year’s surprisingly strong market performance through July—with more upside to come. My only caveat has been that the 2-year Treasury yield needs to remain below 5%—a critical “line in the sand,” so to speak. Although I (and many others) often cite the 10-year yield because of its link to mortgage rates, I think the 2-year is important because it reflects a broad expectation of inflation and the duration of the Fed’s “higher for longer” policy. Notably, during this latest spike in rates, the 2-year again eclipsed that critical 5-handle for the third time this year and challenged the 7/5 intraday high of 5.12%, before pulling back sharply to close the month below 4.9%.

If the 2-year reverses again and surges to new highs, I think it threatens a greater impact on our economy (as well as our trading partners’) as businesses, consumers, and governments manage their maturing lower-rate debt—and ultimately impacts the housing market and risk assets, like stocks. But instead, I see it as just another short-term rate spike like we saw in March and July, as investors sort out the issues described in my full post below. Indeed, August finished with a big fall in rates in concert with a big jump in stocks, gold, crypto, and other risk assets across the board, as cracks in the jobs and housing markets are showing up, leading to a growing belief that the Fed is finished with its rate hikes—as I think they should be, particularly given the resumption of disinflationary secular trends and a deflationary impulse from China.

Some economists believe that extreme stock valuations and the ultra-low equity risk premium are pricing in both rising earnings and falling rates—an unlikely duo, in their view, on the belief that a strong economy is inherently inflationary while a weakening economy suggests lower earnings—and thus, recession is inevitable. But I disagree. For one, respected economist Ed Yardeni has observed that we have already been in the midst of a “rolling recession” across segments of the economy that is now turning into a “rolling expansion.” And regarding elevated valuations in the major indexes, my observation is that they are primarily driven by a handful of mega-cap Tech names. Minus those, valuations across the broader market are much more reasonable, as I discuss in today’s post.

Indeed, rather than passive positions in the broad market indexes, investors may be better served by strategies that seek to exploit improving market breadth and the performance dispersion among individual stocks. Sabrient’s portfolios include Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend, each of which provides exposure to market segments and individual companies that our models suggest may outperform. Let me know how I can better serve your needs, including speaking at your events (whether by video or in person).

As stocks and other risk assets finish what was once destined to be a dismal month with a show of renewed bullish conviction, allow me to step through in greater detail some of the key variables that will impact the market through year-end and beyond, including the economy, valuations, inflation, Fed policy, the dollar, and China…and why I remain bullish. I also review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors (topped by Technology and Energy) and serve up some actionable ETF trading ideas.

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Stocks continued their impressive 2023 rally through July, buoyed by rapidly falling inflation, steady GDP and earnings growth, improving consumer and investor sentiment, and a fear of missing out (FOMO). Of course, the big story this year has been the frenzy around the promise of artificial intelligence (AI) and leadership from the “Magnificent Seven” Tech-oriented mega caps—Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), NVIDIA (NVDA), Meta (META), Tesla (TSLA), and Microsoft (MSFT), which have led the powerhouse Nasdaq 100 (QQQ) to a +44.5% YTD return (as of 7/31) and within 5% of its all-time closing high of $404 from 11/19/2021. Such as been the outperformance of these 7 stocks that Nasdaq chose to perform a special re-balancing to bring down their combined weighting in the Nasdaq 100 index from 55% to 43%!

Because the Tech-heavy Nasdaq badly underperformed during 2022, mostly due to the long-duration nature of aggressive growth stocks in the face of a rising interest rate environment, it was natural that it would lead the rally, particularly given: 1) falling inflation and an expected Fed pause/pivot on rate hikes, 2) resilience in the US economy, corporate profit margins (largely due to cost discipline), and the earnings outlook; 3) the exciting promise of disruptive/transformational technologies like regenerative artificial intelligence (AI), blockchain and distributed ledger technologies (DLTs), and quantum computing.

But narrow leadership isn’t healthy—in fact, it reflects defensive sentiment, as investors prefer to stick with the juggernauts rather than the vast sea of economically sensitive companies. However, since June 1, there have been clear signs of improving market breadth, with the iShares Russell 2000 small caps (IWM), S&P 400 mid-caps (MDY), and S&P 500 Equal Weight (RSP) all outperforming the QQQ and S&P 500 (SPY). Industrial commodities oil, silver, and copper prices rose in July. This all bodes well for market health through the second half of the year (and perhaps beyond), as I discuss in today’s post below.

But for the moment, an overbought stock market is taking a breather to consolidate gains, take some profits, and pull back. The Fitch downgrade of US debt is helping fuel the selloff. I view it as a welcome buying opportunity.

Although rates remain elevated, they haven’t reached crippling levels (yet), and although M2 money supply has topped out and fallen a bit, the decline has been offset by a surge in the velocity of money supply, as I discuss in today’s post. So, assuming the Fed is done raising rates—and I for one believe the fed funds rate is already beyond the neutral rate (and thus contractionary)—and as long as the 2-year Treasury yield remains below 5% (it’s around 4.9% today), I think the economy and stocks will be fine, and the extreme yield inversion will begin to reverse.

The Fed’s dilemma is to facilitate the continued process of disinflation without inducing deflation, which is recessionary. Looking ahead, Nick Colas at DataTrek recently highlighted the disconnect between fed funds futures (which are pricing in 1.0-1.5% in rate cuts early next year) and US Treasuries (which do not suggest imminent rate cuts). He believes, “Treasuries have it right, and that’s actually bullish for stocks” (bullish because rate cuts only become necessary when the economy falters).

So, today we see inflation has fallen precipitously as supply chains improve (manufacturing, transport, logistics, energy, labor), profit margins are beating expectations (largely driven by cost discipline), corporate earnings have been resilient, earnings forecasts are seeing upward revisions, capex and particularly construction spending on manufacturing facilities has been surging, hiring remains robust (almost 2 job openings for every willing worker), the yield curve inversion is trying to flatten, gold and high yield spreads have been falling since May 1 (due to recession risk receding, the dollar firming, and real yields rising), risk appetite (“animal spirits”) is rising, and stock market leadership is broadening. It all sounds promising to me.

Regardless, the passive broad-market mega-cap-dominated indexes that were so hard for active managers to beat in the past may well face tough constraints on performance, particularly in the face of elevated valuations (i.e., already “priced for perfection”), slow real GDP growth, and an ultra-low equity risk premium. Thus, investors may be better served by strategic-beta and active strategies that can exploit the performance dispersion among individual stocks, which should be favorable for Sabrient’s portfolios including Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend.

As a reminder, Sabrient’s enhanced Growth at a Reasonable Price (GARP) “quantamental” selection process strives to create all-weather growth portfolios, with diversified exposure to value, quality, and growth factors, while providing exposure to both longer-term secular growth trends and shorter-term cyclical growth and value-based opportunities—with the potential for significant outperformance versus market benchmarks. Indeed, the Q2 2022 Baker’s Dozen that recently terminated on 7/20 handily beat the benchmark S&P 500, +28.3% versus +3.8% gross total returns. In addition, each of our other next-to-terminate portfolios are also outperforming their relevant market benchmarks (as of 7/31), including Small Cap Growth 34 (16.9% vs. 9.9% for IWM), Dividend 37 (24.0% vs. 8.5% for SPYD), Forward Looking Value 10 (38.9% vs. 20.8% for SPY), and Q3 2022 Baker’s Dozen (28.4% vs. 17.9% for SPY).

Also, please check out Sabrient’s simple new stock and ETF screening/scoring tools called SmartSheets, which are available for free download for a limited time. SmartSheets comprise two simple downloadable spreadsheets—one displays 9 of our proprietary quant scores for stocks, and the other displays 3 of our proprietary scores for ETFs. Each is posted weekly with the latest scores. For example, Lantheus Holdings (LNTH) was ranked our #1 GARP stock at the beginning of February. Accenture (ACN) was at the top for March, Kinsdale Capital (KNSL) in April, Crowdstrike (CRWD) in May, and at the start of both June and July, it was discount retailer TJX Companies (TJX). Each of these stocks surged higher (and outperformed the S&P 500)—over the ensuing weeks after being ranked on top. We invite you to download the latest weekly sheets for stocks and ETFs using the link above—it’s free of charge for now. And please send me your feedback!

Here is a link to my full post in printable format. In this periodic update, I provide a comprehensive market commentary, including discussion of inflation, money supply, and why the Fed should be done raising rates; as well as stock valuations and opportunities going forward. I also review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors and serve up some actionable ETF trading ideas. Read on…

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

After five straight weeks of gains—goosed by a sudden surge in excitement around the rapid advances, huge capex expectations, and promise of Artificial Intelligence (AI), and supported by the CBOE Volatility Index (VIX) falling to its lowest levels since early 2020 (pre-pandemic)—it was inevitable that stocks would eventually take a breather. Besides the AI frenzy, market strength also has been driven by a combination of “climbing a Wall of Worry,” falling inflation, optimism about a continued Fed pause or dovish pivot, and the proverbial fear of missing out (aka FOMO).

Once a debt ceiling deal was struck at the end of May, a sudden jump in sentiment among consumers, investors, and momentum-oriented “quants” sent the mega-cap-dominated, broad-market indexes to new 52-week highs. Moreover, the June rally broadened beyond the AI-oriented Tech giants, which is a healthy sign. AAIA sentiment moved quickly from fearful to solidly bullish (45%, the highest since 11/11/2021), and investment managers are increasing equity exposure, even before the FOMC skipped a rate hike at its June meeting. Other positive signs include $7 trillion in money market funds that could provide a sea of liquidity into stocks (despite M2 money supply falling), the US economy still forecasted to be in growth mode (albeit slowly), corporate profit margins beating expectations (largely driven by cost discipline), and improvements in economic data, supply chains, and the corporate earnings outlook.

Although the small and mid-cap benchmarks joined the surge in early June, partly boosted by the Russell Index realignment, they are still lagging quite significantly year-to-date while reflecting much more attractive valuations, which suggests they may provide leadership—and more upside potential—in a broad-based rally. Regardless, the S&P 500 has risen +20% from its lows, which market technicians say virtually always indicates a new bull market has begun. Of course, the Tech-heavy Nasdaq badly underperformed during 2022, mostly due to the long-duration nature of growth stocks in the face of a rising interest rate environment, so it is no surprise that it has greatly outperformed on expectations of a Fed pause/pivot.

With improving market breadth, Sabrient’s portfolios—which employ a value-biased Growth at a Reasonable Price (GARP) style and hold a balance between cyclical sectors and secular-growth Tech and across market caps—this month have displayed some of their best-ever outperformance days versus the benchmark S&P 500.

Of course, much still rides on Fed policy decisions. Inflation continues its gradual retreat due to a combination of the Fed allowing money supply to fall nearly 5% from its pandemic-response high along with a huge recovery in supply chains. Nevertheless, the Fed has continued to exhibit a persistently hawkish tone intended to suppress an exuberant stock market “melt-up” and consumer spending surge (on optimism about inflation and a soft landing and the psychological “wealth effect”) that could hinder the inflation battle.

Falling M2 money supply has been gradually draining liquidity from the financial system (although the latest reading for May showed a slight uptick). And although fed funds futures show a 77% probably of a 25-bp hike at the July meeting, I’m not so sure that’s going to happen, as I discuss in today’s post. In fact, I believe the Fed should be done with rate hikes…and may soon reverse the downtrend in money supply, albeit at a measured pace. (In fact, the May reading for M2SL came in as I was writing this, and it indeed shows a slight uptick in money supply.) The second half of the year should continue to see improving market breadth, in my view, as capital flows into the stock market in general and high-quality names in particular, from across the cap spectrum, including the neglected cyclical sectors (like regional banks).

Regardless, the passive broad-market mega-cap-dominated indexes that were so hard for active managers to beat in the past may well face high-valuation constraints on performance, particularly in the face of slow real GDP growth (below inflation rate), sluggish corporate earnings growth, elevated valuations, and a low equity risk premium. Thus, investors may be better served by strategic-beta and active strategies that can exploit the performance dispersion among individual stocks, which should be favorable for Sabrient’s portfolios—including Q2 2023 Baker’s Dozen, Small Cap Growth 38, and Dividend 44—all of which combine value, quality, and growth factors while providing exposure to both longer-term secular growth trends and shorter-term cyclical growth and value-based opportunities. (Note that Dividend 44 offers both capital appreciation potential and a current yield of 5.1%.)

Quick reminder about Sabrient’s stock and ETF screening/scoring tool called SmartSheets, which is available for free download for a limited time. SmartSheets comprise two simple downloadable spreadsheets—one displays 9 of our proprietary quant scores for stocks, and the other displays 3 of our proprietary scores for ETFs. Each is posted weekly with the latest scores. For example, Lantheus Holdings (LNTH) was ranked our #1 GARP stock at the beginning of February before it knocked its earnings report out of the park on 2/23 and shot up over +20% in one day (and kept climbing). At the start of March, it was Accenture (ACN). At the beginning of April, it was Kinsdale Capital (KNSL). At the beginning of May, it was Crowdstrike (CRWD). At the start of June, it was again KNSL (after a technical pullback). All of these stocks surged higher—while significantly outperforming the S&P 500—over the ensuing weeks. Most recently, our top-ranked GARP stock has been discount retailer TJX Companies (TJX), which was up nicely last week while the market fell. Feel free to download the latest weekly sheets using the link above—free of charge for now—and please send us your feedback!

Here is a link to my full post in printable format. In this periodic update, I provide a comprehensive market commentary, including discussion of inflation and why the Fed should be done raising rates, stock valuations, and the Bull versus Bear cases. I also review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors and serve up some actionable ETF trading ideas. Read on…

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

April CPI and PPI both reflect continued moderation—albeit as much as the precipitous fall in the Global Supply Chain Pressure Index would suggest (given that supply chains comprise nearly 40% of inflation, according to the New York Fed). The fed funds rate is now officially above both CPI and PCE. Nevertheless, despite hinting in their May FOMC statement that a pause in rate hikes may be imminent, the Fed insists there are no rate cuts in the foreseeable future because inflation remains stubbornly high. But this singular focus on inflation is ignoring all the fallout their hawkishness is causing—which is why investors are not buying it, and instead are pricing in a 99% chance of at least one 25-bp rate cut by year-end and a 17% chance of four cuts (according to CME Group fed funds futures, as of 5/12) while scooping up Treasuries. Regardless, I expect inflation readings to fall substantially over the coming months.

On the good-news front, both investment grade and high yield bond spreads remain tame and in fact are roughly the same level as they were one year ago. Typically, a rise in credit spreads corresponds to a drop in the S&P 500, and indeed the SPY is roughly unchanged over the past year as well. So, apparently there is little fear of a “hard landing” or mass defaults on corporate debt. And given the historical 90% correlation between economic growth and corporate profits, the better-than-expected Q1 earnings season is promising. Certainly juggernaut/bellwether Apple (AAPL) and most of its mega-cap Tech (or near-Tech) cohorts (aka FAANGM) have done their part.

So, this all supports the bull case, right? If inflation remains in a downward trend while earnings are holding up, and investors are so confident in imminent rate cuts, then why are most stocks (other than the aforementioned mega caps) struggling for traction?

Well, it seems there’s always something else to worry about. There is the regional banking crisis (and associated credit crunch) that refuses to go away quietly, thanks to nervous depositors who don’t want to be the last ones left holding the bag. And then there is that pesky debt ceiling standoff, which is easily fixable but also highly politically charged. Amazingly, US credit default swaps are currently priced higher than in emerging markets (including debt graveyards like Mexico, Greece, and Brazil), with potential payouts upwards of 2,500% if the crap hits the fan, according to Bloomberg! Why then are Treasuries simultaneously getting bought up? I think it’s because there’s no doubt about “if” interest will be paid but rather “when,” so they serve as both a value play and a safe haven.

In my view, overly dovish fiscal and monetary policies during the pandemic lockdowns (helicopter money and surging money supply) followed by hawkish policies (rapid increase in interest rates and shrinking of money supply) have been overly disruptive to the both the US and global economies, including a severely inverted yield curve (consistently 50-60 bps on the 10-2 year Treasuries), a banking crisis, and a strong dollar (as a safe haven, despite the recent pullback), which has exported inflation to emerging markets, exacerbating geopolitical turmoil and mass migration (including our border crisis)—not to mention paralysis in the US housing market as homeowners are reluctant to sell and give up their low interest rate mortgages. So, I continue to believe the FOMC has gone too far, too fast in raising rates in its single-minded focus on inflation—which was already destined to fall as supply chains (including manufacturing, transportation, logistics, labor, and energy) gradually recovered.

Moreover, the apparent strength and resilience of the mega-cap-dominated S&P 500 and Nasdaq 100 is a bit of an illusion. While the FAANGM stocks provided strong earnings reports and have performed quite well this year, beneath the surface the story is less inspiring, as illustrated by the relative performance of the equal-weight and small-cap indexes, as I discuss below. From a positive standpoint, fearful investor sentiment is often a contrarian signal, and elevated valuations of the broad market indexes—24.6x forward P/E for the Nasdaq 100 (QQQ) and 18.1x for the S&P 500 (SPY)—suggest that investors expect lower interest rates ahead. However, the high valuations and relatively low equity risk premium (ERP) on those mega-cap-dominated indexes may lead institutional investors to target small and mid-cap stocks as inflation falls and rate cuts arrive, such that market breadth improves.

I believe this enhances the opportunity for skilled active selection and strategic beta indexes that can exploit elevated dispersion among individual stocks. It was money supply (and the resultant asset inflation) that pushed up stock prices. So, if money supply continues to recede, while it will help suppress inflationary pressures, it will be difficult for the mega-cap-driven market indexes to advance—although well-chosen, high-quality individual stocks can still do well.

On that note, the Q2 2023 Baker’s Dozen launched on 4/20. The portfolio has a diverse mix across market caps, equally split between value and growth and between cyclical and secular growers. Some of the constituents are familiar names, like large-cap Delta Airlines (DAL), but many are relatively “under the radar” stocks, like mid-cap cloud security firm Zscaler (ZS), small-cap oil & gas services firm NextTier Oilfield Solutions (NEX), and small-cap mortgage servicer Mr. Cooper Group (COOP). By the way, Sabrient’s newest investor tool is called SmartSheets, providing fast and easy scoring, screening, and monitoring of over 4,200 stocks and 1,200 equity ETFs, and they are available for free download for a limited time. SmartSheets comprise two simple downloadable spreadsheets with 9 of our proprietary quant scores for stocks and 3 scores for ETFs. Please check them out and send me your feedback!

Here is a link to my full post in printable format. In this periodic update, I provide a comprehensive market commentary, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors, and serve up some actionable ETF trading ideas. Read on…