by Scott Martindale
CEO, Sabrient Systems LLC
Quick note 1: Sabrient’s Q3 2026 Baker’s Dozen portfolio (13 top picks) will launch on 10/20. On that day, our Q2 2025 Baker’s Dozen will terminate, and it is up +37.2% gross total return vs. +24.4% for SPY as of 10/2. Also, our quarterly Small Cap Growth 52 portfolio launched on 9/15, with a mix of 44 small-cap stocks across 9 business sectors. SCG 47 terminates on 10/16 and is up +38.9% vs. +22.5% for S&P 600 Small Cap Growth (SLYG) as of 10/2. It followed the launch of Sabrient’s annual Forward Looking Value 14 portfolio on 8/26, having a diverse mix of 31 stocks across 9 business sectors and a large/SMID-cap mix. Last year’s FLV 13 terminates on 11/17 and is up +35.7% vs. +16.3% for S&P 500 Value (SPYV) and +21.2% for S&P 500 (SPY) as of 10/2.
Quick note 2: I was recently a guest on the “Biz Wiz” podcast to tell my humble career story from engineering school to the oil industry to investment research and eventually CEO of Sabrient Systems. Key takeaway from the 30-minute discussion is that an entrepreneurial mindset means adaptability, resilience, focusing on high-potential projects, avoiding rabbit holes, responding to customer needs, creating and scaling value, and advocating for yourself and your ideas. I’d love to hear your impressions!
Overview:
September saw the convergence of several big issues for investors, including: 1) oil price (WTI) and the diesel crack spread both surging above the $100 mark, 2) soaring bond yields and bond volatility (with the 10-year Treasury hitting 5.35%, its highest since 2002, and 30-year mortgages hitting 7.28%), 3) the first Fed rate hike since July 2023, and 4) sudden apocalyptic warnings that unbridled AI could “kill us all by the end of the decade.” And on top of it all, companies and funds with “AI” in their name may to have change it to “SI” (for super intelligence), at least according to our president. The bond market (and the so-called “bond vigilantes”) drove up longer-term rates too rapidly, and so the Fed seems to have decided it had to react to what the market was reflecting—even though jobs and wage growth are stagnant while core inflation is moderating.
Alas, after a one-day pullback, yields surged higher anyway. But I think this is simply a “blowoff top” that will soon put a cap on the 10-year, which suggests to me a buying opportunity for longer duration bonds. Just as the adage about inflation says, “the cure for high prices is high prices,” suggesting a self-correcting loop, similarly the cure for high yields is high yields, meaning that the guaranteed return of bonds becomes increasingly competitive with more-volatile equity returns, attracting demand. I also think oil prices have seen their highs given all the effective workarounds, which should further reduce inflationary pressures and help cap bond yields.
Regardless, I believe the Fed’s hawkishness is a policy mistake given our bifurcated K-shaped economy. We have soaring corporate profits and stock prices juxtaposed with stagnant labor and housing markets, negative real wage growth, a low personal saving rate, and surging high-yield spreads—not to mention softening core inflation and underlying structural disinflationary trends.
In my comprehensive commentary below, I discuss:
1. The sudden AI panic is just the latest in a long lineage of imminent existential doomerism
2. Bureaucrats blunder into the AI fray
3. Stock valuations and bond yields
4. National debt and de-dollarization debate
5. The “debasement trade”
6. Jobs, inflation, and the K-shaped economy
7. My Final Comments essay: Time to vote!
8. Sabrient’s sector rankings, positioning of our sector rotation model, and some top-ranked ETF ideas
The healthy improvement in market breadth we saw for much of the year ended in mid-August, at which time bitcoin surged, the S&P 500 went sideways, the Nasdaq 100 consolidated gains and then surged to new highs, while the equal-weight S&P 500 (RSP), mid-cap S&P 400 (MDY), and small-cap Russell 2000 (IWM) all sold off. And of course, all of September saw a surge in yields—which is correlated with the selloff in all those non-Tech, interest-rate-sensitive stocks.
It seems that the FOMC saw rising yields as a supply problem at its July meeting but a demand problem today. By that I mean a supply-driven rise in yields reflects global supply shocks that raise inflation and weaken economic growth, whereas a demand-driven rise in yields reflects stronger-than-expected economic activity such that markets expect the Fed to keep rates higher-for-longer and thus are demanding more term premium.
The Fed's earlier patience assumed the supply/energy shock would soon fade. But with relentless AI/SI spending driving strong demand, the supply/energy problem became a demand problem in the eyes of the FOMC. And when all you have is a hammer, every problem looks like a nail—thus the rate hike. Fed chair Kevin Warsh said, “Our decision comes at a time when the American economy appears to be strengthening. New hiring, private-sector earnings, business capital investment. Each of these markers has improved in recent months and is pointing in a good direction. Credit flows have been robust, particularly for businesses.”
Indeed, on 9/11, the Fed announced that US national household net worth surged to over $195.9 trillion in Q2 (604% of GDP), primarily driven by capital gains on stocks. Q2 saw the 11th straight quarterly increase and the largest in history at $12.8 trillion—which amazingly exceeds the total annual GDP of every country in the world except the US ($32.4 trillion) and China ($20.8 trillion) as well as the aggregate GDP of the EU ($23.0 trillion, led by Germany’s $5.4 trillion). It’s the 11th consecutive quarterly rise, and the current number is 2x our household wealth since 2020. In addition, the ratio of net worth to disposable personal income (DPI), a measure of households’ potential to finance consumption out of their wealth, reached a record high of 8.3x in Q2.
As for inflation, Trimmed Mean PCE inflation, Core CPI, all the 3-month annualized trends, the 5-year breakeven, and real-time, blockchain-based Truflation all put underlying inflation much closer to (or even below) the Fed’s 2.0% target, as I detail below. Once the energy/supply shock resolves, the structural disinflationary trends should take control once again, e.g., aging demographics, slowing global population growth, accelerating disruptive innovation, automation, rising productivity, and re-globalization of supply chains (“excess productive capacity”).
Last Friday’s disappointing jobs report seemed to trigger an oversold bounce in stocks on the expectation that the Fed will soften. The question is whether this is sustainable or whether it’s just a technical bounce that will be stymied by overhead resistance (aka the proverbial “dead cat bounce”).
Again, I think the Fed made a policy mistake by hiking. The problem is, interest rates impact the whole economy—they can’t be targeted—and monetary policy is clearly restrictive in the most rate-sensitive industries and demographics (despite what Warsh states in his official comments about the broader economy). And even if they could be targeted, the upper leg of the K-shaped economy is largely rate-insensitive, including 1) cash-rich hyperscalers and other equity-capitalized Tech companies that are driving record earnings growth in a powerful secular growth story, and 2) Baby Boomers who are now freely spending their wealth in retirement without taking on debt. But the struggling lower leg of the K (small businesses and lower-income and working-class consumers) is highly rate-sensitive, and yet it is being given the same bad medicine as the robust upper leg. Moreover, it’s bad for government borrowing, further raising out-of-control interest expense, with a massive debt maturity wall coming due for rollover.
Regardless, I expect to see—through the end of this decade and likely beyond—smaller government and less low-ROI government spending in favor of more high-ROI capital allocation from an unleashed private sector as the primary engine of organic economic growth through fiscal support like favorable tax policy, deregulation, and other supply-side incentives for reshoring/onshoring to increase productive capacity. And for now, global liquidity remains abundant, continuing to hit new highs.
As such, I still think the S&P 500 will reach 8,000 by year end. Of course, it largely depends on the upcoming Q3 earnings reports and forward guidance, which have been beyond stellar so far this year, but expectations are becoming challenging. We got the September pullback I expected, with the S&P 500 successfully testing support at its 50-day moving average. However, as the GMO Asset Allocation team observed, “For the first time in twenty years, with the brief exception of the Global Financial Crisis, we are seeing net dilution in the U.S. stock market (i.e., share issuance exceeding share buybacks) as the hyperscalers continue their capital expenditure spree.”
But assuming core inflation metrics continue to moderate and the Fed comes to its senses on tightening, I expect a resumption in the healthy market broadening beyond the AI trade, and I continue to see opportunities in active stock selection, equal-weight indexes, value stocks, cyclical sectors, small caps, and bond-alternative dividend payers.
Indeed, Sabrient’s quant-based, actively selected (“quantamental”), equal-weight Baker’s Dozen, Forward Looking Value, Dividend, and Small Cap Growth portfolios have been largely outperforming their benchmarks—several by substantial margins. And as a reminder, our Earnings Quality Rank (EQR) is licensed as a quality prescreen to the actively managed, low-beta First Trust Long-Short ETF (FTLS), which now holds more than $2.6 billion in AUM.
Sabrient employs a wide variety of fundamental financial factors in our quantitative multifactor models and portfolio selection process. Sabrient Scorecards for Stocks and ETFs are investor tools that provide access to several of our proprietary models for portfolio monitoring and for idea generation for four key investing styles—Growth, Value, Dividend, and Small Cap Growth. To learn more, visit this link: https://www.moonrockstopowerstocks.com/scorecard.
Here is a link to this full post in printable PDF format. As always, I’d love to hear from you! Please feel free to email me your thoughts on this article or if you’d like me to speak on any of these topics at your event. Read on….
