by Scott Martindale
  CEO, Sabrient Systems LLC

  Overview

So much for the adage, “Sell in May and go away.” May was the best month for the stock market since November 2023 and the best month of May for the stock market in 35 years, with the S&P 500 up +6.1% and Nasdaq 100 up +9.3%. Moreover, the S&P 500 has risen more than 1,000 points (20%) from its 4/8 low and is back into positive territory YTD (and challenging the 6,000 level). History says when stocks rally so strongly off a low, the 12-month returns tend to be quite good. Even better news is that the rally has been broad-based, with the equal-weight versions of the indexes performing in line with the cap-weights, and with the advance/decline lines hitting all-time highs. An as Warren Pies of 3Fourteen Research observed on X.com, “…the S&P 500 has retraced 84% of its peak-to-trough decline. The [market] has never retraced this much of a bear market and subsequently revisited the lows. The technical evidence points, overwhelmingly, to the beginning of another leg to the bull market and new ATHs.” We certainly aren’t seeing the H1 volatility I expected, with the CBOE Volatility Index (VIX) back down to February levels. So, is this the all-clear signal for stocks? Well, let’s explore this a bit.

As Josh Brown of Ritholtz Wealth Management reminds us, “Stocks [tend to] bottom in price a full 9 months before earnings do… By the time earnings are reaching their cycle low, stocks have already been rallying for three quarters of a year in advance of that low. This is why you don’t wait to get invested or attempt to sit out the economic or earnings downturns.” Typically, the growth rates for GDP, corporate earnings, wages, and stock prices should not stray too far apart since they are all closely linked to a strong economy. And as of 6/9, the Atlanta Fed’s GDPNow model indicates an eye-popping +3.8% growth is in store for Q2 (albeit largely due to a collapse in imports following the negative Q1 print from front-running of imports, ahead of the tariffs).

And with the last administration’s last-minute surge in deficit spending wearing off, the new administration is doing quite well in bringing down inflation, starting with oil prices. Indeed, April CPI came in at +2.33% YoY and the rolling 3-month annualized CPI (a better measure of the current trend) is +1.56%. Looking ahead, the Cleveland Fed’s Inflation NowCasting model forecasts May CPI of +2.40% YoY and an annualized Q2 CPI of +1.70%, while the real-time, blockchain-based Truflation metric is +1.90% (as of 6/9). After all, disruptive innovation like AI is deflationary by increasing productivity, China’s economic woes are deflationary (cheaper goods), and tariffs are deflationary (in the absence of commensurate rise in income), so the rising GDP forecast and falling CPI numbers reflect the exact oppositive of the “stagflation” scare the MSM keeps trumpeting. I discuss inflation in greater length in today’s post below.

It all sounds quite encouraging, right? Well, not so fast. For starters, the charts look severely overbought with ominous negative divergences that could retrace a lot of gains. Moreover, with ISM manufacturing and services indexes both in contraction, with so much lingering uncertainty around trade negotiations, with President Trump’s “one big, beautiful bill” (aka OBBB) wending a treacherous path through congress, and with his ambitious drive to reverse the course and negative outcomes of decades of hyper-globalization, entitlement creep, and climate/cultural activism facing fierce resistance both at home and abroad, the coast is hardly clear.

Witness the rise in bond term premiums even as the Fed contemplates cutting its benchmark rate as foreign central banks and bond vigilantes slash demand for Treasuries (or even sell them short) due to expectations of unbridled federal debt and Treasury issuance. According to Mike Wilson of Morgan Stanley: “we identified 4%-4.5% [10-year yield] as the sweet spot for equity multiples, provided that growth and earnings stay on track.” Similarly, Goldman Sachs sees 4.5% acting as a ceiling for stock valuations—and that is precisely where the rate closed on Friday 6/6. Wilson identified four factors that he believes would sustain market strength: 1) a trade deal with China, 2) stabilizing earnings revisions, 3) a more dovish Fed (i.e., rate cuts), and 4) the 10-year yield below 4% (without being driven by recessionary data)—but there has been observable progress only in the first two.

Regarding our debt & deficit death spiral, I will argue in my full commentary below that despite all the uproar, the OBBB might not need to institute harsh austerity with further cuts to entitlements (which, along with interest on the debt, amount to 73% of spending) that would mostly hurt the middle/working classes. The bill rightly repeals low-ROI tax credits and spending for boondoggles from prior bills, most notably low-transformity/low-reliability wind and solar energy projects that require government subsidies to be economically viable. But beyond that, the focus should be on lowering the debt/GDP ratio through fiscal and monetary policies that foster robust organic economic growth (the denominator) led by an unleashed private sector fueled by tax rate cuts and incentives for capital investment, deregulation, disruptive innovation, and high-transformity/high-reliability natural gas and next-generation nuclear technology. Real Investment Advice agrees, arguing that market pundits might be “too focused on the deficit amount…rather than our ability to pay for it, i.e., economic growth.”  The charts below show the debt-to-GDP ratio, which is about 120% today, alongside the federal deficit-to-GDP ratio, which is about 6.6% today. (Note that US Treasury Secretary Scott Bessent’s target of 3% deficit-to-GDP was last seen in 2016.)

Of course, nothing is all bad or all good. But Trump is shining a bright light on the devastating fallout on our national security, strategic supply chains, and middle/working classes. Changing the pace and direction of globalization, including deglobalizing some supply chains, reshoring strategic manufacturing, and focusing on low-cost energy solutions for a power-hungry world cannot occur without significant disruption. Within the US, we can have different states provide different types of industries and services depending upon their comparative advantages like natural resources, labor costs, demographics, geography, etc.—after all, we are all part of one country. But on a global scale, with some key trading partners that might be better considered rivals, or even enemies in some cases, we can’t entrust our national security to the goodwill and mutual benefit of international trade. Indeed, China has a history of not fulfilling its commitments in prior trade agreements, like reducing state subsidies overproduction (“dumping”), and IP theft, moving some manufacturing into the US, and increasing imports of US goods.

I have talked often about the 3-pronged approach of addressing our federal debt by: 1) inflating it away with slightly elevated inflation around 2.4% to erode the value of dollars owed and increase nominal GDP to reduce the debt-to-GDP ratio, 2) cutting it away with modest reductions or at least freezes on spending and entitlements, and 3) growing it away by fostering robust organic growth from a vibrant private sector with pro-cyclical fiscal and monetary policies that ultimately grows tax receipts on higher income and GDP (even at lower tax rates) and reduces the debt-to-GDP ratio. But of these three, the big “clean-up hitter” must be #3—robust growth. In fact, a key reason that the OBBB does not propose more austerity measures (i.e., spending cuts beyond waste, fraud, and the “peace dividend”) is to ensure that GDP grows faster than the debt and deficit. We can only live with slightly elevated inflation, and it is difficult to cut much spending given the dominance of mandatory spending (entitlements and interest payments) over discretionary spending. So, the primary driver must be robust private sector organic growth—and by extension an embrace of disruptive innovation and a productivity growth boom that boosts real GDP growth, keeps a lid on inflation, widens profit margins—leading to rising wages tax remittances.

As a case in point, I highly recommend a recent episode of the All-In Podcast in which the panel of four Tech billionaires (of various political persuasions) speak with Miami Mayor Francis Suarez. In 2017, Suarez took over leadership of a city that was in distress, near bankruptcy, and a murder capital of the country, and he resurrected it with three core principles for success: “keep taxes low, keep people safe, lean into innovation”—whereas he laments that most other big-city mayors prefer to do the opposite, i.e., raise taxes, tolerate crime, create suffocating regulations, and reject the offers and entreaties of billionaire entrepreneurs like Jeff Bezos (Amazon) and Elon Musk (Tesla) as overly disruptive or politically incorrect.

May inflation metrics will come out this week, and then the June FOMC meeting convenes 6/17-18. So far, the FOMC has been quite happy to just sit on its hands (while the ECB just cut for an 8th time) in the face of tariff paralysis; falling oil prices, unit labor costs, and New Tenant Rents; declining inflation and savings rates; rising delinquencies; and slowing jobs growth; instead preferring to be reactive to sudden distress rather than proactive in preventing such distress. Inflation metrics continue to pull back after being propped up by elevated energy prices, long-lag shelter costs, and the prior administration’s profligate federal deficit spending that overshadowed—and indeed created—sluggish growth in the private sector. Economist Michael Howell of CrossBorder Capital persuasively asserts that monetary policy “must prioritize liquidity over inflation concerns, so the Fed’s current hands-off, higher-for-longer, reactionary approach risks causing a liquidity crunch.”

So, I believe it’s going to be hard for Fed Chair Jay Powell to justify continuing to “wait & watch.” As of 6/9, CME Group fed funds futures show zero odds of a 25-bp rate cut this month, but increases to 17% at the July meeting, and 64% odds of at least 50 bps by year-end. I have been insisting for some time that the FFR needs to be 100 bps lower, as the US economy's headline GDP and jobs numbers were long artificially propped up by excessive, inefficient, and often unproductive federal deficit spending, while the hamstrung private sector has seen sluggish growth, and 30-year mortgage rates need to be closer to 5% to allow the housing market to function properly. But regardless of the FOMC decision this month, I expect the rate-cutting cycle to restart soon and signed trade deals to emerge with our 18 key trading partners, calming domestic and foreign investors.

I still expect new highs in stocks by year end. For now, traders might wait for a pullback and bounce from support levels, or perhaps an upside breakout beyond the 6,000 level on the S&P 500. But my suggestion to investors remains this: Don’t chase the highflyers and instead focus on high-quality businesses at reasonable prices, expect elevated volatility given the uncertainty of the new administration’s policies and impact, and be prepared to exploit any market pullbacks by accumulating those high-quality stocks in anticipation of gains by year end and beyond, fueled by the massive and relentless capital investment in blockchain and AI applications, infrastructure, and energy, leading to rising productivity, increased productive capacity (or “duplicative excess capacity,” in the words of Secretary Bessent, which would be disinflationary), and economic expansion, as I explore in greater depth in my full post below.

Rather than investing in the passive cap-weighted indexes dominated by Big Tech, investors may be better served by active stock selection that seeks to identify under-the-radar, undervalued, high-quality gems. This is what Sabrient seeks to do in our various portfolios, all of which provide exposure to Value, Quality, Growth, and Size factors and to both secular and cyclical growth trends. When I say, “high-quality company,” I mean one that is fundamentally strong, displaying a history of consistent, reliable, and accelerating sales and earnings growth, a history of meeting/beating estimates, high capital efficiency, rising profit margins and free cash flow, solid earnings quality, low debt burden, and a reasonable valuation compared to its peers and its own history. These are the factors Sabrient employs in selecting our Baker’s Dozen, Forward Looking Value, Dividend, and Small Cap Growth portfolios (which are packaged and distributed as UITs by First Trust Portfolios). We also use many of those factors in our SectorCast ETF ranking model, and notably, our proprietary Earnings Quality Rank (EQR) is a key factor used in each of our portfolios, and it is also licensed to the actively managed First Trust Long-Short ETF (FTLS) as a quality prescreen.

Sabrient founder David Brown describes these and other factors as well as his portfolio construction process in his latest book. He also describes his path from NASA scientist in the Apollo moon landing program to creating quant models for ranking stocks and building stock portfolios. And as a companion product to the book, we have launched our next-generation Sabrient Scorecards for Stocks and ETFs, which are powerful digital tools that rank stocks and ETFs using our proprietary factors. You can learn more about both the book and scorecards by visiting: http://HighPerformanceStockPortfolios.com.

Keep in mind, stock market tops rarely happen when investors are cautious, as they continue to be today. So, I continue to believe in staying invested in stocks but also in gold, gold royalty companies, Bitcoin (as an alternative store of value), and perhaps Ethereum (for its expanding use case). These not only serve as hedges against dollar debasement but as core holdings within a strategically diversified portfolio. Bitcoin’s climb back to new highs in May has been much more methodical and disciplined than its previous history of maniacal FOMO momentum surges that were always destined to retrace. This is what comes from maturity and broader institutional acceptance, characterized by “stickier” holders and strategic allocations. Notably, iShares Bitcoin Trust ETF (IBIT) had its largest-ever monthly inflow during May.

I highly encourage you to read my full commentary below. I discuss in greater depth the economic metrics, the truth about the OBBB, deglobalization, trade wars, affordable energy, economic growth, jobs, inflation, and global liquidity. I also discuss Sabrient’s latest fundamental-based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model, and several top-ranked ETF ideas. Click HERE for a link to this post in printable PDF format.

By the way, rather than including my in-depth discussion of energy and electrical power generation in this post, I will be releasing it in a special report a little later this month, so please watch for it. As always, please let me know your thoughts on this article, and feel free to contact me about speaking on any of these topics at your event!  Read on….

 Overview

 Market indexes regained all of their losses since the president’s “Liberation Day” tariff announcement one month ago, culminating in an historic +10% 9-day rally for the S&P 500 (and +18% from its 4/7 intraday low) that sent it back above its 20-day and 50-day moving averages to test resistance at its 200-day. But was this just a short-covering relief rally as bearish commentators assert? I said in my April post that the $10 trillion that left the stock market was not the “capital destruction” they claimed, like a wildfire burning down homes, but rather a rotation into the safety of bonds and cash that could quickly rotate back. Sure enough, when retail investors swooped in to scoop up the suddenly fair valuations of the capitulation selloff, leveraged algo momentum traders quickly joined in. But while I think the longer term holds promise, the chart became short-term overbought (and is pulling back this week), and macro conditions are still treacherous, keeping investors jittery and headline-driven. So, the market remains fragile even as we wind down a solid Q1 earnings reporting season, with the FOMC policy announcement on tap this week.

Nevertheless, in my view, positive signs are emerging to suggest: 1) the trade war (particularly with China) and the hot war in Ukraine will both find their way to a resolution, 2) the fiscal legislation (“one big, beautiful bill”) with new tax cuts working its way through congress will soon be passed, 3) the size and scope of federal government that has crowded out the private sector is shrinking and making way for re-privatization and de-regulation of the economy to unleash organic private sector growth, 4) corporate earnings and capex commitments remain strong, and 5) the Federal Reserve will ensure liquidity growth and restart its rate-cutting cycle like other central banks—and liquidity leads pricing in risk asset markets, gold, and cryptocurrencies. So, I think the noise will quiet and the clouds will clear, making way for a renewed focus on corporate earnings and global liquidity to power forward the economy and stocks. And don’t forget—the market loves to climb a wall of worry, which means it discounts the future and typically turns well in advance of the economic and sentiment metrics.

Of course, the biggest news that juiced the stock market is the apparent offramp forming for the trade stalemate between the US and China. Publicly, China has been saber-rattling as a Trumpian bargaining tactic, in my view, and to stoke the flames of political division in our country with midterms on the docket next year—something the CCP doesn’t have to worry much about. Indeed, it has been loath to give an inch even though its economy was already struggling with deflation, a long-running property crisis, sluggish consumer demand, overcapacity, and weak business and consumer confidence well before the recent tariff escalation. Its services PMI just hit a 7-month low, its manufacturing PMI has officially fallen into contraction at 49.0, and its new export orders component plunged to the lowest reading since the pandemic at 44.7. And although China insists the US “unilaterally” started the trade war, the truth is we are finally pushing back after years of turning a blind eye to their tariffs, IP theft, forced technology transfers, hacking, state subsidies, dumping of goods, fentanyl trafficking, and currency manipulation.

In my view, the US is in far better position to weather a brief trade war than mercantilist China. As Treasury Secretary Scott Bessent succinctly articulated, “China’s business model is predicated on selling cheap, subsidized goods to the US, and if there is a sudden stop in that, they will have a sudden stop in their economy. So, they will negotiate.” Both governments know that an escalating trade war with big tariffs and a tight US Federal Reserve is especially bad for China. The dollar/yuan exchange rate is crucially important to China, and the dollar today is nearly as strong it has been against the yuan since yuan’s devaluation during the Global Financial Crisis. With its massive dollar-denominated debt, a weaker dollar relieves China’s financial strain by boosting global liquidity to the benefit of both countries. So, despite its theatrical saber-rattling, China needs a trade deal that ensures a weaker dollar to shore up the yuan and reduce capital flight.

Indeed, we are now hearing from China that “the door is open” to trade talks, and its security czar is evaluating ways to address the use of Chinese precursor chemicals by Mexican cartels to produce fentanyl for distribution in the US. Moreover, although the Port of Los Angeles announced that volumes will fall be 1/3 as several major American retailers are halting all shipments from China, in reality, American businesses as usual are finding a way to succeed (and skirt the most onerous tariffs) by rerouting supply chains through 3rd party countries like Vietnam and Mexico (“trans-shipping”) and delivering to bonded warehouses to delay the official receipt of goods. Also offsetting the tariffs is the 10% drop in the dollar index.

Looking ahead, although volatility likely will remain elevated for the next few months, unless something crazy comes out of left field, I think the market has seen its lows, and the path of least resistance is higher. American consumers, corporations, and entrepreneurs are optimistic by nature and are always pushing boundaries and seeking a path forward, rather than sitting on their hands waiting for government to tell them what to do. And of course, President Trump is not one to sit on his hands for one minute in his effort to “fix” our unsustainable “death spiral” of inflation, debt, deficit spending, offshoring, and hyper-financialization.

But then we have the FOMC, whose members have been quite happy to sit on their hands in the face of tariff turmoil, falling inflation, and slowing GDP and jobs growth. Among the 19 FOMC participants (the 7 Board of Governors and 12 Reserve Bank regional presidents, which includes both the 12 voting members and the 7 non-voting members who serve as voting members on a rotating basis), they almost unanimously (18 of 19) agreed at their March meeting that growth and employment risks are skewed to the downside while inflation risks are skewed to the upside. Overall, the Fed has taken a dovish stance but will be reactive to sudden distress in growth and jobs rather than proactive in preventing such distress.

Although Fed Chair Powell often talks about tariffs as being inflationary, in fact tariffs are deflationary like all forms of taxation—i.e., without a commensurate increase in income or credit, they necessitate a rethinking and reallocation of one’s existing disposable income. Furthermore, Powell & Co. seem to be ignoring the deflationary signals of falling oil prices, slowing household consumption, declining savings rates, and rising delinquencies. Inflation metrics are pulling back after being propped up by elevated energy prices and long-lag components (like shelter costs) and the prior administration’s profligate federal deficit spending that overshadowed—and indeed created—sluggish growth in the private sector. I talk more about inflation metrics and expectations for next week’s CPI and PPI releases in my full commentary below.

To be fair, government spending (to the tune of nearly 6.5% of GDP) exacerbated the inflation and private sector malaise it created by making it difficult for the Powell & Co. to justify helping out the private sector with lower interest rates, thus crowding out the efficient capital allocation and high return on investment of the private sector with the inefficient capital allocation of bloated government boondoggles. Economist Michael Howell of CrossBorder Capital reminds us that “public debt is expanding faster than private debt, fueled by welfare commitments and rising interest burdens, ensuring persistent liquidity growth.” Importantly, Howell persuasively asserts that, “monetary policy must prioritize liquidity over inflation” concerns, so the Fed’s current hands-off, higher-for-longer, reactionary approach risks causing a liquidity crunch. In his view, “The modern financial system is a fragile, collateral-driven mechanism, and one that requires constant intervention [through proactive management] to avoid collapse.”

As Andrew Lees of MacroStrategy Partners has pointed out, “Economies naturally self-order productively when not constrained by excessive regulation and over-bearing government intervention. The current "financialized" economic system as it is, is dependent on debt and unproductive use of capital (Wall Street vs Main Street).” The private sector has proven to be much better at the efficient and highly productive allocation of capital to maximize ROI. So, as Secretary Bessent has described, the Trump administration seeks to reduce the budget deficit to 3% of GDP and increase real GDP growth to 3%, which would lead to the same kind of small-government/strong-private-sector economy that has turned around a foundering Argentina under President Milei.

The May FOMC meeting convenes this week, so we shall see. CME Group fed funds futures show only 3% odds of a 25-bp rate cut, but increases to 32% at the June meeting, and 78% odds of at least 75 bps (3 cuts) by year-end. In my view, they should be readying for 50 bps in rate cuts by July and a target neutral rate of around 3.25-3.50% by early 2026. Certainly the 2-year Treasury yield (the shortest term that is substantially market driven) at 3.80% (as of 5/6) is signaling to the Fed that rates should be much lower than the current 4.25-4.50% fed funds rate. According to a recent post by AlpineMacro, “…the current 10-2 year spread in the bond market is not sustainable, particularly if the economy slows sharply. Ultimately, the long end of the curve will gravitate to the short end, particularly when investors realize that tariff-induced price increases are temporary.” Notably, projections on bond issuance from Secretary Bessent suggest a gradual return to an 80/20 split between T-bonds & notes (80%) versus T-bills (20%) going forward as opposed to the nearly 100% allocation to T-bills (< 1 year) under his predecessor Janet Yellen.

I have been insisting for some time that the FFR needs to be 100 bps lower, as the US economy's headline GDP and jobs numbers were long artificially propped up by excessive, inefficient, and often unproductive federal deficit spending, while the hamstrung private sector has seen sluggish growth. Moreover, today’s DOGE-led spending cuts, trade war uncertainty, and with budget reconciliation and fiscal legislation still in progress have removed much of that artificial stimulus. But regardless of the May FOMC decision, I expect the rate-cutting cycle to restart in June and signed trade deals with our 18 key trading partners beginning this month.

But for the near term, until those things come to fruition, I continue to expect stocks will remain volatile (with VIX above the 20 “fear threshold” but below the 30 “panic threshold”). CNN's Fear & Greed Index just jumped from "Fear” to “Greed” on the dial but remains volatile. The American Association of Individual Investors' ("AAII") Investor Sentiment Survey has shown more than 50% bearish (vs. historical average of 31%) for 10 consecutive weeks, which is the longest streak since 1990. Capital flows reflect a sharp drop in foreign capital flight into US bonds and equities over the past two months in something of a “buyers’ strike,” adding pressure to the US dollar. And last week saw a negative Q1 GDP print, somewhat offset by an upside beat from the jobs report and rising labor force participation.

There are certainly plenty of high-profile bears. One market technician I respect a lot, A.J. Monte of Sticky Trades, still believes stocks will eventually retest their pandemic lows (!). He warned of the dreaded “death cross” when the 50-day moving average crossed down through the 200-day moving average on 4/12. And then we have Christoper Wood of Jefferies, who believes that US stocks saw a permanent (!) peak last December (at lofty valuations) and will never (!) see those levels again—much like Japan’s market peak in 1989. Instead of US stocks, Wood thinks investors should buy Europe, China, Japan, and India. Others have pronounced that the US brand is permanently damaged and that we have witnessed the end of “American exceptionalism.” Heavy sigh.

Call me overly patriotic with rose-colored glasses, but my view is a little different. Capital tends to flow to where it is most welcome and earns its highest returns, so the recent falling tide of foreign capital flight leaving the US will surely return once visibility clears and the dollar firms up. Most any foreign investor will tell you there is no other place in the world to invest capital for the innovation and expected return than the US given our entrepreneurial culture, technological leadership in disruptive innovation, strong focus on building shareholder value, low interest-rate exposure, global scalability, wide protective moats, and our reliable and consistently strong earnings growth, free cash flow, margins, and return ratios, particularly among the dominant, cash flush, Big Tech titans, which continue to use their piles of cash to seed AI startups and other disruptive technologies. Notably, the US boasts more than 50% of the world’s privately owned late-stage start-ups valued at over $1 billion (aka “unicorns”) and leads in R&D spending and patent applications.

Moreover, it’s not just the Technology sector that is appealing to investors. As BlackRock wrote in their Q2 2025 Equity Market Outlook, “Commentators will often cite the prevalence of a large number of Tech companies in the U.S. as the driver of U.S. equity dominance. But our analysis points to wider breadth in U.S. quality. Current return on tangible invested capital (ROTIC), a proxy for a company’s ability to allocate capital for optimal profitability, is significantly higher in the U.S. than elsewhere in the world, suggesting quality exists not in pockets but across sectors.”

As Kevin O’Leary has opined, “Our number one export is the American dream. Everyone wants to come to America and start a business and become personally free." And this will not change just because our president seeks to incentivize the private sector to strategically reshore manufacturing with the ultimate goals of reviving the middle class, narrowing the wealth gap, reducing the trade deficit, ensuring reliable supply chains, and reinforcing national security. Moreover, Trump’s federal cost-cutting, tariff regime, and America-First rhetoric does not aim for absolute deglobalization, fiscal austerity, mercantilism, and isolationism as the MSM would have you believe, but rather to simply rebalance a system that had become completely out of balance—and indeed was falling into that aforementioned death spiral of rising inflation, debt, deficit spending, offshoring, and hyper-financialization. The rebalancing involves re-privatization and de-regulation rather than relying on massive government spending—and what I call “smart austerity” to eliminate waste, fraud, abuse, corruption and unaccountability, plus a “peace dividend” from ending the war in Ukraine.

So, I continue to believe the macro uncertainty and jittery market will ultimately give way to a melt-up, sending the market to back near its highs of Q1 by year-end or early-2026, driven by rising global liquidity, a weaker US dollar, reduced wasteful/reckless government spending and regulatory red tape, lower interest and tax rates, massive corporate capex, and the “animal spirits” of a rejuvenated private sector and housing market.

The early April selloff brought down some of the loftiest valuations among the popular mega-cap stocks, with the forward P/E on the S&P 500 falling to 18.5x on 4/8 versus 22.7x at its February peak and today’s 20.6x (as of 5/5). In fact, many of the prominent names in the Technology and Communication Services sectors saw their valuations retreat such that they are scoring well in Sabrient’s growth models (as shown in our next-gen Sabrient Scorecards subscription product)—including large caps like Taiwan Semiconductor (TSM), Broadcom (AVGO), and Spotify (SPOT) that are in the new Q2 2025 Sabrient Baker’s Dozen portfolio, and small caps like Freshworks (FRSH), QuinStreet (QNST), and RingCentral (RNG) that are in our new Sabrient Small Cap Growth 46 portfolio. These portfolios along with Sabrient Dividend 51 (a growth & income strategy yielding 4.05% as of 5/5) are packaged and distributed quarterly to the financial advisor community as unit investment trusts through First Trust Portfolios.

Indeed, rather than the passive cap-weighted indexes dominated by Big Tech, investors may be better served by active stock selection that seeks to identify under-the-radar and undervalued gems primed for explosive growth—many of whom could coattail on the Big Tech names and provide greater returns. This is what Sabrient seeks to do in our various portfolios, all of which provide exposure to Value, Quality, Growth, and Size factors and to both secular and cyclical growth trends.

As a reminder, the “Size” factor refers to market cap and the Fama French study that showed small caps historically tend to outperform over time. Although that has not been the case for the small cap indexes (like Russell 2000) for most of the past 20 years, I still think the small cap universe is where to find the most explosive growth opportunities, even if the broad passive indexes can't keep up. So, insightful active selection is important for small cap investing—which is easier to do given the relative lack of analyst coverage and institutional ownership of small caps.

For each of our portfolios, we seek high-quality, fundamentally strong companies displaying a history of consistent, reliable, and accelerating sales and earnings growth, rising profit margins and free cash flow, solid earnings quality, low debt burden, and a reasonable valuation. Notably, our proprietary Earnings Quality Rank (EQR) is a key factor in each of our growth, value, dividend, and small cap models, and it is also licensed to the actively managed First Trust Long-Short ETF (FTLS).

Sabrient founder David Brown describes these and other factors as well as his portfolio construction process in his latest book. David describes his path from NASA engineer in the Apollo moon landing program to creating quant models for ranking stocks and building stock portfolios. And as a companion product to the book, we have launched next-gen versions of Sabrient Scorecards for Stocks and ETFs. You can learn more about both the book and scorecards by visiting: http://DavidBrownInvestingBook.com.

In my full commentary below, I discuss earnings, gold, tariffs, inflation, global liquidity, the power of free market capitalism, and the imminent “bullish triumvirate” of tariff resolution, tax cuts, and deregulation. I also discuss Sabrient’s latest fundamental-based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model, and several top-ranked ETF ideas. Our model likes Technology, Healthcare, Communication Services sectors, and assuming interest rates indeed come down and liquidity rises as I expect, I also like dividend stocks and gold. HERE is a link to this post in printable PDF format.

I had so much to say this month that I decided to defer until next month my in-depth commentary on the exciting new developments in energy and electrical generation. Please contact me to speak on any of these topics at your event!  Read on….

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The first half of 2024 looked a lot like the first half of 2023. As you recall, H1 2023 saw a strong stock market despite only modest GDP growth as inflation metrics fell, and H2 2023 continued on the same upward path for stocks despite a slowdown in inflation’s retreat, buoyed by robust GDP growth. Similarly, for H1 2024, stocks have surged despite a marked slowdown in GDP growth (from 4.1% in the second half of 2023 to an estimated 1.5% in the first half of 2024) and continued “stickiness” in inflation—causing rate-cut expectations to fall from 7 quarter-point cuts at the start of the year to just 2 at most.

And yet stocks have continued to surge, with 33 record highs this year for the S&P 500 through last Friday, 7/5. Of course, it is no secret that the primary driver of persistent market strength, low volatility (VIX in the mid-12’s), and an extreme low in the CBOE put/call ratio (around 0.50) has been the narrow leadership of a handful of dominant, innovative, mega-cap Tech titans and the promise of (and massive capital expenditures on) artificial intelligence. But while the S&P 500 is up +17.4% YTD and Nasdaq 100 +21.5% (both at all-time highs), the small cap indexes are flat to negative, with the Russell 2000 languishing -14% below its June 2021 all-time high.

Furthermore, recessionary signals abound. GDP and jobs growth are slowing. Various ISM indexes have fallen into economic contraction territory (below 50). Q2 earnings season kicks off in mid-July amid more cuts to EPS estimates from the analyst community. Given a slowing economy and falling estimates, it’s entirely possible we will see some high-profile misses and reduced forward guidance. So, investors evidently believe that an increasingly dovish Fed will be able to revive growth without revving up inflation.

But is this all we have to show for the rampant deficit spending that has put us at a World War II-level ratio of 120% debt (nearly $35 trillion) to GDP (nearly $29 trillion)? And that doesn’t account for estimated total unfunded liabilities—comprising the federal debt and guaranteed programs like Social Security, Medicare, employee pensions, and veterans’ benefits—estimated to be around $212 trillion and growing fast, not to mention failing banks, municipal pension liabilities, and bankrupt state budgets that might eventually need federal bailouts.

Moreover, the federal government “buying” jobs and GDP in favored industries is not the same as private sector organic growth and job creation. Although the massive deficit spending might at least partly turn out to be a shrewd strategic investment in our national and economic security, it is not the same as incentivizing organic growth via tax policies, deregulation, and a lean government. Instead, we have a “big government” politburo picking and choosing winners and losers, not to mention funding multiple foreign wars, and putting it all on a credit card to be paid by future generations. I have more to say on this—including some encouraging words—in my Final Comments section below.

As for inflation, the Fed’s preferred gauge, Core Personal Consumption Expenditures (PCE, aka Consumer Spending), for May was released on 6/28 showing a continued downward trend (albeit slower than we all want to see). Core PCE came in at just +0.08% month-over-month (MoM) from April and +2.57% YoY. But Core PCE ex-shelter is already below 2.5%, so as the lengthy lag in shelter cost metrics passes, Core PCE should fall below 2.5% as well, perhaps as soon as the update for June on 7/26, which could give the Fed the data it needs to cut. By the way, the latest real-time, blockchain-based Truflation rate (which historically presages CPI) hit a 52-week low the other day at just 1.83% YoY.

In any case, as I stated in my June post, I am convinced the Fed would like to starting cutting soon—and it may happen sooner than most observers are currently predicting. Notably, ever since the final days of June—marked by the presidential debate, PCE release, various jobs reports, and the surprising results in Europe and UK elections, the dollar and the 10-year yield have both pulled back—perhaps on the view that rate cuts are indeed imminent. On the other hand, the FOMC might try to push it out as much as possible to avoid any appearance of trying to impact the November election. However, Fed chair Powell stated last week that the committee stands ready to cut rates more aggressively if the US labor market weakens significantly (and unemployment just rose above the magic 4-handle to 4.1%)—so it appears the investor-friendly “Fed put” is back in play, which has helped keep traders bullishly optimistic. The June readings for PPI and CPI come out later this week on 7/11-12, and July FOMC policy announcement comes out on 7/31.

And as inflation recedes, real interest rates rise. As it stands today, I think the real yield is too high—great for savers but bad for borrowers, which would suggest the Fed is behind the curve. The current fed funds rate is roughly 3% above the CPI inflation forecast, which means we have the tightest Fed interest rate policy since before the 2008 Global Financial Crisis (aka Great Recession). This tells me that the Fed has plenty of room to cut rates and still maintain restrictive monetary policy.

As I have said many times, I believe a terminal fed funds rate of 3.0-3.5% would be the appropriate level so that borrowers can handle the debt burden while fixed income investors can receive a reasonable real yield.

Nevertheless, even with rates still elevated today, I believe any significant pullback in stocks (which I still think is coming before the November election, particularly in light of the extraordinarily poor market breadth) would be a buying opportunity. It’s all about investor expectations. As I’ve heard several commentators opine, the US, warts and all, is the “best house in a lousy [global] neighborhood.” I see US stocks and bonds (including TIPS) as good bets, particularly as the Fed and other central banks inject liquidity. But rather than chasing the high-flyers, I suggest sticking with high-quality, fundamentally strong stocks, displaying accelerating sales and earnings and positive revisions to Wall Street analysts’ consensus estimates.

By “high quality,” I mean fundamentally strong companies with a history of, and continued expectations for, consistent and reliable sales and earnings growth, upward EPS revisions from the analyst community, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are the factors Sabrient employs in selecting our growth-oriented Baker’s Dozen (primary market for the Q2 portfolio ends on 7/18), value-oriented Forward Looking Value portfolio, growth & income-oriented Dividend portfolio, and our Small Cap Growth portfolio (an alpha-seeking alternative to a passive position in the Russell 2000), as well as in our SectorCast ETF ranking model. Notably, our Earnings Quality Rank (EQR) is a key factor in each of these models, and it is also licensed to the actively managed, absolute-return-oriented First Trust Long-Short ETF (FTLS) as an initial screen.

Each of these alpha factors and how they are used within Sabrient’s Growth, Value, Dividend income, and Small Cap investing strategies is discussed in detail in David Brown’s new book, How to Build High Performance Stock Portfolios, which will be out shortly (I will send out a notification soon!).

In today’s post, I provide a detailed commentary on the economy, inflation, valuations, Fed policy expectations, and Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model heading into earnings season, and several top-ranked ETF ideas.

Click here to continue reading my full commentary. Or if you prefer, here is a link to this post in printable PDF format. I invite you to share it with your friends, colleagues, and clients (to the extent compliance allows). You also can sign up for email delivery of this periodic newsletter at Sabrient.com.

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Last week, the much-anticipated inflation readings for May—and the associated reaction from the Fed on planned rate cuts—was pretty much a non-event. The good news is core inflation continues to gradually fall. The bad news is it isn’t falling fast enough for the Fed. Headline CPI and PPI are pretty much stagnant over the past 12 months. This led the Fed to be mealy-mouthed about rate cuts. One might ask, why does it matter so much what the Fed does when the economy is doing fine, we have avoided recession, wages are growing, jobs are plentiful, unemployment is low, and asset prices are rising?

But the reality is there is a slow underlying deterioration happening from the lag effects of monetary tightening that is becoming increasingly apparent, including a lack of organic jobs and GDP growth (which is instead largely driven by government deficit spending) and a housing market (important for creating a “wealth effect” in our society) that is weakening (with growing inventory and slowing sales) given high mortgage rates that make for reluctant sellers and stretched buyers (notably, the 10-year yield and mortgage rates have pulled back of late just from rate cut talk). Moreover, real-time shelter inflation (e.g., rent) has been flat despite what the long-lagged CPI metrics indicate, and the real-time, blockchain-based Truflation reading has been hovering around 2.2% YoY, which happens to match the April and May PPI readings—all of which are very close to the Fed’s 2.0% inflation target.

Of course, stock market valuations are reliant upon expectations about economic growth, corporate earnings, and interest rates; and interest rates in turn are dependent on inflation readings. Although some observers saw promising trends in some components of May CPI and PPI, Fed chair Jay Powell played it down with the term “modest further progress,” and the “dot plot” on future rate cuts suggests only one or perhaps two rate cuts later this year.

Nevertheless, I continue to believe the Fed actually wants to cut rates sooner than later, and likely will do so during Q3—especially now that central banks in the EU, Canada, Sweden, Switzerland, Brazil, Chile, and Mexico have all cut rates. Moreover, Japan is struggling to support the yen with a positive interest rate—but it needs to keep rates low to prevent hurting its highly leveraged economy, so it needs the US to cut rates instead. The popular yen “carry trade” (short the yen, buy the dollar and US Treasuries) has been particularly difficult for the BoJ. All told, without commensurate cuts here in the US, it makes the dollar even stronger and thus harder on our trading partners to support their currencies and on emerging markets that tend to carry dollar-denominated debt. I talk more about this and other difficulties outside of the (often misleading) headline economic numbers in today’s post—including the “tapped out” consumer and the impact of unfettered (wartime-esque) federal spending on GDP, jobs, and inflation.

As for stocks, so far, the market’s “Roaring 20’s” next-century redux has proven quite resilient despite harsh obstacles like global pandemic, multiple wars, a surge in inflation, extreme political polarization and societal discord, unpredictable Fed policy, rising crime and mass immigration, not to mention doors flying off commercial aircraft (and now counterfeit titanium from China!). But investors have sought safety in a different way from the past, particularly given that stubborn inflation has hurt real returns. Rather than traditional defensive plays like non-cyclicals, international diversification, and fixed income, investors instead have turned to cash-flush, secular-growth, Big Tech. Supporting the bullishness is the CBOE Volatility Index (VIX), which is back down around the 12 handle and is approaching levels not seen since 2017 during the “Trump Bump.” And given their steady performance coupled with the low market volatility, it has also encouraged risk-taking in speculative companies that may ride coattails of the Big Tech titans.

But most of all, of course, driving the rally (other than massive government deficit spending) has been the promise, rapid development, and implementation of Gen AI—as well as the new trends of “on-premises AI” for the workplace that avoids disruptions due to connectivity, latency, and cybersecurity, and AI personal computers that can perform the complex tasks of an analyst or assistant. The Technology sector has gone nearly vertical with AI giddiness, and it continues to stand alone atop Sabrient’s SectorCast rankings. And AI poster child NVIDIA (NVDA), despite being up 166% YTD, continues to score well in our Growth at Reasonable Price (GARP) model (95/100), and reasonably well in our Value model (79/100).

Nevertheless, I continue to believe there is more of a market correction in store this summer—even if for no other reason than mean reversion and the adage that nothing goes up in a straight line. Certainly, the technicals have become extremely overbought, especially on the monthly charts—which show a lot of potential downside if momentum gets a head of steam and the algo traders turn bearish. On the other hand, the giddy anticipation of rate cuts along with the massive stores of cash in money market funds as potential fuel may well keep a solid bid under stocks. Either way, longer term I expect higher prices by year end and into 2025 as high valuations are largely justified by incredible corporate earnings growth, a high ratio of corporate profits to GDP, and the promise of continued profit growth due to tremendous improvements in productivity, efficiency, and the pace of product development across the entire economy from Gen AI. In addition, central banks around the world are starting to cut rates and inject liquidity, which some expect to add as much as $2 trillion into the global economy—and into stocks and bonds.

On another note, it is striking that roughly half the world’s population goes to the polls to vote on their political leadership this year, and increasingly, people around the world have been seeking a different direction, expressing dissatisfaction with the status quo of their countries including issues like crime, mass immigration (often with a lack of assimilation), sticky inflation, stagnant economic growth, and a growing wealth gap—all of which have worsened in the aftermath of the pandemic lockdowns and acquiescence to social justice demands of the Far Left. Ever since the Brexit and Trump victories in 2016, there has been a growing undercurrent of populism, nationalism, capitalism, and frustration with perceived corruption, dishonesty, and focus on global over local priorities. Not so long ago, we saw a complete change in direction in El Salvador (Bukele) and Argentina (Milei) with impressive results (e.g., reducing rampant crime and runaway inflation), at least so far. Most recently, there were surprises in elections in India, Mexico, and across Europe. Although we are seeing plenty of turmoil of our own in the US, global upheaval and uncertainty always diverts capital to the relative safety of the US, including US stocks, bonds, and the dollar.

I expect US large caps to remain an attractive destination for global investment capital. But while Tech gets all the (well deserved) attention for its disruptive innovation and exponential earnings growth, there are many companies that can capitalize on the productivity-enhancing innovation to drive their own growth, or those that are just well positioned as “boring” but high-quality, cash-generating machines that enjoy strong institutional buying, strong technicals, and strong fundamentals in stable, growing business segments—like insurers and reinsurers for example.

So, I believe both US stocks and bonds will do well this year (and next) but should be hedged with gold, crypto, and TIPS against a loss in purchasing power (for all currencies, not just the dollar). Furthermore, I believe all investors should maintain exposure to the Big Tech titans with their huge cash stores and wide moats, as well as perhaps a few of the speculative names (as “lottery tickets”) having the potential to profit wildly as suppliers or “coat-tailers” to the titans, much of their equity exposure should be in fundamentally solid names with a history of and continued expectations for consistent and reliable sales and earnings growth, rising profit margins and cash flow, sound earnings quality, and low debt.

Indeed, Sabrient has long employed such factors in our GARP model for selecting our growth-oriented Baker’s Dozen portfolio, along with other factors for other portfolios like our Forward Looking Value portfolio, which relies upon our Strategic Valuation Rank (SVR), our Dividend portfolio, which is a growth & income strategy that relies on our proprietary Dividend Rank (DIV), and our Small Cap Growth portfolio, an alpha-seeking alternative to the Russell 2000. Notably, our Earnings Quality Rank (EQR) is not only a key factor we use internally for each of these portfolios, but it is also licensed to the actively managed First Trust Long-Short ETF (FTLS) as an initial screen.

Each of these alpha factors and how they are used within Sabrient’s Growth, Value, Dividend income, and Small Cap investing strategies is discussed in detail in David Brown’s new book, How to Build High Performance Stock Portfolios, which will be published imminently. (I will send out a notification soon!)

In today’s post, I talk more about inflation, the Fed, and the extreme divergences in relative performance and valuations. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which, no surprise, continue to be led by Technology), current positioning of our sector rotation model, and several top-ranked ETF ideas. And don’t skip my Final Comments section, in which I have something to say about BRICS’ desire to create a parallel financial system outside of US dollar dominance, and the destructiveness of our politically polarized society and out-of-control deficit spending.

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). 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

StocksThe S&P 500 fell more than 5% over the first three weeks of April (it’s largest pullback since last October). Bonds also took it on the chin (as they have all year), with the 2-year Treasury yield briefly eclipsing 5%, which is my “line in the sand” for a healthy stock market. But the weakness proved short-lived, and both stocks and bonds have regained some footing to start May. During the drawdown, the CBOE Volatility Index (VIX), aka fear index, awakened from its slumber but never closed above the 20 “panic threshold.”

In a return to the “bad news is good news” market action of yore, stocks saw fit to gap up last Friday as the US dollar weakened and stocks, bonds, and crypto all caught a nice bid (with the 10-year yield falling 30 bps)—on the expectation of sooner rate cuts following the FOMC’s softer tone on monetary policy and a surprisingly weak jobs report. So, the cumulative “lag effects” of quantitative tightening (QT), falling money supply, and elevated interest rates finally may be coming to roost. In fact, Fed chairman Jay Powell suggested that any sign of weakening in inflation or employment could lead to the highly anticipated rate cuts—leaving the impression that the Fed truly wants to start cutting rates.

But I can’t help but wonder whether that 5% pullback was it for the Q2 market correction I have been predicting. It sure doesn’t seem like we got enough cleansing of the momentum algo traders and other profit-protecting “weak holders.” But no one wants to miss out on the rate-cut rally. Despite the sudden surge in optimism about rates, inflation continues to be the proverbial “fly in the ointment” for rate cuts, I believe we are likely to see more volatility before the Fed officially pivots dovish, although we may simply remain in a trading range with downside limited to 5,000 on the S&P 500. Next week’s CPI/PPI readings will be crucial given that recent inflation metrics have ticked up. But I don’t expect any unwelcome inflationary surprises, as I discuss in today’s post.

The Fed faces conflicting signals from inflation, unemployment, jobs growth, GDP, and the international impact of the strong dollar on the global economy. Its preferred metric of Core PCE released on 4/26 stayed elevated in March at 2.82% YoY and a disheartening 3-month (MoM) rolling average of 4.43%. But has been driven mostly by shelter costs and services. But fear not, as I see a light at the end of the tunnel and a resumption of the previous disinflationary trend. Following one-time, early-year repricing, services prices should stabilize as wage growth recedes while labor demand slows, labor supply rises, productivity improves, and real disposable household income falls below even the lowest pre-pandemic levels. (Yesterday, the San Francisco Fed reported that American households have officially exhausted all $2.1 trillion of their pandemic-era excess savings.) Also, rental home inflation is receding in real time (even though the 6-month-lagged CPI metrics don’t yet reflect it), and inflation expectations of consumers and businesses are falling. Moreover, Q1 saw a surge in oil prices that has since receded, the Global Supply Chain Pressure Index (GSCPI) fell again in April. So, I think we will see Core PCE below 2.5% this summer. The Fed itself noted in its minutes that supply and demand are in better balance, which should allow for more disinflation. Indeed, when asked about the threat of a 1970’s-style “stagflation, the Fed chairman said, "I don't see the stag or the 'flation."

The Treasury's quarterly refunding announcement shows it plans to borrow $243 billion in Q2, which is $41 billion more than previously projected, to continue financing our huge and growing budget deficit. Jay Powell has said that the fiscal side of the equation needs to be addressed as it counters much of the monetary policy tightening. It seems evident to me that government deficit spending has been a key driver of GDP growth and employment—as well as inflation.

And as if that all isn’t enough, some commentators think the world is teetering on the brink of a currency crisis, starting with the collapse of the Japanese yen. Indeed, Japan is in quite the pickle with the yen and interest rates, which is a major concern for global financial stability given its importance in the global economy. Escalating geopolitical tensions and ongoing wars are also worrisome as they create death, destruction, instability, misuse of resources, and inflationary pressures on energy, food, and transportation prices.

All of this supports the case for why the Fed would want to start cutting rates (likely by mid-year), which I have touched on many times in the past. Reasons include averting a renewed banking crisis, fallout from the commercial real estate depression, distortion in the critical housing market, the mirage of strong jobs growth (which has been propped up by government spending and hiring), and of course the growing federal debt, debt service, and debt/GDP ratio (with 1/3 of the annual budget now earmarked to pay interest on the massive and rapidly growing $34 trillion of federal debt), which threatens to choke off economic growth. In addition, easing financial conditions would help highly indebted businesses, consumers, and our trading partners (particularly emerging markets). Indeed, yet another reason the Fed is prepared to cut is that other central banks are cutting, which would strengthen the dollar even further if the Fed stood pat. And then we have Japan, which needs to raise rates to support the yen but doesn’t really want to, given its huge debt load; it would be better for it if our Federal Reserve cuts instead.

So, the Fed is at a crossroads. 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, assuming inflation has already (in real time, not lagged) resumed its downtrend, I think the real yield is too high—i.e., great for savers but bad for borrowers.

Nevertheless, I still believe any significant pullback in stocks would be a buying opportunity. As several commentators have opined, the US is the “best house in a lousy (global) neighborhood.” In an investment landscape fraught with danger nearly everywhere you turn, I see US stocks and bonds as the place to be invested, particularly as the Fed and other central banks restore rising liquidity (Infrastructure Capital Advisors predicts a $2 trillion global injection to make rates across the yield curve go down). But I also believe they should be hedged with gold and crypto. According to Michael Howell of CrossBorder Capital, a strong dollar will still devalue relative to gold and bitcoin when liquidity rises, and gold price tends to rise faster than the rise in liquidity—and bitcoin has an even higher beta to liquidity. Ever since Russia invaded Ukraine on 2/24/2022 and was sanctioned with confiscation of $300 billion in reserves, central banks around the world have been stocking up, surging gold by roughly +21% and bitcoin +60%, compared to the S&P 500 +18% (price return). During Q1, institutions bought a record 290 tons, according to the World Gold Council (WGC).

With several trillions of dollars still sitting defensively in money market funds, we are nowhere near “irrational exuberance” despite somewhat elevated valuations and the ongoing buzz around Gen AI. At the core of an equity portfolio should be US large cap exposure (despite its significantly higher P/E versus small-mid-cap). But despite strong earnings momentum of the mega-cap Tech darlings (which are largely driven by robust share buyback programs), I believe there are better investment opportunities in many under-the-radar names (across large, mid, and small caps), including among cyclicals like homebuilders, energy, financials, and REITs.

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 latest Q2 2024 Baker’s Dozen (a concentrated 13-stock portfolio offering the potential for significant outperformance) which launched on 4/19, Small Cap Growth 42 (an alpha-seeking alternative to the Russell 2000 index) which just launched last week on 5/1, and Dividend 47 (a growth plus income strategy) paying a 3.8% current yield. Notably, Dividend 47’s top performer so far is Southern Copper (SCCO), which is riding the copper price surge and, by the way, is headquartered in Phoenix—just 10 miles from my home in Scottsdale.

I talk more about inflation, federal debt, the yen, and oil markets in today’s post. 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, and several top-ranked ETF ideas. And in my Final Comments section, I have a few things to say about the latest lunacy on our college campuses (Can this current crop of graduates ever be allowed a proper ceremony?).

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). 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. I will send out an email once it becomes available on Amazon.

  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

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

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).