by Scott Martindale
  President, Sabrient Systems LLC

The market this year has been oscillating between fear and optimism, risk-off and risk-on. Until 8/27/19, risk-off defensive sentiment was winning, but since that date a risk-on sentiment has taken hold, and the historic divergence favoring secular growth, low-volatility and momentum factors, defensive sectors, and large caps (i.e., late-stage economic cycle behavior) over cyclical growth, value and high-beta factors, cyclical sectors, and small-mid caps (i.e., expansionary cycle behavior) continues to reverse, as fickle investors have become optimistic about at least a partial resolution to the trade war (including the lifting of tariffs), an improving outlook for 2020-21 corporate earnings, and resurgent capital investment. Investors have moved from displaying tepid and fleeting signs of risk-on rotation to full-blown bullish enthusiasm and reluctance to sell in a fear of missing out (FOMO), even though the short-term technical picture has become overbought.

The late-August risk-on rotation came in the nick of time. Last year at that same time of the year, the S&P 500 was marching higher until peaking on 9/20/18, but it was doing so on the backs of defensive sectors along with secular-growth Tech mega-caps, and I was opining at the time that the rally would fizzle if there wasn’t some rotation into the risk-on cyclicals and small-mid caps – which as you know didn’t happen, leading to the Q4 selloff. But, happily, this year has played out quite differently.

Nevertheless, a lot of successful fundamentals-based strategies (including powerhouse quant firm AQR Capital, discussed below) really took it on the chin for the roughly 14-18 months preceding 8/27, ostensibly due to fear that a “late-cycle” economy was on the verge of recession. And indeed it was becoming a self-fulfilling prophesy, as the dominos seemed to be falling one by one:  escalating trade wars creating uncertainty leading to a global manufacturing slowdown, a hold-off in corporate capital spending, and negative interest rates overseas, which pushed global capital into US debt, which temporarily inverted the yield curve, which brought out the doomsaying pundits – all of which was beginning to negatively impact the previously-bulletproof consumer sentiment that had been carrying US GDP growth.

But it was all based on false pretenses, in my view, and investors now seem to be convinced that the bottom is in for the industrial cycle and the corporate earnings recession, and particularly for prices of value/cyclical stocks with solid fundamentals. Results haven’t been as bad as feared, and some of the macro clouds are parting. Ultimately, stock prices are driven by earnings expectations and interest rates (for discounted cash flow valuation), and as the external obstacles hindering the free market are lessened or removed, the outlook brightens. And when investors focus on the fundamentals rather than the latest tweet, CNN headline, or single economic number taken out of context, it bodes well for Sabrient’s value-tilted GARP (growth at a reasonable price) portfolios, which of course includes our flagship Baker’s Dozen.

In this periodic update, I provide a detailed market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings still look neutral to me, while the longer-term technical picture remains bullish, and our sector rotation model retains a solidly bullish posture. Read on….

Well, Fed Chairman Bernanke has proved me wrong by dipping his toe into the dreaded tapering of QE3. In retrospect, I suppose he preferred to take this first step on his own rather than put the onus (and any associated fallout) on the back on his successor.

The stock market’s technical consolidation continues, and in fact anyone who missed last week’s entry point for the widely-anticipated year-end rally is getting another shot at it. The S&P 500 and Dow Jones Industrials both lost round-number support again this week at 1800 and 16,000, after briefly recovering them from last week’s pullback.

“Stocks fall on Fed taper discussion.” That’s the gist of what you heard in the media on Wednesday to account for the market’s late-day pullback. There’s always some sort of attempt to explain daily market action. But the reality is that investors simply must take a periodic breather to regroup and retrench, particularly when making an assault on round-number resistance for a major index.

As most everyone expected, Congressional brinksmanship gave way to an eleventh hour agreement that will put the government back in business and raise the debt ceiling. However, it’s only a temporary measure that merely defers another knock-down/drag-out for a few months. The question is, how will investors react after an initial bullish burst of relief?

Anxious bulls no doubt are looking for ways to rustle awake this sleepy late-summer stock market, before the bears stealthily bring it down. Investors’ focus has been on the Fed and what it might do next month, and Wednesday’s release of the July FOMC meeting minutes showed almost all the voting members supported no change in stimulus, with only a few hawks insisting that tapering should begin sooner.

The world has been watching every peep, sniffle, or innuendo associated with any voting member of the FOMC. What is the future of the latest in their ongoing market manipulation, in which money is printed to buy bonds to hold down interest rates, spur corporate borrowing, and artificially inflate stocks? Lately, that’s all investors have cared about.

Here in Santa Barbara, we refer to the annual summer ritual of heavy marine layer engulfing the coastline for much of the day as the “June gloom.” It can be frustrating to beach-going visitors since there are otherwise no clouds, and the inland areas are brilliantly sunny.

Five years ago this month, the S&P 500 hit all-time high of 1576. It closed Wednesday at 1461. Can the market make a run at that all-time high? Well, the biggest threat at the moment to bullish sentiment is the Fiscal Cliff, but both presidential candidates have a plan for dealing with it, and Congress is unlikely to want to take the fall for defying the new President and sending the country back into recession.

As earnings season gets underway, it has become clear that there is a disconnect between the bull market in stocks and the ability of the companies behind those stocks to generate any revenue growth in a weak global economy. Although U.S. companies have shown eleven consecutive quarters of year-over-year earnings growth, Wall Street analysts have continued to slash forward earnings estimates, and indeed it is reflected in Sabrient’s SectorCast model.