by Scott Martindale
  President & CEO, Sabrient Systems LLC

It would be an understatement to say that last week was particularly eventful, what with the elections and FOMC policy decision, plus some impressive earnings announcements. Election Day is finally behind us, and the results sent investors into a fit of stock market FOMO—in one of the greatest post-election rallies ever—while dumping their bonds. Much like the day after President Trump’s win in 2016, the leading sectors were cyclicals: Industrials, Energy, Financials. And then on Fed Day, markets got their locked-in 25-bp rate cut, and the rally kept going across all risk assets, including strengthening the US dollar on the expectation of accelerating capital flight into the US as Trump’s policies, particularly with support from a Republican-led congress, should be quite business-friendly, with lower tax rates and red tape and much less focus on anti-trust lawfare.

So, there was a lot for investors to absorb last week, and this week brings the October CPI and PPI reports. Indeed, the whole world has been pining for clarity from the US—and they got it. And I’m sure no one misses the barrage of political ads and bitter electioneering. Hopefully, it marks the peak in election divisiveness our society will ever see again. Notably, inflation hedges gold and bitcoin have suddenly diverged, with gold pulling back from its all-time high while bitcoin—which can be considered both a dollar hedge and a risk asset for its utility—has continued its surge to new highs (now over $85k as I write!) on the added optimism around Trump’s crypto-friendly stance.

Besides expectations of a highly aggressive 15% earnings growth in the S&P 500 over the next couple of years, venture capital could be entering a boom following four years of difficulty in raising capital. In an interview with Yahoo Finance, Silicon Valley VC Shervin Pishevar opined, “I think there’s going to be a renaissance of innovation in America…It’s going to be exciting to see… AI is going to accelerate so fast we’re going to reach AGI [Artificial General Intelligence, or human-like thinking] within the next 2-3 years. I think there will be ‘Manhattan Projects’ for AI, quantum computing, biotech.”

It all sounds quite appealing, but there’s always a Wall of Worry for investors, and the worry now is whether Trump’s pro-growth policies like reducing tax rates, deregulation, rooting out government waste and inefficiency (i.e., “drain the swamp”) combined with his more controversial intentions like tariffs, mass deportations of cheap migrant labor, and threats to Big Pharma, the food industry, and key trading partners (including Mexico)—in concert with a dovish Fed—will create a resurgence in inflation and unemployment and push the federal debt and budget deficit to new heights before the economy is ready to stand on its own—i.e., without the massive federal deficit spending and hiring we saw under Biden—thus creating a period of stagflation and perhaps a credit crisis. Rising interest rates and a stronger dollar are creating tighter financial conditions and what Michael Howell of CrossBorder Capital calls “a fast-approaching debt maturity wall” that adds to his concerns that 2025 might prove tougher for investors if the Global Liquidity cycle peaks and starts to decline.

But in my view, the end goals of shrinking the size and scope of our federal government and restoring a free, private-sector-driven economy are worthy, and we can weather any short-term pain along the way and perhaps fend off that looming “debt maturity wall.” Nevertheless, given the current speculative fervor (“animal spirits”) and multiple expansion in the face of surging bond yields (i.e., the risk-free discount rate on earnings streams), it might be time to exercise some caution and perhaps put on some downside hedges. Remember the old adage, “Stocks take the stairs up and the elevator down” (be sure to read my recent post with 55 timeless investing proverbs to live by).

In any case, at the moment, I believe the stock market has gotten a bit ahead of itself with frothy valuations and extremely overbought technical conditions (with the major indexes at more than two standard deviations above their 50-day moving averages). But I think any significant pullback or technical consolidation to allow the moving averages to catch up would be a buying opportunity into year-end and through 2025, and perhaps well into 2026—assuming the new administration’s policies go according to plan. As DataTrek Research pointed out, there is plenty of dry powder to buy stocks as cash balances are high (an average of 19.2% of institutional portfolios vs.10-15% during the bull market of the 2010’s).

This presumes that the proverbial “Fed Put” is indeed back in play. Also, I continue to believe that rate normalization means the FOMC ultimately taking the fed funds rate down to a terminal rate of about 3.0-3.5%—although I’m now leaning toward the higher side of that range as new fiscal policy from the “red wave” recharges private-sector growth (so that GDP and jobs are no longer reliant on government deficit spending and hiring) and potentially reignites some inflationary pressures.

This is not necessarily a bad thing. Although inflation combined with stagnant growth creates the dreaded “stagflation,” moderate inflation with robust growth (again, driven by the private sector rather than the government) can be healthy for the economy, business, and workers while also helping to “inflate away” our massive debt. Already, although supply chain pressures remain low, inflation has perked up a bit recently, likely due to rising global liquidity and government spending, as I discuss in detail in today’s post.

So, my suggestions remain: Buy high-quality businesses at reasonable prices, hold inflation hedges like gold and bitcoin, and be prepared to exploit any market correction—both as stocks sell off (such as by buying out-of-the-money put options, while VIX is low) and as they begin to rebound (by buying stocks and options when share prices are down). A high-quality company is one that is fundamentally strong (across any market cap) in that it displays consistent, reliable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus estimates, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are the factors Sabrient employs in selecting the growth-oriented Baker’s Dozen (our “Top 13” stocks), the value-oriented Forward Looking Value, the growth & income-oriented Dividend portfolio, and Small Cap Growth. We also use many of those factors in our SectorCast ETF ranking model. And 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).

Each of our key alpha factors and their usage within Sabrient’s Growth, Value, Dividend, and Small Cap investing strategies (which underly those aforementioned portfolios) is discussed in detail in Sabrient founder David Brown’s new book, How to Build High Performance Stock Portfolios, which is now available to buy in both paperback and eBook formats on Amazon.com.

And in conjunction with David’s new book, we are also offering a subscription to our next-generation Sabrient Scorecard for Stocks, which is a downloadable spreadsheet displaying our Top 30 highest-ranked stock picks for each of those 4 investing strategies. And as a bonus, we also provide our Scorecard for ETFs that scores and ranks roughly 1,400 US-listed equity ETFs. Both Scorecards are posted weekly in Excel format and allow you to see how your stocks and ETFs rank in our system…or for identifying the top-ranked stocks and ETFs (or for weighted combinations of our alpha factors). You can learn more about both the book and the next-gen Scorecards (and download a free sample scorecard) at http://DavidBrownInvestingBook.com.

In today’s post, I dissect in greater detail GDP, jobs, federal debt, inflation, corporate earnings, stock valuations, technological trends, and what might lie ahead for the stock market with the incoming administration. 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. And be sure to check out my Final Thoughts section in which I offer my post-mortem on the election.

Click HERE to continue reading my full commentary or to sign up for email delivery of this monthly market letter. Also, here is a link to this post in printable PDF format. I invite you to share it as appropriate (to the extent your compliance allows).

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The S&P 500 rose 20.8% during the first three quarters of 2024, which is its best start since 1997 and the best for any presidential election year in history. Moreover, for perspective, the ratio of US stock market capitalization to the global stock market has risen from 30% in 2009 (following the GFC) to almost 50% today. This has happened despite escalation in multiple wars, numerous catastrophic weather events ravaging the country, a highly contentious election tearing apart friends and families, strapped consumers (after 25%+ cumulative inflation over the past few years), falling consumer confidence, and jobs and GDP growth over-reliant on government deficit spending, with national debt approaching $35.7 trillion and rising $2 trillion/year (as debt carrying costs alone cost over $1 trillion/year). Even over the past several days when oil prices spiked above $75/bbl (on sudden escalation in the Middle East conflict) and bond yields surged (with the 10-year reaching 4.05%), the major indexes continue to hold near their highs.

As investor Howard Lindzon (of StockTwits fame) said the other day, “There is a fear trade happening (e.g., gold and bitcoin) while there is growth trade happening. It’s really mind-boggling.” Indeed, many of the most prominent investors are wary, including the likes of Warren Buffett, Jamie Dimon, and Jeff Bezos, and corporate insider buying has slowed.

I’m not an economist. I started my career as a structural engineer with Chevron Corporation, then earned an MBA in night school and moved into the business side of the company before venturing into the world of investment research. But as a long-time student of the economy and capital markets, combined with my critical-thinking nature and engineering training, I’ve developed a healthy skepticism of numbers presented to me, even from supposedly objective sources like the government. They have to pass the “smell test.”

Of course, the Fed has been basing its monetary policy primarily on metrics calculated by federal agencies regarding inflation, jobs, and GDP. But headline YoY numbers can be illusory—particularly when they are propped up by massive government deficit spending. So, I like to look beyond the headline numbers. For inflation, my skepticism of official numbers (with the long lag times of key components, like shelter cost, and distorted metrics like “owner’s equivalent rent,” which is highly subjective and based on surveys of homeowners) is why I seek alternative metrics like: 1) the annualized rolling 3-month average of month-over-month price changes (which better reflects current trends), 2) a European method (quietly published by the BLS since 2006) called the Harmonized Index of Consumer Prices (HICP), and 3) the real-time, blockchain-based Truflation, which is published daily.

My skepticism was further elevated when I saw the jobs, retail sales, and ISM Services metrics all suddenly perk up in September—right before the election after a lengthy period of decline and contrary to several negative developments like a record divergence between rising consumer credit card debt and falling personal savings and The Conference Board’s Consumer Confidence dropping to the bottom of its 2-year range and showing increasing pessimism about labor market conditions.

On the other hand, it is notable that Truflation also has risen quickly over the past couple of weeks to nearly 2.0% YoY, so could this be corroborating the apparent rise in consumer demand? Could it be that the Fed’s dovish pivot and 50-bps rate cut has suddenly emboldened consumers to start spending again and businesses to ramp up hiring? Or are my suspicions correct such that we are in store for more downward revisions on some these rosy metrics post-election? After all, the last set of major revisions in early September showed not just an over-reliance on government jobs and government-supported jobs (through targeted spending bills), but the August household survey showed 66,000 fewer employed than in August 2023, 609,000 more “”part-time for economic reasons,” and 531,000 more “part time for noneconomic reasons,” which implies 1.2 million fewer full-time jobs in August 2024 versus August 2023.

Then along came the big 254,000 jobs gain in the September report that made investors so giddy last week, and the household survey showed 314,000 more employed workers than in September of last year. However, digging into the numbers, there are 555,000 more “”part-time for economic reasons” and 389,000 more “part time for noneconomic reasons,” which suggests 630 million fewer full-time jobs in September 2024 versus September 2023, so it’s no surprise that the average weekly hours worked also fell. Furthermore, government spending (and the growing regulatory state) continues to account for much of the hiring as government jobs have soared by 785,000 (seasonally adjusted) over this 12-month timeframe, which was the largest month-over-month (MoM) gain on record. Also, workers holding multiple jobs hit an all-time high. And notably, native-born workers have lost 1.62 million net jobs since their peak employment in July 2023 while foreign-born workers have gained 1.69 million over the same period.

Hmmm. I continue to see the GDP and jobs growth numbers as something of a mirage in that they have been propped up by government deficit spending (which our leaders euphemistically call “investment”). As you recall, leading into the September FOMC announcement I had been pounding the table on the need for a 50-bps rate cut, which we indeed got. Many observers, and at least one Fed governor, believe it was a mistake to go so big, but as I discussed in my post last month, recessionary pressures were mounting despite the impressive headline numbers, and the pain felt by our trading partners from high US interest rates and a strong dollar essentially required some agreement among the major central banks, particularly Japan and China, to weaken the dollar and thus allow an expansion in global liquidity without inciting capital flight to the US. And the PBOC soon did exactly that—slashing its reserve requirement ratio (RRR), cutting its benchmark interest rate, and loosening scores of rules regarding mortgages and the property market—which has restrengthened the dollar after its summer decline.

Of course, cutting taxes and regulation is the best way to unleash the private sector, but it's often argued that a tax cut without a corresponding reduction in spending only serves to increase the budget deficit and add to the federal debt. In fact, I saw a Harris campaign commercial with an average guy named “Buddy” lamenting that it’s “not cool” with him that Trump would give “billionaires” a tax break because they should “pay their fair share.” But Buddy and Harris both need to know what DataTrek Research has observed—i.e., since 1960, regardless of individual and corporate tax rates, federal receipts have averaged 17% of GDP. This means that raising taxes stunts GDP growth while cutting taxes boosts GDP growth by leaving more money in the pockets of consumers, business owners, and corporations to spend and invest with the wisdom of a free and diverse marketplace (Adam Smith’s “invisible hand”). In other words, the path to rising tax revenues is through strong economic growth—and the best return on capital comes from the private sector, which has proven itself much more adept at determining the most efficient allocation of capital rather than Big Government’s top-down picking of winners and losers, like a politburo.

Nevertheless, given the Fed’s dovish pivot (and despite the “heavy hand” of our federal government), I continue to expect higher prices by year end and into 2025. Bond credit spreads remain tight (i.e., no fear of recession), and although the CBOE Volatility Index (VIX) is back above the 20 “fear threshold,” it is far from panic levels. So, I believe any “October surprise” that leads to a pre-election selloff—other than a cataclysmic “Black Swan” event—would likely be a welcome buying opportunity, in my view. But besides adding or maintaining exposure to the dominant MAG-7 titans—which provide defensive qualities (due to their disruptive innovation and wide moats) as well as long-term appreciation potential—I think other stocks may offer greater upside as the economic cycle continues its growth run and market rotation/broadening resumes.

So, my suggestions are to buy high-quality businesses at reasonable prices on any pullback, hold inflation hedges like gold and bitcoin, and be prepared to exploit any credit-related panic—both as stocks sell off (such as by buying out-of-the-money put options while VIX is low) and before they rebound (when share prices are low). Regardless, I continue to recommend high-quality, fundamentally strong stocks across all market caps that display consistent, reliable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus estimates, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are the factors Sabrient employs in selecting the growth-oriented Baker’s Dozen (our “Top 13” stocks), the value-oriented Forward Looking Value, the growth & income-oriented Dividend portfolio, and Small Cap Growth, which is an alpha-seeking alternative to a passive position in the Russell 2000.

We also use many of those factors in our SectorCast ETF ranking model. And 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).

Each of our key alpha factors and their usage within Sabrient’s Growth, Value, Dividend, and Small Cap investing strategies (which underly those aforementioned portfolios) is discussed in detail in Sabrient founder David Brown’s new book, How to Build High Performance Stock Portfolios, which is now available for pre-order on Amazon at a special pre-order price.

And in conjunction with David’s new book, we are also offering a subscription to our next-generation Sabrient Scorecard for Stocks, which is a downloadable spreadsheet displaying our Top 30 highest-ranked stock picks for each of those 4 investing strategies. And as a bonus, we also provide our Scorecard for ETFs that scores and ranks roughly 1,400 US-listed equity ETFs. Both Scorecards are posted weekly in Excel format and allow you to see how your stocks and ETFs rank in our system…or for identifying the top-ranked stocks and ETFs (or for weighted combinations of our alpha factors). You can learn more about both the book and the next-gen Scorecards (and download a free sample scorecard) at http://DavidBrownInvestingBook.com.

In today’s post, I discuss in greater detail the current trend in inflation, Fed monetary policy, stock valuations, technological trends, and what might lie ahead for the stock market. 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. And be sure to check out my Final Thoughts section with a few off-topic comments on the imminent election and escalating Middle East conflict.

Click here to continue reading my full commentary online or to sign up for email delivery of this monthly market letter. Also, here is a link to this post in printable PDF format. I invite you to share it as appropriate (to the extent your compliance allows).

  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

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

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

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

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

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

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

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

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

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

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

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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

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

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

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

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested). And please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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

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

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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