Scott Martindale  by Scott Martindale
  President, Sabrient Systems LLC

In case you didn’t notice, the past several days have brought an exciting and promising change in character in the US stock market. Capital has been rotating out of the investor darlings – including the momentum, growth, and low-volatility factors, as well as Treasury bonds and “bond proxy” defensive sectors – and into the neglected market segments like value, small-mid caps, and cyclical sectors favored by Sabrient’s GARP (growth at a reasonable price) model, many of which have languished with low valuations despite solid forward growth expectations. And it came just in the nick of time.

In Q3 of last year, the S&P 500 was hitting new highs and the financial press was claiming that investors were ignoring the trade war, when in fact they weren’t ignoring it at all, as evidenced by narrow leadership coming primarily from the mega-cap secular Technology names and large cap defensive sectors (risk-off). In reality, such market behavior was unhealthy and doomed to failure without a broadening into higher-beta cyclical sectors and small-mid caps, which is what I was opining about at the time. Of course, you know what happened, as Q4 brought about an ugly selloff. And this year, Q3 was looking much the same – at least until this sudden shift in investor preferences.

Last month, as has become expected given its typically low-volume summer trading, August saw increased volatility – and also brought out apocalyptic commentaries similar to what we heard from the talking heads in December. In contrast to the severely overbought technical conditions in July when the S&P 500 managed to make a new high, August saw the opposite, with the major indices becoming severely oversold and either challenging or losing support at their 200-day moving averages or even testing their May lows, as investors grew increasingly concerned about a protracted trade war, intensifying protectionist rhetoric, geopolitical turmoil, Hard Brexit, slowing global economy, and US corporate earnings recession. Utilities and Real Estate led, while Energy trailed. Bonds surged and yields plunged. August was the worst month for value stocks in over 20 years.

But alas, it appears it we may have seen a blow-off top in bonds, and Treasury yields may have put in a bottom. All of a sudden, the major topic of conversation among the talking heads this week has been the dramatic rotation from risk-off market segments to risk-on, which has been a boon for Sabrient’s Baker’s Dozen portfolios, giving them the opportunity to gain a lot of ground versus the S&P 500 benchmark. The Energy sector had been a persistent laggard, but the shorts have been covering as oil prices have firmed up. Financials have caught a bid as US Treasury prices have fallen (and yields have risen). Small cap value has been greatly outperforming large cap growth. It seems investors are suddenly less worried about a 2020 recession, ostensibly due to renewed optimism about trade talks, or perhaps due to the apparent resilience of our economy to weather the storm.

The question, though, is whether this is just a temporary reversion to the mean – aka a “junk rally,” as some have postulated – or if it is the start of a healthy broadening in the market and a rotation from the larger, high-quality but high-priced stocks (which have been bid up by overly cautious sentiment, passive index investing, and algorithmic trading, in my view), into the promising earnings growers, cyclicals, and good-quality mid and small caps that would normally lead a rising market. After all, despite its strong year-to-date performance, the S&P 500 really hasn’t progressed much at all from last September’s high. But a real breakout finally may be in store if this risk-on rotation can continue.

I think the market is at a critical turning point. We may be seeing a tacit acknowledgment among investors that perhaps the economy is likely to hold up despite the trade war. And perhaps mega-caps with a lot of international exposure are no longer the best place to invest. And perhaps those mega-caps, along with the defensive sectors that have been leading the market for so long, are largely bid up and played out at this point such that the more attractive opportunities now lie in the unjustly neglected areas – many of which still trade at single-digit forward P/Es despite solid growth expectations.

September is historically a bad month for stocks. It is the only month in which the Dow Jones Industrials index has averaged negative performance over the past 100 years, showing positive returns about 40% of the time (according to Bespoke Investment Group). But this budding rotation may be setting up a more positive outcome. I was on the verge of publishing this month’s article early last week, but the market’s sudden (and important!) change in character led me to hold off for a few days to see how the action unfolded, and I have taken a new tack on my content.

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 look defensive to me, while the technical picture is short-term overbought but longer-term bullish, and the sector rotation model takes to a solidly bullish posture. Read on…

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

Stocks are rocketing to new highs almost every day. Jeff Bezos of Amazon.com (AMZN) saw his net worth exceed $100 billion. Bonds are still strong (and interest rates low). Real estate pricing is robust. DaVinci painting sells for $450 million. Bitcoin – having no intrinsic value other than a frenzy of speculative demand – trades above $11,000 (up from $1,000 on January 1), with surprising enthusiasm brewing among institutional investors, including some of the wealthiest and most successful, and with futures and derivatives on cryptocurrencies in the pipeline. (By the way, if you are afraid of a global internet crash disrupting your holdings, fear not, as there is a bitcoin satellite accessible by dish.)

Investors are desperately seeking the next hot area before it gets bid up. (Maybe marijuana stocks are next, in anticipation of broader legalization.) Indeed, central bank monetary policies have created significant asset inflation, with cheap money from around the globe burning a hole in investors’ pockets. So now it’s high time to invite to the party some of the huddled masses (who don’t have direct access to the Fed’s largesse) – through fiscal stimulus. We are already getting some of that in the form of regulatory reform, which the Administration has largely done on its own. But the eagerly anticipated big-hitter is tax reform, which requires the cooperation of Congress. And despite the Republicans’ inability to come to consensus on anything else, investors are already bidding up equities in anticipation of the House and Senate reconciling a tax bill that becomes law – so expect to see a big correction if it fails.

The promise of regulatory and tax reform have kept me positive all year on mid and small caps as the primary beneficiaries, and I remain so now more than ever. In addition, they offer a way to better leverage continued economic expansion and rising equity prices, particularly those that supply (or that seek to take away a small piece of a growing pie from) the dominant mega caps. Moreover, as the valuations for the mega-cap Technology names in particular grow ever more elevated, we are starting to see a passing of the baton to smaller players and other market segments that display more attractive forward valuation multiples.

In this periodic update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and offer up some actionable ETF trading ideas. In summary, our sector rankings still look bullish, while the sector rotation model also maintains its bullish bias. A steady and improving global growth outlook and a persistently low interest rate environment continues to foster low volatility and an appetite for risk assets. Read on....