by Scott Martindale
  President & CEO, Sabrient Systems LLC

Overview:

The year began with impressive strength and resilience in risk assets despite all the uncertainties around tariffs, trade wars, hot wars, slowing GDP growth, inflation, stagflation, AI impact and capex, and myriad other concerns. The US was considered the rock in a recessionary world, attracting massive foreign capital flight (according to Nasdaq, total foreign holdings of US equities as of June 2024 was $17 trillion—almost double versus 2019). But once the dam broke, stocks, crypto, and the US dollar started melting down in a “waterfall decline” culminating in a “flash crash” on Monday with the CBOE Volatility Index (VIX) nearly hitting 30 before closing at 27.86. As the adage goes, “Stocks take the stairs up and the elevator down.” But I believe this is a valuation-driven correction, as stocks had become “priced for perfection,” and the rapid meltdown ultimately will give way to a gradual melt-up, driven by rising global liquidity, a weaker US dollar, reduced wasteful government spending, lower tax and interest rates, less regulatory red tape, and the “animal spirits” of a rejuvenated private sector and housing market.

Prop desks and algorithmic trading systems hit sell stops to exacerbate the selloff, with many flipping from long to short exposure, and markets imploded as average investors quickly swung from extreme greed to extreme fear. According to Real Investment Advice, “The last time the market was this oversold and 3 standard deviations below the [50-day moving average] was in August of last year during the 10% correction as the Yen Carry Trade erupted.” The AAII weekly sentiment survey hit a bearish extreme of 60% on 2/26, after surging from 40% just one week earlier when the S&P 500 was at an all-time high. However, it’s important to note that stocks have historically recovered quite impressively over the 12 months following such extreme bearish readings.

The rising bond term premium in Q4 suggested that investors were becoming increasingly anxious about rising deficits and inflation, which also pushed gold higher. Meanwhile, the Fed has maintained tight monetary policy—and high real interest rates—given the uptick in inflation and apparently solid employment reports. However, I have consistently argued that the real-time inflation trend (without the lag in key components) has been falling and that massive government spending and hiring masked underlying issues with growth and employment in the private sector. So, this is not due to anything the new administration has done. As Renaissance Macro economist Neil Dutta recently opined, "[President Trump] inherited an economy with deep imbalances and a frozen housing and labor market."

In fact, John Burns Research & Consulting has observed that 3.8 million employees work directly for the government, but an additional 7.5 million workers indirectly receive some or all of their wages from the government—which totals 11.3 million workers or roughly 8% of the total US workforce (134 million) and accounts for much of the jobs growth. This is why I continue to advocate for both smaller government and another 100 bps in Fed rate cuts to achieve a neutral fed funds rate around 3.5% and stimulate private sector growth. As a result, I would expect a 10-year yield to stabilize around 4.0-4.5%, which would justify a forward P/E multiple for the S&P 500 around 20x (i.e., an earnings yield of 5%).

From their highs this year, “the S&P 500 and crypto have erased a combined -$5.5 trillion of market cap,” according to The Kobeissi Letter. The highflyers have led the carnage, most notably semiconductor stocks. Meta Platforms (META) is the only MAG-7 stock still positive YTD, while defensive sectors (like staples, telecom, and utilities), gold and silver miners, low/minimum volatility, value, high dividend payers, REITs, and long-duration bonds are among the best performers. The fact that bonds have caught a bid and credit spreads remain tight are positive signs that investors do not fear recession (or economic collapse). But investors continue to be shy about the amount and duration of tariffs, the aggressive DOGE actions, timing of fiscal policy implementation (tax cuts and deregulation), and Fed monetary policy (a Fed put?), and the collective impact on jobs, inflation, GDP growth, and risk asset prices as they retreat from historically high valuations.

To be sure, the Big Tech darlings had become overvalued, which is why the equal-weight versions of the S&P 500 and Nasdaq 100 have held up significantly better during the selloff. But keep in mind, the first year of a 4-year presidential term is typically the most volatile during the transition to new policies—and Trump 2.0 (“wrecking-ball”) policies are bringing quite a change from the norm. As Treasury Secretary Scott Bessent said, “The economy has become hooked [on government spending], and there is going to be a detox period.”

So, knowing that he must show significant progress before the 2026 midterms, Trump is “ripping off the band-aid” to fully reveal the infected wound and wasting no time in addressing it with what he and his team strongly believes are healing policies that will restructure our nation for long-term prosperity, public safety, and national security. This is why his popularity among younger voters is holding firm. Although not nearly as extreme, it is like what Javier Milei has done to resurrect Argentina. I expect the political, economic, and market fallout will take its course during H1 2025 before giving way to a rapid building process during H2.

Investors have been increasingly scared away from risk assets at least partly due to the constant carping from both the mainstream media (MSM) and social media (usually misleadingly) about a “growth scare” (as the Atlanta Fed’s GDPNow forecast for Q1 plummeted to a recessionary -2.4% annualized growth rate), an “inflation scare” (due to tariffs, chickens, and migrant deportations), an “AI scare” (as China may be usurping our dominance with cheaper models, a “trade war scare” (as we alienate our international allies and trading partners), and various other scares that escape me at the moment (perhaps a “Hollywood exodus scare,” as celebs move out of country?). This diversified fearmongering has finally come to roost leading to the rapid unwinding of crowded long trades.

But no matter what you think of the longstanding system of global trade and whether the US was being taken advantage of, there is no doubting that the fiscal path we were on was unsustainable, with a bloated and intractable bureaucracy, wasteful boondoggles, entrenched interests, and funding of corruption, graft, fraud, racketeering, cronyism, kickbacks, and obfuscation both at home and around the world. Until now, no president has been willing or able to adequately address it, including Trump 1.0. But the new Trump 2.0 administration came in well prepared (and with a voter majority mandate) to tackle it head on. I have come to appreciate the method to our president’s apparent madness, as I discuss in my full post.

So, is this selloff likely to become a buyable dip rather than the start of a bear market? I would say yes. Although there might be some further volatility into the 4/2 tariff implementation date and perhaps the 4/15 Tax Day, I expect higher prices ahead. Why? First, from a short-term technical standpoint, the S&P 500, Nasdaq 100, and Dow Jones Industrials have diverged well below their 20-day moving averages, and they seem to have found support around their critical 300-day moving averages. Second, from a longer-term standpoint, despite all this chaos and turmoil from an administration emboldened to reverse and repair decades of neglect (and a continual “kicking the can down the road” for future generations to suffer the consequences), I remain optimistic that after some short-term pain during this transition period—including upticks in inflation, debt, and market volatility and a downtick in economic growth—the private sector will be equipped and unleashed to drive robust economic growth through productive, high-ROI investments and hiring.

In addition, as DataTrek Research recently observed, stocks have only fallen more than 10% in a given year in just 12 of the past 97 years, and each was driven either by a new hot war, recession (generally related to an oil price shock), or a Fed policy mistake—none of which are likely. So, don’t be too bearish. And as for a long entry point, the VIX can provide some guidance. It closed above 27 this week, which DataTrek considers to be a “capitulation” signal to consider getting back into stocks. And don’t forget all the cash sitting in money market funds earning those juicy risk-free rates. As money market rates recede, some of that cash may finally find its way into stocks at these more favorable valuations. Indeed, the rising price of gold may be signaling a global dovish pivot and massive liquidity support, as I discuss in my full post.

Yes, liquidity is key to keeping us out of a recession and a bear market in risk assets. Lower interest rates and a weaker US dollar are long-term economic tailwinds, while debt reduction is a short-term headwind until a rejuvenated (and turbocharged) private sector makes up for the lower deficit spending.

I expect the S&P 500 to rise above 6500 before year-end with a modest double-digit gain. Could it take longer for the expected fiscal stimulus (lower tax and interest rates, less red tape, and smaller government) to serve alongside the incredible promise of AI (on productivity, efficiency, and speed of product development) to boost the GDP such that the 6500 mark isn’t achieved until next year? Sure. But I think ultimately an economy driven by organic private sector growth is stronger and more reliable and sustainable than one driven by government (deficit) spending bills. As Elon Musk opined, “A more accurate measure of GDP would exclude government spending… Otherwise, you can scale GDP artificially high by spending money on things that don’t make people’s lives better.”

In the view of Treasury Secretary Scott Bessent, we have “a generational opportunity to unleash a new economic golden age that will create more jobs, wealth and prosperity for all Americans.” Indeed, if the fed funds rate begins to come down toward my 3.5% target, today’s slightly elevated valuations can be justified given solid corporate earnings growth, a high ratio of corporate profits to GDP, and the promise of continued margin growth across all industries due to the promise of rising productivity, efficiency, and product development speed from Generative AI, Large Language Models (LLMs), and Big Data. AI investment is not slowing down but simply shifting from a singular “builder” focus to a broader focus on AI applications. This is where productivity enhancement will shift into gear. And don’t forget energy, as affordable power is the lifeblood of an economy. Costs must stay low, and Trump 2.0 is prioritizing energy independence and lower energy costs.

Because this market correction was led by the bull market-leading MAG-7 stocks and all things AI related, investors now have a second chance to get positions in some of those mega-cap titans at more attractive prices. Notably, some of these names have seen their valuations retreat such that they are once again scoring well in Sabrient’s growth models (as found in our next-gen Sabrient Scorecards subscription product)—including names like Amazon (AMZN), NVIDIA (NVDA), Salesforce (CRM), Arista Networks (ANET), Fortinet (FTNT), Palo Alto Networks (PANW), Palantir (PLTR), Microsoft (MSFT), and Taiwan Semiconductor (TSM). Our models focus on high quality and fundamental strength, with a history of consistent, reliable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus forward estimates, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are factors Sabrient employs in selecting our portfolios and 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).

Sabrient founder David Brown describes these (and other) factors and his portfolio construction process in his new book, How to Build High Performance Stock Portfolios, which is available on Amazon for investors of all experience levels. David describes his path from NASA engineer on the Apollo 11 moon landing project to creating quant models for ranking stocks and building stock portfolios in four distinct investing styles—growth, value, dividend, or small cap growth. You can learn more about David's book, as well as the companion subscription product (Sabrient Scorecards) that does most of the stock evaluation work for you, by visiting: https://HighPerformanceStockPortfolios.com.

As you might expect from former engineers, Sabrient employs the scientific method and hypothesis-testing to build quantitative models that make sense. We have become best known for our “Baker’s Dozen” portfolio of 13 diverse growth-at-a-reasonable-price (GARP) stocks, which is packaged and distributed quarterly to the financial advisor community as a unit investment trust through First Trust Portfolios, along with three other offshoot strategies based on value, dividend, and small cap investing.

Click HERE to continue reading my full post (and to sign up for email delivery). I examine in greater detail the “growth scare,” inflation, tariffs, and DOGE shock, equity valuations, and what lies ahead. 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. Also, here is a link to this post in printable PDF format.

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Overview:

The stock market continues to chop around within a 2-month sideways trend, as uncertainty about fiscal and monetary policies confront elevated (some might say extreme) valuations, risk premia, and market cap concentration (with the top 10% of stocks by market cap now accounting for about 75% of the total), as well as slowing growth among the MAG-7 stocks. Uncertainty ranges from DeepSeek’s implications on the massive capex spending plan for AI, to DOGE’s rapid discovery of the shocking array of wasteful spending and corruption, to President Trump’s starling proposals regarding Gaza, Greenland, and Canada, to the frantic protests of Democrats and injunctions from federal judges on his dizzying array of executive orders.

Nevertheless, investors seem broadly optimistic about Trump 2.0 policies in the longer term but are concerned about near-term pain (which he has warned them about) from things like tariffs, trade wars, widespread job cuts across the federal government (from DOGE), and civil unrest and political dysfunction from those pushing back on the new policies—and the near-term impact on geopolitical tensions and the trajectories of GDP, the budget deficit, federal debt, inflation, the dollar, interest rates, and new issuances of Treasuries. As a result, gold has gone parabolic and seems determined to challenge the $3,000 mark. Bond investors may be rewarded handsomely when economic fundamentals normalize and the term premium fades. Until then, sentiment rather than data has been the key driver of bond yield rates.

Since the Fed started its rate cutting cycle, the fed funds rate is 100 bp lower while the 10-year Treasury yield jumped as much as 100 bps mostly due to short-selling “bond vigilantes,” although it has receded quite a bit of late. But more important than the fed funds rate is bringing down the 10-year Treasury yield, which has a much greater impact on long-term borrowing costs—like home mortgages—but is primarily driven by market forces and sentiment. So, other than direct intervention via QE (buying longer-term Treasuries and MBS on the open market), all the Fed and Trump administration can do is try to shore up investor confidence and expectations for economic growth, jobs, inflation, deficits, interest rates, productivity, and earnings.

Indeed, new Treasury Secretary Scott Bessent says the president believes, “if we deregulate the economy, if we get this tax bill done, if we get energy down, then [interest] rates will take care of themselves.” To that end, Bessent has espoused a “3-3-3” economic plan to increase GDP growth to 3%, reduce the budget deficit to 3% of GDP, and boost oil production by 3 million bbls/day (and according to Ed Yardeni, you might throw in 3% productivity growth as a fourth “3”). In Bessent’s view, we have “a generational opportunity to unleash a new economic golden age that will create more jobs, wealth and prosperity for all Americans.”

The recent uptick in US inflation has not been due to supply chain disruptions, as the Global Supply Chain Pressure Index (GSCPI) is negative (below its long-run average) at -0.31 (Z-score, or number of standard deviations from the mean). Instead, it seems to be more about: 1) money supply and velocity both rising in tandem, and 2) heavy foreign capital flight into the US (much of which remains outside of our banking system and is not captured by M2 money supply metrics) and interest payments on US debt (which goes primarily to wealthy individuals and sovereign governments) going toward asset purchases, which creates a consumer "wealth effect." This surge in foreign capital into the US is driven by our strong dollar, innovative public companies and start-ups, higher bond yields, desirable real estate, property rights, and business- and crypto-friendly policies.

Many commentators have called current stock valuations “priced for perfection.” Much like China’s mercantilist economy facing falling growth rates—as it has become so large it simply can’t find enough people to sell to maintain its previous trajectory—the MAG-7 stocks also seem to be hitting limits to their growth rates from sheer size. In fact, according to the The Market Ear, the “big four” richest executives (Musk, Bezos, Zuckerberg, Ellison) have seen their combined wealth explode from $74 billion in 2013 to $1.1 trillion today—nearly as much as the total US trade deficit ($1.2 trillion), or our total annual imports from China, Canada and Mexico ($1.3 trillion). Insane. But because of the extreme level of market concentration among the market juggernauts that distort the valuation multiples of the broad market indexes, I believe there are still many smaller “under-the-radar” stocks offering fair valuations for attractive growth, which is what Sabrient’s models seek to identify. I discuss this further in my full commentary below.

For 2025, my view is that, after a period of digestion and adjustment to this current flurry of activity (and likely a more significant market correction than most investors expect), we will see the stimulative and transformational impacts of: 1) business-friendly fiscal policies and deregulation, 2) less anti-trust enforcement and lawfare, 3) massive cuts to wasteful/unproductive government spending (including on illegal migrants and foreign wars), 4) tame supply chain pressures and labor, oil, and shelter costs all stabilizing, and 5) supportive monetary policy and a steepening yield curve (through normalization in interest rates and the term premium). Collectively, this promises to unleash our private sector and recharge economic growth.

Furthermore, I think recent signs of resurgent inflation and fears of a ballooning deficit will both recede, as I discuss in greater depth in my full post, which will allow the Fed to make two-to-three 25-bp rate cuts on its path toward what I believe is a terminal (aka neutral) rate around 3.50%...and the 10-year yield likely settling into the 4.25-4.50% range (i.e., a term premium of 75-100 bps)—particularly given that many of our global trading partners likely will be forced to cut rates to stave off recession (in Europe) and deflation (in China). Of course, what happens outside our border impacts us. China’s deflationary economy is still slowing and the CCP remains reluctant to use broad stimulus, but rate cuts have been signaled. Japan finally decided to increase its policy rate from 0.25% to 0.50% (still quite low), which strengthened the yen, as it tries to stave off stagflation. Europe is a basket case, especially the manufacturing sector, with recession expected in its largest economies, Germany and France. The ECB will likely cut rates several times and further weaken the euro.

Keep in mind, Treasury yields tend to be self-correcting in that as they rise investors become more defensive and drawn to the higher yields, which increases demand for bonds and brings yields back down. Of course, fiscal policy, deficit spending, inflation, and corporate earnings all come into play as well. But regarding interest rates alone, as long as the Fed is not raising the fed funds rate or tightening liquidity, the environment for stocks is supportive.

Overall, I think this all bodes well for banks, mortgage services, and indeed the whole financial sector, as well as for IPOs/M&A (after a steep downtrend over the past 4 years), small-mid-cap stocks, solid dividend payers, and longer-duration fixed income. Top-ranked sectors in Sabrient’s SectorCast rankings include Technology, Healthcare, and Consumer Discretionary. However, other market segments that don’t rank very high right now but may gain traction in the Trump 2.0 economy include oil & gas, nuclear, and transports, as well as industrials and utilities involved in building out the AI infrastructure and power grid. I also think there is turnaround potential in the beaten-down homebuilders and REITs. And I continue to like gold, silver, and cryptocurrencies as uncorrelated asset classes, market/dollar hedges, and stores of value.

So, rather than the high-valuation MAG-7 stocks, investors are advised to focus on high-quality, fundamentally strong companies displaying a history of consistent, reliable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus forward estimates, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are factors Sabrient employs in selecting our portfolios and 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).

Sabrient founder David Brown describes these (and other) factors and his portfolio construction process in his new book, How to Build High Performance Stock Portfolios, which is available on Amazon for investors of all experience levels. David describes his path from NASA engineer on the Apollo 11 moon landing project to creating quant models for ranking stocks and building stock portfolios in 4 distinct investing styles—growth, value, dividend, or small cap growth. You can learn more about David's book and the companion subscription product we offer (that does most of the stock evaluation work for you) by visiting: https://DavidBrownInvestingBook.com

As a reminder, our research team at Sabrient leverages a process-driven, quantitative methodology to build predictive multifactor models, data sets, stock and ETF rankings, rules-based equity indexes, and thematic stock portfolios. As you might expect from former engineers, we use the scientific method and hypothesis-testing to build models that make sense—and we do that for growth, value, dividend, and small cap strategies. We have become best known for our “Baker’s Dozen” growth portfolio of 13 diverse picks, which is packaged and distributed quarterly to the financial advisor community as a unit investment trust, along with three other offshoot strategies for value, dividend, and small cap investing.

Click HERE to continue reading my full commentary (and to sign up for email delivery). I examine in greater detail the DeepSeek and DOGE shocks, AI spending, equity valuations, GDP, jobs, inflation, tariffs, and what lies ahead for 2025. 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. Also, here is a link to this post in printable PDF format.