by Scott Martindale
  President & CEO, Sabrient Systems LLC

The New York Fed’s Global Supply Chain Pressure Index (GSCPI) for November was released today, and although it rose more than expected (likely due to disruptions from heightened global hostilities), it still suggests inflation will continue its gradual retreat, with a reading near the long-run average. But let me start by talking about October’s inflation indicators. Last week, the headline reading for Personal Consumption Expenditures (PCE) for October came in at 3.0% YoY, helped quite a bit by the fall in oil and gasoline prices (note: the US is producing an all-time high of 13.2 million barrels/day of crude oil). Core PCE, which is the Federal Reserve's preferred inflation metric, came in at 3.46% year-over-year. However, the month-over-month number for October versus September, which better reflects today's inflation trends and the lag effects of higher interest rates, came in at 0.16%, which annualizes to 1.98%. Keep in mind, the Fed's inflation target is 2.0%. But monthly data can be choppy, so looking at the rolling 3-month average, it annualizes to 2.37%.

Earlier reports had shown October PPI at 1.3% YoY and CPI at 3.2%, with core PPI (excluding food & energy) was 2.4% YoY, and core CPI was 4.0%. All of this was presaged by the GSCPI, which measures the number of standard deviations from the historical average value (aka Z-score) and generally foreshadows movements in inflation metrics. It plummeted from a December 2021 all-time high of +4.31 down to the October reading of -1.74—its lowest level ever. However, that ultra-low October reading has been revised to -0.39 due to “a change in exchange rate weighting methodology,” according to the New York Fed. Nevertheless, the writing was on the wall for last week’s favorable PCE report. The chart below illustrates the correlation between GSCPI, PPI, and CPI.

So, what to expect for November inflation? Well, as shown in the chart, GSCPI for November just came in today at 0.11. Although rising from its ultra-low levels, it still remains at the long-run average, and the chart illustrates that volatility is to be expected. All in all, I think it still bodes well for the next week’s CPI/PPI readings as supply chains continue to heal and diversify (albeit with occasional hiccups like we see today from heightened global hostilities), especially when you also consider that the consumer has become stretched with rising household debt and falling growth in job openings and wages, money supply growth is stagnant, and budget hawks are increasingly flexing their fiscal muscles in Congress. Thus, I believe the probability of a resurgence in either inflation or fiscal expansion is quite low.

Furthermore, although the second estimate for Q3 GDP was ultra-strong (the highest in 2 years), revised up to 5.2% annual rate (from previous 4.9%), the boost came from state and federal government spending, which was revised up to 5.5% from the prior estimate of 4.6% (i.e., more unsustainable deficit spending and issuance of Treasuries paying high coupons, mostly from an 8.2% increase in defense spending), while personal consumption was revised down to 3.6% from 4.0%. This tells me the “robust” GDP number was something of an illusion.

Indeed, looking ahead, the Atlanta Fed’s GDPNow forecasts only 1.3% GDP growth and 1.9% PCE growth for Q4 (as of 12/6). Moreover, the good folks at Real Investment Advice observed that Gross Domestic Income (GDI) for Q3 was reported at only +1.5%, displaying the widest gap below GDP in 50 years. (Note: GDP measures the value of goods and services produced, including consumption expenditures, investments and exports, while GDI measures incomes earned and costs incurred in production of GDP, including wages, profits, and taxes.) Also, last week’s Fed Beige Book showed that two-thirds of Fed districts reported slower economic activity over the prior six weeks, and the ISM Manufacturing Index came in at an anemic 46.7, showing continued contraction for the 15th straight month.

So, this all seems to be more “bad news is good news” when it comes to Fed policy moves, and investors will be eagerly watching Friday’s jobs report followed by next week’s CPI, PPI, and FOMC policy announcement. Stocks have been taking a healthy breather and consolidation in anticipation of it all, but so far, no major pullback. This year seems to be following the playbook of what economist Ed Yardeni has characterized as a series of “rolling recessions” (among sectors) and an “Immaculate Disinflation,” i.e., moderating inflation without a harsh recession or massive layoffs. As an aside, I have opined many times that it is ridiculous that we constantly find ourselves awaiting the edict of this unelected board of “wise elders” to decide our economic fate. Why can’t they take emergency measures only when absolutely necessary to avert economic cataclysm, and then once the crisis has passed, those emergency measures are quickly withdrawn so that the free market can get back to doing its productive, creative, wonderful thing? One can dream.

Regardless, in my view, the Fed is likely done with rate hikes and preparing for its eventual pivot to rate cuts—which I think will come sooner than most expect, likely before the end of H1 2024. Why? Because if inflation maintains its gradual downtrend while the Fed holds its overnight borrowing rate steady, the real (inflation-adjusted) rate keeps rising, i.e., de facto tightening. Indeed, Fed funds futures are projecting 98% chance for no rate change next week, and for 2024, 62% chance for at least one 25-bp rate cut by March, 97% for at least one 25-bp cut by June, and 89% chance of a full 1.0% in total rate cuts by December 2024, which would put the fed funds rate below 4.5%.

Accordingly, after kissing the 5% handle, the 10-year Treasury yield has fallen precipitously to below 4.2%—a level last seen at the end of August. So, I encourage and expect the FOMC to follow the message of the bond market and begin cutting the fed funds rate back towards the neutral rate, which I think is around 2.5-3.0% nominal (i.e., 2% target inflation plus 0.5-1.0% r-star), and hand back control of the economy to the free market. As of now, the Fed is on the verge of crushing the housing market…and by extension the broader economy. In addition, it must ensure money supply resumes a modest growth rate (albeit slowly), not continue to shrink or stagnate.

To be sure, the safe steadiness of bond yields was disrupted this year. After rising much faster than anyone anticipated, interest rates have fallen much faster than expected, especially considering that the Fed hasn’t made any dovish policy changes. Nevertheless, if rates are going to generally meander lower, investors might be expected to lock in sustainable yield with capital appreciation potential through longer-duration securities, including long-term bonds, “bond proxies” like dividend-paying equities (e.g., utilities, staples, and REITs), and growth stocks (like high-quality technology companies).

I also like oil, gold and uranium stocks, as well as gold, silver, and cryptocurrency as stores of value in an uncertain macro climate. Notably, gold is challenging its highs of the past few years as global investors and central banks are both hedging and/or speculating on a weaker dollar, falling real interest rates, rising geopolitical tensions, and potential financial crisis, and the World Gold Council reported robust demand among central banks, which purchased a record 800 tons during the first three quarters of the year. Similarly, Bitcoin is catching a bid on speculation of broader investor access (through spot-price ETFs) and dollar debasement (if debt and deficit spending continue to spiral).

Keep in mind that, when valuations get lofty within a given asset class, volatility and performance/valuation dispersion among stocks often increases while correlations decrease. For stocks, active selection strategies that can exploit the dispersion to identify under-the-radar and undervalued companies primed for explosive growth become more appealing versus passive index investing. Sabrient’s actively selected portfolios include the Q4 2023 Baker’s Dozen (launched on 10/20), Small Cap Growth 40 (launched on 11/3), and Sabrient Dividend 46 (just launched on 11/29, and today offers a 4.7% dividend yield).

In today’s post, I further discuss inflation, the US dollar, Fed monetary policy implications, and relative performance of asset classes. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which is topped by Technology and Industrials), current positioning of our sector rotation model (which turned bullish in early November and remains so), and some actionable ETF trading ideas.

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested).

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

As expected, last week the FOMC left the fed funds rate as is at 5.25-5.50%. Fed funds futures suggest the odds of a hike at the December meeting have fallen to less than 10%, and the odds of at least three 25-bp rate cuts by the end of 2024 have risen to nearly 80%, with a 25% chance the first cut comes as soon as March. As a result, after moving rapidly to cash for the past few months, stock and bond investors came rushing back with a vengeance. But what really goosed the market were underwhelming economic reports leading to Fed Chair Jerome Powell’s comments suggesting the lag effects on surging interest rates and the strong US dollar are finally manifesting. Investors apparently believed the Fed’s promise of “higher for longer” (making the Fed’s job easier), which spiked Treasury yields (and by extension, mortgage rates) much faster and more severely than the Fed intended.

The S&P 500 had fallen well below all major moving averages, accelerating downward into correction territory, and was down 10% from its 7/31 high. Moreover, the S&P 500 Bullish Percent Index (BPSPX), which rarely drops below 25, had fallen to a highly oversold 23 (anything below 30 is considered oversold), and the CBOE Volatility Index (VIX) had surged above the 20 “panic threshold” to hit 23. Both were contrarian bullish signals. Then stocks began to recover ahead of the FOMC meeting, and after the less-than-hawkish policy announcement, it triggered short covering and an options-driven “gamma squeeze,” with the S&P 500 surging above its 200-day, 50-day, and 20-day moving averages (leaving only the 100-day still above as potential resistance), the BPSPX bullish percent closed the week at 43 (which is still well below the overbought level of 80 last hit on 7/31), and the VIX closed the week below 15.

The recovery rally was broad, and in five short days put the major indexes back to where they were two weeks ago. The best performers were those that sold off the most, essentially erasing the late-October swoon in any instant. As for Treasury yields, the week ended with the 2-year at 4.84% (after hitting 5.24% in mid-October) and the 10-year at 4.57% (after touching 5.0% in mid-October), putting the 2-10 inversion at -27 bps. The 30-year mortgage rate has fallen back below 7.50%. Recall that my “line in the sand” for stocks has been the 2-year staying below 5.0%, and indeed falling below that level last week correlated with the surge in equities.

Looking ahead, investors will be wondering whether last week’s huge relief rally is sustainable, i.e., the start of the much-anticipated Q4 rally. After all, it is well known that some of the most startling bull surges happen during bear markets. Regardless, stock prices are ultimately based on earnings and interest rates, and earnings look quite healthy while interest rates may have topped out, as sentiment indicators are flashing contrarian buy signals (from ultra-low levels). But much still hinges on the Fed, which is taking its cues from inflation and jobs reports. Last week’s FOMC statement suggests a lessening of its hawkishness, but what if the Fed has viewed our post-pandemic, return-to-normalcy, sticky-inflation economic situation—and the need for harsh monetary intervention—all wrong?

Much of the empirical data shows that inflation was already set to moderate without Fed intervention, given: 1) post-lockdown recovery in supply chains, rising labor force participation, and falling excess savings (e.g., the end to relief payments and student debt forbearance); and 2) stabilization/contraction in money supply growth. These dynamics alone inevitably lead to consumer belt-tightening and slower economic growth, not to mention the resumption in the disinflationary secular trends and the growing deflationary impulse from a struggling China.

Notably, the New York Fed’s Global Supply Chain Pressure Index (GSCPI), which measures the number of standard deviations from the historical average value (aka Z-score) and generally presages movements in PPI (and by extension, CPI), was released earlier today for October, and it plummeted to -1.74, which is its lowest level ever. This bodes well for CPI/PPI readings next week and PCE at month end, with a likely resumption in their downtrends. So, although the Fed insists the economy and jobs are strong and resilient so it can focus on taming the scourge of inflation through “higher for longer” interest rates, I remain less concerned about inflation than whether the Fed will pivot quickly enough to avoid inducing an unnecessary recession.

Assuming the Fed follows through on its softer tone and real yields continue to fall (and we manage to avoid World War III), I think this latest rally has given investors renewed legs—likely after a profit-taking pullback from last week’s 5-day moonshot. With over 80% of the S&P 500 having reported, Q3 earnings are handily exceeding EPS expectations (3.7% YoY growth, according to FactSet, driven mostly by a robust profit margin of 12.1%), and optimistic forecasts for 2024-2025 earnings growth are holding up. Meanwhile, a renewed appetite for bonds promises to drive down interest rates.

I like the prospects for high-quality/low-debt technology companies, bonds and bond-proxies (e.g., utilities and consumer staples), oil and uranium stocks, gold miners, and bitcoin in this macro climate. Furthermore, we continue to believe that, rather than the broad-market, passive indexes that display high valuations, investors may be better served by active stock selection Sabrient’s portfolios include the new Q4 2023 Baker’s Dozen (launched on 10/20), Small Cap Growth 40 (just launched on 11/3), and Sabrient Dividend 45 (launched on 9/1, and today offers a 5.5% dividend yield).

In today’s post, I discuss the trend in supply chains and inflation, equity valuations, and Fed monetary policy implications. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which is topped by Technology and Industrials), current positioning of our sector rotation model (which is switching from neutral to a bullish bias, assuming support at the 50-day moving average holds for the S&P 500), and some actionable ETF trading ideas.

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested).

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Federal shutdown averted, at least for another 6 weeks, which may give investors some optimism that cooler heads will prevail in the nasty tug-of-war between the budget hawks and the spendthrifts on the right and left flanks. Nevertheless, I think stocks still may endure some turmoil over the next few weeks before the historically bullish Q4 seasonality kicks in—because, yes, there are still plenty of tailwinds.

From a technical standpoint, at the depths of the September selloff, 85% of stocks were trading below their 50-day moving averages, which is quite rare, and extreme September weakness typically leads to a strong Q4 rally. And from a fundamental standpoint, corporate earnings expectations are looking good for the upcoming Q3 reporting season and beyond, as analysts are calling for earnings growth of 12.2% in 2024 versus 2023, according to FactSet. But that still leaves us with the interest rate problem—for the economy and federal debt, as well as valuation multiples (e.g., P/E) and the equity risk premium—given that my “line in the sand” for the 2-year Treasury yield at the 5% handle has been solidly breached.

But the good news is, we learned last week that the Fed’s preferred inflation metric, core PCE (ex-food & energy), showed its headline year-over-year (YoY) reading fall to 3.9% in August (from 4.3% in July). And more importantly in my view, it showed a month-over-month (MoM) reading of only 0.14%, which is a better indicator of the current trend in consumer prices (rather than comparing to prices 12 months ago), which annualizes to 1.75%—which of course is well below the Fed’s 2% inflation target. Even if we smooth the last 3 MoM reports for core PCE of 0.17% in June, 0.22% in July, and 0.14% in August, the rolling 3-month average annualizes to 2.16%. Either way, it stands in stark contrast to the upward reversal in CPI that previously sent the FOMC and stock and bond investors into a tizzy.

Notably, US home sales have retreated shelter costs have slowed, wage inflation is dropping, and China is unleashing a deflationary impulse by dumping consumer goods and parts on the global market in a fit of desperation to maintain some semblance of GDP growth while its critical real estate market teeters on the verge of implosion.

So, core inflation is in a downtrend while nominal interest rates are rising, which is rapidly driving up real rates, excessively strengthening the dollar, threatening our economy, and contributing to distress among our trading partners and emerging markets—including capital flight, destabilization, and economic migration. Also, First Trust is projecting interest on federal debt to hit 2.5% of GDP by year-end, up sharply from 1.85% last year (which was the highest since 2001 during a steep decline from its 1991 peak of 3.16%).

Therefore, I believe the Fed is going to have to lighten up soon on hawkish rate policy and stagnant/falling money supply. When the Fed decides it’s time to cut rates—both to head off escalating crises in banking and housing and to mitigate growing strains on highly leveraged businesses, consumers, and foreign countries (from an ultra-strong dollar and high interest rates when rolling maturing debt)—it would be expected to ignite a sustained rally in both stocks and bonds.

But even if the AI-leading, Big Tech titans can justify their elevated valuations with extraordinary growth—and according to The Market Ear, they trade at the largest discount to the median stock in the S&P 500 stock in over 6 years on a growth-adjusted basis—investors still may be better served by active strategies that exploit improving market breadth by seeking “under the radar” opportunities poised for explosive growth, rather than the broad passive indexes. So, we believe this is a good time to be invested in Sabrient’s portfolios—including the new Q3 2023 Baker’s Dozen (launched on 7/20), Forward Looking Value 11 (launched on 7/24), Small Cap Growth 39 (launched on 8/7), and Sabrient Dividend 45 (launched on 9/1 and today offers a 5.5% dividend yield).

In today’s post, I discuss inflation, stock-bond relative performance, equity valuations, and Fed monetary policy implications. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which continues to be topped by Technology and Energy), current positioning of our sector rotation model (neutral bias), and some actionable ETF trading ideas. Your feedback is always welcome!

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested).

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Stocks and bonds both sold off in August before finishing the month with a flourish, as signs that the jobs market is weakening suggest an end to Fed rate hikes is nigh. The summer correction in equities was entirely expected after the market’s extraordinary display of strength for the first seven months of the year in the face of a relentlessly hawkish Federal Reserve, even as CPI and PPI have fallen precipitously. State Street’s Institutional Investor Risk Appetite Indicator moved dramatically from bearish in May to highly bullish at the end of July, and technical conditions were overbought. And although the depth of the correction took the bulls by surprise, it was quite orderly with the CBOE Volatility Index (VIX) staying tame (i.e., never even approaching the 20 handle). In fact, a 5% pullback in the S&P 500 is not unusual given the robust 20% YTD return it had attained in those seven months. Weakness in bonds, gold, and commodity prices also reversed.

Moreover, IG, BBB, and HY bond spreads have barely moved during this market pullback despite rising real rates, which signals that the correction in stocks is more about valuations in the face of the sudden spike in interest rates (and fears of “higher for longer”) rather than the health of the economy, earnings, or fundamentals. Certainly, the US economy looks much stronger than any of our trading partners (which Fed chair Powell seems none too happy about), with the Atlanta Fed’s GDPNow model estimating a robust 5.6% growth for Q3 (as of 8/31) and the dollar surging in a flight to safety [in fact, the US Dollar Index Fund (UUP) recently hit a 2023 high].

However, keep in mind that the US is not an island unto itself but part of a complex global economy and thus not immune to contagion, so the GDP growth rate will likely come down. Moreover, Powell said in his Jackson Hole speech that the Fed’s job is “complicated by uncertainty about the duration of the lags with which monetary tightening affects economic activity and especially inflation.”

Investors have generally retained their enthusiasm about stocks despite elevated valuations, rising real interest rates (creating a long-lost viable alternative to stocks—and a poor climate for gold), a miniscule equity risk premium, and a Fed seemingly hell-bent on inducing recession in order to crush sticky core inflation. Perhaps stock investors have been emboldened by the unstoppable secular force of artificial intelligence (AI) and its immediate benefits to productivity and profitability (not just “hope”)—as evidenced by Nvidia’s (NVDA) incredible earnings release last week.

I have discussed in recent posts about how the Bull case seems to outweigh the (highly credible) Bear case. However, the key tenets of the Bull case—and avoidance of recession—include a stable China. Since 2015, I have been talking about a key risk to the global economy being the so-called “China Miracle” gradually being exposed as a House of Cards, and perhaps never before has it seemed so close to implosion, as it tests the limits of debt-fueled growth—and a creeping desperation coupled with an inability (or unwillingness) to pivot sharply from its longstanding policies makes it even more dangerous. I talk more about this in today’s post.

Yet despite all the significant challenges and uncertainties, I still believe stocks are in a normal/predictable summer consolidation—particularly after this year’s surprisingly strong market performance through July—with more upside to come. My only caveat has been that the 2-year Treasury yield needs to remain below 5%—a critical “line in the sand,” so to speak. Although I (and many others) often cite the 10-year yield because of its link to mortgage rates, I think the 2-year is important because it reflects a broad expectation of inflation and the duration of the Fed’s “higher for longer” policy. Notably, during this latest spike in rates, the 2-year again eclipsed that critical 5-handle for the third time this year and challenged the 7/5 intraday high of 5.12%, before pulling back sharply to close the month below 4.9%.

If the 2-year reverses again and surges to new highs, I think it threatens a greater impact on our economy (as well as our trading partners’) as businesses, consumers, and governments manage their maturing lower-rate debt—and ultimately impacts the housing market and risk assets, like stocks. But instead, I see it as just another short-term rate spike like we saw in March and July, as investors sort out the issues described in my full post below. Indeed, August finished with a big fall in rates in concert with a big jump in stocks, gold, crypto, and other risk assets across the board, as cracks in the jobs and housing markets are showing up, leading to a growing belief that the Fed is finished with its rate hikes—as I think they should be, particularly given the resumption of disinflationary secular trends and a deflationary impulse from China.

Some economists believe that extreme stock valuations and the ultra-low equity risk premium are pricing in both rising earnings and falling rates—an unlikely duo, in their view, on the belief that a strong economy is inherently inflationary while a weakening economy suggests lower earnings—and thus, recession is inevitable. But I disagree. For one, respected economist Ed Yardeni has observed that we have already been in the midst of a “rolling recession” across segments of the economy that is now turning into a “rolling expansion.” And regarding elevated valuations in the major indexes, my observation is that they are primarily driven by a handful of mega-cap Tech names. Minus those, valuations across the broader market are much more reasonable, as I discuss in today’s post.

Indeed, rather than passive positions in the broad market indexes, investors may be better served by strategies that seek to exploit improving market breadth and the performance dispersion among individual stocks. Sabrient’s portfolios include Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend, each of which provides exposure to market segments and individual companies that our models suggest may outperform. Let me know how I can better serve your needs, including speaking at your events (whether by video or in person).

As stocks and other risk assets finish what was once destined to be a dismal month with a show of renewed bullish conviction, allow me to step through in greater detail some of the key variables that will impact the market through year-end and beyond, including the economy, valuations, inflation, Fed policy, the dollar, and China…and why I remain bullish. I also review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors (topped by Technology and Energy) and serve up some actionable ETF trading ideas.

Click here to continue reading my full commentary … or if you prefer, here is a link to my full post in printable PDF format (as some of my readers have requested).

  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

The year began with the market showing resilience in the face of the Fed’s rate hikes, balance sheet contraction, hawkish rhetoric, and willingness to inflict further economic pain, including a recession and rising unemployment (if that’s what it takes). Of course, we also had a treacherous geopolitical landscape of escalating aggression by Russia in Ukraine, by China (regarding both Ukraine and Taiwan), and North Korea (persistent rocket launches and saber-rattling). But really, the direction for stocks came down to the trend in inflation and the Fed’s response—and the latest readings on CPI and especially PPI are quite encouraging. But alas, it now appears it isn’t quite that simple, as we have a burgeoning banking crisis to throw another monkey wrench into the mix. As Roseanne Roseannadanna used to say in the early Saturday Night Live sketches, "It just goes to show you, it's always something—if it ain't one thing, it's another."

I warned in my January post that 1H 2023 would be volatile as investors searched for clarity amid a fog of macro uncertainties. And I often opine that the Fed can’t rapidly raise rates on a heavily leveraged economy—which was incentivized by ZIRP and massive money supply growth to speculate for higher returns—without fallout (aka “breaking something”). Besides impacts like exporting inflation and societal turmoil to our trading partners, the rapid pace of rate hikes has quickly lowered the value of bank reserves (as bond prices fell). Last week this in turn led to massive portfolio losses and a federal takeover for SVB Financial (SIVB) which caters to California’s start-up and technology community, as it was pushed into selling reserves to meet an onslaught of customer withdrawals. The normally stable 2-year T-Note spiked, crashing its yield by over 100 bps in just a few days. Other regional banks have required rescue or support as well, including stalwarts like Signature Bank (SBNY) and First Republic (FRC)…and then scandal-prone European behemoth Credit Suisse (CS) revealed “material weaknesses” in its accounting…and Moody’s cut its outlook on US banks from stable to negative. So, something indeed broke in the financial system.

Fortunately, inflation fears were somewhat assuaged this week, as all reports showed trends that the Fed (and investors) hoped to see. February CPI registered 6.0%, which is the lowest reading since September 2021. Despite the historical observation that a CPI above 5% has never come back down to a desirable level without the fed funds rate exceeding CPI, we already have seen CPI fall substantially from 9.1% last June without fed funds even cracking the 5% handle, much less 6%—and CPI is a lagging indicator. So, given the 12 encouraging signs I describe in my full post below, I believe the writing is on the wall, so to speak, for a continued inflation downtrend.

So, the question is, will the Fed feel it must follow-through on its hawkish inflation-busting jawboning at the FOMC meeting next week to force the economy into recession? Or will recovering supply chains (including manufacturing, transportation, logistics, energy, labor) and disinflationary secular trends continue to provide the restraint on wage and price inflation that the Fed seeks without having to double-down on its intervention/manipulation?

My expectation is the latter—and it’s not just due to the sudden banking crisis magnifying fragility in our economy. Nothing goes in a straight line for long, and inflation is no different, i.e., the path is volatile, but disinflationary trends remain intact. I talk more about this in my full post below. Regardless, given the anemic GDP growth forecast (well below inflation) and the historical 90% correlation between economic growth and aggregate corporate profits, the passive broad-market mega-cap-dominated indexes that have been so hard for active managers to beat in the past may well continue to see volatility.

Nevertheless, many individual companies—particularly within the stronger sectors—could still do well. Thus, investors may be better served by pursuing equal-weight and strategic-beta ETFs as well as active strategies that can exploit the performance dispersion among individual stocks—which should be favorable for Sabrient’s portfolios, including the newest Q1 2023 Baker’s Dozen, Small Cap Growth 37, and Dividend 43 (offering both capital appreciation potential and a current yield of 5.2%), all of which combine value, quality, and growth factors while providing exposure to both longer-term secular growth trends and shorter-term cyclical growth opportunities.

Quick plug for Sabrient’s newest product, a stock and ETF screening and scoring tool called SmartSheets, which comprise two simple downloadable spreadsheets that provide access to 9 of our proprietary quant scores. Prior to the sudden fall of SIVB, on a scale of 0-100 with 100 the “best,” our rankings showed SIVB carried a low score in our proprietary Earnings Quality Rank of 35, a GARP (growth at a reasonable price) score of 37, and a BEAR score (relative performance in weak market conditions) of 13. Also worth mentioning, Lantheus Holdings (LNTH) was consistently ranked our #1 GARP stock for the first several months of the year before it knocked its earnings report out of the park on 2/23 and shot up over +20% in one day. (Note: you can find our full Baker’s Dozen performance details here.) 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 a printable version of this post. In this periodic update, I provide a comprehensive market commentary, 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 slightly bullish-to-neutral bias, the technical picture looks short-term oversold, and our sector rotation model has taken a defensive posture. Technology has taken over the top position in our sector rankings. Read on…

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Needless to say, investors have been piling out of stocks and bonds and into cash. So much for the 60/40 portfolio approach that expects bonds to hold up when stocks sell off. In fact, few assets have escaped unscathed, leaving the US dollar as the undisputed safe haven in uncertain times like these, along with hard assets like real estate, oil, and commodities. Gold was looking great in early-March but has returned to the flatline YTD. Even cryptocurrencies have tumbled, showing that they are still too early in adoption to serve as an effective “store of value”; instead, they are still leveraged, speculative risk assets that have become highly correlated with aggressive growth stocks.

From its record high in early January to Thursday’s intraday low, the S&P 500 (SPY) was down -19.9% (representing more than $7.5 trillion in value). At its lows on Thursday, the Nasdaq 100 (QQQ) was down as much as -29.2% from its November high. Both SPY and QQQ are now struggling to regain critical “round-number” support at 400 and 300, respectively. The CBOE Volatility Index (VIX) further illustrates the bearishness. After hitting 36.6 on May 2, which is two standard deviations above the low-run average of 20 (i.e., Z-score of 2.0), VIX stayed in the 30’s all last week, which reflects a level of panic. This broad retreat from all asset classes has been driven by fear of loss, capital preservation, deleveraging/margin calls among institutional traders, and the appeal of a strong dollar (which hit a 20-year high last week). The move to cash caused bond yields to soar and P/E ratios to crater. Also, there has been a striking preference for dividend-paying stocks over bonds.

It appears I underestimated the potential for market carnage, having expected that the March lows would hold as support and the “taper tantrum” surge in bond yields would soon top out once the 10-year yield rose much above 2%, due to a combination of US dollar strength as the global safe haven, lower comparable rates in most developed markets, moderating inflation, leverage and “financialization” of the global economy, and regulatory or investor mandates for holding “cash or cash equivalents.” There are some signs that surging yields and the stock/bond correlation may be petering out, as last week was characterized by stock/bond divergence. After spiking as high as 3.16% last Monday, the 10-year yield fell back to close Thursday at 2.82% (i.e., bonds attracted capital) while stocks continued to sell off, and then Friday was the opposite, as capital rolled out of bonds into stocks.

Although nominal yields may be finally ready to recede a bit, real yields (net of inflation) are still solidly negative. Although inflation may be peaking, the moderation I have expected has not commenced – at least not yet – as supply chains have been slow to mend given new challenges from escalation in Russian’s war on Ukraine, China’s growth slowdown and prolonged zero-tolerance COVID lockdowns in important manufacturing cities, and various other hindrances. Indeed, the risks to my expectations that I outlined in earlier blog posts and in my Baker’s Dozen slide deck have largely come to pass, as I discuss in this post.

Nevertheless, I still expect a sequence of events over the coming months as follows: more hawkish Fed rhetoric and some tightening actions, modest demand destruction, a temporary economic slowdown, and more stock market volatility … followed by mending supply chains, some catch-up of supply to slowing demand, moderating inflationary pressures, bonds continuing to find buyers (and yields falling), and a dovish turn from the Fed – plus (if necessary) a return of the “Fed put” to support markets. Time will tell. Too bad the Fed can’t turn its printing press into a 3D printer and start printing supply chain parts, semiconductors, oil, commodities, fertilizers, and all the other goods in short supply – that would be far more helpful than the limited tools they have at hand.

Although both consumer and investor sentiment are quite weak (as I discuss below), and there has been no sustained dip-buying since March, history tells us bear markets do not start when everyone is already bearish, so perhaps Friday’s strong rally is the start of something better. Perhaps the near -20% decline in the S&P 500 is all it took to wring out the excesses, with Thursday closing at a forward P/E of 16.8x ahead of Friday’s rally, which is the lowest since April 2020. So, the S&P 500 is trading at a steep 22% discount compared to 21.7x at the start of the year, a 5-year average of 18.6x, and a 20-year post-Internet-bubble average of 15.5x (according to FactSet), Moreover, the Invesco S&P 500 Equal Weight (RSP) is at 15.0x compared to 17.7x at the beginning of the year, and the S&P 600 small cap forward P/E fell to just 11.6x (versus 15.2x at start of the year).

But from an equity risk premium standpoint, which measures the spread between equity earnings yields and long-term bond yields, stock valuations have actually worsened relative to bonds. So, although this may well be a great buying opportunity, especially given the solid earnings growth outlook, the big wildcards for stocks are whether current estimates are too optimistic and whether bond yields continue to recede (or at least hold steady).

Recall Christmas Eve of 2018, when the market capitulated to peak-to-trough selloff of -19.7% – again, just shy of the 20% bear market threshold – before recovering in dazzling fashion. The drivers today are not the same, so it’s not necessarily and indicator of what comes next. Regardless, you should be prepared for continued volatility ahead.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 5 of the top 6 scorers being cyclical sectors, Energy, Basic Materials, Financials, Industrials, and Technology. In addition, the near-term technical picture looks bullish for at least a solid bounce, if not more (although the mid-to-long-term is still murky, subject to news developments), but our sector rotation model switched to a defensive posture last month when technical conditions weakened.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines Quality, Value, and Growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s latest Q2 2022 Baker’s Dozen launched on 4/20/2022 and is off to a good start versus the benchmark, led by three Energy firms, with a diverse mix across market caps and industries. In addition, the live Dividend and Small Cap Growth portfolios have performed quite well relative to their benchmarks. Read on....

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

I have been warning that the longer the market goes up without a significant pullback, the worse the ultimate correction is likely to be. So, with that in mind, we might not have seen the lows for the year quite yet, as I discuss in the chart analysis later in this post. January saw a maximum intraday peak-to-trough drawdown on the S&P 500 of -12.3% and the worst monthly performance (-5.3%) for the S&P 500 since March 2020 (-12.4%). It was the worst performance for the month of January since 2009 (during the final capitulation phase of the financial crisis) and one of the five worst performances for any January since 1980. The CBOE Volatility Index (VIX), aka “fear gauge,” briefly spiked to nearly 39 before settling back down to the low-20s.

It primarily was driven by persistently high inflation readings – and a suddenly hawkish-sounding Federal Reserve – as the CPI for the 12 months ending in December came in at 7.0% YoY, which was the largest increase for any calendar year since 1981. Then on Feb 10, the BLS released a 7.5% CPI for January, the highest YoY monthly reading since 1982. Of course, stocks fell hard, and the 10-year T-note briefly spiked above 2% for the first time since August 2019.

Looking under the hood is even worse. Twelve months ago, new 52-week highs were vastly outpacing new 52-week lows. But this year, even though new highs on the broad indexes were achieved during January, we see that 2/3 of the 3,650 stocks in the Nasdaq Composite have fallen at least 20% at some point over the past 12 months – and over half the stocks in the index continue to trade at prices 40% or more below their peaks, including prominent names like DocuSign (DOCU), Peloton Interactive (PTON), and of course, Meta Platforms, nee Facebook (FB). Likewise, speculative funds have fallen, including the popular ARK Innovation ETF (ARKK), which has been down as much as -60% from its high exactly one year ago (and which continues to score near the bottom of Sabrient’s fundamentals based SectorCast ETF rankings).

Pundits are saying that the “Buy the Dip” mentality has suddenly turned into “Sell the Rip” (i.e., rallies) in the belief that the fuel for rising asset prices (i.e., unlimited money supply and zero interest rates) soon will be taken away. To be sure, the inflation numbers are scary and unfamiliar. In fact, only a minority of the population likely can even remember what those days of high inflation were like; most of the population only has experienced decades of falling CPI. But comparing the latest CPI prints to those from 40 years ago has little relevance, in my view, as I discuss in the commentary below. I continue to believe inflation has been driven by the snapback in demand coupled with slow recovery in hobbled supply chains – largely due to “Nanny State” restrictions – and that inflationary pressures are peaking and likely to fall as the year progresses.

In response, the Federal Reserve has been talking down animal spirits and talking up interest rates without actually doing much of anything yet other than tapering its bond buying and releasing some thoughts and guidance. The Fed’s challenge will be to raise rates enough to dampen inflation without overshooting and causing a recession, i.e., the classic policy mistake. My prediction is there will be three rate hikes over the course of the year, plus some modest unwinding of its $9 trillion balance sheet by letting some maturing bonds roll off. Note that Monday’s emergency FOMC meeting did not result in a rate hike due to broad global uncertainties.

Longer term, I do not believe the Fed will be able to “normalize” interest rates over the next decade, much less the next couple of years, without causing severe pain in the economy and in the stock and bond markets. Our economy is simply too levered and “financialized” to absorb a “normalized” level of interest rates. But if governments around the world (starting with the US and Canada!) can stand aside and let the economy work without heavy-handed societal restrictions and fearmongering, we might see the high supply-driven excess-demand gap close much more quickly.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with the top three scorers being deep-cyclical sectors, Energy, Basic Materials, and Financials. In addition, the near-term technical picture remains weak, and our sector rotation model moved from a neutral to a defensive posture this week as the market has pulled back.

Overall, I expect a continuation of the nascent rotation from aggressive growth and many “malinvestments” that were popular during the speculative recovery phase into the value and quality factors as the Fed tries to rein in the speculation-inducing liquidity bubble. And although I don’t foresee a major selloff in the high-valuation-multiple mega-cap Tech names, I think investors can find better opportunities this year among high-quality stocks outside of the Big Tech favorites – particularly among small and mid-caps – due to lower valuations and/or higher growth rates, plus some of the high-quality secular growth names that were essentially the proverbial “baby thrown out with the bathwater.” But that’s not say we aren’t in for further downside in this market over the near term. In fact, I think we will see continued volatility and technical weakness over the next few months – until the Fed’s policy moves become clearer – before the market turns sustainably higher later in the year.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines quality, value, and growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s new Q1 2022 Baker’s Dozen launched on 1/20/2022 and is already off to a good start versus the benchmark. In addition, our Dividend and Small Cap Growth portfolios have been performing well versus their benchmarks. In fact, all 7 of the Small Cap Growth portfolios launched since the March 2020 COVID selloff have outperformed the S&P 600 SmallCap Growth ETF (SLYG), and 7 of the 8 Dividend portfolios have outperformed the S&P 500 (SPY). In particular, the Energy sector still seems like a good bet, as indicated by its low valuation and high score in our SectorCast ETF rankings.

Furthermore, we have created the Sabrient Quality Index Series comprising 5 broad-market and 5 sector-specific, rules-based, strategic beta and thematic indexes for ETF licensing, which we are pitching to various ETF issuers. Please ask your favorite ETF wholesaler to mention it to their product team!
Read on....