by Scott Martindale
  President & CEO, Sabrient Systems LLC

Stocks are pulling back a bit to start Q2 but have shown remarkable resilience throughout their nearly 6-month (and nearly straight-up) bull run, with the S&P 500 (SPY) finding consistent support at its 20-day simple moving average on several occasions, while the slightly more volatile Nasdaq 100 (QQQ, beta=1.18) has found solid support at the 40-day moving average. Moreover, the Relative Strength Index (RSI) on SPY has reliably bounced off the neutral line (50) on every test. And it all happened again early last week—at least until Thursday afternoon when Minnesota Fed president Neel Kashkari ventured off Fed chairman Jerome Powell’s carefully crafted script to say they may not cut interest rates at all this year if inflation’s decline continues to stall.

Before that moment, Powell had been keeping his governors in line and saying all the right things about imminent rate cuts in the pipeline (albeit making sure not to provide a firm timetable). And the pervasive Goldilocks outlook has lifted stocks to uncomfortably elevated valuations (current forward P/E for SPY of 21.3x and for QQQ of 26.6x) that suggest a need for and expectation of both solid earnings growth in 2024-25 and falling interest rates (as the discount rate on future earnings streams).

Up until Kashkari’s unexpected remarks, it appeared that once again—and in fact every time since last November, when the indexes look extremely overbought and in need of a significant pullback (as typically happens periodically in any given year) a strong bid arrived like the Lone Ranger to save the day and push stocks higher. It has burned bears and kept swing traders who like to “fade” spikes hesitant. Not surprisingly, the CBOE Volatility Index (VIX) has seen only a couple of brief excursions above the 15 line and has been nowhere near the 20 “fear threshold.”

But after his remarks, the market finished Thursday with a huge, high-volume, “bearish engulfing candle,” and the CBOE Volatility Index (VIX) surged 20% intraday (closing at 16.35), and all those previously reliable support levels gave way—until the very next day. On Friday, they quickly recovered those support levels following the apparently strong March jobs report, finishing with a “bullish harami” pattern (that typically leads to some further upside). As you recall from my March post, I have felt a correction is overdue—and the longer it holds off, the more severe the fall. The question now is whether SPY and QQQ are destined for an upside breakout to new highs and a continuation of the bull run…or for a downside breakdown to test lower levels of support. I believe we may get a bit of a bounce here, but more downside is likely before an eventual resumption in the bull run to new highs.

Regardless, the persistent strength in stocks has been impressive, particularly in the face of the Fed's quantitative tightening actions (balance sheet reduction and “higher for longer” rates)—along with the so-called “bond vigilantes” who protest excessive spending by not buying Treasuries and thus further driving up rates—that have created the highest risk-free real (net of inflation) interest rates since the Financial Crisis and reduced its balance sheet by $1.5 trillion from its April 2022 peak to its lowest level since February 2021.

But (surprise!) gold has been performing even better than either SPY or QQQ (as have cryptocurrencies, aka “digital gold”). Gold’s appeal to investors is likely in anticipation of continued buying by central banks around the world as a hedge against things like growing geopolitical turmoil, our government’s increasingly aggressive “weaponization” of the dollar to punish rogue nations, and rising global debt leading to a credit or currency crisis.

To be sure, solid GDP and employment data, a stall in inflation’s decline, rosy earnings growth forecasts for 2024-2025, tight investment-grade and high-yield credit spreads, low volatility in interest rates, a low VIX, and a sudden recovery in manufacturing activity, with the ISM Manufacturing Index having finally eclipsed the 50 threshold (indicating expansion) after 16 straight months below 50 (contraction), all beg the question of why the Fed would see a need to cut rates. As Powell himself said the other day, we have seen an unusual and unforeseen occurrence in which “productive capacity is going up even more than actual output. The economy actually isn't becoming tighter; it's actually becoming a little looser…” Indeed, the “higher for longer” mantra might seem more appropriate, at least on the surface.

Yet despite the rosy outlook and investor confidence/complacency (and Kashkari’s latest comments), the Fed continues to suggest there will be multiple rate cuts this year, as if it knows of something lurking in the shadows. And that something might be a credit crisis stemming from our hyper-financialized/ultra-leveraged economy—and the growing debt burden across government, small business, and consumers being refinanced at today’s high interest rates. We are all aware of the outright depression in commercial real estate today; perhaps there is a contagion lurking. Or perhaps it’s the scary projection for the federal debt/GDP ratio (rising from 97% of GDP last year to 166% by 2054). Or perhaps it is a brewing currency crisis with the Japanese yen, given its historic weakness that may lead the BOJ to hike rates to stem capital outflows. Or perhaps it’s because they follow the real-time “Truflation” estimate, which indicates a year-over-year inflation rate of 1.82% in contrast to the latest headline CPI print of 3.2% and headline PCE of 2.5%.

I discuss all these topics in today’s post, as well as the relative performance of various equity and asset-class ETFs that suggests a nascent market rotation and broadening may be underway, which is a great climate for active managers. Likewise, Michael Wilson of Morgan Stanley asserts that the stock rally since last fall has been driven more by loose financial conditions, extreme liquidity (leverage), and multiple expansion (rather than earnings growth), but now it's time to be a stock picker rather than a passive index investor.

So, if you are looking outside of the cap-weighted passive indexes (and their elevated valuation multiples) for investment opportunities, let me remind you that Sabrient’s actively selected portfolios include the Baker’s Dozen (a concentrated 13-stock portfolio offering the potential for significant outperformance), Small Cap Growth (an alpha-seeking alternative to the Russell 2000 index), and Dividend (a growth plus income strategy paying a 3.74% current yield). The latest Q1 2024 Baker’s Dozen launched on 1/19/24 and remains in primary market until 4/18/24 (and is already well ahead of SPY).

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

By the way, Sabrient founder David Brown has a new book coming out soon through Amazon.com in which he describes his approach to quantitative modeling and stock selection for four distinct investing strategies (Growth, Value, Dividend, and Small Cap). It is concise, informative, and a quick read. David has written a number of books through the years, and in this new one he provides valuable insights for investors by unveiling his secrets to identifying high-potential stocks. Please let me know if you’d like to be an early book reviewer!

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

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

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

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

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

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

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

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

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

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

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

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

The April-August 5-month stretch was the best 5-month period for the S&P 500 (+35%) since 1938. The index was +6.3% higher than its pre-COVID high on 2/19/20 and +56.2% higher than its COVID selloff low on 3/23/20. But any market technician would tell you that the further the market rises without a pause, the more severe the inevitable pullback. And indeed, along came the traditionally challenging month of September and a nasty bout of profit-taking mixed with capital preservation – and exacerbated by the standoff on new fiscal stimulus, an uptick in COVID cases hindering global economic reopening, and the potential for a SCOTUS nomination firestorm. Many of the investor darlings from among the disruptive, secular-growth Technology companies that had been surging so strongly have suddenly fallen hard, with the S&P 500 (SPY) pulling back -10.3% from its 9/2/20 intraday high to its 9/21/20 intraday low and the tech-laden Nasdaq 100 (QQQ) falling -14.3%.

After giving back all of August’s strong gains, perhaps Monday was the capitulation day from which the market can recover anew. Q3 earnings reporting season starts in a couple of weeks, so it will be important to get a read on the trajectory of earnings recovery and forward guidance.

I have written often about the stark market bifurcation that has developed over the past few years, beginning with the unwinding of the “Trump Bump” reflation trade in light of the emerging trade wars. It led to historic extremes in Growth over Value and Large over Small caps, with the broad-market, cap-weighted indexes hitting new highs as investment capital has favored mega-cap, secular-growth Tech and passive, market-cap-weighted ETFs. But today, although I think it is unlikely that investors are giving up on Technology names, their high relative valuations as the economy enters what I see as an early-stage expansionary cycle appear to be opening the door for greater market breadth and some capital rotation into value, cyclicals, and smaller caps.

My expectation is that, as the historic imbalances in Value/Growth and Small/Large performance ratios gradually revert and market leadership broadens, strategic beta ETFs, active selection, and equal weighting should thrive once again. This should be favorable for value, growth-at-a-reasonable-price (GARP), and quality-oriented strategies like Sabrient’s, although not to the exclusion of secular growth industries. In other words, an investor should be positioned for both cyclical and secular growth.

This is why, rather than continuing to wait around for the value/growth performance gap to converge, we chose to introduce new enhancements to our GARP stock selection process to better balance value-oriented cyclical growers with consistent secular growers while also reducing relative volatility versus the benchmark. Moreover, we have leveraged our full suite of 7 core quantitative models to create 11 new strategic-beta, passive indexes. You will be hearing more about these in the near future.

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 rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, while I still have a favorable long-term view on stocks, there will be plenty of volatility ahead. In addition, our sector rankings have a moderately defensive bias (given that the near-term outlook in our fundamentals-based model is muddled and the Outlook scores are tightly bunched), the technical picture looks might be setting up for a bullish reversal, and our sector rotation model sits in a neutral posture. As a reminder, you can find my latest Baker’s Dozen slide deck and commentary on terminating portfolios at http://bakersdozen.sabrient.com/bakers-dozen-marketing-materials.

Read on....