by Scott Martindale
  President & CEO, Sabrient Systems LLC

 Overview

 Market indexes regained all of their losses since the president’s “Liberation Day” tariff announcement one month ago, culminating in an historic +10% 9-day rally for the S&P 500 (and +18% from its 4/7 intraday low) that sent it back above its 20-day and 50-day moving averages to test resistance at its 200-day. But was this just a short-covering relief rally as bearish commentators assert? I said in my April post that the $10 trillion that left the stock market was not the “capital destruction” they claimed, like a wildfire burning down homes, but rather a rotation into the safety of bonds and cash that could quickly rotate back. Sure enough, when retail investors swooped in to scoop up the suddenly fair valuations of the capitulation selloff, leveraged algo momentum traders quickly joined in. But while I think the longer term holds promise, the chart became short-term overbought (and is pulling back this week), and macro conditions are still treacherous, keeping investors jittery and headline-driven. So, the market remains fragile even as we wind down a solid Q1 earnings reporting season, with the FOMC policy announcement on tap this week.

Nevertheless, in my view, positive signs are emerging to suggest: 1) the trade war (particularly with China) and the hot war in Ukraine will both find their way to a resolution, 2) the fiscal legislation (“one big, beautiful bill”) with new tax cuts working its way through congress will soon be passed, 3) the size and scope of federal government that has crowded out the private sector is shrinking and making way for re-privatization and de-regulation of the economy to unleash organic private sector growth, 4) corporate earnings and capex commitments remain strong, and 5) the Federal Reserve will ensure liquidity growth and restart its rate-cutting cycle like other central banks—and liquidity leads pricing in risk asset markets, gold, and cryptocurrencies. So, I think the noise will quiet and the clouds will clear, making way for a renewed focus on corporate earnings and global liquidity to power forward the economy and stocks. And don’t forget—the market loves to climb a wall of worry, which means it discounts the future and typically turns well in advance of the economic and sentiment metrics.

Of course, the biggest news that juiced the stock market is the apparent offramp forming for the trade stalemate between the US and China. Publicly, China has been saber-rattling as a Trumpian bargaining tactic, in my view, and to stoke the flames of political division in our country with midterms on the docket next year—something the CCP doesn’t have to worry much about. Indeed, it has been loath to give an inch even though its economy was already struggling with deflation, a long-running property crisis, sluggish consumer demand, overcapacity, and weak business and consumer confidence well before the recent tariff escalation. Its services PMI just hit a 7-month low, its manufacturing PMI has officially fallen into contraction at 49.0, and its new export orders component plunged to the lowest reading since the pandemic at 44.7. And although China insists the US “unilaterally” started the trade war, the truth is we are finally pushing back after years of turning a blind eye to their tariffs, IP theft, forced technology transfers, hacking, state subsidies, dumping of goods, fentanyl trafficking, and currency manipulation.

In my view, the US is in far better position to weather a brief trade war than mercantilist China. As Treasury Secretary Scott Bessent succinctly articulated, “China’s business model is predicated on selling cheap, subsidized goods to the US, and if there is a sudden stop in that, they will have a sudden stop in their economy. So, they will negotiate.” Both governments know that an escalating trade war with big tariffs and a tight US Federal Reserve is especially bad for China. The dollar/yuan exchange rate is crucially important to China, and the dollar today is nearly as strong it has been against the yuan since yuan’s devaluation during the Global Financial Crisis. With its massive dollar-denominated debt, a weaker dollar relieves China’s financial strain by boosting global liquidity to the benefit of both countries. So, despite its theatrical saber-rattling, China needs a trade deal that ensures a weaker dollar to shore up the yuan and reduce capital flight.

Indeed, we are now hearing from China that “the door is open” to trade talks, and its security czar is evaluating ways to address the use of Chinese precursor chemicals by Mexican cartels to produce fentanyl for distribution in the US. Moreover, although the Port of Los Angeles announced that volumes will fall be 1/3 as several major American retailers are halting all shipments from China, in reality, American businesses as usual are finding a way to succeed (and skirt the most onerous tariffs) by rerouting supply chains through 3rd party countries like Vietnam and Mexico (“trans-shipping”) and delivering to bonded warehouses to delay the official receipt of goods. Also offsetting the tariffs is the 10% drop in the dollar index.

Looking ahead, although volatility likely will remain elevated for the next few months, unless something crazy comes out of left field, I think the market has seen its lows, and the path of least resistance is higher. American consumers, corporations, and entrepreneurs are optimistic by nature and are always pushing boundaries and seeking a path forward, rather than sitting on their hands waiting for government to tell them what to do. And of course, President Trump is not one to sit on his hands for one minute in his effort to “fix” our unsustainable “death spiral” of inflation, debt, deficit spending, offshoring, and hyper-financialization.

But then we have the FOMC, whose members have been quite happy to sit on their hands in the face of tariff turmoil, falling inflation, and slowing GDP and jobs growth. Among the 19 FOMC participants (the 7 Board of Governors and 12 Reserve Bank regional presidents, which includes both the 12 voting members and the 7 non-voting members who serve as voting members on a rotating basis), they almost unanimously (18 of 19) agreed at their March meeting that growth and employment risks are skewed to the downside while inflation risks are skewed to the upside. Overall, the Fed has taken a dovish stance but will be reactive to sudden distress in growth and jobs rather than proactive in preventing such distress.

Although Fed Chair Powell often talks about tariffs as being inflationary, in fact tariffs are deflationary like all forms of taxation—i.e., without a commensurate increase in income or credit, they necessitate a rethinking and reallocation of one’s existing disposable income. Furthermore, Powell & Co. seem to be ignoring the deflationary signals of falling oil prices, slowing household consumption, declining savings rates, and rising delinquencies. Inflation metrics are pulling back after being propped up by elevated energy prices and long-lag components (like shelter costs) and the prior administration’s profligate federal deficit spending that overshadowed—and indeed created—sluggish growth in the private sector. I talk more about inflation metrics and expectations for next week’s CPI and PPI releases in my full commentary below.

To be fair, government spending (to the tune of nearly 6.5% of GDP) exacerbated the inflation and private sector malaise it created by making it difficult for the Powell & Co. to justify helping out the private sector with lower interest rates, thus crowding out the efficient capital allocation and high return on investment of the private sector with the inefficient capital allocation of bloated government boondoggles. Economist Michael Howell of CrossBorder Capital reminds us that “public debt is expanding faster than private debt, fueled by welfare commitments and rising interest burdens, ensuring persistent liquidity growth.” Importantly, Howell persuasively asserts that, “monetary policy must prioritize liquidity over inflation” concerns, so the Fed’s current hands-off, higher-for-longer, reactionary approach risks causing a liquidity crunch. In his view, “The modern financial system is a fragile, collateral-driven mechanism, and one that requires constant intervention [through proactive management] to avoid collapse.”

As Andrew Lees of MacroStrategy Partners has pointed out, “Economies naturally self-order productively when not constrained by excessive regulation and over-bearing government intervention. The current "financialized" economic system as it is, is dependent on debt and unproductive use of capital (Wall Street vs Main Street).” The private sector has proven to be much better at the efficient and highly productive allocation of capital to maximize ROI. So, as Secretary Bessent has described, the Trump administration seeks to reduce the budget deficit to 3% of GDP and increase real GDP growth to 3%, which would lead to the same kind of small-government/strong-private-sector economy that has turned around a foundering Argentina under President Milei.

The May FOMC meeting convenes this week, so we shall see. CME Group fed funds futures show only 3% odds of a 25-bp rate cut, but increases to 32% at the June meeting, and 78% odds of at least 75 bps (3 cuts) by year-end. In my view, they should be readying for 50 bps in rate cuts by July and a target neutral rate of around 3.25-3.50% by early 2026. Certainly the 2-year Treasury yield (the shortest term that is substantially market driven) at 3.80% (as of 5/6) is signaling to the Fed that rates should be much lower than the current 4.25-4.50% fed funds rate. According to a recent post by AlpineMacro, “…the current 10-2 year spread in the bond market is not sustainable, particularly if the economy slows sharply. Ultimately, the long end of the curve will gravitate to the short end, particularly when investors realize that tariff-induced price increases are temporary.” Notably, projections on bond issuance from Secretary Bessent suggest a gradual return to an 80/20 split between T-bonds & notes (80%) versus T-bills (20%) going forward as opposed to the nearly 100% allocation to T-bills (< 1 year) under his predecessor Janet Yellen.

I have been insisting for some time that the FFR needs to be 100 bps lower, as the US economy's headline GDP and jobs numbers were long artificially propped up by excessive, inefficient, and often unproductive federal deficit spending, while the hamstrung private sector has seen sluggish growth. Moreover, today’s DOGE-led spending cuts, trade war uncertainty, and with budget reconciliation and fiscal legislation still in progress have removed much of that artificial stimulus. But regardless of the May FOMC decision, I expect the rate-cutting cycle to restart in June and signed trade deals with our 18 key trading partners beginning this month.

But for the near term, until those things come to fruition, I continue to expect stocks will remain volatile (with VIX above the 20 “fear threshold” but below the 30 “panic threshold”). CNN's Fear & Greed Index just jumped from "Fear” to “Greed” on the dial but remains volatile. The American Association of Individual Investors' ("AAII") Investor Sentiment Survey has shown more than 50% bearish (vs. historical average of 31%) for 10 consecutive weeks, which is the longest streak since 1990. Capital flows reflect a sharp drop in foreign capital flight into US bonds and equities over the past two months in something of a “buyers’ strike,” adding pressure to the US dollar. And last week saw a negative Q1 GDP print, somewhat offset by an upside beat from the jobs report and rising labor force participation.

There are certainly plenty of high-profile bears. One market technician I respect a lot, A.J. Monte of Sticky Trades, still believes stocks will eventually retest their pandemic lows (!). He warned of the dreaded “death cross” when the 50-day moving average crossed down through the 200-day moving average on 4/12. And then we have Christoper Wood of Jefferies, who believes that US stocks saw a permanent (!) peak last December (at lofty valuations) and will never (!) see those levels again—much like Japan’s market peak in 1989. Instead of US stocks, Wood thinks investors should buy Europe, China, Japan, and India. Others have pronounced that the US brand is permanently damaged and that we have witnessed the end of “American exceptionalism.” Heavy sigh.

Call me overly patriotic with rose-colored glasses, but my view is a little different. Capital tends to flow to where it is most welcome and earns its highest returns, so the recent falling tide of foreign capital flight leaving the US will surely return once visibility clears and the dollar firms up. Most any foreign investor will tell you there is no other place in the world to invest capital for the innovation and expected return than the US given our entrepreneurial culture, technological leadership in disruptive innovation, strong focus on building shareholder value, low interest-rate exposure, global scalability, wide protective moats, and our reliable and consistently strong earnings growth, free cash flow, margins, and return ratios, particularly among the dominant, cash flush, Big Tech titans, which continue to use their piles of cash to seed AI startups and other disruptive technologies. Notably, the US boasts more than 50% of the world’s privately owned late-stage start-ups valued at over $1 billion (aka “unicorns”) and leads in R&D spending and patent applications.

Moreover, it’s not just the Technology sector that is appealing to investors. As BlackRock wrote in their Q2 2025 Equity Market Outlook, “Commentators will often cite the prevalence of a large number of Tech companies in the U.S. as the driver of U.S. equity dominance. But our analysis points to wider breadth in U.S. quality. Current return on tangible invested capital (ROTIC), a proxy for a company’s ability to allocate capital for optimal profitability, is significantly higher in the U.S. than elsewhere in the world, suggesting quality exists not in pockets but across sectors.”

As Kevin O’Leary has opined, “Our number one export is the American dream. Everyone wants to come to America and start a business and become personally free." And this will not change just because our president seeks to incentivize the private sector to strategically reshore manufacturing with the ultimate goals of reviving the middle class, narrowing the wealth gap, reducing the trade deficit, ensuring reliable supply chains, and reinforcing national security. Moreover, Trump’s federal cost-cutting, tariff regime, and America-First rhetoric does not aim for absolute deglobalization, fiscal austerity, mercantilism, and isolationism as the MSM would have you believe, but rather to simply rebalance a system that had become completely out of balance—and indeed was falling into that aforementioned death spiral of rising inflation, debt, deficit spending, offshoring, and hyper-financialization. The rebalancing involves re-privatization and de-regulation rather than relying on massive government spending—and what I call “smart austerity” to eliminate waste, fraud, abuse, corruption and unaccountability, plus a “peace dividend” from ending the war in Ukraine.

So, I continue to believe the macro uncertainty and jittery market will ultimately give way to a melt-up, sending the market to back near its highs of Q1 by year-end or early-2026, driven by rising global liquidity, a weaker US dollar, reduced wasteful/reckless government spending and regulatory red tape, lower interest and tax rates, massive corporate capex, and the “animal spirits” of a rejuvenated private sector and housing market.

The early April selloff brought down some of the loftiest valuations among the popular mega-cap stocks, with the forward P/E on the S&P 500 falling to 18.5x on 4/8 versus 22.7x at its February peak and today’s 20.6x (as of 5/5). In fact, many of the prominent names in the Technology and Communication Services sectors saw their valuations retreat such that they are scoring well in Sabrient’s growth models (as shown in our next-gen Sabrient Scorecards subscription product)—including large caps like Taiwan Semiconductor (TSM), Broadcom (AVGO), and Spotify (SPOT) that are in the new Q2 2025 Sabrient Baker’s Dozen portfolio, and small caps like Freshworks (FRSH), QuinStreet (QNST), and RingCentral (RNG) that are in our new Sabrient Small Cap Growth 46 portfolio. These portfolios along with Sabrient Dividend 51 (a growth & income strategy yielding 4.05% as of 5/5) are packaged and distributed quarterly to the financial advisor community as unit investment trusts through First Trust Portfolios.

Indeed, rather than the passive cap-weighted indexes dominated by Big Tech, investors may be better served by active stock selection that seeks to identify under-the-radar and undervalued gems primed for explosive growth—many of whom could coattail on the Big Tech names and provide greater returns. This is what Sabrient seeks to do in our various portfolios, all of which provide exposure to Value, Quality, Growth, and Size factors and to both secular and cyclical growth trends.

As a reminder, the “Size” factor refers to market cap and the Fama French study that showed small caps historically tend to outperform over time. Although that has not been the case for the small cap indexes (like Russell 2000) for most of the past 20 years, I still think the small cap universe is where to find the most explosive growth opportunities, even if the broad passive indexes can't keep up. So, insightful active selection is important for small cap investing—which is easier to do given the relative lack of analyst coverage and institutional ownership of small caps.

For each of our portfolios, we seek high-quality, fundamentally strong companies displaying a history of consistent, reliable, and accelerating sales and earnings growth, rising profit margins and free cash flow, solid earnings quality, low debt burden, and a reasonable valuation. Notably, our proprietary Earnings Quality Rank (EQR) is a key factor in each of our growth, value, dividend, and small cap models, and it is also licensed to the actively managed First Trust Long-Short ETF (FTLS).

Sabrient founder David Brown describes these and other factors as well as his portfolio construction process in his latest book. David describes his path from NASA engineer in the Apollo moon landing program to creating quant models for ranking stocks and building stock portfolios. And as a companion product to the book, we have launched next-gen versions of Sabrient Scorecards for Stocks and ETFs. You can learn more about both the book and scorecards by visiting: http://DavidBrownInvestingBook.com.

In my full commentary below, I discuss earnings, gold, tariffs, inflation, global liquidity, the power of free market capitalism, and the imminent “bullish triumvirate” of tariff resolution, tax cuts, and deregulation. 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. Our model likes Technology, Healthcare, Communication Services sectors, and assuming interest rates indeed come down and liquidity rises as I expect, I also like dividend stocks and gold. HERE is a link to this post in printable PDF format.

I had so much to say this month that I decided to defer until next month my in-depth commentary on the exciting new developments in energy and electrical generation. Please contact me to speak on any of these topics at your event!  Read on….

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

 Key Points:

 1. The country’s 40-year path into a debt & deficit spending spiral was not working and had to change dramatically, not gradually, and the process to fix it is scary and uncomfortable.

2. The president’s “Liberation Day” tariff regime is at once simplistic and perplexing, but the selloff seems overdone, in my view, although the market remains fragile.

3. After an initial price shock, tariffs are deflationary like any tax; and countries are already coming to the table to negotiate them down.

4. The US is much less dependent on trade, less vulnerable to trade disruptions, and in far better position to weather a brief trade war than any other country, including mercantilist China, which is saber-rattling as a Trumpian bargaining tactic and to stoke the flames of political division in our country, in my view.

5. The $10 trillion that left the stock market was not lost like a wildfire burning down homes; it simply rotated into bonds and cash and can quickly rotate back if the outlook does not change and we have fiscal stimulus, supportive Fed, and rising global liquidity.

6. Volatility (up and down) may be sticking around through H1 until clarity improves later in the year.

7. For those still contributing to a 401(k), the selloff has presented a long-awaited opportunity to “buy low.”

8. Investors may be better served by active stock selection, such as Sabrient’s Baker’s Dozen, Small Cap, and Dividend portfolios.

Overview:

The news has been dominated by President Trump’s announced “Liberation Day” regimen of draconian tariffs, which are intended to induce both fairer trade policies from our trading partners and the onshoring of manufacturing. As his words moved from a 10% across-the-board baseline tariff (a nominal amount that initially sent stocks higher) to the gory details of his broader plan, the swan dive commenced. Negative volume went through the roof. Margin calls rained in. Algorithmic trading systems switched from leveraged long to either leveraged short or out of the market completely (thus removing critical liquidity), tripping stop losses and creating a cascade of selling pressure. The next day’s weekly AAII Sentiment Survey hit an extreme 62% bearish reading and will likely fall lower in this week’s survey. IPOs are being put on hold. The Polymarket odds of an emergency rate cut surged to 285, as did the odds of a rate cut meeting (36% at the May FOMC meeting but a 92% lock by the June meeting).

As of Monday morning’s open, the stock market had essentially given back all last year’s gains. Chartists are lamenting the failure of scary-bearish chart patterns (like the dreaded inverse flag pattern) that could potentially send stock indexes all the way down to their pandemic lows. The CBOE Volatility Index (VIX) surged above 45 on Friday 4/4 and then touched 60 in the pre-hours on Monday 4/7, which is reminiscent of the pandemic lockdown five years ago.

But are things today really as bad as that, when global supply chains were paralyzed and people were falling ill (and/or dying) en masse? I would say no, and in just a couple of blood-red, gap-down days, the rapid market meltdown already seems overdone, as I discuss further in today’s post. As famed value investor Ben Graham once said, “In the short run, the market is a voting machine, but in the long run it is a weighting machine.”

Although the VIX certainly could still go higher (perhaps a lot higher) and stocks lower, Friday looked to me a lot like capitulation and perhaps the start of a bottoming process leading to a great (and long-awaited) buying opportunity for long-term investors. Just be careful about “catching a falling knife.” Many countries (reportedly more than 50) have apparently reached out to fix their trade arrangements, although the biggie, China, is still in saber-rattling mode, at least for now.

Of course, the current selloff also was exacerbated by “priced for perfection” valuations and a complacent “buy every dip” mentality, largely driven by AI exuberance (and its promise of transformation disruption and rapid growth in productivity) and the massive capex allocated for AI infrastructure and datacenters. Furthermore, during the run-up to all-time highs in 2024, hedge funds had become more heavily leveraged long in US equities than at any time since the pandemic lockdown (as much 300% leveraged), essentially pulling forward gains from 2025 based on strong earnings expectations. So, there might be some similarities to the dot-com bubble bursting in 2001 in that respect. But even at its recent high, the overvaluation was nowhere near 1999 levels of the dot-com mania, and we don’t have the systemic credit and accounting issues leading into the 2008 Global Financial Crisis. Company balance sheets are quite sound, and although credit spreads have spiked, they remain low on a historical basis.

Even before the 4/2 tariff announcement, stocks were already looking shaky. It was fascinating to watch the charts of the major indexes like the S&P 500 ETF (SPY) and Nasdaq 100 ETF (QQQ) as they struggled for several days to hold support at the 300-day simply moving average, like a sloth hanging from a tree branch, until ultimately losing grip in dramatic fashion following the big tariff announcement. I opined in my March post that it might be time to create a shopping list of stocks but that volatility would likely continue into the tariff target date (4/2) and perhaps into Tax Day (as liquidity draws down for making tax payments). But few (including me) expected the cataclysmic selloff. Volatility may be sticking around for a while until clarity improves, particularly as Q1 earnings season (and forward guidance) kicks off this week.

To be sure, the reality of the new administration’s aggressive policies to fix many long-festering trade issues has caused much consternation and gnashing of teeth, drawn swift retaliation (particularly from China), disrupted global supply chains, lowered corporate earnings estimates, and raised recession risk (both domestically and globally). In response, just like when the so-called “bond vigilantes” short Treasury notes and bonds (or go to cash) in protest of rising budget deficits and total debt, the “stock vigilantes” went to work shorting stocks (or defensively moving to cash or Treasuries, removing market liquidity and briefly driving the 10-year yield below 4.0%) in protest of the uncertain impacts on the economy and corporate earnings. Or as former Democrat turned Trump supporter Batya Ungar-Sargon sees it, “Suddenly, everybody is sitting around saying, ‘Oh, no, the stock market!’ Yeah, the stock market looks like that because the rich [i.e., Wall Street institutional investors and hedge funds] are punishing Trump for siding with the neglected and humiliated American working class over them.” Indeed, the top 10% of Americans by income own 88% of stocks, the next 40% own 12%, and the bottom 50% are shut out.

So, yes, stock portfolios, IRAs, and 401(k) plans are way down, as the evening news keeps telling us. According to Bespoke Investment Group, the Russell 3000 has seen well over $10 trillion in lost market cap since Inauguration Day (1/20). However—and this is an important point—this is not “capital destruction” in the same sense that a wildfire can destroy homes and businesses. The capital pulled from the stock market didn’t vanish from the earth. It simply rotated into cash and bonds. And it very likely will return to stocks once trade situations are ironed out and visibility improves. It might take several months…or it could come back in a hurry. Be prepared. Perhaps start nibbling at stocks now. If you’re like me, you probably received a slew of low-price alerts for your target list. Some speculative investors might be going all-in at current levels. Regardless, for those still contributing to their IRA or 401(k) and not yet drawing on it, this selloff is a gift to be appreciated, in my view, restoring some value back into the market. After all, when you are in long-term accumulation mode, you want to “buy low.”

Of course, no one knows for sure how low it can go and when the selloff will bottom—and the bottoming process may be lengthy and volatile. The wild card for stocks going forward is uncertainty around the severity and duration of tariffs, which seem designed by their sheer audacity to induce a swift resolution. After all, there is no underlying malady in the economy that prevents business leaders and entrepreneurs from adapting like they always do, and only pride and prejudice can prevent a quick resolution to most of the trade arrangements.

Political, economic, and market volatility will surely continue during H1. But even if we get a larger correction than I expect, I continue to believe stocks will soon find support and ultimately give way to a gradual melt-up, sending the market to back near its highs of Q1 by year-end or early-2026, driven by rising global liquidity, a weaker US dollar, reduced wasteful/reckless government spending and regulatory red tape, lower interest and tax rates, massive corporate capex, and the “animal spirits” of a rejuvenated private sector and housing market. So, if you have been hoping and praying for lower prices in risk assets (including stocks and crypto) or for a lower mortgage rate to buy a house, you are getting them now, with the forward P/E on the S&P 500 at 18.7x as of 4/4 (before any significant downward revisions to earnings estimates), versus 22.7x at its February peak. As the poet Virgil once said (in Latin), “audentes Fortuna iuvat” — i.e., “fortune favors the bold.”

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. There remains a persistent sense among global investors of “American exceptionalism” based on ouir entrepreneurial culture, a tenacious focus on building shareholder value, and the mesmerizing appeal of our Big Tech companies that offer disruptive innovation, huge cash positions, reliable and consistently strong earnings growth, free cash flow, margins, return ratios, low interest-rate exposure, global scalability, and wide protective moats.

So, the initial recovery may well be led by the Big Tech titans that are now much more fairly valued, such as NVIDIA (NVDA) at a forward P/E of 21x (as of 4/4). 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), Alphabet (GOOGL), Meta Platforms (META), Microsoft (MSFT), Broadcom (AVGO), Oracle (ORCL), Arista Networks (ANET), Fortinet (FTNT), Palo Alto Networks (PANW), Palantir (PLTR), and Taiwan Semiconductor (TSM)—two of which (TSM and AMZN) are in the Q1 2025 Sabrient Baker’s Dozen.

But longer term, rather than the passive cap-weighted indexes dominated by Big Tech, investors may be better served by active stock selection that seeks to identify under-the-radar and undervalued gems primed for explosive growth—many of whom could coattail on the Big Tech names and provide greater returns. This is what Sabrient seeks to do in our various portfolios, all of which provide exposure to Value, Quality, Growth, and Size factors and to both secular and cyclical growth trends.

As for small caps, which as pointed out by Fama French used to outperform large caps over the long haul (higher risk, higher reward), the small cap indexes have been consistently lagging large cap indexes over the past 20 years, mostly due to their much lower allocation to the Technology sector. For example, the S&P 500 has a massive 17.6% relative overweight to the Tech sector (30.3%) versus the Russell 2000 (12.7%). And if you include the Tech-adjacent MAG-7 names that are categorized as Consumer Discretionary (i.e., Amazon and Tesla totaling 5.3%) and Communications (Alphabet and Meta Platforms totaling 6.4%), the S&P 500 allocation to the MAG-7 is 30.5%, and the combined Tech plus Tech-adjacent allocation is a whopping 42.0%—or a 28.9% relative overweight versus the Russell 2000!

Some might say that small caps are due for a mean reversion versus the S&P 500, but it seems its relative overweight to cyclical sectors like Industrials, Financials, Real Estate, Materials, and Energy (with only noncyclical/secular growth Healthcare having an overweight of 5.9%) rather than to secular growth Technology would make any attempt at mean reversion temporary. Nevertheless, I still think the small cap universe is where to find the most explosive growth opportunities (with the notable exception of large cap names like NVDA), even if the broad passive indexes (like Russell 2000) can't keep up. So, insightful active selection is important for small cap investing—which is easier to do given the relative lack of analyst coverage and institutional ownership of small caps.

We at Sabrient 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. By the way, our Q1 2025 Baker’s Dozen remains in primary market until 4/16, after which time the Q2 portfolio launches. Also, our Small Cap Growth 45 portfolio remains in primary market until 4/21, followed by the launch of Small Cap Growth 46, and Dividend 51 is in primary market paying a 4.25% yield on new purchases.

As a reminder, Sabrient founder David Brown’s new book, How to Build High Performance Stock Portfolios, is available in both paperback and eBook versions on Amazon. And as a companion product to the book, we have launched next-gen versions of Sabrient Scorecards for Stocks and ETFs. You can learn more about the scorecards book and, download a sample scorecard, and sign-up for a free trial subscription—by visiting: http://DavidBrownInvestingBook.com/

In today's post, I examine in detail the new tariff regimen, the case for reducing (but not eliminating) the trade deficit, the liquidity challenge and “debt maturity wall,” and the case for tariffs and trade realignment. You won’t regret reading it through! 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. Here is a link to this post in printable PDF format.  Read on….

  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

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

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

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

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

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

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

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

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

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

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

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

In today’s post, I dissect in greater detail GDP, jobs, federal debt, inflation, corporate earnings, stock valuations, technological trends, and what might lie ahead for the stock market with the incoming administration. I also discuss Sabrient’s latest fundamental-based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model, and several top-ranked ETF ideas. And be sure to check out my Final Thoughts section in which I offer my post-mortem on the election.

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

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

I have been expecting elevated volatility, and it has surely arrived. The CBOE Volatility Index (VIX) briefly spiked above 35 on 12/3 before settling back down below 20 last week as stocks resurged. Given lofty valuations (S&P 500 at 21.4x forward P/E) that appear to be pricing in continued economic recovery and strong corporate earnings further exceeding expectations, any hint of new obstacles – like onerous new COVID variants, renewed lockdowns, persistent supply chain disruptions, anemic jobs report, or relentless inflationary pressures – naturally sends fidgety investors to the sell button on their keyboards, at least momentarily. And now we learn that the Fed might have joined the legions of dour pundits by removing the word “transitory” from its inflation description while hastening its timetable for QE tapering (but don’t call it QE!) and interest rate hikes. Nevertheless, despite the near-term challenges that likely will lead to more spikes in volatility, investors are buying the dip, and I believe the path of least resistance is still higher for stocks over the medium term, but with a greater focus on quality rather than speculation.

However, investors are going to have to muster up stronger bullish conviction for the market to achieve a sustainable upside breakout. Perhaps Santa will arrive on queue to help. But with this new and unfamiliar uncertainty around Fed monetary policy, and with FOMC meeting and announcement later this week combined with an overbought technical picture (as I discuss in today’s post below), I think stocks may pull back into the FOMC meeting – at which time we should get a bit more clarity on its intentions regarding tapering of its bond buying and plan for interest rate hikes. Keep in mind, the Fed still insists that “tapering is not tightening,” i.e., they remain accommodative.

The new hawkish noises from the Fed came out of left field to most observers, and many growth stocks took quite a hit. Witness the shocking 42% single-day haircut on 12/3 for a prominent company like DocuSign (DOCU), for example. And similar things have happened to other such high-potential but speculative/low-quality names, many of which are held by the ARK family of ETFs. In fact, of the 1,086 ETFs scored by Sabrient’s fundamentals based SectorCast rankings this week, most of Cathie Woods’ ARK funds are ranked at or near the bottom.

Although I do not necessarily see DOCU and its ilk as the proverbial canary in the coal mine for the broader market, it does serve to reinforce that investors are displaying a greater focus on quality as the economy has moved past the speculative recovery phase, which is a healthy development in my view. In response, 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. Moreover, we continue to suggest staying long but hedged, with a balance between 1) value/cyclicals and 2) high-quality secular growers & dividend payers. Hedges might come from inverse ETFs, out-of-the-money put options, gold, and cryptocurrencies (I personally hold all of them).

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 highly bullish bias, with the top two scorers being deep-cyclical sectors, Basic Materials and Energy, which are seeing surging forward EPS estimates and ultra-low forward PEG ratios (forward P/E divided by projected EPS growth rate) under 0.50. In addition, the technical picture is somewhat mixed and suggestive of a near-term pullback, although our sector rotation model maintains its bullish posture.

By the way, Sabrient’s latest Q4 2021 Baker’s Dozen model portfolio is already displaying solid performance despite having a small-cap bias and equal weighted position sizes that would typically suggest underperformance during periods of elevated market volatility. It is up +5.3% since its 10/20/2021 launch through 12/10/2021 versus +4.1% for the cap-weighted S&P 500, +1.2% for the equal-weight S&P 500, and -3.3% for the Russell 2000. Also, last year’s Q4 2020 Baker’s Dozen model portfolio, which terminates next month on 1/20/2022, is looking good after 14 months of life with a gross return of +43%. As a reminder, our various portfolios – including Baker’s Dozen, Small Cap Growth, and Dividend – all employ our enhanced growth-at-a-reasonable-price (aka GARP) approach that combines value, growth, and quality factors while seeking a balance between secular growth and cyclical/value stocks and across market caps. Read on....

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

  As the New Year gets underway, stocks have continued their impressive march higher. Comparing the start of this year to the start of 2019 reveals some big contrasts. Last January, the market had just started to recover from a nasty 4Q18 selloff of about 20% (a 3-month bear market?), but this time stocks have essentially gone straight up since early October. Last January, we were still in the midst of nasty trade wars with rising tariffs, but now we have a “Phase 1” deal signed with China and the USMCA deal with Mexico and Canada has passed both houses of Congress. At the beginning of last year, the Fed had just softened its hawkish rhetoric on raising rates to being "patient and flexible" and nixing the “autopilot” unwinding of its balance sheet (and in fact we saw three rate cuts), while today the Fed has settled into a neutral stance on rates for the foreseeable future and is expanding its balance sheet once again (to shore up the repo market and finance federal deficit spending (but don’t call it QE, they say!). Last year began in the midst of the longest government shutdown in US history (35 days, 12/22/18–1/25/19), but this year’s budget easily breezed through Congress. And finally, last year began with clear signs of a global slowdown (particularly in manufacturing), ultimately leading to three straight quarters of YOY US earnings contraction (and likely Q4, as well), but today the expectation is that the slowdown has bottomed and there is no recession in sight.

As a result, 2019 started with the S&P 500 displaying a forward P/E ratio of 14.5x, while this year began with a forward P/E of 18.5x – which also happens to be what it was at the start of 2018, when optimism reigned following passage of the tax cuts but before the China trade war got nasty. So, while 2018 endured largely unwarranted P/E contraction that was more reflective of rising interest rates and an impending recession, 2019 enjoyed P/E expansion that essentially accounted for the index’s entire performance (+31% total return). Today, the forward P/E for the S&P 500 is about one full standard deviation above its long-term average, but the price/free cash flow ratio actually is right at its long-term average. Moreover, I think the elevated forward P/E is largely justified in the context of even pricier bond valuations, low interest rates, favorable fiscal policies, the appeal of the US over foreign markets, and supply/demand (given the abundance of global liquidity and the shrinking float of public companies due to buybacks and M&A).

However, I don’t think stocks will be driven much higher by multiple expansion, as investors will want to see rising earnings once again, which will depend upon a revival in corporate capital spending. The analyst consensus according to FactSet is for just under 10% EPS growth this year for the S&P 500, so that might be about all we get in index return without widespread earnings beats and increased guidance, although of course well-selected individual stocks could do much better. Last year was thought to be a great setup for small caps, but alas the trade wars held them back from much of the year, so perhaps this will be the year for small caps. While the S&P 500 forward P/E has already risen to 19.0x as of 1/17, the Russell 2000 small cap index is 17.2x and the S&P 600 is only 16.8x.

Of course, there are still plenty of potential risks out there – such as a China debt meltdown, a US dollar meltdown (due to massive liquidity infusions for the dysfunctional repo market and government deficit spending), a US vote for democratic-socialism and MMT, a military confrontation with Iran, or a reescalation in trade wars – but all seem to be at bay for now.

In this periodic update, I provide a detailed market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings look neutral, while the technical picture also is quite bullish (although grossly overbought and desperately in need of a pullback or consolidation period), and our sector rotation model retains its bullish posture. Notably, the rally has been quite broad-based and there is a lot of idle cash ready to buy any significant dip.

As a reminder, Sabrient now publishes a new Baker’s Dozen on a quarterly basis, and the Q1 2020 portfolio just launched on January 17. You can find my latest slide deck and Baker’s Dozen commentary at http://bakersdozen.sabrient.com/bakers-dozen-marketing-materials, which provide discussion and graphics on process, performance, and market conditions, as well as the introduction of two new process enhancements to our long-standing GARP (growth at a reasonable price) strategy, including: 1) our new Growth Quality Rank (GQR) as an alpha factor, which our testing suggests will reduce volatility and provide better all-weather performance, and 2) “guardrails” against extreme sector tilts away from the benchmark’s allocations to reduce relative volatility. Read on....