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

July saw new highs for the broad market indexes followed by a big fall from grace among the Magnificent Seven (MAG-7) stocks. But it looked more like a healthy rotation than a flight to safety, with a broadening into neglected market segments, as inflation and unemployment metrics engendered optimism about a dovish policy pivot from the Federal Reserve. The rotation of capital within the stock market—as opposed to capital flight out of stocks—kept overall market volatility modest. But then along came the notorious month of August. Is this an ominous sign that the AI hype will come crashing down as the economy goes into a recession? Or is this simply a 2023 redux—another “summer sales event” on stock prices—with rate cuts, accelerating earnings, and new highs ahead? Let’s explore the volatility spike, the reset on valuations, inflation trends, Fed policy, and whether this is a buying opportunity.

Summary

Up until this month, a pleasant and complacent trading climate had been in place essentially since the Federal Reserve announced in Q4 2023 its intended policy pivot, with a forecast of at least three rate cuts. But August is notorious for its volatility, largely from instability on the trading floor due to Wall Street vacations and exacerbated by algorithmic (computer-based) trading systems. In my early-July post, I wrote that I expected perhaps a 10% correction this summer and added, “the technicals have become extremely overbought [with] a lot of potential downside if momentum gets a head of steam and the algo traders turn bearish.” In other words, the more extreme the divergence and euphoria, the harsher the correction.

Indeed, last Monday 8/5 saw the worst one-day selloff since the March 2020 pandemic lockdown. From its all-time high on 7/16 to the intraday low on Monday 8/5 the S&P 500 (SPY) fell -9.7%, and the Technology Select Sector SPDR (XLK) was down as much as -20% from its 7/11 high. The CBOE Volatility Index (VIX) hit a colossal 67.73 at its intraday peak (although tradable VIX futures never came close to such extremes). It was officially the VIX’s third highest reading ever, after the financial crisis in 2008 and pandemic lockdown in 2020. But were the circumstances this time around truly as dire as those two previous instances? Regardless, it illustrates the inherent risk created by such narrow leadership, extreme industry divergences, and high leverage bred from persistent complacency (including leveraged short volatility and the new zero-day expiry options).

The selloff likely was ignited by the convergence of several issues, including weakening economic data and new fears of recession, a concern that the AI hype isn’t living up to its promise quite fast enough, and a cautious Fed that many now believe is “behind the curve” and making a policy mistake by not cutting rates. (Note: I have been sounding the alarm on this for months.) But it might have been Japan at the epicenter of this financial earthquake when the Bank of Japan (BoJ) suddenly hiked its key policy rate and sounded a hawkish tone, igniting a “reverse carry trade” and rapid deleveraging. I explain this further in today’s post.

Regardless, by week’s end, it looked like a non-event as the S&P 500 and Nasdaq 100 clawed back all their losses from the Monday morning collapse. So, was that it for the summer correction? Are we all good now? I would say no. A lot of traders were burned, and it seems there is more work for bulls to do to prove a bottom was established. Although the extraordinary spike in fear and “blood in the streets” was fleeting, the quick bounce was not convincing, and the monthly charts look toppy—much like last summer. In fact, as I discuss in today’s post, the market looks a lot like last year, which suggests the weakness could potentially last into October. As DataTrek opined, “Investor confidence in the macro backdrop was way too high and it may take weeks to fully correct this imbalance.”

Stock prices are always forward-looking and speculative with respect to expectations of economic growth, corporate earnings, and interest rates. The FOMC held off on a rate cut at its July meeting even though inflation is receding and recessionary signals are growing, including weakening economic indicators (at home and abroad) and rising unemployment (now at 4.3%, after rising for the fourth straight month). Moreover, the Fed must consider the cost of surging debt and the impact of tight monetary policy and a strong dollar on our trading partners. On the bright side, the Fed no longer sees the labor market as a source of higher inflation. As Fed Chair Jerome Powell said, “The downside risks to the employment mandate are now real.” 

The real-time, blockchain-based Truflation metric (which historically presages CPI) keeps falling and recently hit yet another 52-week low at just 1.38%; Core PCE ex-shelter is already below 2.5%; and the Fed’s preferred Core PCE metric will likely show it is below 2.5% as well. So, with inflation less a worry than warranted and with corporate earnings at risk from the economic slowdown, the Fed now finds itself having to start an easing cycle with the urgency of staving off recession rather than a more comfortable “normalization” objective within a sound economy. As Chicago Fed president Austan Goolsbee said, “You only want to stay this restrictive for as long as you have to, and this doesn’t look like an overheating economy to me.”

The Fed will be the last major central bank in the West to launch an easing cycle. I have been on record for months that the Fed is behind the curve, as collapsing market yields have signaled (with the 10-year Treasury note yield falling over 80 bp from its 5/29 high before bouncing). It had all the justification it needed for a 25-bp rate cut at the July FOMC meeting, and I think passing on it was a missed opportunity to calm global markets, weaken the dollar, avert a global currency crisis, and relieve some of the burden on highly indebted federal government, consumers, businesses, and the global economy. Indeed, I believe Fed inaction forced the BoJ rate hike and the sudden surge in US recession fears, leading to last week’s extreme stock market weakness (and global contagion).

In my view, a terminal fed funds “neutral” rate of 3.0-3.5% (roughly 200 bps below the current “effective” rate of 5.33%) seems appropriate. Fortunately, today’s lofty rate means the Fed has plenty of potential rate cuts in its holster to support the economy while still remaining relatively restrictive in its inflation fight. And as long as the trend in global liquidity is upward, then the risk of a major market crash this year is low, in my view. Even though the Fed has kept rates “higher for longer” throughout this waiting game on inflation, it has also maintained liquidity in the financial system, which of course is the lifeblood of economic growth and risk assets. Witness that, although corporate credit spreads surged during the selloff and market turmoil (especially high yield spreads), they stayed well below historical levels and fell back quickly by the end of the week.

So, I believe this selloff, even if further downside is likely, should be considered a welcome buying opportunity for long-term investors, especially for those who thought they had missed the boat on stocks this year. This assumes that the proverbial “Fed Put” is indeed back in play, i.e., a willingness to intervene to support markets (like a protective put option) through asset purchases to reduce interest rates and inject liquidity (aka quantitative easing). The Fed Put also serves to reduce the term premium on bonds as investors are more willing to hold longer-duration securities.

Longer term, however, is a different story, as our massive federal debt and rampant deficit spending is not only unsustainable but potentially catastrophic for the global economy. The process of digging out of this enormous hole will require sustained, solid, organic economic growth (supported by lower tax rates), modest inflation (to devalue the debt without crippling consumers), and smaller government (restraint on government spending and “red tape”), in my view, as I discuss in today’s post.

In buying the dip, the popular Big Tech stocks got creamed. However, this served to bring down their valuations somewhat, their capital expenditures and earnings growth remains robust, and hedge funds are generally underweight Tech, so this “revaluation” could bode well for a broader group of Tech stocks for the balance of the year. Rather than rushing back into the MAG-7, I would suggest targeting high-quality, fundamentally strong stocks across all market caps that display 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 our growth-oriented Baker’s Dozen, value-oriented Forward Looking Value (which just launched on 7/31), growth & income-oriented Dividend portfolio, and the Small Cap Growth (an alpha-seeking alternative to a passive position in the Russell 2000).

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) as an initial screen.

Each of our alpha factors and their usage within Sabrient’s Growth, Value, Dividend income, and Small Cap investing strategies is discussed in detail in Sabrient founder David Brown’s new book, How to Build High Performance Stock Portfolios, which will be published this month (I will send out a notification).

Click here to continue reading my full commentary, in which I go into greater detail on the economy, inflation, monetary policy, valuations, and 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. I invite you to share it as appropriate (to the extent compliance allows). You also can sign up for email delivery of this periodic newsletter at Sabrient.com.

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

As COVID-19 quickly moved from outbreak to epidemic to full-fledged pandemic in a matter of weeks, hospitalizations and deaths gained momentum, as did the panic selling of risk assets. It demonstrates how interconnected the world has become. The pandemic has become a generational crisis – and the very definition of the proverbial Black Swan event – bringing the global economy to its knees, at least temporarily. As a result, Q1 closed with a rare and dreaded trifecta of three down months, which historically does not lead to a quick recovery (albeit with a small sample size). It was the worst Q1 performance since 1987 and the fastest fall from record highs in history.

From its intraday all-time high on 2/19/20 to the intraday low on 3/23/20 (i.e., a little over one month), the S&P 500 fell an incredible -35.3%, wiping out the entire “Trump Bump” and about $10 trillion in US market cap in almost the blink of an eye. Moreover, asset classes were highly correlated in a mass liquidation, leaving no place to hide other than US Treasuries or cash (thus strengthening the US dollar). Even gold and cryptocurrencies largely failed to serve as the safe havens from financial distress they are intended to be, at least initially, as traders liquidated everything into cold hard cash. Indeed, money market funds surged above $4 trillion for the first time ever. Never truer was the old saying, “Stocks take the stairs up and the elevator down” – or perhaps more fittingly in this case, stocks had rock-climbed up the cliff and swan-dived back down.

But the news has gotten better, as social distancing seems to be doing its job to “flatten the curve” of new hospitalizations, while the Federal Reserve and Congress have flooded the economy with unprecedented levels of fiscal and monetary support, stimulus, and liquidity. As a result, the S&P 500 has retraced over half of the selloff, and just posted its best week in 46 years (+12.1% in a shortened holiday week, at that). Now, the big question on everyone’s mind is, “What’s next?” Some see this as the end to a very brief bear market and the start of a brand new bull market, while others see it as just a bear market bounce and an opportunity to sell into strength before the next downswing. Some prominent names even think we are the verge of the next Great Depression. But from my standpoint, as we enter Passover and Easter weekend, I am optimistic that mass liquidation of financial assets is likely behind us, the economy will reopen sooner than previously expected, and that we have seen the market lows (although there may be some backfilling of technical gaps and retesting of support levels).

Perhaps a resumption of last fall’s fledgling broad-based rally (8/27/19 – 12/20/19) will persist much longer this time and favor the cyclical market segments (as many prominent names on Wall Street expect) and valuation-oriented strategies like Sabrient’s Baker’s Dozen – particularly given our newly-enhanced approach designed to improve all-weather performance and reduce relative volatility versus the benchmark S&P 500 (which has been tough to beat over the past couple of years given the narrow leadership of secular-growth mega-cap Tech and persistently defensive investor sentiment).

In this periodic update, I provide a market commentary, discuss Sabrient’s new process enhancements, offer my technical analysis of the S&P 500, and review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. Notably, Healthcare is suddenly the hero during this COVID-19 scare instead of the avoided sector from all the “Medicare for All” talk. (Perhaps that is behind us now that Bernie Sanders has suspended his presidential campaign.) In summary, our sector rankings remain neutral, and our sector rotation model moved to a defensive posture last month. The technical picture shows a market that has likely bottomed and begun to recover, although with elevated volatility likely to persist and strong directional signals that are suddenly invalidated and reversed by the latest news report on COVID-19 or government stimulus.

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. Click to read on...

  by Scott Martindale
  President, Sabrient Systems LLC

July was yet another solid month for stocks, as the major market indexes eclipsed and held above psychological barriers, like the S&P 500 at 3,000, and the technical consolidation at these levels continued with hardly any give back at all. But of course, the last day of July brought a hint of volatility to come, and indeed August has followed through on that with a vengeance. As the old adage goes, “Stocks take the stairs up but ride the elevator down,” and we just saw a perfect example of it. The technical conditions were severely overbought, with price stretched way above its 20-day simple moving average, and now suddenly the broad indexes (S&P 500, Dow, Nasdaq) are challenging support at the 200-day moving average, while the small cap Russell 2000 index has plummeted well below its 200-day and is now testing its May low.

For the past 18 months (essentially starting with the February 2018 correction), investor caution has been driven by escalating trade wars and tariffs, rising global protectionism, a “race to the bottom” in currency wars, and our highly dysfunctional political climate. However, this cautious sentiment has been coupled with an apparent fear of missing out (aka FOMO) on a major market melt-up that together have kept global capital in US stocks but pushed up valuations in low-volatility and defensive market segments to historically high valuations relative to GARP (growth at a reasonable price), value, and cyclical market segments. Until the past few days, rather than selling their stocks, investor have preferred to simply rotate into defensive names when the news was distressing (which has been most of the time) and then going a little more risk-on when the news was more encouraging (which has been less of the time). I share some new insights on this phenomenon in today’s article.

The market’s gains this year have not been based on excesses (aka “irrational exuberance”) but instead stocks have climbed a proverbial Wall of Worry – largely on the backs of defensive sectors and mega-caps and fueled by persistently low interest rates, and mostly through multiple expansion rather than earnings growth. In addition, the recent BAML Global Fund Manager Survey indicated the largest jump in cash balances since the debt ceiling crisis in 2011 and the lowest allocation ratio of equities to bonds since May 2009, which tells me that deployment of this idle cash and some rotation out of bonds could really juice this market. It just needs that elusive catalyst to ignite a resurgence in business capital spending and manufacturing activity, raised guidance, and upward revisions to estimates from the analyst community, leading to a sustained risk-on rotation.

As a reminder, I am always happy to take time for conversations with financial advisors about market conditions, outlook, and Sabrient’s portfolios.

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 to me (i.e., neither bullish nor defensive), while the sector rotation model retains a bullish posture. Read on…