by Scott Martindale
  CEO, Sabrient Systems LLC
 

Quick note 1: Sabrient’s Q3 2026 Baker’s Dozen portfolio (13 top picks) will launch on 10/20. On that day, our Q2 2025 Baker’s Dozen will terminate, and it is up +37.2% gross total return vs. +24.4% for SPY as of 10/2. Also, our quarterly Small Cap Growth 52 portfolio launched on 9/15, with a mix of 44 small-cap stocks across 9 business sectors. SCG 47 terminates on 10/16 and is up +38.9% vs. +22.5% for S&P 600 Small Cap Growth (SLYG) as of 10/2. It followed the launch of Sabrient’s annual Forward Looking Value 14 portfolio on 8/26, having a diverse mix of 31 stocks across 9 business sectors and a large/SMID-cap mix. Last year’s FLV 13 terminates on 11/17 and is up +35.7% vs. +16.3% for S&P 500 Value (SPYV) and +21.2% for S&P 500 (SPY) as of 10/2.

Quick note 2: I was recently a guest on the “Biz Wiz” podcast to tell my humble career story from engineering school to the oil industry to investment research and eventually CEO of Sabrient Systems. Key takeaway from the 30-minute discussion is that an entrepreneurial mindset means adaptability, resilience, focusing on high-potential projects, avoiding rabbit holes, responding to customer needs, creating and scaling value, and advocating for yourself and your ideas. I’d love to hear your impressions!

Overview:

September saw the convergence of several big issues for investors, including: 1) oil price (WTI) and the diesel crack spread both surging above the $100 mark, 2) soaring bond yields and bond volatility (with the 10-year Treasury hitting 5.35%, its highest since 2002, and 30-year mortgages hitting 7.28%), 3) the first Fed rate hike since July 2023, and 4) sudden apocalyptic warnings that unbridled AI could “kill us all by the end of the decade.” And on top of it all, companies and funds with “AI” in their name may to have change it to “SI” (for super intelligence), at least according to our president. The bond market (and the so-called “bond vigilantes”) drove up longer-term rates too rapidly, and so the Fed seems to have decided it had to react to what the market was reflecting—even though jobs and wage growth are stagnant while core inflation is moderating.

Alas, after a one-day pullback, yields surged higher anyway. But I think this is simply a “blowoff top” that will soon put a cap on the 10-year, which suggests to me a buying opportunity for longer duration bonds. Just as the adage about inflation says, “the cure for high prices is high prices,” suggesting a self-correcting loop, similarly the cure for high yields is high yields, meaning that the guaranteed return of bonds becomes increasingly competitive with more-volatile equity returns, attracting demand. I also think oil prices have seen their highs given all the effective workarounds, which should further reduce inflationary pressures and help cap bond yields.

Regardless, I believe the Fed’s hawkishness is a policy mistake given our bifurcated K-shaped economy. We have soaring corporate profits and stock prices juxtaposed with stagnant labor and housing markets, negative real wage growth, a low personal saving rate, and surging high-yield spreads—not to mention softening core inflation and underlying structural disinflationary trends.

In my comprehensive commentary below, I discuss:

1. The sudden AI panic is just the latest in a long lineage of imminent existential doomerism
2. Bureaucrats blunder into the AI fray
3. Stock valuations and bond yields
4. National debt and de-dollarization debate
5. The “debasement trade”
6. Jobs, inflation, and the K-shaped economy
7. My Final Comments essay: Time to vote!
8. Sabrient’s sector rankings, positioning of our sector rotation model, and some top-ranked ETF ideas

The healthy improvement in market breadth we saw for much of the year ended in mid-August, at which time bitcoin surged, the S&P 500 went sideways, the Nasdaq 100 consolidated gains and then surged to new highs, while the equal-weight S&P 500 (RSP), mid-cap S&P 400 (MDY), and small-cap Russell 2000 (IWM) all sold off. And of course, all of September saw a surge in yields—which is correlated with the selloff in all those non-Tech, interest-rate-sensitive stocks.

It seems that the FOMC saw rising yields as a supply problem at its July meeting but a demand problem today. By that I mean a supply-driven rise in yields reflects global supply shocks that raise inflation and weaken economic growth, whereas a demand-driven rise in yields reflects stronger-than-expected economic activity such that markets expect the Fed to keep rates higher-for-longer and thus are demanding more term premium.

The Fed's earlier patience assumed the supply/energy shock would soon fade. But with relentless AI/SI spending driving strong demand, the supply/energy problem became a demand problem in the eyes of the FOMC. And when all you have is a hammer, every problem looks like a nail—thus the rate hike. Fed chair Kevin Warsh said, “Our decision comes at a time when the American economy appears to be strengthening. New hiring, private-sector earnings, business capital investment. Each of these markers has improved in recent months and is pointing in a good direction. Credit flows have been robust, particularly for businesses.”

Indeed, on 9/11, the Fed announced that US national household net worth surged to over $195.9 trillion in Q2 (604% of GDP), primarily driven by capital gains on stocks. Q2 saw the 11th straight quarterly increase and the largest in history at $12.8 trillion—which amazingly exceeds the total annual GDP of every country in the world except the US ($32.4 trillion) and China ($20.8 trillion) as well as the aggregate GDP of the EU ($23.0 trillion, led by Germany’s $5.4 trillion). It’s the 11th consecutive quarterly rise, and the current number is 2x our household wealth since 2020. In addition, the ratio of net worth to disposable personal income (DPI), a measure of households’ potential to finance consumption out of their wealth, reached a record high of 8.3x in Q2.

As for inflation, Trimmed Mean PCE inflation, Core CPI, all the 3-month annualized trends, the 5-year breakeven, and real-time, blockchain-based Truflation all put underlying inflation much closer to (or even below) the Fed’s 2.0% target, as I detail below. Once the energy/supply shock resolves, the structural disinflationary trends should take control once again, e.g., aging demographics, slowing global population growth, accelerating disruptive innovation, automation, rising productivity, and re-globalization of supply chains (“excess productive capacity”).

Last Friday’s disappointing jobs report seemed to trigger an oversold bounce in stocks on the expectation that the Fed will soften. The question is whether this is sustainable or whether it’s just a technical bounce that will be stymied by overhead resistance (aka the proverbial “dead cat bounce”).

Again, I think the Fed made a policy mistake by hiking. The problem is, interest rates impact the whole economy—they can’t be targeted—and monetary policy is clearly restrictive in the most rate-sensitive industries and demographics (despite what Warsh states in his official comments about the broader economy). And even if they could be targeted, the upper leg of the K-shaped economy is largely rate-insensitive, including 1) cash-rich hyperscalers and other equity-capitalized Tech companies that are driving record earnings growth in a powerful secular growth story, and 2) Baby Boomers who are now freely spending their wealth in retirement without taking on debt. But the struggling lower leg of the K (small businesses and lower-income and working-class consumers) is highly rate-sensitive, and yet it is being given the same bad medicine as the robust upper leg. Moreover, it’s bad for government borrowing, further raising out-of-control interest expense, with a massive debt maturity wall coming due for rollover.

Regardless, I expect to see—through the end of this decade and likely beyond—smaller government and less low-ROI government spending in favor of more high-ROI capital allocation from an unleashed private sector as the primary engine of organic economic growth through fiscal support like favorable tax policy, deregulation, and other supply-side incentives for reshoring/onshoring to increase productive capacity. And for now, global liquidity remains abundant, continuing to hit new highs.

As such, I still think the S&P 500 will reach 8,000 by year end. Of course, it largely depends on the upcoming Q3 earnings reports and forward guidance, which have been beyond stellar so far this year, but expectations are becoming challenging. We got the September pullback I expected, with the S&P 500 successfully testing support at its 50-day moving average. However, as the GMO Asset Allocation team observed, “For the first time in twenty years, with the brief exception of the Global Financial Crisis, we are seeing net dilution in the U.S. stock market (i.e., share issuance exceeding share buybacks) as the hyperscalers continue their capital expenditure spree.”

But assuming core inflation metrics continue to moderate and the Fed comes to its senses on tightening, I expect a resumption in the healthy market broadening beyond the AI trade, and I continue to see opportunities in active stock selection, equal-weight indexes, value stocks, cyclical sectors, small caps, and bond-alternative dividend payers.

Indeed, Sabrient’s quant-based, actively selected (“quantamental”), equal-weight Baker’s Dozen, Forward Looking Value, Dividend, and Small Cap Growth portfolios have been largely outperforming their benchmarks—several by substantial margins. And as a reminder, our Earnings Quality Rank (EQR) is licensed as a quality prescreen to the actively managed, low-beta First Trust Long-Short ETF (FTLS), which now holds more than $2.6 billion in AUM.

Sabrient employs a wide variety of fundamental financial factors in our quantitative multifactor models and portfolio selection process. Sabrient Scorecards for Stocks and ETFs are investor tools that provide access to several of our proprietary models for portfolio monitoring and for idea generation for four key investing styles—Growth, Value, Dividend, and Small Cap Growth. To learn more, visit this link: https://www.moonrockstopowerstocks.com/scorecard.

Here is a link to this full post in printable PDF format. As always, I’d love to hear from you! Please feel free to email me your thoughts on this article or if you’d like me to speak on any of these topics at your event.  Read on….

  by Scott Martindale
  CEO, Sabrient Systems LLC

Quick portfolio update: Sabrient’s Q3 2026 Baker’s Dozen quarterly portfolio launched on 7/20 with a diverse group of 13 stocks across market caps and business sectors, including both prominent and under-the-radar names. Also, the new Sabrient Dividend 57 quarterly portfolio just launched on 8/4 as a growth & income strategy, with a diverse group of 48 high-quality stocks across market caps and sectors and a current yield of 3.8%. Additionally, our annual Forward Looking Value 14 portfolio will launch on 8/26 with a diverse group of high-quality, value-oriented stocks having good growth potential across market caps and sectors.

Overview

There has been outsized investor focus on inflation and the Fed’s response to it—something that new chairman Kevin Warsh is trying to diminish. He has stated, "…market participants are learning to play the ball, not the referee." Warsh has suggested a preference fulfilling the mandate of price stability through a combination of lower policy rates, continued balance sheet reduction, and structural reform of the official inflation metrics (which rely on many lagged, imputed, and low-relevance components). Some observers and several FOMC members say we must have rate hikes to control the inflationary spiral, while others say we need rate cuts to boost the struggling lower leg of our K-shaped economy (lower-income and working-class consumers, small businesses, and housing) and the alarmingly low personal savings rate (2.7% versus a long-term average of 8.3%) that has been supporting personal consumption. Count me in the latter group, as I explain in my full commentary below.

But that’s not stopping the bond vigilantes from boycotting the massive issuance of debt and thus pushing up longer-term rates at an alarming pace, which negatively impacts mortgage rates, corporate borrowing costs, and the discount rate on stock valuations. Uncertainty leads to higher term premiums. It might be not only a protest against rising federal debt but also anticipation of the Fed shrinking its balance sheet (aka QT), which pulls cash (bank reserves) out of the financial system while increasing the supply of bonds in the market (leading to higher yields)—even though the Fed has already reduced its balance sheet by $2.4 trillion (from $9 trillion in 2022) to remove about half its pandemic-era QE accumulation.

As a result, 10-year Treasury yields made another new 18-month high at 4.74% at the end of July, and the 30-year reached its highest yield since 2007 of 5.27%, entirely due to rising real rates not inflation expectations (which remain modest). Although yields pulled back last week on hopeful Iran news, plunging crude oil prices, and weak jobs reports, providing hope of a less restrictive Fed. So, although longer-term yields may well rise further—with the 10-year potentially challenging 5% for the first time in three years—I see this as a buying opportunity for fixed income, such as with iShares 20+ Year Treasury ETF (TLT) with a current yield of 4.75%, particularly if inflation has seen its peak and is pulling back, as I suspect it is.

The federal deficit is now roughly $2 trillion out of a $7 trillion total budget (that’s nearly 30% of the total budget!), which must be financed through Treasury issuance. And roughly half that deficit is interest on debt payments (now exceeding $1 trillion/yr and growing fast), which rises as debt increases, requiring new issuances and debt rollovers—both at higher interest rates than before as the Treasury Dept. has focused on the short end of the yield curve, thus lowering the weighted average maturity of federal debt.

It’s a death spiral rapidly overwhelming the budget, which (as I have discussed at length in many prior posts) must be addressed with a 3-prong approach of: 1) growing away the debt through robust GDP growth given that tax receipts historically average 17% of GDP no matter the tax rates, 2) cutting away the debt through reduced spending growth below the rate of GDP growth and rooting out waste and fraud, and 3) inflating away the debt through elevated inflation rates that reduce the dollar value of the debt.

Meanwhile, the giant hyperscalers are not only spending most or all of the massive cash flows but are also flooding the corporate bond market with as much as $1 trillion for AI infrastructure buildout. So, perhaps part of Warsh’s plan is to let the market do the dirty work of suppressing economic activity by raising longer-term rates—leading to higher mortgage rates, corporate borrowing costs, and the discount rate on stocks valuations—hopefully not to the point of causing a recession.

For now, there is no sign of recession as the Atlanta Federal Reserve’s purely model-driven GDPNow forecast shows an estimate for Q3 real GDP growth of a robust +5.8% as of 8/6 (although the more nuanced consensus of “Blue Chip” economists is only 2.0%). You might recall the forecast showing strong numbers for Q2 with a high of +4.3% in late May before falling to a low of +1.2% in early July, with the final BEA report coming in at just +1.5%. Nonetheless, there was plenty of good in the report, as non-government private spending (consumers and private fixed investment) grew +3.9%.

And although this private spending was offset by 1) falling net exports (as imports surged +11.5%, driven by AI-related components), which alone reduced the final number by 1.01 percentage points (pps), and 2) private inventory drawdowns, which reduced it by 0.67 pps, both of these metrics in fact reflect robust underlying domestic demand, consumer spending, corporate capex, and overall economic activity. Indeed, when high imports and low inventories suppress GDP, it typically suggests impending economic acceleration and revved-up domestic manufacturing, which would boost GDP metrics in subsequent quarters—which the Atlanta Fed’s GDPNow forecast seems to be reflecting.

In my full commentary below, I discuss:

1. The selloff in the AI trade and the restoration of Apple’s prominence
2. Hyperscaler capex, free cash flow, and power demand
3. Solid GDP growth but mixed messages on jobs and housing
4. Trends in inflation, supply chain pressures, and productivity
5. The bond vigilantes, rising federal debt, China’s woes, and Fed policy
6. My final comments section pushing back on the overwrought AI backlash/alarmism
7. Sabrient’s sector rankings, positioning of our sector rotation model, and some top-ranked ETF ideas

With all the turmoil in the AI trade, which was overdue after such a meteoric rise, market leadership continues to broaden and rotate. The fact that the market rotated rather than sell everything and go to cash is encouraging and suggestive of continued bullish conviction. Russell 2000 companies’ earnings growth forecasts for CY2026 have climbed to 38% from about 23% at the beginning of the year—in spite of rising interest rates that tend to have outsized impact on the floating-rate debt typically carried by smaller firms. And the equal-weight S&P 500 ETF (RSP) is approaching $100 billion in AUM, with performance led by many of the “S&P 493” rather than the MAG7.

Chamath Palihapitiya, entrepreneur and All-In Podcast team member, recently quipped, “Fundraising requires narrative, and ‘we are building God’ is a better pitch than ‘we wrote some very clever linear algebra, pirated the internet, and threw a bunch of compute at it.’”  Perhaps that’s what investors reduced it to as they abandoned the AI trade—at least for the moment. And perhaps it is true that our economy has been overly reliant upon AI-led expansion with yet-to-be-proven ROI, especially datacenters.

Indeed, the dollar value of datacenter construction plus computers and communications equipment are up 23% YoY, with the hyperscalers’ capex [in order of dollar commitments: Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOGL), Meta (META), Oracle (ORCL), and now SpaceX (SPCX)] projected to be in the range of $700-800 billion for CY2026 (40% higher than CY2025)—leading to reduced shareholder-friendly buybacks but surging global semiconductor sales. According to the Semiconductor Industry Association, chip sales worldwide were up +123% YoY in the month of June, totaling over $400 billion during Q2, and are expected to exceed $1.5 trillion for CY2026.

That’s a lot of investment to recover. But as Tech executive and investor Nat Friedman opined, “Pessimists sound smart. Optimists make money.” Indeed, longer term, I believe the broad potential ROI of AI—in reshaping our economy and society through massive productivity gains, solving complex scientific and technological challenges, and fundamentally transforming the workplace and daily life—is stronger and materializing faster than anticipated even at the beginning of the year.

The use cases and compute demand for AI have barely begun to manifest, with a future encompassing autonomous transportation, factory automation, humanoid robots, personal assistants for hundreds of millions of individual users, and AI assistance on everything from drones for law enforcement, to surgery and drug discovery, to optimized asset maintenance, smart grid energy, and fraud monitoring—not to mention the associated power demand for it all.

So, am I concerned about whether the massive AI capex by the hyperscalers on infrastructure (like datacenters) and power generation will see attractive ROI anytime soon? I am not. In fact, I bought into the July “tech wreck,” including some names in memory and storage as well as the MAG7 ETF (MAGS), and I bought into the “SaaSpocalypse” in February and again in April via the iShares Tech-Software ETF (IGV). In its earnings report the other day, Palantir (PLTR) described commercial demand as “otherworldly,” and the stock surged 30%. In my view, for anyone who felt they had missed the boat on the AI surge and didn’t want to chase it—this was the pullback you were waiting for.

Of course, there is no guarantee that the market won’t turn tail once again, given the unresolved conflict with Iran and its terrorist proxies and the real potential for reescalation. And besides Iran, a plethora of uncertainties persist with oil prices, shipping and supply chains, trade deals and tariffs, Ukraine, China, Japanese yen, federal debt, civil strife, midterm elections and the unnerving rise of DSA candidates, inflation, jobs, and monetary policy from a revamped Fed. Did I miss anything?

But fundamental tailwinds still outweigh headwinds, in my view, given AI optimism, robust capex, deregulation, lower taxes, re-privatization, re-industrialization (onshoring of manufacturing), diversification of supply chains (not deglobalization), rising productivity/margins/earnings, low credit spreads, and resumed disinflationary trends. Deregulation is focused heavily on encouraging domestic fossil fuel production, less burdensome financial oversight, and less onerous climate rules, mostly to the advantage of Energy, Financials, and Industrials sectors.

Forward P/E multiples have receded largely due to a rising discount rate as bond yields surge. And yet stocks keep going up on the back of incredible earnings growth and fast-rising forward estimates. According to First Trust, “Analyst estimates have increased as the year has unfolded, with Large Cap, Mid Cap, and Small Cap Index EPS estimated to reach a record $354.46, $219.63, and $107.53, respectively, in 2026 (as of 8/3/26) [according to Bloomberg]. For comparison, analyst estimates were much lower at the start of the year, with the same indices estimated to see calendar year 2026 earnings of $310.84, $202.91, and $96.06 (as of 12/31/25).”

Indeed, the S&P 500 is on pace for blended earnings growth in Q2 of 47% versus a forecast of 23% just a few weeks ago. However, if you strip out Amazon (AMZN) and Alphabet (GOOGL), whose incredible earnings reports were largely driven by non-operating gains on investments in Anthropic and SpaceX, the blended S&P 500’s blended EPS growth falls to around 29%, which is still quite impressive.

Overall, given the market broadening beyond the Big Tech titans, and assuming the Fed does not become more hawkish, I continue to see opportunities in active stock selection, as well as in cyclicals, value stocks, small caps, and bond-alternative dividend payers. Indeed, Sabrient’s Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend portfolios have been largely outperforming their benchmarks—some by substantial margins. And as a reminder, our Earnings Quality Rank (EQR) is licensed as a quality prescreen to the actively managed, low-beta First Trust Long-Short ETF (FTLS), which now has nearly $2.5 billion in AUM.

By the way, in my July post, I wrote a long Final Comments section on the alarming rise of socialism, which I would encourage you to read if you haven’t already. Although I acknowledge the disparate impacts of the K-shaped economy, the socialists’ harping on fairness and wealth inequality is largely a red herring as living standards, real incomes, consumption, and life expectancies have generally risen across demographics nationally. It certainly doesn’t warrant dismantling the capitalist system that has created so much innovation, value, wealth, comfort, and good for the world.

The exception to broadly rising living standards seems to lie in many of our deep-blue cities and states. So today, let me also add a comment on the “affordability” issue that has become the main talking point of the Left against the Trump Administration. The reality is that the bluest cities and states tend to have the worst affordability, as reinforced by US News & World Report’s latest 2026 rankings of states that put California dead last in its specific “Affordability” metric, followed by other deep-blue states, namely New Jersey, Hawaii, New York, Washington, Massachusetts, Maryland, and Colorado. It also put California dead last for the broader “Opportunity” category, which comprises the subcategories of Economic Opportunity, Affordability, and Equality across demographic groups.

So, don’t be gaslighted by deceptive electioneering. The answer is not to double down on the same misguided and counterproductive policies—like onerous zoning restrictions and permitting processes, punitive taxation, high energy prices, mandated worker benefits, rent control, sanctuary policies, and permissiveness on crime and homelessness—that have degraded quality of life for everyone while inviting fraud and corruption. Rather, voters should pivot back to embracing free markets, meritocracy, property rights, and the rule of law that built our great country. Such principles have proven much more adept at solving problems than dogmatic bureaucrats, virtually none of whom have any private-sector leadership experience. Affordability is a genuine problem, particularly in several high-cost blue states, and policymakers in these locales shouldn't assume that further expanding redistribution or intervention policies will solve the problems that were likely created by these policies in the first place.

Here is a link to this full post in printable PDF format. As always, I’d love to hear from you! Please feel free to email me your thoughts on this article or if you’d like me to speak on any of these topics at your event!  Read on….