by Scott Martindale
President, Sabrient Systems LLC
In my prior commentary in early May, I wrote that investors were aggressively bidding up stocks and appeared to have “stopped looking over their shoulders with fear and anxiety and are instead focused on the opportunities ahead.” The S&P 500 was retrenching after a breakout to new highs in preparation for a major upside move driven by a risk-on rotation – which I expected would bode quite well for Sabrient’s Baker’s Dozen portfolios that have been predominantly composed of stocks from growth-oriented cyclical sectors and small-mid caps. After all, recession fears had subsided, US and Chinese economic data were improving, Q1 corporate profits were coming in better than expected, the Fed had professed that it had our backs, and of course, a resolution to the US/China trade impasse was imminent. Or so it seemed. Instead, the month of May gave stocks a wild ride.
It was exactly one year ago that President Trump escalated the trade war with China from simple threats of tariffs to actual numbers and dates, which ignited a risk-off rotation and a starkly bifurcated market, as the S&P 500 large-cap index continued to rise on the backs of defensive sectors and mega-caps while risk-on cyclical sectors and small-mid caps sold off. The big oversold risk-on recovery following Christmas Eve began to peter out in late-April as the S&P 500 challenged its all-time high, but then the breakdown in negotiations in last month created another risk-off market reaction reminiscent of last summer. In other words, stocks and investor sentiment have been jerked around by Trump’s tweetstorms.
I talk a lot more about China and the trade war in today’s commentary, but the upshot is that this problem has been festering for a long time, and to his credit, President Trump decided he wasn’t going to continue the practice of kicking the can down the road to a future administration. China clearly (and dangerously) is intent on challenging the US for global dominance – economically, technologically, and militarily – with its powerful brand of state-sponsored capitalism. I support the cause against China’s unfair practices, given the enormous importance for our nation’s future – even though the resulting lengthy period of risk-off sentiment (essentially 9 of the past 12 months) has been challenging for Sabrient’s growth-and-valuation-driven portfolios (which are dominated by the neglected cyclical sectors and smaller caps), as the negative news stream creates a disconnect between analyst consensus earnings estimates and investor preferences. Fund flows instead suggest strong demand for low-volatility and momentum strategies as well as fixed income (tilted to shorter maturities and higher credit quality), and the 10-year TIPS breakeven inflation rate has fallen to 1.73% (as worries of deflation have set in).
In response to the recession fears and rampant defensive sentiment, the FOMC felt compelled last week to issue a highly accommodative statement that essentially said, we got your back, which turned around the fading stock market. Fed chairman Jay Powell asserted that the trade war is on the list of the committee’s concerns and that the central bank would “act as appropriate to sustain the expansion,” i.e., cut interest rates if necessary. This explicitly reestablished the proverbial “Fed put” as a market backstop, and investors liked it. We already are seeing a somewhat weaker dollar, which could be a further boost to US equities (especially those that sell internationally).
My view is that the May pullback was another buy-the-dip opportunity, particularly in risk-on market segments, as the pervasive worries about imminent global recession and a bear market caused by escalating trade wars have little basis in reality. The latest defensive rotation, including shunning of cyclical sectors, relative weakness in small caps, and global capital flight into Treasuries causing plunging yields (and a 3-mo/10-yr yield curve inversion), has been driven by uncertainty rather than hard data. Every piece of worsening economic data can be offset with encouraging data, in my view. Yes, the economic expansion (consecutive positive GDP prints) has been going on for a longer-than-average period of time, but there is no time limit on expansions, i.e., they don’t die of old age but rather from excesses and inflation that must be reined in (but there is nary of whiff of inflation anywhere in the developed world). I still expect that a resolution to the trade war will send stocks in general, and risk-on market segments in particular, into orbit … but until then, it is hard to predict when investor sentiment will again align with the still-solid fundamentals.
In this periodic update, I provide a 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 have turned neutral, while the sector rotation model retains its bullish posture. Read on…
By Scott Martindale
Last Monday was a banner day for most indices with S&P 500 hitting at new 46-month high of 1422. Alas, a week later, today, it closed at 1382, down nearly -3%. The NASDAQ and DJIA exhibited similar behavior.