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  • Sector Detector

    Market analysis, technical analysis of the S&P 500, and SectorCast ETF rankings, written by Scott Martindale.
     

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2nd Quarter Baker's Dozen UIT Launched

April 20, 2020:  The 12nd Quarter 2020 Baker’s Dozen UIT Portfolio (FRWMKX) was launched by First Trust Portfolios on April 20, 2020. This portfolio, like all Baker's Dozen portfolios, comprises 13 top-ranked stocks from a cross-section of market caps and industries based on our GARP approach, i.e., growth at a reasonable price. Sabrient believes each of these stocks is positioned to perform well for the next 15 months. The portfolio will terminate on July 20, 2021. For more information and a fact sheet please visit First Trust Portfolios

New Small Cap Growth UIT Launched

March 11, 2020: The 26th Sabrient Small Cap Growth UIT Series (FRDAAX) was launched by First Trust Portfolios on March 11, 2020. The portfolio invests in top-ranked (at the time of their selection) small-cap stocks that represent a cross-section of industries that Sabrient believes are positioned to perform well in the coming year. The stocks are GARP stocks—stocks that represent "growth at a reasonable price”—and they are meant to be held for the full term of the trust. This portfolio terminates June 11, 2021. For a prospectus or fact sheet, please visit First Trust Portfolios

Scott Martindale  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Optimism reigns for the pandemic slowing and the economy reopening. And because stocks tend to be several months forward looking (and remarkably predictive, at that), April saw the best single-month performance for the S&P 500 in 33 years (+12.7%), while the Nasdaq saw its best month in 20 years (+15.4%). The S&P 500 Growth Index recorded its highest ever monthly return (+14.3%). In addition, gold and bitcoin have been rising as a hedge against all sorts of outcomes, including geopolitical instability, trade wars, de-globalization, unfettered monetary & fiscal liquidity (i.e., MMT), inflation, a weakening dollar, a “toppy” bond market, etc. (plus the periodic bitcoin “halving” event that occurs this week).

This impressive rally off the lows seems justified for several reasons:

  1. the coronavirus, as bad as it is, falling well short of the dire lethality predictions of the early models and our ability to “flatten the curve”
  2. massive monetary and fiscal policy support and the associated reduction in credit risk
  3. low interest rates driving retirees and other income seekers into the higher yields and returns of stocks
  4. household income holding up relatively well, as the main impact has been on lower wage workers who can’t work remotely (and government support should cover much of their losses)
  5. escalation of tensions with China seems to be “all hat and no cattle” for now, with a focus on economic recovery
  6. massive short covering and a bullish reversal among algorithmic traders
  7. the growing dominance and consistent performance of the secular-growth Technology sector plus other “near-Tech” names (like Facebook and Amazon.com)
  8. the steepening yield curve, as capital has gradually rotated out of the “bond bubble”

What the rally doesn’t have at the moment, however, is a strong near-term fundamental or valuation-based foundation. But although the current forward P/E of the S&P 500 of 20x might be overvalued based on historical valuations, I think in today’s unprecedented climate there actually is room for further multiple expansion before earnings begin to catch up, as investors position for a post-lockdown recovery.

In any case, it has been clear to us at Sabrient that the market has developed a “new normal,” which actually began in mid-2015 when the populist movement gained steam and the Fed announced a desire to begin tightening monetary policy. Investors suddenly become wary of traditional “risk-on” market segments like small-mid caps, value stocks, cyclical sectors, and emerging markets, even though the economic outlook was still strong, instead preferring to focus on mega-cap Technology, long-term secular growth industries, and “bond proxy” dividend-paying defensive sectors. And more recently, investor sentiment coming out of the COVID-19 selloff seems to be more about speculative optimism of a better future rather than near-term earnings reports and attractive valuation multiples.

In response, Sabrient has enhanced our forward-looking and valuation-oriented Baker’s Dozen strategy to improve all-weather performance and reduce relative volatility versus the benchmark S&P 500, as well as put secular-growth companies (which often display higher valuations) on more equal footing with cyclical-growth firms (which tend to display lower valuations). Those secular growth trends include 5G, Internet of Things (IoT), e-commerce, cloud computing, AI/ML, robotics, clean energy, blockchain, quantum computing, nanotechnology, genomics, and precision medicine. So, we felt it was necessary that our stock selection strategy give due consideration to players in these market segments, as well.

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.

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. In summary, our sector rankings now look defensive, and our sector rotation model maintains a neutral posture as it climbs from the depths of the selloff. Meanwhile, the technical picture remains bullish as it continues to gather speculative conviction on a better future, although with elevated volatility amid progress/setbacks as the economy tries to gradually reopen in the face of an ongoing coronavirus threat.  Read on....

Byron Macleod  by Byron Macleod
  Associate Director of Research, Gradient Analytics LLC (a Sabrient Systems company)

In any given quarter for almost every company, there is often a swirling vortex of different signals as to the long-term health and future opportunities for each particular firm. Within this conflux of signals, there are two that often cause investor stress and confusion when they contradict each other: the firm’s GAAP versus non-GAAP earnings.

The simple rubric that often comes to mind is that GAAP earnings are the more conservative figure for the firm [as these accounting standards are closely monitored and controlled by a governing board, the Financial Accounting Standards Board (FASB)], while its non-GAAP earnings are the more optimistic view (after being heavily tweaked and adjusted by management). However, this assumption does not always hold true. Often, a firm’s non-GAAP results will be the more accurate representation of its historical earnings power.

Although Gradient Analytics specializes in forensic accounting research and consulting to identify weak earnings quality for short idea generation, our expertise is also valuable for identifying solid earnings quality for the vetting of long candidates, as we discussed in a previous article. And with the impacts of the coronavirus still working their way through both the US and global economies, it is a certainty that the next twelve months of corporate financial reports will be littered with a variety of non-GAAP adjustments that will need to be deciphered.

With this flood of adjusted earnings about to hit the market, we felt it would be a good time for some examples to illustrate that not all non-GAAP adjustments are created equal, and although investors need to carefully consider when and how they use non-GAAP results, often they may be better served by focusing on non-GAAP earnings.  Read on....

gradient / Tag: accounting, earnings quality, GAAP, non-GAAP, tax, IRS, FASB, APO, MET, NKE / 0 Comments

  Scott Martindaleby 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...

Rachel Bradley  by Rachel Bradley
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

“Every man hears only what he understands.” – Goethe

Often, details in the financial statements hold the key to understanding a company. Here at Gradient Analytics, we specialize in forensic accounting research and consulting, and our analysts stay up-to-date on changes in the regulatory landscape, including crucial updates to disclosure requirements. Normally, we focus research on areas that might tempt companies to “manage” or overstate earnings, either by pulling forward future revenues or pushing out current expenses. Layer on more complexity from changing reporting requirements and it becomes clearer how a vital piece to the puzzle might slip through the cracks.

Below, I cover three broad topics. First, effective January 1, 2020, the governing accounting boards updated the very definition of a business. This new definition has multiple implications for reporting, but my focus in this article is the impact on M&A transactions. Moreover, this year both the Financial Accounting Standards board (FASB) and the International Accounting Standards Board (IASB) changed required disclosures for U.S. and international companies. Among other things, there is a new method for determining appropriate loan loss reserves, and there will soon be a requirement for companies to stop using Inter-Bank Offered Rates (IBOR) as reference rates, instead switching to Alternative Reference Rates (ARR). I describe these updates with four real-life examples of how they shape financial statements, with the potential to mislead investors. Read on….

  Scott Martindaleby Scott Martindale
  President & CEO, Sabrient Systems LLC

What a week. From its intraday all-time high on 2/19/20 to the intraday low on Friday 2/28/20, the S&P 500 fell -15.8%. It was a rare and proverbial “waterfall decline,” typically associated with a Black Swan event – this time apparently driven primarily by fears that the COVID-19 virus would bring the global economy to its knees. Once cases started popping up across the globe and businesses shuttered their doors, it was clear that no amount of central bank liquidity could help.

But in my view, it wasn’t just the scare of a deadly global pandemic that caused last week’s selloff. Also at play were the increasing dominance of algorithmic trading to exaggerate market moves, as well as the surprising surge in popularity of dustbin Bolshevik Bernie Sanders. I think both lent a hand in sending investors into a tizzy last week.

Even before fears of a pandemic began to proliferate, market internals were showing signs of worry. After a sustained and long-overdue risk-on rotation into the value factor, small-mid caps, and cyclical sectors starting on 8/27/19, which boosted the relative performance of Sabrient’s portfolios, investor sentiment again turned cautious in the New Year, even as the market continued to hit new highs before last week’s historic selloff. It was much the same as the defensive sentiment that dominated for most of the March 2018 — August 2019 timeframe, driven mostly by the escalating China trade war. (It seems like all market swoons these days are related to China!)

Alas, I think we may have seen on Friday a selling climax (or “capitulation”) that should now allow the market to recover going forward. In fact, the market gained back a good chunk of ground in the last 15 minutes of trading on Friday – plus a lot more in the afterhours session – as the extremely oversold technical conditions from panic selling triggered a major reversal, led by institutional and algorithmic traders. That doesn’t mean there won’t be more volatility before prices move higher, but I think we have seen the lows for this episode.

The selloff wasn’t pretty, to be sure, but for those who were too timid to buy back in October, you have been given a second chance at those similar prices, as the forward P/E on the S&P 500 fell from nearly 19.0x to 16.3x in just 7 trading days. Perhaps this time the broad-based rally will persist much longer and favor the risk-on market segments 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.

In this periodic update, I provide a detailed market commentary (including other factors at play in the market selloff), 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. In summary, our sector rankings look neutral, and our sector rotation model moved to a defensive posture when the S&P 500 lost support from its 200-day moving average. The technical picture has moved dramatically from grossly overbought to grossly oversold in a matter of a few days, such that the S&P 500 has developed an extreme gap below its 20-day moving average and the VIX is at an extreme high. Thus, I believe a significant bounce is likely.

As a reminder, you can find my latest Baker’s Dozen presentation slide deck and commentary at http://bakersdozen.sabrient.com/bakers-dozen-marketing-materials. Click to Read on....

Ian Striplin  by Ian Striplin
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

Here at Gradient Analytics, where we specialize in forensic accounting research and consulting, it may seem to the outsider that we are just a bunch of pessimistic short researchers, sniffing out aggressive accounting practices that might soon cause a given company to miss earnings expectations and reduce forward guidance, for the benefit of our clientele of long/short hedge funds. To be honest, we are jaded in our belief that most companies will, from time to time, take liberties with their accrual accounting in order to achieve short-term reporting objectives. But most only do it sparingly and temporarily, and only those that become overly extended in employing aggressive practices – while facing fundamental headwinds that make it likely certain metrics will persist or worsen – make good short candidates. But that doesn’t automatically make all the others good long candidates.

Thus, our expertise is also useful for identifying solid earnings equality for the vetting of long candidates. Earnings quality analysis can reveal accounting benefits to future earnings potential and help ensure that a quant model or fundamental analysis that created a positive equity profile for a given company is indeed based on the underlying economics of the business rather than an aberration of accrual accounting. In other words, it can serve to add conviction or a confirmation signal to a long thesis.

In this article, we will describe several positive earnings quality factors that can act as a tailwind to sustainable future earnings growth, with four real-life examples. In forming a stock universe for this article, we screened the output file of our proprietary Earnings Quality Rank (EQR), which assigns a quintile score of 1-5 (with 5 being the “best” earnings quality relative to peers), and limited the population to companies in the top quintile and a market capitalization greater than $500 million, to avoid liquidity constraints. (Note: On the other hand, when seeking short candidates, we look to the bottom quintile of the EQR model.)  Read on….

gradient / Tag: forensic accounting, earnings quality, CFOA, GAAP, non-GAAP, accruals, AFDA, COGS, TTEK, ASML, PRO, FELE / 0 Comments

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