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

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New Small Cap Growth Portfolio Launched

September 26, 2018:  The 20th Sabrient Small Cap Growth UIT (FJPHTX) was launched by First Trust Portfolios on September 26, 2018. 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, which terminates December 26, 2019. For a prospectus or fact sheet, please visit For a fact sheet or prospectus, please visit  First Trust Portfolios.

September 2018 Baker’s Dozen UIT Launched

September 20, 2018: The Sabrient Baker’s Dozen UIT Portfolio for September 2018 (FQNWMX) was launched by First Trust Portfolios on September 20, 2018. 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 13 months. The portfolio will terminate on October 21, 2019. For more information and a fact sheet please visit   FirstTrustPortfolios.com.

by Scott Martindale
President, Sabrient Systems LLC

Volatility suddenly returned with a vengeance last week – to both stocks and bonds. In fact, on Wednesday, while the -3.1% single-day selloff in the S&P 500 didn’t quite equal the -4.1% fall on February 3, the normal “flight to safety” into US Treasuries when stocks sell off didn’t occur, which was quite distressing to market participants and pundits alike. But on Thursday, bonds caught a bid while equities continued their fall. Suddenly, talk has become more serious about the potential for slower global growth due to rising interest rates and escalating trade wars.

But has anything really changed from a fundamental standpoint? I would say, absolutely not. Although the risk-off rotation since June 11 continues to hold back Sabrient’s cyclicals-oriented portfolios, our quantitative model still suggests that little has changed with the fundamentally strong outlook characterized by global economic growth, impressive US corporate earnings, modest inflation, low real interest rates, a stable global banking system, and historic fiscal stimulus in the US (including both tax relief and deregulation). Moreover, it appears to me that equities are severely oversold, and now is a good time to be accumulating high-quality stocks with attractive forward valuations from the cyclical sectors and small caps.

When a similar correction happened in February, the main culprits were inflation worries and hawkish rhetoric from the Federal Reserve regarding interest rates. After all, the so-called “Fed Put” has long supported the stock market. But then the Fed commentary became less hawkish and more data-driven, which was helpful given modest inflation data, but the start of the trade war rhetoric kept the market from bouncing back with as much gusto as it had been displaying.

So, what caused the correction this time? Well, to an extent, bipartisan support for heightened regulation and consumer privacy protections hit some of the mega-cap InfoTech stocks that had been leading the market. But in my view, the sudden spikes in fear (and the VIX) and in Treasury yields and the resulting rush to the exit in stocks was due to a combination of the Federal Reserve chairman’s suddenly hawkish rhetoric about interest rates and China’s extreme measures to offset damage from its trade war with the US.

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 remain bullish, while the sector rotation model has switched to a neutral posture due to the recent correction. Read on....

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

Some investors transitioned from a “fear of missing out” (aka FOMO) at the beginning of the year to a worry that things are now “as good as it gets” – meaning that the market is in its last bullish move before the inevitable downturn kicks in. And now, escalating trade wars and a flattening yield curve have added to those fears. However, it appears to me that little has changed with the fundamentally strong outlook characterized by global economic growth, strong US corporate earnings, modest inflation, low real interest rates, a stable global banking system, and historic fiscal stimulus in the US (including both corporate tax cuts and deregulation). Moreover, the Fed may be sending signals of a slowing of rate hikes, while great strides have been made in reworking trade deals.

Many followers of Sabrient are wondering why our Baker’s Dozen portfolios – most of which had been performing quite well until mid-June – suddenly saw performance go south even though the broad market averages have managed to achieve new highs. Their concerns are understandable. However, if you look under the hood of the S&P 500, leadership over the past three months has not come from where you would expect in a robust economy. An escalation in trade wars (moving from posturing to reality) led industrial metals prices to collapse while investors suddenly shunned cyclical sectors in favor of defensive sectors in a “risk-off” rotation, along with some of the mega-cap momentum Tech names. This was not healthy behavior reflecting the fundamentally-strong economy and reasonable equity valuations.

But consensus forward estimates from the analyst community for most of the stocks in these cyclical sectors have not dropped, and in fact, guidance has generally improved as prices have fallen, making forward valuations much more attractive. Sabrient’s fundamentals-based GARP (growth at a reasonable price) model, which analyzes the forward estimates of the analyst community, still suggests solid tailwinds and an overweight in cyclical sectors. Thus, we expect that investor sentiment will eventually fall in line and we will see a “risk-on” rotation back into cyclicals as the market once again rewards stronger GARP qualities rather than just the momentum or defensive names. In other words, we think that now is the wrong time to exit our cyclicals-heavy Baker’s Dozen portfolios. I talk a lot more about this in today’s commentary.

Of course, risks abound. One involves divergent central bank monetary policies, with some continuing to ease while others (including the US and China) begin a gradual tightening process, and the enormous impact on currency exchange rates. Moreover, the gradual withdrawal of massive liquidity from the global economy is an unprecedented challenge rife with uncertainty. Another is the high levels of global debt (especially China) and escalating trade wars (most importantly with China). Because China is mentioned in every one of these major risk areas, I talk a lot more about China in today’s commentary.

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 now look even more strongly bullish, while the sector rotation model retains its bullish posture. Read on....

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

Market conditions remain strong for equities, in my view, with stocks being held back only by the (likely transient) trade war uncertainty. The US economy appears to be hitting on all cylinders, with the new fiscal stimulus (tax reform, deregulation) providing the long-missing ingredient for a real economic “boom cycle” to finally get some traction. For too long, the US economy had to rely solely on Federal Reserve monetary stimulus (ZIRP and QE), which served mainly to create asset inflation to support the economy (aka “Ponzi financing”), while the bulk of our working population had to endure de facto recessions in corporate profits, capital investment, and hiring. But with fiscal stimulus, corporate earnings growth is on fire, underpinned by solid revenue growth and record levels of profitability.

So far, 2Q18 earnings reporting season has come in even better than expected, with year-over-year EPS growth for S&P 500 companies approaching 24%. Even when taking out the favorable impact of lower tax rates, organic earnings growth for full-year 2018 still looks as though it will come in around the low to mid-teens.

Cautious investors are seeing the fledgling trade war as a game of brinksmanship, with positions becoming ever more entrenched. But I actually see President Trump as a free-trade advocate who is only using tariffs to force our trading partners to the bargaining table, which they have long avoided doing (and given the advantages they enjoy, why wouldn’t they avoid it?). China is the biggest bogeyman in this game, and given the challenges it faces in deleveraging its enormous debt without upsetting growth targets, not to mention shoring up its bear market in stocks, its leaders are loath to address their rampant use of state ownership, subsidy, overcapacity, tariffs, forced technology transfer, and outright theft of intellectual property to give their own businesses an unfair advantage in the global marketplace. But a trade war couldn’t come at a worse time for China.

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 still look moderately bullish, while the sector rotation model retains its bullish posture. Read on....

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

From the standpoint of the performance of the broad market indexes, US stocks held up okay over the past four weeks, including a good portion of a volatile June. However, all was not well for cyclicals, emerging markets (including China), and valuation-driven active selection in general, including Sabrient’s GARP (growth at reasonable price) portfolios. Top-scoring cyclical sectors in our models like Financial, Industrial, and Materials took a hit, while defensive sectors (and dividend-paying “bond proxies”) Utilities, Real Estate, Consumer Staples, and Telecom showed relative strength. According to BofA’s Savita Subramanian, “June was a setback for what might have been a record year for active managers.” The culprit? Macro worries in a dreaded news-driven trading environment, given escalating trade tensions, increasing protectionism, diverging monetary policy among central banks, and a strong dollar. But let’s not throw in the towel on active selection just yet. At the end of the day, stock prices are driven by interest rates and earnings, and both remain favorable for higher equity prices and fundamentals-based stock-picking.

Some investors transitioned from a “fear of missing out” at the beginning of the year to a worry that things are now “as good as it gets” … and that it might be all downhill from here. Many bearish commentators expound on how we are in the latter stages of the economic cycle while the bull market in stocks has become “long in the tooth.” But in spite of it all, little has changed with the fundamentally strong outlook underlying our bottom-up quant model, characterized by synchronized global economic growth (albeit a little lower than previously expected), strong US corporate earnings, modest inflation, low global real interest rates, a stable global banking system, and of course historic fiscal stimulus in the US (tax cuts and deregulation), with the US displaying relative favorability for investments. Sabrient’s fundamentals-based GARP model still suggests solid tailwinds for cyclicals, and indeed the start of this week showed some strong comebacks in several of our top picks – not surprising given their lower valuations, e.g., forward P/E and PEG (P/E to EPS growth ratio).

Looking ahead, expectations are high for a big-league 2Q18 earnings reporting season. But the impressive 20% year-over-year EPS growth rate for the S&P 500 is already baked into expectations, so investor focus will be on forward guidance and how much the trade rhetoric will impact corporate investment plans, including capex and hiring. I still don’t think the trade wars will escalate sufficiently to derail the broad economic growth trajectory; there is just too much pain that China and the EU would have to endure at a time when they are both seeking to deleverage without stunting growth. So, we will soon see what the corporate chieftains decide to do, hopefully creating the virtuous circle of supply begetting demand begetting more supply, and so on. Furthermore, the compelling valuations on the underappreciated market segments may be simply too juicy to pass up – unless you believe there’s an imminent recession coming. For my money, I still prefer the good ol’ USA for investing, and I think there is sufficient domestic and global demand for both US fixed income and equities, especially small caps.

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 still look bullish, while the sector rotation model has returned to a bullish posture as investors position for a robust Q2 earnings season. Read on....

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

In mid-June, the Federal Reserve raised interest rates by 25 bps and signaled it was on track to raise rates twice more in 2018. With interest rates near zero for almost ten years, we believe that this gradual normalization to higher rates signals a long-term positive for the sustainable growth of the economy. The Fed is signaling its satisfaction with current inflation and unemployment trends and its confidence in the health of the broad economy. Fed chair Jerome Powell has stated that the economy has become sufficiently healthy such that the Fed can be more hands-off in stimulating economic activity.

During a normal expansion phase characterized by robust economic growth and rising equity prices, the Fed typically will push up interest rates (causing bond prices to fall). But in its most recent comments, the FOMC signaled it would likely allow inflation to hover above its official 2.0% target. Such a lenient (or dovish) stance on inflation is generally more favorable for continued growth as the Fed is in no hurry to increase the speed of its rate hikes. Even after the latest rate hike, the target nominal fed funds rate is 1.75%-2.00%, which is still a negative real rate once inflation is subtracted. The last time the fed funds rate was over 2.00% was in 2008.

One of the basic tenants of finance is the inverse relationship between interest rates and bond values. However, as the Federal Reserve continues on its path to normalize rates, we believe it’s worth exploring how interest rate changes can also affect equity valuations. The questions that seem to be on the collective investment community’s mind is, “What does this mean for me and my holdings? Are valuations peaking? Should I sell?” While it normally takes a year or more for changes in interest rates to be felt across the entire economy, the market often has a more immediate response.

To explore this in greater detail, we analyzed SeaWorld Entertainment, Inc. (SEAS) as an illustrative example of the potential impact of a future rate hike, given that it is heavily levered with a material proportion of variable-rate debt. We believe that the consensus forward EPS estimates for SeaWorld are likely overstated (and out of management’s control) as interest rates – and the firm’s interest expense – continue to rise, putting downward pressure on its valuation. Other companies with similar balance sheet exposure may be similarly at risk. Read on....

smartindale / Tag: interest rates, earnings quality, forensic accounting, federal reserve, SEAS, leverage, debt / 0 Comments

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

The month of May turned out to be pretty decent for stocks overall, with the S&P 500 large caps up about +2%, with growth greatly outperforming value, and June has got off to a good start, as well. But the smaller caps were the bigger stars, as I have been predicting for several months, with the S&P 600 small caps up +6% for the month. Even after a volatile April, and even though the headlines on trade wars, oil prices, Iran, North Korea, Venezuela, Italy, et al were confusing if not frightful, and even though technical signals suggested overbought conditions and a likely pullback, investors have been reluctant to sell their equities and the late-month pullback was fleeting.

Nevertheless, many commentators are offering up lots of reasons why further upside is limited and stocks likely will turn tail into a downtrend, including political contagion in the EU, the US dollar strengthening too much such that overseas corporate profits take a hit, and yields rising too quickly such that they 1) burden a heavily-leveraged economy and 2) suppress stock prices by spiking the risk-free rate used in a discounted cash flow analysis. But I think the main thing weighing on investors’ minds right now is fear that things are “as good as it gets” when it comes to synchronized global growth, monetary and fiscal stimulus, and year-over-year growth in corporate earnings. In other words, now that the hope and optimism for strong growth actually has materialized into reality, there is nothing more to look forward to, so to speak. The year-over-year EPS comparisons won’t be so eye-popping. Earnings growth inevitably will slow, higher interest rates will suppress valuations, and P/E compression will set in.

However, recall that the so-called “taper tantrum” a few years ago led to similar investor behavior, but then eventually cooler heads prevailed as investors realized that the fundamental picture was strong and in fact extraordinary monetary accommodation was no longer necessary (or even desirable). Similarly, I think there is still plenty of fuel in the tank from tax reform, deregulation, and new corporate and government spending plans, offering up the potential to drive strong growth for at least the next few years (e.g., through revived capex, onshoring of overseas capital and operations, and M&A).

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 still look bullish, while the sector rotation model takes a bullish posture as stocks try to break out.

By the way, in response to popular demand, Sabrient is launching this week our first International Opportunity portfolio comprising 30-35 stocks from non-US developed markets (e.g., Canada, Western Europe, Australasia, Far East) based on the same “quantamental” growth-at-reasonable-price (GARP) portfolio construction process used for our Baker’s Dozen portfolios, including the in-depth earnings quality review and final vetting by our wholly-owned forensic accounting subsidiary Gradient Analytics. In addition, we are nearing two years since the inception of our Sabrient Select actively-managed strategy, a 30-stock all-cap GARP portfolio that is available for investment as a separately managed account (SMA) through a dual-contract arrangement. (Please contact me directly if you would like to learn more about this.) Read on....

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