Scott Martindaleby 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…

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

The first two months of 2019 have treated Sabrient’s portfolios quite well. After a disconcerting 3Q2018, in which small-cap and cyclicals-heavy portfolios badly trailed the broad market amid a fear-driven defensive rotation, followed by a dismal Q4 for all stocks, the dramatic V-bottom recovery has been led by those same forsaken small-mid caps and cyclical sectors. All of our 12 monthly all-cap Baker’s Dozen portfolios from 2018 have handily outperformed the S&P 500 benchmark since then, as fundamentals seem to matter once again to investors. Indeed, although valuations can become disconnected from fundamentals for a given stretch of time (whether too exuberant or too pessimistic), share prices eventually do reflect fundamentals. Indeed, it appears that institutional fund managers and corporate insiders alike have been scooping up shares of attractive-but-neglected companies from cyclical sectors and small-mid caps in what they evidently saw as a buying opportunity.

And why wouldn’t they? It seems clear that Q4 was unnecessarily weak, with the ugliest December since the Great Depression, selling off to valuations that seem more reflective of an imminent global recession and Treasury yields of 5%. But when you combine earnings beats and stable forward guidance with price declines – and supported by a de-escalation in the trade war with China and a more “patient and flexible” Federal Reserve – it appears that the worst might be behind us, as investors recognize the opportunity before them and pay less attention to the provocative news headlines and fearmongering commentators. Moreover, I expect to see a renewed appreciation for the art of active selection (rather than passive pure-beta vehicles). However, we must remain cognizant of 2018’s lesson that volatility is not dead, so let’s not be alarmed if and when we encounter bouts of it over the course of the year.

Looking ahead, economic conditions appear favorable for stocks, with low unemployment, rising wages, strong consumer sentiment, and solid GDP growth. Moreover, Q4 corporate earnings are still strong overall, with rising dividends, share buybacks at record levels, and rejuvenated capital investment. So, with the Fed on the sidelines and China desperately needing an end to the trade war, I would expect that any positive announcement in the trade negotiations will recharge the economy in supply-side fashion, as US companies further ramp up capital spending and restate guidance higher, enticing risk capital back into stocks (but again, not without bouts of volatility). This should then encourage investors to redouble their current risk-on rotation into high-quality stocks from cyclical sectors and small-mid caps that typically flourish in a growing economy – which bodes well for Sabrient’s growth-at-a-reasonable-price (GARP) portfolios.

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 returned to a bullish posture. Read on…

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

There is a stock market adage that says, “as goes January, so goes the year.” Well, if that comes true this year, we are in for some robust gains, as stocks just enjoyed the strongest January since 1987 (when it rose +13.2%). For the full month of January, the S&P 500 gained +8.0% (and S&P mid and small caps were even stronger at around +10.5%). Meanwhile, after a dismal 2H2018 in which Sabrient’s cyclicals-heavy portfolios trailed the broad market in the wake of a fear-driven defensive rotation that began in June, our 12 monthly all-cap Baker’s Dozen portfolios from 2018 handily outperformed by gaining an average of +11.8% for the full-month of January (and +19.7% since the low on Christmas Eve through 1/31, versus +15.2% for the SPY), and our actively-managed SMA portfolio (which holds 30 GARP stocks) gained +13.2%. Fundamentals seem to matter again, and institutional fund managers and corporate insiders have been suddenly scooping up shares of attractive-but-neglected companies in what they evidently see as a welcome buying opportunity.

On the other hand, it’s pretty clear to me that 4Q2018 was unnecessarily weak, with the ugliest December since the Great Depression, selling off to valuations that seem more reflective of an imminent global recession and Treasury yields of 5%. So, some might argue that January’s big rally was just a temporary bounce from massively oversold conditions – a case of “righting the ship” back to more appropriate valuations – and as such is giving us little indication about the balance of the year.

My view is more on the bullish side. When you combine earnings beats and stable or rising forward guidance with price declines, it sure seems to me that the worst is behind us, as investors recognize the opportunities before them and pay less attention to the gloomy news headlines and fearmongering commentators. Moreover, I expect to see a renewed appreciation for active management and a return to a more selective stock-picker’s market, with a rising stock market fueled by a de-escalation (or preliminary resolution) to the trade war with China and a more patient and accommodative Fed. In fact, as I said at the start of the year, I think the S&P 500 will finish the year with a gain in the 20-25% range – but savvy stock selection could produce even better returns. However, please be cognizant of 2018’s lesson that volatility is not dead, so try not to be alarmed when we encounter bouts of it over the course of the year.

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 slightly bullish, while the sector rotation model has returned to a neutral posture after a few months of defensiveness. Read on…

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

After an “investor’s paradise” year in 2017 – buoyed by ultra-low levels of volatility, inflation, and interest rates, and fueled even more by the promise of fiscal stimulus (which came to fruition by year end) – 2018 was quite different. First, it endured a long overdue correction in February that reminded investors that volatility is not dead, and the market wasn’t quite the same thereafter, as investors’ attention focused on escalating trade wars and central bank monetary tightening, leading to a defensive risk-off rotation mid-year and ultimately to new lows, a “technical bear market” (in the Nasdaq and Russell 2000), and the worst year for stocks since the 2008 financial crisis. Then, it was confronted with the Brexit negotiations falling apart, Italy on the verge of public debt default, violent “yellow vest” protests in France, key economies like China and Germany reporting contractionary economic data, and bellwether companies like FedEx (FDX) and Apple (AAPL) giving gloomy sales forecasts that reflect poorly on the state of the global economy. The list of obstacles seems endless.

Moreover, US stocks weren’t the only asset class to take a beating last year. International equities fared even worse. Bonds, oil and commodities, most systematic strategies, and even cryptocurrencies all took a hit. A perfect scenario for gold to flourish, right? Wrong, gold did poorly, too. There was simply nowhere to hide. Deutsche Bank noted that 93% of global financial markets had negative returns in 2018, the worst such performance in the 117-year history of its data set. It was a bad year for market beta, as diversification didn’t offer any help.

Not surprisingly, all of this has weighed heavily upon investor sentiment, even though the US economy, corporate earnings, and consumer sentiment have remained quite strong, with no recession in sight and given low inflation and interest rates. So, despite the generally positive fundamental outlook, investors in aggregate chose to take a defensive risk-off posture, ultimately leading to a massive selloff – accentuated by the rise of passive investing and the dominance of algorithmic trading – that did huge technical damage to the chart and crushed investor sentiment.

But fear not. There may be a silver lining to all of this, as it has created a superb buying opportunity, and it may finally spell a return to a more selective stock-picker’s market, with lower correlations and higher performance dispersion. Moreover, my expectation for 2019 is for a de-escalation in the trade war with China, a more accommodative Fed, and for higher stock prices ahead. Forward valuations overall have become exceedingly attractive, especially in the cyclical sectors that typically flourish in a growing economy.

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 remains in a defensive posture. Read on…

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

Last week was the market’s worst since March. After Q3 had zero trading days with more than 1% move (up or down), our cup runeth over in Q4 with the stock rollercoaster so far offering up 22 days that saw a 1% move. Volatility seems rampant, but the CBOE Volatility Index (VIX) has not even eclipsed the 30 level during Q4 (whereas it hit 50 back in February). Even after Friday’s miserable day, the VIX closed at 23.23. Of course, the turbulence has been driven primarily by two big uncertainties: the trade dispute with China and the Federal Reserve’s interest rate policy, both of which have the potential to create substantial impacts on the global economy. As a result, investor psychology and the technical picture have negatively diverged from a still solid fundamental outlook.

For about a minute there, it seemed that both situations had been somewhat diffused, with Presidents Trump and Xi agreeing at the G20 summit to a temporary truce on further escalation in tariffs, while Fed chairman Powell made some comments about the fed funds rate being “just below” the elusive neutral rate. But investors’ cheers soon switched back to fears (soon to be tears?) with the latest round of news headlines (e.g., Huawei CFO arrest, Trump’s “Tariff Man” comment, Mueller indictments, and the imminent federal debt ceiling showdown). The uncertainty and fear-mongering led to a buyers’ strike that emboldened the short sellers, which in turn triggered forced selling in passive ETFs and automated liquidation in quant hedge funds, high-frequency trading (HFT) accounts, and leveraged institutional portfolios, which removed liquidity from the system (i.e., no bids), culminating in a retail investor panic. As it stands today, the charts look woefully weak and investor psychology has turned bearish, with selling into rallies rather than buying of dips.

Ever since June 11, when the trade war with China escalated from rhetoric to reality, stocks have seen a dramatic risk-off defensive rotation, with Healthcare, Utilities, Consumer Staples, and Telecom the only sectors in positive territory and the only ones outperforming the broad S&P 500 Index. It’s as if investors see the strong GDP prints, the +20% corporate earnings growth (of which about half is organic and half attributable to the tax cut), record profitability, and record levels of consumer confidence and small business optimism as being “as good as it gets,” i.e., just a fleeting final gasp in a late-stage economy, rather than the start of a long-awaited boom cycle fueled by unprecedented fiscal stimulus and a still-supportive (albeit not dovish) Federal Reserve. As a result, forward P/E on the S&P 500 is down a whopping -19% this year, which is huge – especially considering this year’s stellar earnings reports and solid forward guidance.

But has anything really changed substantially with regard to expectations for corporate earnings and interest rates (the two most important factors) to so severely impact valuations? Not that I can see. And Sabrient’s quantitative rankings imply that the economy and forward guidance remain quite strong, such that the market is simply responding to the proverbial Wall of Worry by offering up a nice buying opportunity, particularly in beaten down cyclical sectors and in solid dividend payers – although there might be some more pain first. Over the past 10 years of rising stock prices since the Financial Crisis, there have been eight corrections of roughly -10% (including nearly -20% in 2011), and this year’s correction has led to the fourth major drawdown for Sabrient’s Baker’s Dozen annual top picks list (1Q2009, mid-2011, 2H2015, and now). But selling at each of those previous times would have been the wrong thing to do, and this time seems no different.

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 remains in a defensive posture due to the persistent market weakness. 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 Scott Martindale
President, Sabrient Systems LLC

After an inspiring final day of Q1 led by the usual “window dressing” of mutual fund managers, news-driven volatility returned with a vengeance on Monday before recovering some ground on Tuesday. Although I rarely trust market moves on the last day of a quarter or the first day of a new quarter, there is little doubt that market volatility is back this year, as I expected it would be. Last year, rather than enduring scary selloffs to correct imbalances, the market simply rotated into neglected market segments from time to time. This conviction to stay invested was largely due to consistent improvement in global economic fundamentals coupled with rising optimism about new fiscal stimulus – leading to a fear of missing out. But given the passage of the tax bill and plenty of progress with deregulation last year, I expected investors this year to display more of a Missourian “show me” attitude as to what Corporate America actually would do with their newfound cash windfalls and looser regulatory noose. Would this truly spell the end of the capex recession, ushering in a new wave of onshoring, PP&E upgrades, hiring, buybacks, and M&A? For their part, sell-side analysts have been raising corporate earnings estimates at a historically fast pace.

But the proof is in the pudding, as they say, and the price run-up and elevated valuation multiples (that arose in anticipation of tax cuts and new corporate investment) were due for compression, as speculation gives way to reality, along with some “price rationalization” and deleveraging of speculative portfolios. And on top of those dynamics, the market is suddenly fretting about tariffs, trade wars, inflationary pressures, and the Fed. Nevertheless, there seems to be something for all investors to hold on to, as both fundamentalists and technicians alike should be excited by the lower valuations and successful tests of support in a climate of robust growth and corporate earnings. But I’m not talking about a return to market conditions of old, characterized by falling interest rates, slow growth, and low volatility, which rewarded passive investing in cap-weighted indexes with elevated P/E’s. Instead, we likely are entering a new era, characterized by rising interest rates, faster growth, and higher volatility, which rewards sound stock-picking.

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 fallen into a neutral posture during this period of consolidation and testing of support levels. Read on....

Scott Martindaleby Scott Martindale
President, Sabrient Systems LLC

The secular bull market that began on March 9, 2009 in the wake of the Financial Crisis just passed its ninth anniversary last Friday, and as if to celebrate, stocks rallied big on the strong reports of jobs growth, total employment, and labor participation, while wage inflation remained modest. All in all, it was a lot of great news, but instead of selling off – as stocks have done in the past in a “good news means bad news” reaction, assuming the Fed would feel emboldened to raise rates more aggressively – stocks rallied strongly. This is a market of investors looking for reasons to buy rather than to sell, i.e., the bulls are still in charge.

Strong global fundamentals are firmly in place for the foreseeable future, while corporate earnings expectations continue to rise, inflation fears appear to have diminished, and the overall climate remains favorable for equities. After the February selloff was complete, extreme valuations had been reduced, and support levels had been tested, investors were ready to embrace good news – albeit with some renewed caution in the wake of the recent surge in volatility. As we all learned, volatility is not dead. VIX is an oscillator that always eventually mean-reverts. This will surely result in some deleveraging as well as perhaps some P/E compression from the run-up in valuations we saw in anticipation of the fiscal stimulus package.

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 regained its bullish bias during the recovery from the market correction and volatility surge. Read on....