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….

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Overview:

The year began with impressive strength and resilience in risk assets despite all the uncertainties around tariffs, trade wars, hot wars, slowing GDP growth, inflation, stagflation, AI impact and capex, and myriad other concerns. The US was considered the rock in a recessionary world, attracting massive foreign capital flight (according to Nasdaq, total foreign holdings of US equities as of June 2024 was $17 trillion—almost double versus 2019). But once the dam broke, stocks, crypto, and the US dollar started melting down in a “waterfall decline” culminating in a “flash crash” on Monday with the CBOE Volatility Index (VIX) nearly hitting 30 before closing at 27.86. As the adage goes, “Stocks take the stairs up and the elevator down.” But I believe this is a valuation-driven correction, as stocks had become “priced for perfection,” and the rapid meltdown ultimately will give way to a gradual melt-up, driven by rising global liquidity, a weaker US dollar, reduced wasteful government spending, lower tax and interest rates, less regulatory red tape, and the “animal spirits” of a rejuvenated private sector and housing market.

Prop desks and algorithmic trading systems hit sell stops to exacerbate the selloff, with many flipping from long to short exposure, and markets imploded as average investors quickly swung from extreme greed to extreme fear. According to Real Investment Advice, “The last time the market was this oversold and 3 standard deviations below the [50-day moving average] was in August of last year during the 10% correction as the Yen Carry Trade erupted.” The AAII weekly sentiment survey hit a bearish extreme of 60% on 2/26, after surging from 40% just one week earlier when the S&P 500 was at an all-time high. However, it’s important to note that stocks have historically recovered quite impressively over the 12 months following such extreme bearish readings.

The rising bond term premium in Q4 suggested that investors were becoming increasingly anxious about rising deficits and inflation, which also pushed gold higher. Meanwhile, the Fed has maintained tight monetary policy—and high real interest rates—given the uptick in inflation and apparently solid employment reports. However, I have consistently argued that the real-time inflation trend (without the lag in key components) has been falling and that massive government spending and hiring masked underlying issues with growth and employment in the private sector. So, this is not due to anything the new administration has done. As Renaissance Macro economist Neil Dutta recently opined, "[President Trump] inherited an economy with deep imbalances and a frozen housing and labor market."

In fact, John Burns Research & Consulting has observed that 3.8 million employees work directly for the government, but an additional 7.5 million workers indirectly receive some or all of their wages from the government—which totals 11.3 million workers or roughly 8% of the total US workforce (134 million) and accounts for much of the jobs growth. This is why I continue to advocate for both smaller government and another 100 bps in Fed rate cuts to achieve a neutral fed funds rate around 3.5% and stimulate private sector growth. As a result, I would expect a 10-year yield to stabilize around 4.0-4.5%, which would justify a forward P/E multiple for the S&P 500 around 20x (i.e., an earnings yield of 5%).

From their highs this year, “the S&P 500 and crypto have erased a combined -$5.5 trillion of market cap,” according to The Kobeissi Letter. The highflyers have led the carnage, most notably semiconductor stocks. Meta Platforms (META) is the only MAG-7 stock still positive YTD, while defensive sectors (like staples, telecom, and utilities), gold and silver miners, low/minimum volatility, value, high dividend payers, REITs, and long-duration bonds are among the best performers. The fact that bonds have caught a bid and credit spreads remain tight are positive signs that investors do not fear recession (or economic collapse). But investors continue to be shy about the amount and duration of tariffs, the aggressive DOGE actions, timing of fiscal policy implementation (tax cuts and deregulation), and Fed monetary policy (a Fed put?), and the collective impact on jobs, inflation, GDP growth, and risk asset prices as they retreat from historically high valuations.

To be sure, the Big Tech darlings had become overvalued, which is why the equal-weight versions of the S&P 500 and Nasdaq 100 have held up significantly better during the selloff. But keep in mind, the first year of a 4-year presidential term is typically the most volatile during the transition to new policies—and Trump 2.0 (“wrecking-ball”) policies are bringing quite a change from the norm. As Treasury Secretary Scott Bessent said, “The economy has become hooked [on government spending], and there is going to be a detox period.”

So, knowing that he must show significant progress before the 2026 midterms, Trump is “ripping off the band-aid” to fully reveal the infected wound and wasting no time in addressing it with what he and his team strongly believes are healing policies that will restructure our nation for long-term prosperity, public safety, and national security. This is why his popularity among younger voters is holding firm. Although not nearly as extreme, it is like what Javier Milei has done to resurrect Argentina. I expect the political, economic, and market fallout will take its course during H1 2025 before giving way to a rapid building process during H2.

Investors have been increasingly scared away from risk assets at least partly due to the constant carping from both the mainstream media (MSM) and social media (usually misleadingly) about a “growth scare” (as the Atlanta Fed’s GDPNow forecast for Q1 plummeted to a recessionary -2.4% annualized growth rate), an “inflation scare” (due to tariffs, chickens, and migrant deportations), an “AI scare” (as China may be usurping our dominance with cheaper models, a “trade war scare” (as we alienate our international allies and trading partners), and various other scares that escape me at the moment (perhaps a “Hollywood exodus scare,” as celebs move out of country?). This diversified fearmongering has finally come to roost leading to the rapid unwinding of crowded long trades.

But no matter what you think of the longstanding system of global trade and whether the US was being taken advantage of, there is no doubting that the fiscal path we were on was unsustainable, with a bloated and intractable bureaucracy, wasteful boondoggles, entrenched interests, and funding of corruption, graft, fraud, racketeering, cronyism, kickbacks, and obfuscation both at home and around the world. Until now, no president has been willing or able to adequately address it, including Trump 1.0. But the new Trump 2.0 administration came in well prepared (and with a voter majority mandate) to tackle it head on. I have come to appreciate the method to our president’s apparent madness, as I discuss in my full post.

So, is this selloff likely to become a buyable dip rather than the start of a bear market? I would say yes. Although there might be some further volatility into the 4/2 tariff implementation date and perhaps the 4/15 Tax Day, I expect higher prices ahead. Why? First, from a short-term technical standpoint, the S&P 500, Nasdaq 100, and Dow Jones Industrials have diverged well below their 20-day moving averages, and they seem to have found support around their critical 300-day moving averages. Second, from a longer-term standpoint, despite all this chaos and turmoil from an administration emboldened to reverse and repair decades of neglect (and a continual “kicking the can down the road” for future generations to suffer the consequences), I remain optimistic that after some short-term pain during this transition period—including upticks in inflation, debt, and market volatility and a downtick in economic growth—the private sector will be equipped and unleashed to drive robust economic growth through productive, high-ROI investments and hiring.

In addition, as DataTrek Research recently observed, stocks have only fallen more than 10% in a given year in just 12 of the past 97 years, and each was driven either by a new hot war, recession (generally related to an oil price shock), or a Fed policy mistake—none of which are likely. So, don’t be too bearish. And as for a long entry point, the VIX can provide some guidance. It closed above 27 this week, which DataTrek considers to be a “capitulation” signal to consider getting back into stocks. And don’t forget all the cash sitting in money market funds earning those juicy risk-free rates. As money market rates recede, some of that cash may finally find its way into stocks at these more favorable valuations. Indeed, the rising price of gold may be signaling a global dovish pivot and massive liquidity support, as I discuss in my full post.

Yes, liquidity is key to keeping us out of a recession and a bear market in risk assets. Lower interest rates and a weaker US dollar are long-term economic tailwinds, while debt reduction is a short-term headwind until a rejuvenated (and turbocharged) private sector makes up for the lower deficit spending.

I expect the S&P 500 to rise above 6500 before year-end with a modest double-digit gain. Could it take longer for the expected fiscal stimulus (lower tax and interest rates, less red tape, and smaller government) to serve alongside the incredible promise of AI (on productivity, efficiency, and speed of product development) to boost the GDP such that the 6500 mark isn’t achieved until next year? Sure. But I think ultimately an economy driven by organic private sector growth is stronger and more reliable and sustainable than one driven by government (deficit) spending bills. As Elon Musk opined, “A more accurate measure of GDP would exclude government spending… Otherwise, you can scale GDP artificially high by spending money on things that don’t make people’s lives better.”

In the view of Treasury Secretary Scott Bessent, we have “a generational opportunity to unleash a new economic golden age that will create more jobs, wealth and prosperity for all Americans.” Indeed, if the fed funds rate begins to come down toward my 3.5% target, today’s slightly elevated valuations can be justified given solid corporate earnings growth, a high ratio of corporate profits to GDP, and the promise of continued margin growth across all industries due to the promise of rising productivity, efficiency, and product development speed from Generative AI, Large Language Models (LLMs), and Big Data. AI investment is not slowing down but simply shifting from a singular “builder” focus to a broader focus on AI applications. This is where productivity enhancement will shift into gear. And don’t forget energy, as affordable power is the lifeblood of an economy. Costs must stay low, and Trump 2.0 is prioritizing energy independence and lower energy costs.

Because this market correction was led by the bull market-leading MAG-7 stocks and all things AI related, investors now have a second chance to get positions in some of those mega-cap titans at more attractive prices. Notably, some of these names have seen their valuations retreat such that they are once again scoring well in Sabrient’s growth models (as found in our next-gen Sabrient Scorecards subscription product)—including names like Amazon (AMZN), NVIDIA (NVDA), Salesforce (CRM), Arista Networks (ANET), Fortinet (FTNT), Palo Alto Networks (PANW), Palantir (PLTR), Microsoft (MSFT), and Taiwan Semiconductor (TSM). Our models focus on high quality and fundamental strength, with a history of consistent, reliable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus forward estimates, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are factors Sabrient employs in selecting our portfolios and in our SectorCast ETF ranking model. And notably, our Earnings Quality Rank (EQR) is a key factor in each of these models, and it is also licensed to the actively managed, absolute-return-oriented First Trust Long-Short ETF (FTLS).

Sabrient founder David Brown describes these (and other) factors and his portfolio construction process in his new book, How to Build High Performance Stock Portfolios, which is available on Amazon for investors of all experience levels. David describes his path from NASA engineer on the Apollo 11 moon landing project to creating quant models for ranking stocks and building stock portfolios in four distinct investing styles—growth, value, dividend, or small cap growth. You can learn more about David's book, as well as the companion subscription product (Sabrient Scorecards) that does most of the stock evaluation work for you, by visiting: https://HighPerformanceStockPortfolios.com.

As you might expect from former engineers, Sabrient employs the scientific method and hypothesis-testing to build quantitative models that make sense. We have become best known for our “Baker’s Dozen” portfolio of 13 diverse growth-at-a-reasonable-price (GARP) stocks, which is packaged and distributed quarterly to the financial advisor community as a unit investment trust through First Trust Portfolios, along with three other offshoot strategies based on value, dividend, and small cap investing.

Click HERE to continue reading my full post (and to sign up for email delivery). I examine in greater detail the “growth scare,” inflation, tariffs, and DOGE shock, equity valuations, and what lies ahead. I also discuss Sabrient’s latest fundamental-based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model, and several top-ranked ETF ideas. Also, here is a link to this post in printable PDF format.