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

Needless to say, investors have been piling out of stocks and bonds and into cash. So much for the 60/40 portfolio approach that expects bonds to hold up when stocks sell off. In fact, few assets have escaped unscathed, leaving the US dollar as the undisputed safe haven in uncertain times like these, along with hard assets like real estate, oil, and commodities. Gold was looking great in early-March but has returned to the flatline YTD. Even cryptocurrencies have tumbled, showing that they are still too early in adoption to serve as an effective “store of value”; instead, they are still leveraged, speculative risk assets that have become highly correlated with aggressive growth stocks.

From its record high in early January to Thursday’s intraday low, the S&P 500 (SPY) was down -19.9% (representing more than $7.5 trillion in value). At its lows on Thursday, the Nasdaq 100 (QQQ) was down as much as -29.2% from its November high. Both SPY and QQQ are now struggling to regain critical “round-number” support at 400 and 300, respectively. The CBOE Volatility Index (VIX) further illustrates the bearishness. After hitting 36.6 on May 2, which is two standard deviations above the low-run average of 20 (i.e., Z-score of 2.0), VIX stayed in the 30’s all last week, which reflects a level of panic. This broad retreat from all asset classes has been driven by fear of loss, capital preservation, deleveraging/margin calls among institutional traders, and the appeal of a strong dollar (which hit a 20-year high last week). The move to cash caused bond yields to soar and P/E ratios to crater. Also, there has been a striking preference for dividend-paying stocks over bonds.

It appears I underestimated the potential for market carnage, having expected that the March lows would hold as support and the “taper tantrum” surge in bond yields would soon top out once the 10-year yield rose much above 2%, due to a combination of US dollar strength as the global safe haven, lower comparable rates in most developed markets, moderating inflation, leverage and “financialization” of the global economy, and regulatory or investor mandates for holding “cash or cash equivalents.” There are some signs that surging yields and the stock/bond correlation may be petering out, as last week was characterized by stock/bond divergence. After spiking as high as 3.16% last Monday, the 10-year yield fell back to close Thursday at 2.82% (i.e., bonds attracted capital) while stocks continued to sell off, and then Friday was the opposite, as capital rolled out of bonds into stocks.

Although nominal yields may be finally ready to recede a bit, real yields (net of inflation) are still solidly negative. Although inflation may be peaking, the moderation I have expected has not commenced – at least not yet – as supply chains have been slow to mend given new challenges from escalation in Russian’s war on Ukraine, China’s growth slowdown and prolonged zero-tolerance COVID lockdowns in important manufacturing cities, and various other hindrances. Indeed, the risks to my expectations that I outlined in earlier blog posts and in my Baker’s Dozen slide deck have largely come to pass, as I discuss in this post.

Nevertheless, I still expect a sequence of events over the coming months as follows: more hawkish Fed rhetoric and some tightening actions, modest demand destruction, a temporary economic slowdown, and more stock market volatility … followed by mending supply chains, some catch-up of supply to slowing demand, moderating inflationary pressures, bonds continuing to find buyers (and yields falling), and a dovish turn from the Fed – plus (if necessary) a return of the “Fed put” to support markets. Time will tell. Too bad the Fed can’t turn its printing press into a 3D printer and start printing supply chain parts, semiconductors, oil, commodities, fertilizers, and all the other goods in short supply – that would be far more helpful than the limited tools they have at hand.

Although both consumer and investor sentiment are quite weak (as I discuss below), and there has been no sustained dip-buying since March, history tells us bear markets do not start when everyone is already bearish, so perhaps Friday’s strong rally is the start of something better. Perhaps the near -20% decline in the S&P 500 is all it took to wring out the excesses, with Thursday closing at a forward P/E of 16.8x ahead of Friday’s rally, which is the lowest since April 2020. So, the S&P 500 is trading at a steep 22% discount compared to 21.7x at the start of the year, a 5-year average of 18.6x, and a 20-year post-Internet-bubble average of 15.5x (according to FactSet), Moreover, the Invesco S&P 500 Equal Weight (RSP) is at 15.0x compared to 17.7x at the beginning of the year, and the S&P 600 small cap forward P/E fell to just 11.6x (versus 15.2x at start of the year).

But from an equity risk premium standpoint, which measures the spread between equity earnings yields and long-term bond yields, stock valuations have actually worsened relative to bonds. So, although this may well be a great buying opportunity, especially given the solid earnings growth outlook, the big wildcards for stocks are whether current estimates are too optimistic and whether bond yields continue to recede (or at least hold steady).

Recall Christmas Eve of 2018, when the market capitulated to peak-to-trough selloff of -19.7% – again, just shy of the 20% bear market threshold – before recovering in dazzling fashion. The drivers today are not the same, so it’s not necessarily and indicator of what comes next. Regardless, you should be prepared for continued volatility ahead.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 5 of the top 6 scorers being cyclical sectors, Energy, Basic Materials, Financials, Industrials, and Technology. In addition, the near-term technical picture looks bullish for at least a solid bounce, if not more (although the mid-to-long-term is still murky, subject to news developments), but our sector rotation model switched to a defensive posture last month when technical conditions weakened.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines Quality, Value, and Growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s latest Q2 2022 Baker’s Dozen launched on 4/20/2022 and is off to a good start versus the benchmark, led by three Energy firms, with a diverse mix across market caps and industries. In addition, the live Dividend and Small Cap Growth portfolios have performed quite well relative to their benchmarks. Read on....

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

As the economy has emerged from the pandemic and some sense of normalcy has returned around the world, investors had returned to wrestling with the potential impacts of unwinding 13 years of unprecedented monetary stimulus (QE and ZIRP). But then new uncertainties piled on with the onset of Russian’s invasion of Ukraine, Ukraine’s impressive resistance, and the resulting refugee crisis, not to mention new COVID mutations and some renewed lockdowns – all of which has led to historic inflationary pressures on energy, commodities, and food prices, as well as elevated market volatility.

After a solid post-FOMC rally, the CBOE Volatility Index (VIX) fell from a panicky high near 37 – which is more than two sigma above its long-term average of 20 – to close last week at 20.81. At their lows, the S&P 500 had corrected by -13.1% and the Nasdaq Comp by -21.7% (from their all-time high closing prices last November to their lowest close on Monday 3/14/22). But the price action in the SPDR S&P 500 and Tech-heavy Nasdaq 100 over the past few weeks looks very much like a bottoming process going into the FOMC meeting, culminating in a bullish “W” technical formation that broke out strongly to the upside, with recoveries of +9.2% for the S&P 500 and +12.9% for Nasdaq through last Friday. The rally has seen a resurgence in the more speculative growth stocks that had become severely oversold, as illustrated by the ARK Innovation ETF (ARKK), which has risen nearly 25%.

Except for some gyrations in the immediate aftermath of the FOMC announcement, price essentially went straight up. I believe the rocket fuel came from a combination of the Fed providing greater clarity (and not hiking by 50 bps), China’s soothing words (including assurances to global investors and distancing itself from Russia’s aggression), as well as a general fear of missing out (FOMO) among investors on an oversold rally.

Notably, commodities and crude oil have been strong from the start of the year, with oil at one point (March 7) touching $130/bbl after starting the year at $75 (that’s a 73% spike!). For now, oil seems to have stabilized in a trading range, although the future is uncertain and summer driving season is on the horizon. It seems that President Putin finally acting out his goal of restoring historical Russian lands (similar to the jihadist dream of redrawing an Islamic caliphate) may be shaking up our leftists’ utopian vision of a Great Reset and “stakeholder capitalism” and into realizing (at least for the moment) the pitfalls of rapid decarbonization, denuclearization, the embracing of green/renewable energy before the technologies are ready for the role of primary energy source, and the outsourcing of critical energy supplies (the very lifeblood of a modern economy) to mercurial/adversarial dictators. I talk at length about oil production and supply dynamics in today’s post.

So, have we seen the lows for the year in stocks? Is this merely an oversold bounce and end-of-quarter “window dressing” for mutual funds that will soon reverse, or is it a sustainable recovery? Well, my view is that we may have indeed seen the lows, depending upon how the war develops from here, how aggressive the Fed’s actions (not just its language) actually turn out, and how economic growth and corporate earnings are impacted. But I also think there is too much uncertainty – including a possible recessionary dip for one quarter – for there to be new highs in the broad indexes anytime soon. Instead, I think we are in a trader’s market. Although I think stocks will end the year in positive territory, they are unlikely to reach new highs given the vast new disruptions to supply chains and the less-speculative nature of current investor sentiment – meaning that valuations will depend more on earnings growth rather than multiple expansion. In any case, I believe there are many high-quality stocks to be found outside of the mega-cap Tech darlings offering better opportunities.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with 4 of the top 5 scorers being cyclical sectors, Energy, Basic Materials, Financials, and Technology. In addition, the near-term technical picture looks weak, but the mid-to-long-term looks like a bottom is in, and our sector rotation model is back in a bullish posture.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines quality, value, and growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s latest Q1 2022 Baker’s Dozen launched on 1/20/2022 and is off to a good start versus the benchmark, led by an oil & gas firm. In addition, the live Dividend and Small Cap Growth portfolios are performing quite well relative to their benchmarks.  Read on....

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

I have been warning that the longer the market goes up without a significant pullback, the worse the ultimate correction is likely to be. So, with that in mind, we might not have seen the lows for the year quite yet, as I discuss in the chart analysis later in this post. January saw a maximum intraday peak-to-trough drawdown on the S&P 500 of -12.3% and the worst monthly performance (-5.3%) for the S&P 500 since March 2020 (-12.4%). It was the worst performance for the month of January since 2009 (during the final capitulation phase of the financial crisis) and one of the five worst performances for any January since 1980. The CBOE Volatility Index (VIX), aka “fear gauge,” briefly spiked to nearly 39 before settling back down to the low-20s.

It primarily was driven by persistently high inflation readings – and a suddenly hawkish-sounding Federal Reserve – as the CPI for the 12 months ending in December came in at 7.0% YoY, which was the largest increase for any calendar year since 1981. Then on Feb 10, the BLS released a 7.5% CPI for January, the highest YoY monthly reading since 1982. Of course, stocks fell hard, and the 10-year T-note briefly spiked above 2% for the first time since August 2019.

Looking under the hood is even worse. Twelve months ago, new 52-week highs were vastly outpacing new 52-week lows. But this year, even though new highs on the broad indexes were achieved during January, we see that 2/3 of the 3,650 stocks in the Nasdaq Composite have fallen at least 20% at some point over the past 12 months – and over half the stocks in the index continue to trade at prices 40% or more below their peaks, including prominent names like DocuSign (DOCU), Peloton Interactive (PTON), and of course, Meta Platforms, nee Facebook (FB). Likewise, speculative funds have fallen, including the popular ARK Innovation ETF (ARKK), which has been down as much as -60% from its high exactly one year ago (and which continues to score near the bottom of Sabrient’s fundamentals based SectorCast ETF rankings).

Pundits are saying that the “Buy the Dip” mentality has suddenly turned into “Sell the Rip” (i.e., rallies) in the belief that the fuel for rising asset prices (i.e., unlimited money supply and zero interest rates) soon will be taken away. To be sure, the inflation numbers are scary and unfamiliar. In fact, only a minority of the population likely can even remember what those days of high inflation were like; most of the population only has experienced decades of falling CPI. But comparing the latest CPI prints to those from 40 years ago has little relevance, in my view, as I discuss in the commentary below. I continue to believe inflation has been driven by the snapback in demand coupled with slow recovery in hobbled supply chains – largely due to “Nanny State” restrictions – and that inflationary pressures are peaking and likely to fall as the year progresses.

In response, the Federal Reserve has been talking down animal spirits and talking up interest rates without actually doing much of anything yet other than tapering its bond buying and releasing some thoughts and guidance. The Fed’s challenge will be to raise rates enough to dampen inflation without overshooting and causing a recession, i.e., the classic policy mistake. My prediction is there will be three rate hikes over the course of the year, plus some modest unwinding of its $9 trillion balance sheet by letting some maturing bonds roll off. Note that Monday’s emergency FOMC meeting did not result in a rate hike due to broad global uncertainties.

Longer term, I do not believe the Fed will be able to “normalize” interest rates over the next decade, much less the next couple of years, without causing severe pain in the economy and in the stock and bond markets. Our economy is simply too levered and “financialized” to absorb a “normalized” level of interest rates. But if governments around the world (starting with the US and Canada!) can stand aside and let the economy work without heavy-handed societal restrictions and fearmongering, we might see the high supply-driven excess-demand gap close much more quickly.

In this periodic update, I provide a comprehensive market commentary, offer my technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. To summarize, our SectorCast rankings reflect a bullish bias, with the top three scorers being deep-cyclical sectors, Energy, Basic Materials, and Financials. In addition, the near-term technical picture remains weak, and our sector rotation model moved from a neutral to a defensive posture this week as the market has pulled back.

Overall, I expect a continuation of the nascent rotation from aggressive growth and many “malinvestments” that were popular during the speculative recovery phase into the value and quality factors as the Fed tries to rein in the speculation-inducing liquidity bubble. And although I don’t foresee a major selloff in the high-valuation-multiple mega-cap Tech names, I think investors can find better opportunities this year among high-quality stocks outside of the Big Tech favorites – particularly among small and mid-caps – due to lower valuations and/or higher growth rates, plus some of the high-quality secular growth names that were essentially the proverbial “baby thrown out with the bathwater.” But that’s not say we aren’t in for further downside in this market over the near term. In fact, I think we will see continued volatility and technical weakness over the next few months – until the Fed’s policy moves become clearer – before the market turns sustainably higher later in the year.

Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced Growth at a Reasonable Price (GARP) selection approach (which combines quality, value, and growth factors) to provide exposure to both the longer-term secular growth trends and the shorter-term cyclical growth and value-based opportunities – without sacrificing strong performance potential. Sabrient’s new Q1 2022 Baker’s Dozen launched on 1/20/2022 and is already off to a good start versus the benchmark. In addition, our Dividend and Small Cap Growth portfolios have been performing well versus their benchmarks. In fact, all 7 of the Small Cap Growth portfolios launched since the March 2020 COVID selloff have outperformed the S&P 600 SmallCap Growth ETF (SLYG), and 7 of the 8 Dividend portfolios have outperformed the S&P 500 (SPY). In particular, the Energy sector still seems like a good bet, as indicated by its low valuation and high score in our SectorCast ETF rankings.

Furthermore, we have created the Sabrient Quality Index Series comprising 5 broad-market and 5 sector-specific, rules-based, strategic beta and thematic indexes for ETF licensing, which we are pitching to various ETF issuers. Please ask your favorite ETF wholesaler to mention it to their product team!
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....

david trainerThe market decline experienced thus far is closer to its beginning rather than its end. Recent market rises are likely just flashes in the pan.

There is nothing that politicians or regulators can do to prevent the natural price discovery that is critical to the long-term health of our capitalist system.

The market needs to go down again before it can sustain any future rise.