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

The S&P 500 officially entered a bear market by falling more than -20% from its all-time high in January, with a max peak-to-trough drawdown of nearly -25% (as of 6/17). The Nasdaq Composite was down as much as -35% from its November all-time high. During the selloff, there was no place to hide as all asset classes floundered – even formerly uncorrelated cryptocurrencies went into a death spiral (primarily due to forced unwinding of excessive leverage). But then stocks staged an impressive bounce last week, although it was mostly driven by short covering.

Earlier this year when stocks began their initial descent, laggards and more speculative names sold-off first, but later, as the selling accelerated, the proverbial baby was thrown out with the bathwater as investors either were forced to deleverage (i.e., margin calls) or elected to protect profits (and their principal). Even the high-flying Energy sector sold off on this latest down leg, falling over -25% intraday in just 10 days, as the algorithmic momentum trading programs reversed from leveraged buying of Energy to leveraged selling/shorting.

These are common signs of capitulation. So is historically low consumer and investor sentiment, which I discuss in detail later in this post. But despite the negative headlines and ugly numbers, it mostly has been an orderly selloff, with few signs of panic. The VIX has not reached 40, and in fact it hasn’t eclipsed that level since April 2020 during the pandemic selloff. Moreover, equity valuations have shrunk considerably, with the S&P 500 and S&P 600 small caps falling to forward P/Es of 15.6x and 10.8x, respectively, at the depths of the selloff (6/17). This at least partially reflects an expectation that slowing growth (and the ultra-strong dollar) will lead to lower corporate earnings than the analyst community is currently forecasting. Although street estimates have been gradually falling, consensus still predicts S&P 500 earnings will grow +10.4% in aggregate for CY2022, according to FactSet. Meanwhile, Energy stocks are back on the upswing, and the impressive outperformance this year of the Energy sector has made its proportion of the S&P 500 rise from approximately 2% to 5%...and yet the P/Es of the major Energy ETFs are still in the single digits.

A mild recession is becoming more likely, and in fact it has become desirable to many as a way to hasten a reduction in inflationary pressures. Although volatility will likely persist for the foreseeable future, I think inflation and the 10-year Treasury yield are already in topping patterns. In addition, supply chains and labor markets continue their gradual recovery, the US dollar remains strong, and the Fed is reducing monetary accommodation, leading to demand destruction and slower growth, which would reduce the excess demand that is causing inflation.

Bullish catalysts for equity investors would be a ceasefire or settlement of the Russian/Ukraine conflict and/or China abandoning its zero-tolerance COVID lockdowns, which would be expected to help supply chains and further spur a meaningful decline in inflation – potentially leading to a Fed pivot to dovish (or at least neutral)…and perhaps a melt-up in stocks. Until then, a market surge like we saw last week, rather than the start of a V-shaped recovery, is more likely just a bear market short-covering rally – and an opportunity to raise cash to buy the next drawdown.

Nevertheless, we suggest staying net long but hedged, with a heightened emphasis on quality and a balance between value/cyclicals and high-quality secular growers and dividend payers. Moreover, rather than investing in the major cap-weighted index ETFs, stocks outside of the mega-caps may offer better opportunities due to lower valuations and higher growth rates. Regardless, Sabrient’s Baker’s Dozen, Dividend, and Small Cap Growth portfolios leverage our enhanced model-driven 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. In particular, our Dividend Portfolio – which seeks quality companies selling at a reasonable price with a solid growth forecast, a history of raising dividends, a good coverage ratio, and an aggregate dividend yield approaching 4% or more to target both capital appreciation and steady income – has been holding up well this year. So has our Armageddon Portfolio, which is available as a passive index for ETF licensing.

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. In addition, the near-term technical picture looks neutral-to-bearish after last week’s impressive bounce, and our sector rotation model remains in a defensive posture.  Read on...

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

Another positive month for the major indexes, despite plenty of new bricks in the proverbial Wall of Worry. That makes 7 months in a row – the longest streak in over 30 years – and 14 of the past 17 months (since the pandemic low). From a technical (chart) perspective, the S&P 500 has tested its 50-day simple moving average seven times this year, each time going on to hit a new high. And it’s not just the cap-weighted index (SPY) as the equal-weight version (RSP) has been moving in lockstep, illustrating good market breadth and confirming market conviction. Stocks seem to have already priced in some modest tapering of asset purchases by year end, so in the wake of Fed chairman Powell’s late-August speech in Jackson Hole indicating no plans for rate hikes, stocks surged yet again. Indeed, it has become a parabolic “melt-up,” which of course cannot go on forever.

Many investors have been patiently awaiting a significant market correction to use as a buying opportunity, but it remains elusive. What happened to the typical August low-volume technical correction? The big money institutions and hedge funds certainly have stuck to the script by reducing equity exposure and increasing exposure to volatility. But retail investors didn’t get the memo as every time it appears the correction has begun, they treat it like a buyable dip – not just in meme stocks but also the disruptive, secular-growth Tech stocks that so dominate total market cap and the cap-weighted, broad-market indexes. It seems like yet another market distortion caused by government intervention and de facto Modern Monetary Theory (MMT) that has flooded the economy with free money and kept workers at home to troll on social media, gamble on DraftKings, and speculate in Dogecoin, NFTs, SPACs, and meme stocks.

Will September finally bring a significant (and overdue) correction, or will the dip buyers, led by an active, brash, and risk-loving retail investor, continue to scare off the short sellers and prop up the market? Is this week’s pullback yet another head fake? And regardless, will the S&P 500 (both cap-weight and equal-weight) finish the year higher than last week’s all-time highs?

There is little doubt in my mind that the big institutional investors continue to wait patiently in the tall grass like a cheetah to pounce on any significant market weakness, like a 10+% selloff. Valuations are dependent on earnings, interest rates, and the equity risk premium (ERP, i.e., earnings yield minus the risk-free rate), and today we have robust corporate earnings, rising forward guidance, persistently low interest rates, a dovish Fed, and a low ERP – which is related to inflation expectations that are much lower than recent CPI readings would have you expect. I continue to expect inflation to moderate in 2022 while interest rates remain constrained by a stable dollar and Treasury demand. The Fed’s ongoing asset purchases (despite some expected tapering) along with robust demand among global investors (due to global QE and low comparative yields) has put a bid under bonds and kept nominal long term yields low (albeit with negative real yields). Indeed, bond yields today are less sensitive to inflationary signals compared to the past.

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 solidly bullish bias; the technical picture has been strong but remains in dire need of significant (but healthy and buyable, in my view) correction; and our sector rotation model retains its bullish posture. We continue to believe in having a balance between value/cyclicals and secular growth stocks and across market caps, although defensive investors may prefer an overweight on large-cap, secular-growth Tech and high-quality dividend payers.

As a reminder, we post my latest presentation slide deck and Baker’s Dozen commentary on our public website.) Sabrient’s newer portfolios – including Q3 2021 Baker’s Dozen, Small Cap Growth, Dividend, and Forward Looking Value– all reflect the process enhancements that we implemented in December 2019 in response to the unprecedented market distortions that created historic Value/Growth and Small/Large performance divergences. With a better balance between cyclical and secular growth and across market caps, most of our newer portfolios once again have shown solid performance relative to the benchmark during quite a range of evolving market conditions.

By the way, I welcome your comments, feedback, or just a friendly hello!  Read on….