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

As an update to some of the topics I discussed in my lengthy early-January post, I wanted to share an update in advance of the FOMC announcement on Wednesday based on several economic reports that were released last week.

The Fed’s preferred inflation metric, Core Personal Consumption Expenditures (PCE, excluding food & energy) for December came in on Friday at 2.93% YoY and 0.17% MoM. However, I prefer to focus on the most recent trend over the past 3 months. Annualizing the Core PCE price index change over the past 3 months (0.14% in Oct, 0.06% in Nov and 0.17% in Dec) computes a 1.52% annualized inflation rate, as shown in the chart below.

So, it appears to me that inflation today is likely below the 2% target such that the Fed can begin normalizing fed funds rate toward the “neutral rate” (neither contractionary nor expansionary), which I believe ultimately will be around 3.0% nominal (i.e., 2% target inflation plus 1.0% r-star) versus 5.25–5.50% today. Moreover, I think the 10-year Treasury will settle at about 4.0–4.50%, assuming we don’t continue flood the Treasury market with new issuances to fund fiscal boondoggles and rising debt service (we’ll get a clue on Wednesday with the Treasury Refunding announcement). The rate levels I am suggesting seem appropriate so that borrowers can handle the debt burden while fixed income investors can receive a reasonable real yield (i.e., above the inflation rate) so they don’t have to take on undue risk to achieve meaningful income.

The Fed believes the composition of PCE more accurately reflects current impacts on consumers than does CPI. This is because it more quickly adapts to consumer choices through its weighting adjustments to individual items (e.g., shifts from pricier brands to discount brands). Also, while CPI narrowly considers only urban expenditures, PCE considers both urban and rural consumers as well as third-party purchases on behalf of a consumer, such as healthcare insurers buying prescription drugs. Furthermore, items are weighted differently—for example, shelter is the largest component of CPI at 32.9% but only 15.9% of PCE, and healthcare is the largest component of PCE at 16.8% but only 7.0% of CPI. So, while Core PCE shows a 1.52% 3-month annualized inflation rate, Core CPI is 3.33%.

So, let's talk more about shelter cost. I have often discussed the lag in shelter cost metrics distorting both PCE and CPI, particularly as new leases gradually roll over throughout the course of a year while existing lease rates persist. So, let me introduce another metric published by the BLS that provides more current insights into the trend in shelter cost, namely the New Tenant Rent Index (NTR).

The NTR data peaked in Q2 2022 while CPI Shelter didn’t peak until Q2 2023. And NTR has fallen precipitously since then, showing a substantial -8.75% quarter-over-quarter decline in Q4 2023 versus Q3 2023. But because such QoQ comparisons can be quite volatile with this metric, I’m not going to annualize that number. Instead, let’s stick with the year-over-year or 4-quarter comparison, which shows a more modest (but still significant) decline of -4.74% versus Q4 2022. Although CPI Shelter index is still elevated, it is also falling (as shown in the chart), now showing a YoY rate of 6.15% for December.

Inflation metrics

Furthermore, the BLS also publishes an All Tenant Regressed Rent Index (ATRR), which is not restricted only to new leases, so it moves more slowly and with less volatility. ATRR also has been in a steady decline since peaking in Q4 2022 at 7.84%, and it has been steadily falling over the past 4 quarters to its latest Q4 2023 reading of 5.27% YoY, which again reflects rapidly falling rental prices and is in-line with CPI Shelter.

This suggests to me that falling shelter costs will soon be more impactful to PCE and CPI readings. The FOMC is surely aware of this.

As for other economic reports last week, we saw the BEA’s advance (first) estimate of Q4 GDP growth surprised to the upside at a 3.3% annual rate, largely driven by personal consumption. Also, the December reading for M2SL money supply shows it has stayed basically flat since last March, while velocity of money (M2V) continues to ramp up. This suggests that more transactions are occurring in the economy for each dollar in circulation, which has offset the negative impact of stagnant money supply, thus supporting GDP, corporate earnings, and stock prices—although lack of M2 growth creates other strains on liquidity. I discuss this further in today’s post below.

Click here to continue reading my full commentary. And please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com.

  Scott Martindaleby Scott Martindale
  President & CEO, Sabrient Systems LLC

To be sure, 2023 was another eventful year (they just keep coming at us, don’t they?), ranging from escalating hot wars to a regional banking crisis, rising interest rates, falling inflation, a dire migration crisis, and an AI-driven frenzy in the so-called “Magnificent Seven” (MAG7) corporate titans— Meta Platforms (META, ne: FB), Apple (AAPL), Nvidia (NVDA), Alphabet (GOOGL), Microsoft (MSFT), Amazon (AMZN), and Tesla (TSLA), aka “FANGMAT,” as I used to call them—which as a group contributed roughly 60% to the S&P 500’s +26.2% gain in 2023. Their hyper-growth means that they now make up roughly 30% of the index. Nvidia (NVDA), whose semiconductors have become essential for AI applications, was the best performer for the full year at +239%.

Small caps finally found some life late in the year, with the Russell 2000 small cap index essentially keeping up with the S&P 500 starting in May and significantly outperforming in December. Bonds also made a big comeback late in the year on Fed-pivot optimism, which allowed the traditional 60/40 stock/bond allocation portfolio to enjoy a healthy return, which I’m sure made a lot of investors and their advisors happy given that 60/40 had been almost left for dead. The CBOE Volatility Index (VIX) has been below 20 for virtually the entirety of 2023 and as low as 11.81 in December, closing the year at 12.45. Also, as a breadth indicator, the percentage of stocks that finished the year above their 200-day moving average hit 75%, which is bullish.

Nevertheless, the Russell 2000 (+16.8%) and the equal-weight version of the S&P 500 (+13.7%) were up much less for the full year than the cap-weighted S&P 500 (+26.2%) and Nasdaq 100 (+54.9%). In fact, 72% of the stocks in the S&P 500 underperformed the overall index for the full year, illustrating that despite the improvement in breadth during the second half of the year, it could not overcome the huge outperformance of a small cohort of dominant companies. This suggests that either the market is set up for a fall in 2024 (as those dominant companies sell off) …or we’ll get a continued broadening into other high-quality companies, including mid- and small caps. I think it will be the latter—but not without some volatility and a significant pullback. Indeed, despite signaling investor confidence and complacency by remaining low for a long stretch, the VIX appears to be ripe for a spike in volatility. I think we could see a significant market correction during H1 (perhaps to as low as 4,500 on the S&P 500) even if, as I expect, real GDP growth slows but remains positive and disinflationary trends continue, supporting real wage growth and real yields—before seeing an H2 rally into (and hopefully following) the November election. And don’t forget there’s a potential tsunami of cash from the $6 trillion held in money market funds, as interest rates fall, much of it may well find its way into stocks.

Not surprisingly, last year ended with some tax-loss harvesting (selling of big losers), and then the new year began last week with some tax-gain harvesting—i.e., selling of big winners to defer tax liability on capital gains into 2024. There also has been some notable rotation of capital last week into 2023’s worst performers that still display strong earnings growth potential and solid prospects for a rebound this year, such as those in the Healthcare, Utilities, and Consumer Staples sectors. Homebuilders remain near all-time highs and should continue to find a tailwind as a more dovish Fed means lower mortgage rates and a possible housing boom. Energy might be interesting as well, particularly LPG shipping (a big winner last year) due to its growing demand in Europe and Asia.

As I discussed in my December commentary, I also like the prospects for longer-duration bonds, commodities, oil, gold, and uranium miner stocks this year, as well as physical gold, silver, and cryptocurrency as stores of value in an uncertain macro climate. Also, while Chinese stocks are near 4-year lows, many other international markets are near multi-year highs (including Europe and Japan), particularly as central banks take a more accommodative stance. Indeed, Sabrient’s SectorCast ETF rankings show high scores for some international-focused ETFs (as discussed later in this post).

While stocks rallied in 2023 (and bonds made a late-year comeback) mainly due to speculation on a Fed pivot toward lower interest rates (which supports valuations), for 2024 investors will want to see more in the way of actual earnings growth and other positive developments for the economy. I expect something of a “normalization” away from extreme valuation differentials and continued improvement in market breadth, whether it’s outperformance by last year’s laggards or a stagnation/pullback among last year’s biggest winners (especially if there are fewer rate cuts than anticipated)—or perhaps a bit of both. Notably, the S&P 500 historically has risen 20 of the last 24 election years (83%); however, a recent Investopedia poll shows that the November election is the biggest worry among investors right now, so it’s possible all the chaos, wailing and gnashing of teeth about Trump’s candidacy will make this election year unique with respect to stocks.

Regardless, I continue to believe that investors will be better served this year by active strategies that can identify and exploit performance dispersion among stocks across the capitalization spectrum—particularly smaller caps and the underappreciated, high-quality/low-valuation growers. Small caps tend to carry debt and be more sensitive to interest rates, so they have the potential to outperform when interest rates fall, but you should focus on stocks with an all-weather product line, a robust growth forecast, a solid balance sheet, and customer loyalty, which makes them more likely to withstand market volatility—which may well include those must-have, AI-oriented Tech stocks. Much like the impact of the Internet in the 1990s, AI/ML, blockchain/distributed ledger technologies (DLTs), and quantum computing appear to be the “it” technologies of the 2020’s that make productivity and efficiency soar. However, as I discuss in today’s post, the power requirements will be immense and rise exponentially. So, perhaps this will add urgency to what might become the technology of the 2030’s—i.e., nuclear fusion.

On that note, let me remind you that Sabrient’s actively selected portfolios include the Baker’s Dozen (a concentrated 13-stock portfolio offering the potential for significant outperformance), Small Cap Growth (an alpha-seeking alternative to a passive index like the Russell 2000), and Dividend (a growth plus income strategy paying a 4.5% current yield).

By the way, several revealing economic reports were released last week, which I discuss in today’s post. One was the December reading on the underappreciated New York Federal Reserve Global Supply Chain Pressure Index (GSCPI), which has fallen precipitously from it pandemic-era high and now is fluctuating around the zero line. This historically suggests falling inflation readings ahead. As for the persistently inverted yield curve, I continue to believe it has more to do with the unprecedented supply chain shocks coupled with massive fiscal and monetary stimulus to maintain demand and the resulting surge in inflation, which as observed by Alpine Macro, “makes the inversion more reflective of different inflation expectations than a signal for an impending recession.”

Also, although M2 money supply fell -4.6% from its all-time high in July 2022 until its low in April 2023, it has essentially flatlined since then and in fact has been largely offset to a great extent by an increase in the velocity of money supply. Also, we have a robust jobs market that has slowed but is far from faltering. And then there is the yield curve inversion that has been gradually flattening from a low of about -108 bps last July to -35 bps today.

I discuss all of this in greater detail in today’s post, including several illustrative tables and charts. I also discuss Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors (which is topped by Technology), current positioning of our sector rotation model (which turned bullish in early November and remains so), and some actionable ETF trading ideas.

Overall, I expect inflation will resume its decline, even with positive GDP growth, particularly given stagnant money supply growth, mending and diversifying supply chains (encompassing manufacturing, transportation, logistics, energy, and labor), falling or stabilizing home sale prices and new leases, slowing wage inflation, slower consumer spending on both goods and services, and a strong deflationary impulse from China due to its economic malaise and “dumping” of consumer goods to shore up its manufacturing (US imports from China were down 25% in 2023 vs. 2022). This eventually will give the Fed (and indeed, other central banks) license to begin cutting rates—likely by mid-year, both to head off renewed crises in banking and housing and to mitigate growing strains on highly leveraged businesses, consumers, government, and trading partners. Current CBOE fed funds futures suggest a 98% chance of at least 100 bps in rate cuts by year end (target rate of 4.25-4.50%), and 54% chance of at least 150 bps.

Click here to continue reading my full commentary … or if you prefer, here is a link to this post in printable PDF format (as some of my readers have requested). And please feel free to share my full post with your friends, colleagues, and clients! You also can sign up for email delivery of this periodic newsletter at Sabrient.com

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

Stocks continued their impressive 2023 rally through July, buoyed by rapidly falling inflation, steady GDP and earnings growth, improving consumer and investor sentiment, and a fear of missing out (FOMO). Of course, the big story this year has been the frenzy around the promise of artificial intelligence (AI) and leadership from the “Magnificent Seven” Tech-oriented mega caps—Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), NVIDIA (NVDA), Meta (META), Tesla (TSLA), and Microsoft (MSFT), which have led the powerhouse Nasdaq 100 (QQQ) to a +44.5% YTD return (as of 7/31) and within 5% of its all-time closing high of $404 from 11/19/2021. Such as been the outperformance of these 7 stocks that Nasdaq chose to perform a special re-balancing to bring down their combined weighting in the Nasdaq 100 index from 55% to 43%!

Because the Tech-heavy Nasdaq badly underperformed during 2022, mostly due to the long-duration nature of aggressive growth stocks in the face of a rising interest rate environment, it was natural that it would lead the rally, particularly given: 1) falling inflation and an expected Fed pause/pivot on rate hikes, 2) resilience in the US economy, corporate profit margins (largely due to cost discipline), and the earnings outlook; 3) the exciting promise of disruptive/transformational technologies like regenerative artificial intelligence (AI), blockchain and distributed ledger technologies (DLTs), and quantum computing.

But narrow leadership isn’t healthy—in fact, it reflects defensive sentiment, as investors prefer to stick with the juggernauts rather than the vast sea of economically sensitive companies. However, since June 1, there have been clear signs of improving market breadth, with the iShares Russell 2000 small caps (IWM), S&P 400 mid-caps (MDY), and S&P 500 Equal Weight (RSP) all outperforming the QQQ and S&P 500 (SPY). Industrial commodities oil, silver, and copper prices rose in July. This all bodes well for market health through the second half of the year (and perhaps beyond), as I discuss in today’s post below.

But for the moment, an overbought stock market is taking a breather to consolidate gains, take some profits, and pull back. The Fitch downgrade of US debt is helping fuel the selloff. I view it as a welcome buying opportunity.

Although rates remain elevated, they haven’t reached crippling levels (yet), and although M2 money supply has topped out and fallen a bit, the decline has been offset by a surge in the velocity of money supply, as I discuss in today’s post. So, assuming the Fed is done raising rates—and I for one believe the fed funds rate is already beyond the neutral rate (and thus contractionary)—and as long as the 2-year Treasury yield remains below 5% (it’s around 4.9% today), I think the economy and stocks will be fine, and the extreme yield inversion will begin to reverse.

The Fed’s dilemma is to facilitate the continued process of disinflation without inducing deflation, which is recessionary. Looking ahead, Nick Colas at DataTrek recently highlighted the disconnect between fed funds futures (which are pricing in 1.0-1.5% in rate cuts early next year) and US Treasuries (which do not suggest imminent rate cuts). He believes, “Treasuries have it right, and that’s actually bullish for stocks” (bullish because rate cuts only become necessary when the economy falters).

So, today we see inflation has fallen precipitously as supply chains improve (manufacturing, transport, logistics, energy, labor), profit margins are beating expectations (largely driven by cost discipline), corporate earnings have been resilient, earnings forecasts are seeing upward revisions, capex and particularly construction spending on manufacturing facilities has been surging, hiring remains robust (almost 2 job openings for every willing worker), the yield curve inversion is trying to flatten, gold and high yield spreads have been falling since May 1 (due to recession risk receding, the dollar firming, and real yields rising), risk appetite (“animal spirits”) is rising, and stock market leadership is broadening. It all sounds promising to me.

Regardless, the passive broad-market mega-cap-dominated indexes that were so hard for active managers to beat in the past may well face tough constraints on performance, particularly in the face of elevated valuations (i.e., already “priced for perfection”), slow real GDP growth, and an ultra-low equity risk premium. Thus, investors may be better served by strategic-beta and active strategies that can exploit the performance dispersion among individual stocks, which should be favorable for Sabrient’s portfolios including Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend.

As a reminder, Sabrient’s enhanced Growth at a Reasonable Price (GARP) “quantamental” selection process strives to create all-weather growth portfolios, with diversified exposure to value, quality, and growth factors, while providing exposure to both longer-term secular growth trends and shorter-term cyclical growth and value-based opportunities—with the potential for significant outperformance versus market benchmarks. Indeed, the Q2 2022 Baker’s Dozen that recently terminated on 7/20 handily beat the benchmark S&P 500, +28.3% versus +3.8% gross total returns. In addition, each of our other next-to-terminate portfolios are also outperforming their relevant market benchmarks (as of 7/31), including Small Cap Growth 34 (16.9% vs. 9.9% for IWM), Dividend 37 (24.0% vs. 8.5% for SPYD), Forward Looking Value 10 (38.9% vs. 20.8% for SPY), and Q3 2022 Baker’s Dozen (28.4% vs. 17.9% for SPY).

Also, please check out Sabrient’s simple new stock and ETF screening/scoring tools called SmartSheets, which are available for free download for a limited time. SmartSheets comprise two simple downloadable spreadsheets—one displays 9 of our proprietary quant scores for stocks, and the other displays 3 of our proprietary scores for ETFs. Each is posted weekly with the latest scores. For example, Lantheus Holdings (LNTH) was ranked our #1 GARP stock at the beginning of February. Accenture (ACN) was at the top for March, Kinsdale Capital (KNSL) in April, Crowdstrike (CRWD) in May, and at the start of both June and July, it was discount retailer TJX Companies (TJX). Each of these stocks surged higher (and outperformed the S&P 500)—over the ensuing weeks after being ranked on top. We invite you to download the latest weekly sheets for stocks and ETFs using the link above—it’s free of charge for now. And please send me your feedback!

Here is a link to my full post in printable format. In this periodic update, I provide a comprehensive market commentary, including discussion of inflation, money supply, and why the Fed should be done raising rates; as well as stock valuations and opportunities going forward. I also review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors and serve up some actionable ETF trading ideas. Read on…

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

After five straight weeks of gains—goosed by a sudden surge in excitement around the rapid advances, huge capex expectations, and promise of Artificial Intelligence (AI), and supported by the CBOE Volatility Index (VIX) falling to its lowest levels since early 2020 (pre-pandemic)—it was inevitable that stocks would eventually take a breather. Besides the AI frenzy, market strength also has been driven by a combination of “climbing a Wall of Worry,” falling inflation, optimism about a continued Fed pause or dovish pivot, and the proverbial fear of missing out (aka FOMO).

Once a debt ceiling deal was struck at the end of May, a sudden jump in sentiment among consumers, investors, and momentum-oriented “quants” sent the mega-cap-dominated, broad-market indexes to new 52-week highs. Moreover, the June rally broadened beyond the AI-oriented Tech giants, which is a healthy sign. AAIA sentiment moved quickly from fearful to solidly bullish (45%, the highest since 11/11/2021), and investment managers are increasing equity exposure, even before the FOMC skipped a rate hike at its June meeting. Other positive signs include $7 trillion in money market funds that could provide a sea of liquidity into stocks (despite M2 money supply falling), the US economy still forecasted to be in growth mode (albeit slowly), corporate profit margins beating expectations (largely driven by cost discipline), and improvements in economic data, supply chains, and the corporate earnings outlook.

Although the small and mid-cap benchmarks joined the surge in early June, partly boosted by the Russell Index realignment, they are still lagging quite significantly year-to-date while reflecting much more attractive valuations, which suggests they may provide leadership—and more upside potential—in a broad-based rally. Regardless, the S&P 500 has risen +20% from its lows, which market technicians say virtually always indicates a new bull market has begun. Of course, the Tech-heavy Nasdaq badly underperformed during 2022, mostly due to the long-duration nature of growth stocks in the face of a rising interest rate environment, so it is no surprise that it has greatly outperformed on expectations of a Fed pause/pivot.

With improving market breadth, Sabrient’s portfolios—which employ a value-biased Growth at a Reasonable Price (GARP) style and hold a balance between cyclical sectors and secular-growth Tech and across market caps—this month have displayed some of their best-ever outperformance days versus the benchmark S&P 500.

Of course, much still rides on Fed policy decisions. Inflation continues its gradual retreat due to a combination of the Fed allowing money supply to fall nearly 5% from its pandemic-response high along with a huge recovery in supply chains. Nevertheless, the Fed has continued to exhibit a persistently hawkish tone intended to suppress an exuberant stock market “melt-up” and consumer spending surge (on optimism about inflation and a soft landing and the psychological “wealth effect”) that could hinder the inflation battle.

Falling M2 money supply has been gradually draining liquidity from the financial system (although the latest reading for May showed a slight uptick). And although fed funds futures show a 77% probably of a 25-bp hike at the July meeting, I’m not so sure that’s going to happen, as I discuss in today’s post. In fact, I believe the Fed should be done with rate hikes…and may soon reverse the downtrend in money supply, albeit at a measured pace. (In fact, the May reading for M2SL came in as I was writing this, and it indeed shows a slight uptick in money supply.) The second half of the year should continue to see improving market breadth, in my view, as capital flows into the stock market in general and high-quality names in particular, from across the cap spectrum, including the neglected cyclical sectors (like regional banks).

Regardless, the passive broad-market mega-cap-dominated indexes that were so hard for active managers to beat in the past may well face high-valuation constraints on performance, particularly in the face of slow real GDP growth (below inflation rate), sluggish corporate earnings growth, elevated valuations, and a low equity risk premium. Thus, investors may be better served by strategic-beta and active strategies that can exploit the performance dispersion among individual stocks, which should be favorable for Sabrient’s portfolios—including Q2 2023 Baker’s Dozen, Small Cap Growth 38, and Dividend 44—all of which combine value, quality, and growth factors while providing exposure to both longer-term secular growth trends and shorter-term cyclical growth and value-based opportunities. (Note that Dividend 44 offers both capital appreciation potential and a current yield of 5.1%.)

Quick reminder about Sabrient’s stock and ETF screening/scoring tool called SmartSheets, which is available for free download for a limited time. SmartSheets comprise two simple downloadable spreadsheets—one displays 9 of our proprietary quant scores for stocks, and the other displays 3 of our proprietary scores for ETFs. Each is posted weekly with the latest scores. For example, Lantheus Holdings (LNTH) was ranked our #1 GARP stock at the beginning of February before it knocked its earnings report out of the park on 2/23 and shot up over +20% in one day (and kept climbing). At the start of March, it was Accenture (ACN). At the beginning of April, it was Kinsdale Capital (KNSL). At the beginning of May, it was Crowdstrike (CRWD). At the start of June, it was again KNSL (after a technical pullback). All of these stocks surged higher—while significantly outperforming the S&P 500—over the ensuing weeks. Most recently, our top-ranked GARP stock has been discount retailer TJX Companies (TJX), which was up nicely last week while the market fell. Feel free to download the latest weekly sheets using the link above—free of charge for now—and please send us your feedback!

Here is a link to my full post in printable format. In this periodic update, I provide a comprehensive market commentary, including discussion of inflation and why the Fed should be done raising rates, stock valuations, and the Bull versus Bear cases. I also review Sabrient’s latest fundamentals based SectorCast quant rankings of the ten U.S. business sectors and serve up some actionable ETF trading ideas. Read on…