Scott Martindale  by Scott Martindale
  President, Sabrient Systems LLC

In case you didn’t notice, the past several days have brought an exciting and promising change in character in the US stock market. Capital has been rotating out of the investor darlings – including the momentum, growth, and low-volatility factors, as well as Treasury bonds and “bond proxy” defensive sectors – and into the neglected market segments like value, small-mid caps, and cyclical sectors favored by Sabrient’s GARP (growth at a reasonable price) model, many of which have languished with low valuations despite solid forward growth expectations. And it came just in the nick of time.

In Q3 of last year, the S&P 500 was hitting new highs and the financial press was claiming that investors were ignoring the trade war, when in fact they weren’t ignoring it at all, as evidenced by narrow leadership coming primarily from the mega-cap secular Technology names and large cap defensive sectors (risk-off). In reality, such market behavior was unhealthy and doomed to failure without a broadening into higher-beta cyclical sectors and small-mid caps, which is what I was opining about at the time. Of course, you know what happened, as Q4 brought about an ugly selloff. And this year, Q3 was looking much the same – at least until this sudden shift in investor preferences.

Last month, as has become expected given its typically low-volume summer trading, August saw increased volatility – and also brought out apocalyptic commentaries similar to what we heard from the talking heads in December. In contrast to the severely overbought technical conditions in July when the S&P 500 managed to make a new high, August saw the opposite, with the major indices becoming severely oversold and either challenging or losing support at their 200-day moving averages or even testing their May lows, as investors grew increasingly concerned about a protracted trade war, intensifying protectionist rhetoric, geopolitical turmoil, Hard Brexit, slowing global economy, and US corporate earnings recession. Utilities and Real Estate led, while Energy trailed. Bonds surged and yields plunged. August was the worst month for value stocks in over 20 years.

But alas, it appears it we may have seen a blow-off top in bonds, and Treasury yields may have put in a bottom. All of a sudden, the major topic of conversation among the talking heads this week has been the dramatic rotation from risk-off market segments to risk-on, which has been a boon for Sabrient’s Baker’s Dozen portfolios, giving them the opportunity to gain a lot of ground versus the S&P 500 benchmark. The Energy sector had been a persistent laggard, but the shorts have been covering as oil prices have firmed up. Financials have caught a bid as US Treasury prices have fallen (and yields have risen). Small cap value has been greatly outperforming large cap growth. It seems investors are suddenly less worried about a 2020 recession, ostensibly due to renewed optimism about trade talks, or perhaps due to the apparent resilience of our economy to weather the storm.

The question, though, is whether this is just a temporary reversion to the mean – aka a “junk rally,” as some have postulated – or if it is the start of a healthy broadening in the market and a rotation from the larger, high-quality but high-priced stocks (which have been bid up by overly cautious sentiment, passive index investing, and algorithmic trading, in my view), into the promising earnings growers, cyclicals, and good-quality mid and small caps that would normally lead a rising market. After all, despite its strong year-to-date performance, the S&P 500 really hasn’t progressed much at all from last September’s high. But a real breakout finally may be in store if this risk-on rotation can continue.

I think the market is at a critical turning point. We may be seeing a tacit acknowledgment among investors that perhaps the economy is likely to hold up despite the trade war. And perhaps mega-caps with a lot of international exposure are no longer the best place to invest. And perhaps those mega-caps, along with the defensive sectors that have been leading the market for so long, are largely bid up and played out at this point such that the more attractive opportunities now lie in the unjustly neglected areas – many of which still trade at single-digit forward P/Es despite solid growth expectations.

September is historically a bad month for stocks. It is the only month in which the Dow Jones Industrials index has averaged negative performance over the past 100 years, showing positive returns about 40% of the time (according to Bespoke Investment Group). But this budding rotation may be setting up a more positive outcome. I was on the verge of publishing this month’s article early last week, but the market’s sudden (and important!) change in character led me to hold off for a few days to see how the action unfolded, and I have taken a new tack on my content.

In this periodic update, I provide a detailed 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 look defensive to me, while the technical picture is short-term overbought but longer-term bullish, and the sector rotation model takes to a solidly bullish posture. Read on…

Scott Martindale  by Scott Martindale
  President, Sabrient Systems LLC

July was yet another solid month for stocks, as the major market indexes eclipsed and held above psychological barriers, like the S&P 500 at 3,000, and the technical consolidation at these levels continued with hardly any give back at all. But of course, the last day of July brought a hint of volatility to come, and indeed August has followed through on that with a vengeance. As the old adage goes, “Stocks take the stairs up but ride the elevator down,” and we just saw a perfect example of it. The technical conditions were severely overbought, with price stretched way above its 20-day simple moving average, and now suddenly the broad indexes (S&P 500, Dow, Nasdaq) are challenging support at the 200-day moving average, while the small cap Russell 2000 index has plummeted well below its 200-day and is now testing its May low.

For the past 18 months (essentially starting with the February 2018 correction), investor caution has been driven by escalating trade wars and tariffs, rising global protectionism, a “race to the bottom” in currency wars, and our highly dysfunctional political climate. However, this cautious sentiment has been coupled with an apparent fear of missing out (aka FOMO) on a major market melt-up that together have kept global capital in US stocks but pushed up valuations in low-volatility and defensive market segments to historically high valuations relative to GARP (growth at a reasonable price), value, and cyclical market segments. Until the past few days, rather than selling their stocks, investor have preferred to simply rotate into defensive names when the news was distressing (which has been most of the time) and then going a little more risk-on when the news was more encouraging (which has been less of the time). I share some new insights on this phenomenon in today’s article.

The market’s gains this year have not been based on excesses (aka “irrational exuberance”) but instead stocks have climbed a proverbial Wall of Worry – largely on the backs of defensive sectors and mega-caps and fueled by persistently low interest rates, and mostly through multiple expansion rather than earnings growth. In addition, the recent BAML Global Fund Manager Survey indicated the largest jump in cash balances since the debt ceiling crisis in 2011 and the lowest allocation ratio of equities to bonds since May 2009, which tells me that deployment of this idle cash and some rotation out of bonds could really juice this market. It just needs that elusive catalyst to ignite a resurgence in business capital spending and manufacturing activity, raised guidance, and upward revisions to estimates from the analyst community, leading to a sustained risk-on rotation.

As a reminder, I am always happy to take time for conversations with financial advisors about market conditions, outlook, and Sabrient’s portfolios.

In this periodic update, I provide a detailed 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 look neutral to me (i.e., neither bullish nor defensive), while the sector rotation model retains a bullish posture. 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

The escalating trade standoff with China, an increasingly hawkish Federal Reserve, and the impending mid-term elections finally took a toll on investor psyche, creating a rush to the exits in October as concern rises about the sustainability of the ultra-strong corporate earnings given China’s key role in global supply chains. Even some sell-side analysts have seen fit to slightly trim Q4’s strong earnings estimates. Nonetheless, the month ended with an encouraging rally from deeply oversold technical conditions. Overall, Sabrient’s model continues to suggest that little has changed with the positive fundamental outlook characterized by solid global economic growth, strong US corporate earnings, modest inflation, low real interest rates (despite incremental rate hikes), a stable global banking system, and historic fiscal stimulus in the US (especially corporate tax cuts and deregulation) that is only starting to have an impact on all-important capital spending. Also worth mentioning are the Consumer Confidence Index, which rose to its highest level in 18 years, and the Small Business Optimism Index, which continues with the longest streak of sustained optimism in its 45-year history.

Although the S&P 500 managed to plod its way upward during the summer and hit new highs well into September, a dramatic risk-off defensive rotation commenced in mid-June reflecting cautious investor sentiment, which disproportionately impacted Sabrient’s cyclicals-heavy portfolios. But this was not a healthy rotation. In fact, I wrote during the summer that the market wouldn’t be able to move much higher without renewed breadth and leadership from cyclicals. But instead of a risk-on rotation to recharge bullish conviction, we got a big market sell-off in October. Notably, such a pullback is normal in mid-term election years, but what is also normal is a strongly positive market move over the course of the 12 months following the mid-terms.

Last week’s fledgling recovery rally from severely oversold technical conditions showed promising risk-on action – and some relative performance catch-up in Sabrient’s portfolios. Thus, while the aggregate earnings outlooks for companies in the cyclical sectors and smaller caps have held steady or in many cases improved, shares prices have fallen dramatically, making the forward P/Es in these market segments much more attractive, while forward P/Es in the defensive sectors have become quite pricey.

Getting the uncertainty of the mid-term elections behind us should be good for investor sentiment. So, I think the correction lows are in – barring a massive “blue wave” in which Democrats take over both houses of Congress or a total breakdown in the China trade talks. Also, companies are coming out of their reporting-season blackout windows so that they can resume their massive share buybacks, further goosing stock prices. All told, I anticipate a risk-on rotation spurring a year-end rally that should treat our portfolios well.

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 been forced into a defensive posture due to the recent correction. 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

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....

by Scott Martindale
President, Sabrient Systems LLC

The S&P 500 finished 2017 by completing an unusual feat. Not only was the index up +22% (total return), but every single month of the year saw positive performance on a total return basis, and in fact, the index is on a 14-month winning streak (Note: the previous record of 15 straight was set back in 1959!). So, as you might expect, volatility was historically low all year, with the VIX displaying an average daily closing value of 11 (versus a “fear threshold” of 15 and a “panic threshold” of 20). But some of 2017’s strength was due to expansion in valuation multiples in anticipation of tax reform and lower effective tax rates boosting existing earnings, not to mention incentives for repatriating overseas cash balances, expansion, and capex.

Sector correlations also remained low all year, while performance dispersion remained high, both of which are indications of a healthy market, as investors focus on fundamentals and pick their spots for investing – rather than just trade risk-on/risk-off based on the daily news headlines and focus on a narrow group of mega-cap technology firms (like 2015), or stay defensive (like 1H2016). And Sabrient’s fundamentals-based portfolios have thrived in this environment.

Now that the biggest tax overhaul in over 30 years is a reality, investors may do some waiting-and-watching regarding business behavior under the new rules and the impact on earnings, and there may be some normalization in valuation multiples. In other words, we may not see 20% gains in the S&P 500 during 2018, but I still expect a solidly positive year, albeit with some elevated volatility.

In this periodic update, I provide a market outlook, conduct a technical analysis of the S&P 500 chart, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and offer up some actionable ETF trading ideas. In summary, our sector rankings still look bullish, while the sector rotation model also maintains its bullish bias. Read on....