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

From the standpoint of the performance of the broad market indexes, US stocks held up okay over the past four weeks, including a good portion of a volatile June. However, all was not well for cyclicals, emerging markets (including China), and valuation-driven active selection in general, including Sabrient’s GARP (growth at reasonable price) portfolios. Top-scoring cyclical sectors in our models like Financial, Industrial, and Materials took a hit, while defensive sectors (and dividend-paying “bond proxies”) Utilities, Real Estate, Consumer Staples, and Telecom showed relative strength. According to BofA’s Savita Subramanian, “June was a setback for what might have been a record year for active managers.” The culprit? Macro worries in a dreaded news-driven trading environment, given escalating trade tensions, increasing protectionism, diverging monetary policy among central banks, and a strong dollar. But let’s not throw in the towel on active selection just yet. At the end of the day, stock prices are driven by interest rates and earnings, and both remain favorable for higher equity prices and fundamentals-based stock-picking.

Some investors transitioned from a “fear of missing out” at the beginning of the year to a worry that things are now “as good as it gets” … and that it might be all downhill from here. Many bearish commentators expound on how we are in the latter stages of the economic cycle while the bull market in stocks has become “long in the tooth.” But in spite of it all, little has changed with the fundamentally strong outlook underlying our bottom-up quant model, characterized by synchronized global economic growth (albeit a little lower than previously expected), strong US corporate earnings, modest inflation, low global real interest rates, a stable global banking system, and of course historic fiscal stimulus in the US (tax cuts and deregulation), with the US displaying relative favorability for investments. Sabrient’s fundamentals-based GARP model still suggests solid tailwinds for cyclicals, and indeed the start of this week showed some strong comebacks in several of our top picks – not surprising given their lower valuations, e.g., forward P/E and PEG (P/E to EPS growth ratio).

Looking ahead, expectations are high for a big-league 2Q18 earnings reporting season. But the impressive 20% year-over-year EPS growth rate for the S&P 500 is already baked into expectations, so investor focus will be on forward guidance and how much the trade rhetoric will impact corporate investment plans, including capex and hiring. I still don’t think the trade wars will escalate sufficiently to derail the broad economic growth trajectory; there is just too much pain that China and the EU would have to endure at a time when they are both seeking to deleverage without stunting growth. So, we will soon see what the corporate chieftains decide to do, hopefully creating the virtuous circle of supply begetting demand begetting more supply, and so on. Furthermore, the compelling valuations on the underappreciated market segments may be simply too juicy to pass up – unless you believe there’s an imminent recession coming. For my money, I still prefer the good ol’ USA for investing, and I think there is sufficient domestic and global demand for both US fixed income and equities, especially small caps.

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 has returned to a bullish posture as investors position for a robust Q2 earnings season. Read on....