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

The first half of 2024 looked a lot like the first half of 2023. As you recall, H1 2023 saw a strong stock market despite only modest GDP growth as inflation metrics fell, and H2 2023 continued on the same upward path for stocks despite a slowdown in inflation’s retreat, buoyed by robust GDP growth. Similarly, for H1 2024, stocks have surged despite a marked slowdown in GDP growth (from 4.1% in the second half of 2023 to an estimated 1.5% in the first half of 2024) and continued “stickiness” in inflation—causing rate-cut expectations to fall from 7 quarter-point cuts at the start of the year to just 2 at most.

And yet stocks have continued to surge, with 33 record highs this year for the S&P 500 through last Friday, 7/5. Of course, it is no secret that the primary driver of persistent market strength, low volatility (VIX in the mid-12’s), and an extreme low in the CBOE put/call ratio (around 0.50) has been the narrow leadership of a handful of dominant, innovative, mega-cap Tech titans and the promise of (and massive capital expenditures on) artificial intelligence. But while the S&P 500 is up +17.4% YTD and Nasdaq 100 +21.5% (both at all-time highs), the small cap indexes are flat to negative, with the Russell 2000 languishing -14% below its June 2021 all-time high.

Furthermore, recessionary signals abound. GDP and jobs growth are slowing. Various ISM indexes have fallen into economic contraction territory (below 50). Q2 earnings season kicks off in mid-July amid more cuts to EPS estimates from the analyst community. Given a slowing economy and falling estimates, it’s entirely possible we will see some high-profile misses and reduced forward guidance. So, investors evidently believe that an increasingly dovish Fed will be able to revive growth without revving up inflation.

But is this all we have to show for the rampant deficit spending that has put us at a World War II-level ratio of 120% debt (nearly $35 trillion) to GDP (nearly $29 trillion)? And that doesn’t account for estimated total unfunded liabilities—comprising the federal debt and guaranteed programs like Social Security, Medicare, employee pensions, and veterans’ benefits—estimated to be around $212 trillion and growing fast, not to mention failing banks, municipal pension liabilities, and bankrupt state budgets that might eventually need federal bailouts.

Moreover, the federal government “buying” jobs and GDP in favored industries is not the same as private sector organic growth and job creation. Although the massive deficit spending might at least partly turn out to be a shrewd strategic investment in our national and economic security, it is not the same as incentivizing organic growth via tax policies, deregulation, and a lean government. Instead, we have a “big government” politburo picking and choosing winners and losers, not to mention funding multiple foreign wars, and putting it all on a credit card to be paid by future generations. I have more to say on this—including some encouraging words—in my Final Comments section below.

As for inflation, the Fed’s preferred gauge, Core Personal Consumption Expenditures (PCE, aka Consumer Spending), for May was released on 6/28 showing a continued downward trend (albeit slower than we all want to see). Core PCE came in at just +0.08% month-over-month (MoM) from April and +2.57% YoY. But Core PCE ex-shelter is already below 2.5%, so as the lengthy lag in shelter cost metrics passes, Core PCE should fall below 2.5% as well, perhaps as soon as the update for June on 7/26, which could give the Fed the data it needs to cut. By the way, the latest real-time, blockchain-based Truflation rate (which historically presages CPI) hit a 52-week low the other day at just 1.83% YoY.

In any case, as I stated in my June post, I am convinced the Fed would like to starting cutting soon—and it may happen sooner than most observers are currently predicting. Notably, ever since the final days of June—marked by the presidential debate, PCE release, various jobs reports, and the surprising results in Europe and UK elections, the dollar and the 10-year yield have both pulled back—perhaps on the view that rate cuts are indeed imminent. On the other hand, the FOMC might try to push it out as much as possible to avoid any appearance of trying to impact the November election. However, Fed chair Powell stated last week that the committee stands ready to cut rates more aggressively if the US labor market weakens significantly (and unemployment just rose above the magic 4-handle to 4.1%)—so it appears the investor-friendly “Fed put” is back in play, which has helped keep traders bullishly optimistic. The June readings for PPI and CPI come out later this week on 7/11-12, and July FOMC policy announcement comes out on 7/31.

And as inflation recedes, real interest rates rise. As it stands today, I think the real yield is too high—great for savers but bad for borrowers, which would suggest the Fed is behind the curve. The current fed funds rate is roughly 3% above the CPI inflation forecast, which means we have the tightest Fed interest rate policy since before the 2008 Global Financial Crisis (aka Great Recession). This tells me that the Fed has plenty of room to cut rates and still maintain restrictive monetary policy.

As I have said many times, I believe a terminal fed funds rate of 3.0-3.5% would be the appropriate level so that borrowers can handle the debt burden while fixed income investors can receive a reasonable real yield.

Nevertheless, even with rates still elevated today, I believe any significant pullback in stocks (which I still think is coming before the November election, particularly in light of the extraordinarily poor market breadth) would be a buying opportunity. It’s all about investor expectations. As I’ve heard several commentators opine, the US, warts and all, is the “best house in a lousy [global] neighborhood.” I see US stocks and bonds (including TIPS) as good bets, particularly as the Fed and other central banks inject liquidity. But rather than chasing the high-flyers, I suggest sticking with high-quality, fundamentally strong stocks, displaying accelerating sales and earnings and positive revisions to Wall Street analysts’ consensus estimates.

By “high quality,” I mean fundamentally strong companies with a history of, and continued expectations for, consistent and reliable sales and earnings growth, upward EPS revisions from the analyst community, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are the factors Sabrient employs in selecting our growth-oriented Baker’s Dozen (primary market for the Q2 portfolio ends on 7/18), value-oriented Forward Looking Value portfolio, growth & income-oriented Dividend portfolio, and our Small Cap Growth portfolio (an alpha-seeking alternative to a passive position in the Russell 2000), as well as in our SectorCast ETF ranking model. Notably, our Earnings Quality Rank (EQR) is a key factor in each of these models, and it is also licensed to the actively managed, absolute-return-oriented First Trust Long-Short ETF (FTLS) as an initial screen.

Each of these alpha factors and how they are used within Sabrient’s Growth, Value, Dividend income, and Small Cap investing strategies is discussed in detail in David Brown’s new book, How to Build High Performance Stock Portfolios, which will be out shortly (I will send out a notification soon!).

In today’s post, I provide a detailed commentary on the economy, inflation, valuations, Fed policy expectations, and Sabrient’s latest fundamentals based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model heading into earnings season, and several top-ranked ETF ideas.

Click here to continue reading my full commentary. Or if you prefer, here is a link to this post in printable PDF format. I invite you to share it with your friends, colleagues, and clients (to the extent compliance allows). 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

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....