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

Optimism reigns for the pandemic slowing and the economy reopening. And because stocks tend to be several months forward looking (and remarkably predictive, at that), April saw the best single-month performance for the S&P 500 in 33 years (+12.7%), while the Nasdaq saw its best month in 20 years (+15.4%). The S&P 500 Growth Index recorded its highest ever monthly return (+14.3%). In addition, gold and bitcoin have been rising as a hedge against all sorts of outcomes, including geopolitical instability, trade wars, de-globalization, unfettered monetary & fiscal liquidity (i.e., MMT), inflation, a weakening dollar, a “toppy” bond market, etc. (plus the periodic bitcoin “halving” event that occurs this week).

This impressive rally off the lows seems justified for several reasons:

  1. the coronavirus, as bad as it is, falling well short of the dire lethality predictions of the early models and our ability to “flatten the curve”
  2. massive monetary and fiscal policy support and the associated reduction in credit risk
  3. low interest rates driving retirees and other income seekers into the higher yields and returns of stocks
  4. household income holding up relatively well, as the main impact has been on lower wage workers who can’t work remotely (and government support should cover much of their losses)
  5. escalation of tensions with China seems to be “all hat and no cattle” for now, with a focus on economic recovery
  6. massive short covering and a bullish reversal among algorithmic traders
  7. the growing dominance and consistent performance of the secular-growth Technology sector plus other “near-Tech” names (like Facebook and Amazon.com)
  8. the steepening yield curve, as capital has gradually rotated out of the “bond bubble”

What the rally doesn’t have at the moment, however, is a strong near-term fundamental or valuation-based foundation. But although the current forward P/E of the S&P 500 of 20x might be overvalued based on historical valuations, I think in today’s unprecedented climate there actually is room for further multiple expansion before earnings begin to catch up, as investors position for a post-lockdown recovery.

In any case, it has been clear to us at Sabrient that the market has developed a “new normal,” which actually began in mid-2015 when the populist movement gained steam and the Fed announced a desire to begin tightening monetary policy. Investors suddenly become wary of traditional “risk-on” market segments like small-mid caps, value stocks, cyclical sectors, and emerging markets, even though the economic outlook was still strong, instead preferring to focus on mega-cap Technology, long-term secular growth industries, and “bond proxy” dividend-paying defensive sectors. And more recently, investor sentiment coming out of the COVID-19 selloff seems to be more about speculative optimism of a better future rather than near-term earnings reports and attractive valuation multiples.

In response, Sabrient has enhanced our forward-looking and valuation-oriented Baker’s Dozen strategy to improve all-weather performance and reduce relative volatility versus the benchmark S&P 500, as well as put secular-growth companies (which often display higher valuations) on more equal footing with cyclical-growth firms (which tend to display lower valuations). Those secular growth trends include 5G, Internet of Things (IoT), e-commerce, cloud computing, AI/ML, robotics, clean energy, blockchain, quantum computing, nanotechnology, genomics, and precision medicine. So, we felt it was necessary that our stock selection strategy give due consideration to players in these market segments, as well.

As a reminder, you can find my latest Baker’s Dozen slide deck and commentary on terminating portfolios at http://bakersdozen.sabrient.com/bakers-dozen-marketing-materials.

In this periodic update, I provide a market commentary, discuss Sabrient’s new process enhancements, offer my technical analysis of the S&P 500, and 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 now look defensive, and our sector rotation model maintains a neutral posture as it climbs from the depths of the selloff. Meanwhile, the technical picture remains bullish as it continues to gather speculative conviction on a better future, although with elevated volatility amid progress/setbacks as the economy tries to gradually reopen in the face of an ongoing coronavirus threat.  Read on....

Ryan Frederick  by Ryan Frederick
  Equity Analyst, Gradient Analytics LLC (a Sabrient Systems company)

In 2003, the SEC first officially adopted rules (following Sarbanes-Oxley in 2002) related to the reporting of non-GAAP financial metrics. The new regulations called for a reconciliation of GAAP versus non-GAAP results to be included in various investor resources and to refrain from excluding non-recurring items from non-GAAP metrics if they are reasonably likely to reoccur, which is subject to wide interpretation. Since then, it seems the perceived importance among investors of non-GAAP financial performance has been elevated above traditional GAAP measures. Between 2015 and 2017, less than 10.0% of companies in the S&P 500 did not report a non-GAAP income calculation. However, the ability for management to subjectively decide what is or is not relevant to a company’s core business leaves plenty of room for earnings manipulation.

On the one hand, companies tend to justify their exclusion of various transactions as necessary for “comparability” to historical results, given that GAAP rules have changed over time. Fair enough. However, when an investor chooses to rely upon non-GAAP results when comparing a given company’s results to another’s, the comparisons can be deeply misleading as management has great leeway for subjective (and sometimes ad-hoc) adjustments in their exclusions – i.e., what one company concludes should be excluded in a non-GAAP calculation may not be consistent with what another company may exclude.

In fact, in 2010 former SEC chief accountant Howard Scheck identified non-GAAP performance metrics as a “fraud risk factor.” The SEC even created a taskforce to analyze non-GAAP earnings metrics that could be misleading. Then, in an effort to provide more clarity, the commission provided Compliance and Disclosure Interpretations (C&DIs) which detailed ways in which the SEC may find non-GAAP disclosures to be misleading, but more on that later.

Here at Gradient Analytics, our focus on earnings quality analysis (for both short idea generation and vetting of long candidates) regularly includes an examination of non-GAAP adjustments to determine whether they are appropriate in helping represent the true performance of the firm, or whether they are misleading. There is a plethora of unique adjustments a company could make to a non-GAAP income calculation; however, some are more common than others. One of the more frequent adjustments to GAAP income is the exclusion of restructuring costs. Read on….

Last week, stocks cycled bullish yet again. In fact, the S&P 500, NYSE Composite, and NASDAQ each closed at record highs as investors positioned for the heart of earnings season in the wake of strong reports from some of the Tech giants. Notably, Utilities stocks got some renewed traction as yield-starved investors returned to the sector.

When I’m in my sales role, I view every prospective client as falling into one of two broad baskets: those looking for a reason to say yes, and those looking for a reason to say no. I always try to focus on the former and spend little time on the latter. Likewise, last week’s market was dominated by those looking for a reason to sell. And so they did. Good news in the jobs and unemployment reports spooked investors on Friday, and stocks fell hard. So, for the moment we are back to a Fed-driven good-news-is-bad-news story line, or so it would seem.

Investors in U.S. equities seem to have embraced a new market paradigm in which upside spikes come more swiftly than the downside selloffs. Remember when it used to be the other way around? When fear was stronger than greed? The market is consolidating its gains off the early-October V-bottom reversal, and no one seems to be in any hurry to unload shares this time around, with the holidays rapidly approaching and all.

Bulls showed renewed backbone last week and drew a line in the sand for the bears, buying with gusto into weakness as I suggested they would. After all, this was the buying opportunity they had been waiting for. As if on cue, the start of the World Series launched the rapid market reversal and recovery. However, there is little chance that the rally will go straight up. Volatility is back, and I would look for prices to consolidate at this level before making an attempt to go higher. I still question whether the S&P 500 will ultimately achieve a new high before year end.

Scott MartindaleMore unnerving conflicts around the globe have flared up, but as usual, U.S. equity investors have given it nary a yawn as they seem to have become pretty much numb to the steady stream of unwelcome news, particularly out of the Middle East. Now we enter the summer version of earnings season.

Scott MartindaleStocks continued last week to seek some firmer footing, as prices found some support and volatility hit some resistance, and a flight to safety of global capital benefited long-term Treasury bonds -- the very assets that are supposed to be selling off in a secular “Great Rotation” into equities.

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Bulls found fresh legs on Wednesday with support from the FOMC, despite the reluctance of Greece to “play ball” with its creditors, which has been depressing investor sentiment. Everyone seems to agree that the unresolved debt crisis in Europe is the main thing holding back global economic recovery and the snorting stock market bulls. To be sure, the situation in Europe is not good.

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