by Scott Martindale
  CEO, Sabrient Systems LLC

 Quick note: If you are a financial advisor who would like to see Sabrient portfolios packaged in an ETF wrapper, please drop me an email (or suggest it to your local ETF wholesaler). We have a line-up of active and passive alpha-seeking portfolios and indexes ready to go!

Overview

The January BLS jobs report strengthened while CPI cooled—a match made in heaven for the economy, right? But investors are grappling with what it portends for Fed monetary policy, particularly given the impending changing of the guard at the Fed. That seems to be all the market cares about at the moment. But of course, in the longer term, these trends bode well for lower interest rates and growth in GDP, earnings, and stock prices, particularly given full implementation of the One Big Beautiful Bill Act (OBBBA), which focuses on tax reform, deregulation, energy production, border security, and broad support for the private sector to retake its rightful place as the primary engine of growth via re-privatization, reshoring, and re-industrialization, with much more efficient capital allocation and ROI than government. All told, I think the GDP, jobs, and inflation story suggests room for more rate cuts, as I discuss in detail in my full commentary below.

As I expected, particularly after a third straight strong year for the market, stocks have been more volatile during Q1, with the CBOE Volatility Index (VIX) climbing back above the 20 “fear threshold.” Energy, Basic Materials, high-dividend payers (aka “bond proxies”), defensive sectors Consumer Staples and Telecom, small caps and equal-weight versions of the major indexes have all significantly outperformed the long-time high-flying mega-cap Tech-dominated S&P 500 and Nasdaq 100 that have been so hard to beat for so long.

February has been marked by rising volatility plus much wailing and gnashing of teeth as the AI story (big investments now for even bigger returns and productivity growth in the near future) is suddenly being questioned. No doubt, stocks have seen the manifestation of investor worries of disappointing or delayed ROI on the massive capex for AI, as well as a crowding out of other uses for the cash, such as for dividends and share buybacks. In addition, the concern that AI will make all current software/SaaS companies obsolete has cut down most software stocks at the knees. And then we have the impact of Kevin Warsh’s nomination for Fed chair, which initially sent commodities (including surging gold and silver) into a tailspin on expectation of (heaven forbid!) tighter policy, lower debt, and a stronger dollar—which used to be considered good things and signs of a robust economy.

In addition, the macro clouds of uncertainty persist regarding trade deals and tariffs, the intractable Ukraine/Russia war, the Venezuela, Cuba, and Iran situations (which also impact China, Russia, and oil markets broadly), enforcement of immigration law, civil strife in US cities, political polarization, imminent midterm elections, Fed policy uncertainty, a stagnant “no-hire, no-fire” jobs market, signs of consumer distress, another partial government shutdown (or in this case, just the DHS), and rising federal debt now approaching $39 trillion (of which $31 trillion held by the global public)—not to mention the gargantuan total unfunded/underfunded liabilities that comprise guaranteed programs like Social Security, Medicare, employee pensions, and veterans’ benefits (as much as $50-100 trillion), plus over $6 trillion in state and local government debt of which over $2 trillion represents public pension and healthcare liabilities as well as state budget deficits that might eventually need federal bailouts. The states and cities in the worst shape are almost all “blue” due to their onerous tax and regulatory policies and massive nanny-state entitlement programs.

So, is it time to go all-in on these defensive plays? Are we due for another 2022-esque bear market? I think not. I think the core of an equity portfolio still should be US Big Tech stocks, given the entrepreneurial culture of US, disruptive innovation, and world-leading ROI that attract foreign capital, as well as Big Tech’s huge cash stores, wide moats, global scalability, resilient and durable earnings growth, free cash flow, margins. In fact, Bill Ackman’s Pershing Square just announced it increased its holdings in Meta Platforms (META) to $2 billion (10% of investment capital). However, the Big Tech hyperscalers (e.g., Microsoft, Alphabet, Amazon, and Meta) have always been considered “asset-light” with their focus on IP, software, and high ROI on minimal physical infrastructure, but their massive spending on datacenters essentially has transformed them into “asset-heavy,” capital-intensive.

According to the Financial Times, “A total of more than $660 billion is set to be ploughed into chips and data centres this year... The unprecedented infrastructure build-out will force Big Tech executives to choose between stemming capital returns to shareholders, raiding their cash reserves or tapping the bond and equity markets more than previously planned.” This has impacted investor psyches.

Nevertheless, there has been little deterioration in the fundamental story for the economy and stocks, and in fact the earnings projections for the S&P 500 in CY2026 are pushing upwards of 15% YoY, according to FactSet. Moreover, net margins are now at 10-year highs (and climbing)—and it extends beyond just the Tech sector. Cathie Wood of Ark Invest believes the US has suffered through a “rolling recession” (largely due to high interest rates) that have “evolved into a coiled spring that could bounce back powerfully during the next few years.” Indeed, capital flow already seems be returning to the AI infrastructure plays, including semiconductors, hyperscale cloud providers, and specialized networking, if not the software/SaaS firms, as I discuss in greater depth below.

Still, ever since the market low on 11/20, small and micro-cap indexes have greatly outperformed, as have the S&P 500 High Dividend (SPYD), S&P 500 Equal-Weight (RSP), and the Dow Transports (IYT). Value is doing well, too. So, this market broadening and mean reversion on valuations that is underway should also offer other (and likely better) opportunities among the AI infrastructure builders (datacenters and networking equipment) and power generators (beyond the giants and hyperscalers) from Industrials, Utilities, and Energy sectors, as well as small/mid-caps, value, quality, cyclicals, and equal-weight indexes. In addition, you might consider high-quality homebuilders, regional banks, insurers, energy services, transports, and healthcare/biotech/biopharma companies. Also, falling interest rates and rising liquidity suggest bond-proxy dividend stocks. Select small caps can offer the most explosive growth opportunities even if the small-cap indexes continue to lag the S&P 500. When borrowing costs decline and credit spreads tighten, small caps tend to respond earlier and more robustly than their larger brethren.

Historically, small caps tend to outperform during periods of rising economic growth, cooling inflation, and falling interest rates. Indeed, analysts are expecting a rebound in earnings for the Russell 2000 this year, beyond the healthy expectations for the S&P 500. Keep in mind, while the cap-weight large cap indexes are dominated by Technology, small cap indexes tend toward Industrials, Materials, and Financials (including regional banks), which should benefit from broad-based economic activity, infrastructure spending, and reshoring of supply chains. Moreover, a dovish Fed should support the earnings of the more interest rate-sensitive market segments (like small caps) as well as mortgage lenders, credit card issuers, high-quality regional banks, property & casualty insurers (who hold bonds as claim reserves), homebuilders and suppliers, home improvement firms, title insurance firms, REITs, and automakers/dealers.

But whether the broad indexes finish solidly positive this year may depend upon: 1) liquidity growth, 2) the relative strength of the dollar, 3) the steepness of the yield curve (could the 2-10 spread rise above 100 bps?), 4) the status and outlook on capex for AI and onshoring, and 5) the midterm elections and whether Republicans retain the House. According to economist and liquidity expert Michael Howell of CrossBorder Capital, this stage of the liquidity cycle (slowing liquidity growth) is correlated with falling bond term premia and flattening yield curve—which means Treasury notes and bonds may perform well later in the year. Indeed, given where we are with stability in real interest rates and inflation expectations, including the many disinflationary trends—like AI, automation, rising productivity, falling shelter and energy costs, peace deals, a firmer dollar, and the deflationary impulse from a struggling China—bonds seem ready to return to their historical role as a portfolio diversifier.

After the S&P 500’s terrific bull run over the past three years in which the MAG7 accounted for roughly 75% of the index’s total return, I think this year might see the equal-weight RSP and small cap indexes outperform the SPY, with the SPY gaining perhaps only single-digit percentage. This scenario also might favor strategic beta and active management. Regardless, stock market performance should be dependent upon strong ROI and earnings growth rather than significant multiple expansion. So, rather than the broad passive indexes (which are dominated by growth stocks, Big Tech, and the AI hyperscalers), I think 2026 should be a good year for active stock selection, small caps, and bond-alternative dividend payers—which bodes well for Sabrient’s Baker’s Dozen, Forward Looking Value, Small Cap Growth, and Dividend portfolios.

I go much further into all of this in my full post below, particularly regarding inflation and Fed policy. Overall, my recommendation to investors remains this: Focus on high-quality businesses at reasonable prices, hold inflation and dollar hedges like gold, silver, and bitcoin, and be prepared to exploit any market pullbacks by accumulating high-quality stocks as they rebound, with earnings fueled by massive capex in AI, blockchain, energy, and power infrastructure and factory onshoring, leading to rising productivity, increased productive capacity, and economic expansion. Regarding “high-quality businesses,” I mean fundamentally strong, displaying a history of consistent, reliable, resilient, durable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus estimates and a history of meeting/beating estimates, rising profit margins and free cash flow, high capital efficiency (e.g., ROI), solid earnings quality and conservative accounting practices, a strong balance sheet, low debt burden, competitive advantage, and a reasonable valuation compared to its peers and its own history.

These are the factors Sabrient employs in our quantitative models and portfolio selection process. As former engineers, we use the scientific method and hypothesis-testing to build models that make sense. We are best known for our Baker’s Dozen growth portfolio of 13 diverse picks, which is designed to offer the potential for outsized gains. It is packaged and distributed as a unit investment trust (UIT) by First Trust Portfolios—along with three other offshoot strategies for value, dividend, and small cap themes. In fact, the new Q1 2026 Baker’s Dozen portfolio recently launch on 1/20/2026. Also, as small caps and high-dividend payers benefit from falling interest rates and market rotation, the quarterly Sabrient Small Cap Growth and Sabrient Dividend (a growth & income strategy) might be timely investments. Notably, our Earnings Quality Rank (EQR) is a key factor in each of our strategies, and it is also licensed to the actively managed, low-beta First Trust Long-Short ETF (FTLS) as a quality prescreen.

Sabrient founder David Brown reveals the primary financial factors used in our models and his portfolio construction process in his latest book, Moon Rocks to Power Stocks—now an Amazon bestseller—written for investors of any experience level. David describes his path from NASA engineer in the Apollo Program to creating quantitative multifactor models for ranking stocks and building stock portfolios for four distinct investing styles—growth, value, dividend, or small cap.

Here is a link to this post in printable PDF format, where you can also find my latest Baker’s Dozen presentation slide deck. As always, I’d love to hear from you! Please feel free to email me your thoughts on this article or if you’d like me to speak on any of these topics at your event!  Read on….

  by Scott Martindale
  President & CEO, Sabrient Systems LLC

Falling inflation, weak manufacturing activity, cautious consumer sentiment, and sluggish GDP and jobs growth have conspired to elicit a dovish tone from the Federal Reserve and the likely start of a rate cut cycle to avert recession and more jobs losses. I continue to pound the table that the Fed is behind the curve and should have begun to cut at the July meeting.

Why? Well, here are my key reasons:

1. Although official inflation metrics still reflect lingering “stickiness” in consumer prices, my research suggests that real-time inflation is already well below the Fed’s 2% target, as I discuss in detail in today’s post.

2. Last week’s BLS jobs report shows 66,000 fewer employed workers in August 2024 versus 12 months ago after massive downward revisions to prior reports. And if you dig deeper into the August household survey it gets worse, indicating a whopping 1.2 million fewer full-time jobs (yikes!), partially offset by a big growth in part-time jobs.

3. The mirage of modest GDP and jobs growth has been temporarily propped up by unhealthy and inefficient government deficit spending (euphemistically called “investment”) rather than true and sustainable organic growth from a vibrant private sector that is adept at efficient capital allocation. Thus, despite government efforts to “buy” growth, recessionary signals are growing at home and abroad.

4. The burden caused by elevated real interest rates on surging debt across government, business, consumers at home and emerging markets abroad, and the impact of tight monetary policy and a relatively strong dollar on our trading partners must be confronted.

So, a 50-bps cut at the September FOMC meeting next week seems warranted—even if it spooks the markets. As Chicago Fed president Austan Goolsbee said, “You only want to stay this restrictive for as long as you have to, and this doesn’t look like an overheating economy to me.”

A terminal fed funds neutral rate of 3.0-3.5% seems appropriate, in my view, which is roughly 200 bps below the current range of 5.25-5.50%). Fortunately, today’s lofty rate means the Fed has plenty of potential rate cuts in its holster to support the economy while remaining relatively restrictive in its inflation fight. And as long as the trend in global liquidity is upward (which it is once again), then it seems the risk of a major market crash is low.

Regarding the stock market, as the Magnificent Seven (MAG-7) mega-cap Tech stocks continue to flounder, markets have displayed some resilience since the cap-weighted S&P 500 and Nasdaq 100 both topped in mid-July, with investors finding opportunities in neglected market segments like financials, healthcare, industrials, and defensive/higher-dividend sectors utilities, real estate, telecom, and staples—as well as gold (as both a store of value and protection from disaster). However, economic weakness, “toppy” charts, and seasonality (especially in this highly consequential election year) all suggest more volatility and downside ahead into October.

Of course, August was tumultuous, starting with the worst one-day selloff since the March 2020 pandemic lockdown followed by a moon-shot recovery back to the highs for the S&P 500 (SPY) and S&P 400 MidCap (MDY), while the Dow Jones Industrials (DIA) surged to a new high. However, the Nasdaq 100 (QQQ) and Russell 2000 SmallCap (IWM) only partially retraced their losses. And as I said in my August post, despite the historic spike in the CBOE Volatility Index (VIX), it didn’t seem like the selloff was sufficient to shake out all the weak investors and form a solid foundation for a bullish rise into year end. I said that I expected more downside in stocks and testing of support before a tradeable bottom was formed, especially given uncertainty in what the FOMC will do on 9/18 and what the elections have in store.

In addition, September is historically the worst month for stocks, and October has had its fair share of selloffs (particularly in presidential election years). And although the extraordinary spike in fear and “blood in the streets” in early August was fleeting, the quick bounce was not convincing. The monthly charts remain quite extended (“overbought”) and are starting to roll over after August’s bearish “hanging man” candlestick—much like last summer. In fact, as I discussed in my post last month, the daily price pattern for the S&P 500 in 2024 seems to be following 2023 to a T, which suggests the weakness (like last year) could last into October before streaking higher into year end. Anxiety around a highly consequential election on 11/5 (with counting of mail-in ballots likely to last several days beyond that once again) will surely create volatility.

Many commentators believe the Fed is making a policy mistake, but it goes both ways. Some believe the Fed is turning dovish too quickly because inflation is sticky, the jobs market is fine, and GDP is holding up well, so it risks reigniting inflation. Others (like me) think the FOMC is reacting too slowly because the economy, jobs growth, and inflation are weaker than the mirage they seem, masked by inordinate government deficit spending, misleading headline metrics, and political narratives. As Fed Chair Jerome Powell said at the July meeting, “The downside risks to the employment mandate are now real,” and yet the FOMC still chose to hold off on a rate cut. Now it finds itself having to commence an easing cycle with the unwanted urgency of staving off recession rather than a more comfortable “normalization” objective within a sound economy.

Indeed, now that we are past Labor Day, it appears the “adults” are back in the trading room. As I discuss in detail in today’s post, economic metrics seem to be unraveling fast, stocks are selling off, and bonds are getting bought—with the 2-10 yield curve now “un-inverted” (10-year yield exceeds the 2-year). So, let’s get moving on rate normalization. After all, adjusting the interest rate doesn’t flip a switch on economic growth and jobs creation. It takes time for lower rates and rising liquidity to percolate and reverse downward trends, just as it took several months for higher rates and stagnant liquidity to noticeably suppress inflation. Fed funds futures today put the odds of a 50-bps cut at about 27%.

Nevertheless, stock prices are always forward-looking and speculative with respect to expectations of economic growth, corporate earnings, and interest rates, so prices will begin to recover before the data shows a broad economic recovery is underway. I continue to foresee higher prices by year end and into 2025. Moreover, I see current market weakness setting up a buying opportunity, perhaps in October. But rather than rushing back into the MAG-7 stocks exclusively, I think other stocks offer greater upside. I would suggest targeting high-quality, fundamentally strong stocks across all market caps that display consistent, reliable, and accelerating sales and earnings growth, positive revisions to Wall Street analysts’ consensus estimates, rising profit margins and free cash flow, solid earnings quality, and low debt burden. These are the factors Sabrient employs in selecting the growth-oriented Baker’s Dozen (our “Top 13” stocks), the value-oriented Forward Looking Value, the growth & income-oriented Dividend portfolio, and Small Cap Growth, which is an alpha-seeking alternative to a passive position in the Russell 2000.

We also use many of those factors in our SectorCast ETF ranking model. And 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 our alpha factors and their usage within Sabrient’s Growth, Value, Dividend, and Small Cap investing strategies is discussed in detail in Sabrient founder David Brown’s new book, How to Build High Performance Stock Portfolios, which will be published shortly.

In today’s post, I discuss in greater detail the current trend in inflation, Fed monetary policy, and what might lie ahead for the stock market as we close out a tumultuous Q3. I also discuss Sabrient’s latest fundamental-based SectorCast quantitative rankings of the ten U.S. business sectors, current positioning of our sector rotation model, and several top-ranked ETF ideas. And be sure to check out my Final Thoughts section with some political comments—here’s a teaser: Democrats have held the presidency for 12 of the past 16 years since we emerged from the Financial Crisis, so all these problems with the economy, inflation, immigration, and global conflict they promise to “fix” are theirs to own.

Click here to continue reading my full commentary online or to sign up for email delivery of this monthly market letter. And here is a link to it in printable PDF format. I invite you to share it as appropriate (to the extent your compliance allows).

  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....

Stocks continue to consolidate just under their prior high, which is offering formidable resistance. Although many long-standing uncertainties have significantly subsided, others have arisen, including turmoil in a new global hot spot (Ukraine) and the disruptions to the economy caused by the unusually long and brutal winter experienced by most of the U.S.