Stellar Year For Stocks Now Suggests Strong Follow-Through In 2020

As yet another decade comes to a close, the US continues to enjoy the longest economic expansion on record. And as if to put a cherry on top, the economic reports last week hardly could have been more encouraging for the New Year, propelling the S&P 500 index into its third major technical breakout since the recovery from the financial crisis began well over 10 years ago. In particular, the jobs report blew away estimates with 266,000 new jobs, the prior month’s report was revised upward, and the unemployment rate fell to a 50-year low of 3.5%. Importantly, those new jobs included 54,000 manufacturing jobs. Indeed, a growing view is that the manufacturing/industrial segment of the economy has bottomed out along with the corporate earnings recession and capital investment, with an economic upswing in the cards, which has been a key driver for the resurgence in value and cyclical stocks with solid fundamentals.

The good news kept coming, with the Consumer Sentiment report jumping back up to 99.2 (and averaging 97.0 over the past three years, which is the highest sustained level since the Clinton administration’s all-time highs), while wages are up 3.1% year-over-year, and household income is up 4.8% (to the highest levels in 20 years). And with capital rotating out of pricey bonds into riskier assets, it all seems to me to be more indicative of a recovery or expansionary phase of the economic cycle – which could go on for a few more years, given a continuation of current monetary and fiscal policies and a continued de-escalation in trade wars.  

To be sure, there have been plenty of major uncertainties hanging over the global economy, including a protracted trade war with China, an unresolved Brexit deal, an unsigned USMCA deal, and so on. And indeed, investors will want to see the December 15 trade deal deadline for new tariffs on China postponed. But suddenly, each of these seems to have a path to resolution, which gave a big boost to stocks today (Thursday). Moreover, a pervasive fear that we are in a “late-cycle” economy on the verge of recession was becoming more of a self-fulfilling prophesy than a fundamental reality, and now there is little doubt that investor sentiment is starting to ignore the fearmongers and move from risk-averse to risk-embracing, which better matches the fundamental outlook for the US economy and stocks, according to Sabrient’s model.

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 have turned bullish, while the longer-term technical picture remains bullish, and our sector rotation model also retains a solidly bullish posture.

By the way, you can find my latest slide deck and Baker’s Dozen commentary, which provide details and graphics on two key developments:

  1. The bullish risk-on rotation since 8/27/19 is persisting, in which investors have shifted away from their previous defensive risk-off sentiment and back to a more optimistic risk-on preference that better aligns with the solid fundamental expectations of Wall Street analysts and Corporate America.
  2. We have developed and introduced a new Growth Quality Rank (GQR) as an enhancement to our growth-at-a-reasonable-price (aka GARP) model. It is intended to help provide better “all-weather” performance, even when investor sentiment seems “irrational.” Read on….

Market Commentary:

A new enhancement to Sabrient’s GARP model:

First, allow me to expand a bit on Sabrient’s new Growth Quality Rank (GQR). As you recall, we developed and introduced into our GARP model an Earnings Quality Rank (EQR) back in 2013, with expert assistance from the Gradient Analytics team of forensic accounting analysts, to help us focus on companies with less aggressive accounting practices relative to their industry peers. Similarly, GQR will help us to focus on those companies with more consistent and reliable earnings growth trends and are thus more likely to achieve their growth forecasts. We developed it in response to the anomalous market conditions and seemingly irrational price moves (as opposed to changing fundamentals) not only for the June 2018 thru August 2019 timeframe (when a historic valuation bubble formed in low-volatility/defensive/large-cap overvalue/cyclical/small-mid-cap) but in fact for much of the time since mid-2015 (when the last presidential election campaign kicked into gear, the Fed turned hawkish, and China fessed up to its growth challenges).

Our testing shows that the enhanced GARP-GQR model should reduce the volatility (and downside) in our portfolios when adverse and unexpected market conditions arise (like the recent 6/11/18—8/27/19 timeframe) without significantly reducing upside potential – which should be exciting for investors in any of our GARP portfolios, including the Baker’s Dozen. The chart below illustrates the potential improvement in “all-weather” performance.

Comparison of Sabrient GARP models

You can see the strong correlation between a theoretical rolling annual portfolio of our actual published January Baker’s Dozen model portfolios since inception in 2009 and the underlying “GARP-Aggressive” model as run in a 50-stock quant simulation with a quarterly rebalance. Although the new GARP-GQR model is also correlated during most years, the 50-stock quant simulation with quarterly rebalance is notably less volatile. While displaying a similar cumulative return (for the nearly 11-year test), it has a 15.17% standard deviation and a Sharpe Ratio of 1.24 versus 19.94% and 0.95 for the existing model.

And importantly, the down years are significantly ameliorated. Indeed, the horrid performance during 2018 for both the rolling Baker’s Dozen and the underlying GARP-Aggressive model is greatly improved in the new model (and it even beats the benchmark S&P 500). [Note: The gross hypothetical back-tested performance does not represent the results of actual trading and does not consider transaction costs or fees. Actual returns from live portfolios may differ materially from hypothetical returns.]

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Disclaimer: Sabrient's newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into ...

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