The negative sentiment and disbelief about the current stock market rally remain pervasive. With this as a backdrop, we ran our monthly update of our single stock quantitative selection model (ERM) this past week, and the bullish conclusions coming from our deep dive were quite interesting.

Our latest review shows that the healing process, which began in late-March, continues strongly and impressively. The number of stocks in our ERM model that have shifted to favorable has increased nearly every week and is still rising.

I cannot overstate how supportive this is for equities. In other major earnings revisions bottoming periods, post-Tech Wreck in March ’03 and post the Great Financial Crisis in March ‘09, my work looked very similar to the current period. In these periods, when earnings revision hit their lows, powerful rallies followed.

When looking at the broad-based S&P 1500 Index on cap size basis, Large Caps (S&P 500) revisions are still the best followed by Midcaps (S&P 400) and finally Small caps (S&P 600). I believe that structure will stay in place until COVID-19 starts moving into the rearview mirror. But once this does happen, I expect a major shift in relative performance on many levels.

There are currently two main areas of favorable readings: Secular Growth/FAANG and Value/Cyclicals. COVID-19 cases around the U.S. rose over the past four weeks, and economic growth has slightly downshifted. Not surprisingly with this rise in cases, some of the front-line Value/Cyclical impacted names (as my colleague Tom Lee refers to as “Epicenter” stocks) are still struggling. Importantly, however, I have high conviction that this is just part of the longer-term healing process that just takes time.

Relative to low expectations, the 2Q20 earnings season has been a homerun in my view. I had been very bullish on the outcome and the results were even better than expected. We are still recommending a barbell approach that includes a mix of FAANG/secular growth stocks and cyclicals/value as Overweights and defense and cash as Underweights.

I expected that earnings revisions would lag on an absolute basis, but would be “less bad”, which is exactly what has happened. Going forward, profit expectations should start flipping from slowing cuts to outright raises during the next 1-6 months. This will be critical, and, if I am right, the backdrop for equities will stay constructive for the remainder of 2020 and beyond.

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