TradeSmith readers should be more than familiar with my colleague Jason Bodner at this point; he’s the face of Power Trends, the TradeSmith Investment Report, and the head of the Quantum Edge Pro service – where our Quantum Score stock-ranking system gets its name.
Jason is a good friend of mine, and he’s got a background worth keeping in mind: as a former algorithmic trader who’s managed over $13 billion in assets, Jason has a passion for data-driven investing that’s made him a perfect fit here at TradeSmith. He’s been hard at work, maintaining and updating the algorithms and tools at the heart of the Quantum Edge system – and he’s ready to share a few new findings as part of “Project Greenlight.”
I’ve been eager to hear more about his recent research, and I think the developments are worth sharing with the TradeSmith audience as a whole. Read on for a transcript of our latest chat, to get a sneak peek at his latest findings… and to find out what’s been cooking over at Quantum Edge Pro.
Mike Burnick: Thanks for joining us again, Jason.
Jason Bodner: Always a pleasure, Mike!
Mike: All right. The biggest question we’ve got foryou, Jason is you’ve got to tell me:
What in theworld are your New York Rangers going to do duringthe off season, to somehow keep up with myFlorida Panthers? Who are Stanley Cup champions now, by the way.
Jason: Well, let’s just be clear here! I live in Florida. I’ve been a Rangers fan since 1987, but I do live in Florida. The Panthers are my second supported team.
So as painful as it was when they beat the Rangers – you know, it was obvious who I was cheering for in the finals.
Incidentally, I’m about to buy, not season tickets, but the Panthers do like a Flex plan? I’ll be going with that. So, I split and I share my love. It’s like having multiple children.
Mike: Ha!
Jason: But to answer your question, the Rangers didn’t do anything. So, I don’t know. It’s going to be sad… It’ll be sad.
Mike: Maybe a repeat for the Panthers then, this year! But I’m glad to hear you’re buying a season ticket plan. I’ll be sure to hit you up for some seats at some point.
Jason: Yeah! Actually, I believe I owe you at least one lunch – so we can do it over a game.
Mike: That’ll be even better! Let’s go ahead and dive into the financial markets, then – which have been crazy lately, with all the up and down volatility. Of course, I know you follow the hard data Jason, regardless of what the market does on a day to day or week to week basis.
And you know, your Quantum Edge system that you introduced here at TradeSmith, it blends both fundamental and technical data – plus your own proprietary Big Money patterns on about 6000 stocks.
I realize you can’t give away all your secret sauce here, but can you give us an overview of how your Quantum Edge system works? How do you use it to select stocks that are likely to outperform the market?
Jason: That’s a great question. I was actually just talking to a portfolio manager about this. Now he’s a quantitative guy. He got a job at a qualitative-style fund: bottoms-up fundamentals, you know, digging into statements and looking at supply chains and things like that.
And I made this point to him: The beauty of the quantitative process is agnostic. We don’t care what you do, who you are, what kind of company you are, or where you’re based. All I care about are some basic fundamental things – things like, do you make money, are you profitable, are you growing your sales? Are you growing your revenue? And are you doing so responsibly, like debt-wise?
So, we can quantify numbers to neutralize the entire playing field and get little… “grades,” if you will – these are the Quantum Scores.
And then we look at things technically as well, you know, is the stock trending higher? Is there money moving into the stock? How is the stock performing versus its sector? Things like that. I’m giving you actual inputs into my model, which again, tries to level the playing field for all 6000 stocks and score them evenly.
So again, if we’re talking about debt for a moment, somebody might say, “well, you can’t penalize a real estate corporation that has to finance a huge portfolio for its debts, and then compare them to say a big tech company – because it’s not a fair comparison.”
My response to that would be, yeah, you’re right. But in a universe of 6000 stocks, there are real estate companies that don’t have debt. So, I care about those more.
Mike: That makes sense to me!
Jason: We really are agnostic about these things, and we try not to get bogged down by the little differences between companies. And when you have what we in data science call a large sample size… You have 6000 stocks, that’s a lot larger than 600 stocks or 100 stocks.
When you have a large sample size, you can afford to be very choosy. So, we take those inputs, we run them each day. My computers work while I sleep.
And in the morning, I get a printout of stocks. They each have a score based on technicals and fundamentals. And then we look separately through an algorithm that calculates when we believe there are unusual amounts of money moving in or out of a stock.
And when we have unusual amounts of money moving into the best ranked stocks, it’s really only happening on a handful of stocks every single day – and maybe that’s 20 stocks per day that see money flows moving in that are high quality, and 10 stocks per day that are seeing money flows out that are really low quality.
I gather all those up at the end of the week and I take the best of those and the worst of those. If you imagine like a big bell curve, we’re just playing in the little tails.
Everybody else can fight over everything else. That’s kind of how it works.
Mike: So, in other words, you’re looking for just the best of the best.
Jason: Just the best of the best. Yes, exactly.
Mike: And obviously, the proof is in the pudding: your track record’s done extraordinarily well this year, with stocks like, Garmin Ltd. (GRMN) up about 80%, and Tradeweb Markets Inc. (TW) up almost 60%.
And of course, you were early on in Super Micro Computer Inc. (SMCI) and made a killing in that. Do you see technology stocks like these continuing, you know, to be the best bet going forward? Or do you think we may see some changes?
Jason: Well, I thinkthat partially depends on the incoming administration, whoever it is. Is it an extension of the Biden administration, which has been very friendly to tech, or is it a new Trump administration – which we’ve already gotten a sample of what that’s like for four years, he tends to be very friendly for small business, small-caps, and value stocks.
In any case, in the long term, I’m very bullish on technology. I mean, I’m looking at your screens, right? You have four screens in your office there.
You’ve probably got an Alexa if you use Amazon often, you’ve got a phone, you’ve got an Apple Watch, everybody’s wrapped and bathed in technology. Our demand and usage is only increasing.
So, even though we may experience a short to mid-term headwind for technology companies, the bottom line is consumerism is really driven by and along with technology, so I still see a ton of upside there. But we might see some near-term bumps, especially if Trump takes office in January.
It’s going to be a little bit of headwind pressure for stocks in that case, because a Democratic administration has been, historically, very friendly to large cap tech.
But where I will see opportunity if Trump wins is smaller-cap tech, small and mid-cap tech should start to take off because I think, you know as well as I do for much of say, 2023 the Nasdaq was held up by seven stocks. And the capital, the market capitalization of the entire index was like 40% of the market in seven stocks.
Mike: That’s right. Inside TradeSmith readers will be familiar with the idea.
Jason: Right. It was so imbalanced – and that’s where all the performance was. But it will be interesting. And the last footnote there is, regardless of who takes office, interest rates are going to fall.
I have a hunch we’re going tobe talking about that later in this interview. But as interest rates fall, that also benefits small and mid-cap stocks, and even the larger tech stocks.
Mike: Yeah. Absolutely. I’m glad you mentioned small-caps. Because I read something interesting you published last week.
I think it was data showing how much the Russell 2000, which is all small-cap stocks, significantly outperforms most other stocks and sectors or styles when interest rates do decline. Tell us a little bit more about that? What your research showed you in terms of the absolute returns for small-cap?
Jason: I see, I mean, it was really interesting – and we looked at different periods throughout time, what we found were a couple of things. So, let’s just think about it. Logically smaller companies tend to have less cash on hand. Right.
They’re struggling to grow, they’re struggling to emerge and make it. They finance a lot of their growth. So, in a high interest rate environment, that’s kind of punitive to them. It hurts: higher interest rates hurt.
So, one can only imagine that as rates start falling, that can fall directly to the bottom line of the companies as they don’t have to spend more to borrow.
Mike: Yes. It reduces their cost structure quite a bit since they do borrow so much, small caps.
Jason: Yeah, like the noose gets loosened and they can go do what they do best, which is grow, which is great.
So that’s the logical side. Now, we looked at different periods in history and I found three periods which I’m just going to grab while I’m talking to you, so I have them in front of my face here.
In early 1990, interest rates peaked and started to fall. The Russell 2000 rose from 1990 to 1992. It rose 19.5%. Then in 1995, rates peaked somewhere around February – March, I think it was. And the Russell 2000 went on to rally 36%.
Mike: Wow! Big difference.
Jason: Yeah, in 2019, same thing: rates peaked and the Russell 2000 rallied 50%.
Now, what makes these super interesting is in 1995 when we saw really strong performance, that 36%. That was the only time period where there was not a recession.
So, rates are peaking. Now, everybody’s pretty uniformly in agreement: They’re gonna fall, and we’re not in a recession. As a matter of fact, I read somewhere that most S&P 500 earnings calls stopped talking about a recession.
And the Bank of America CEO removed recession from the base case of all of their research. So, if we’re not in a recession and rates are gonna fall, it’s very bullish for small cap stocks, specifically.
Mike: Win-win for small caps, either way.
Jason: That’s how I see it. Absolutely.
Mike: All right. Makes sense.
Of course, small caps are always pretty volatile, with big up and down swings we’ve seen just in the last couple of months. But you, you’re thinking the small caps can continue to outperform going forward – as your study showed?
Jason: Yes. And I think we also want to point to the fact that they’ve been underperforming for a long time now in a high-rate environment.
We just talked about Nasdaq and large-cap tech in 2023. It was obviously a tough year for tech in 2022. But last year, things were great – and much of the beginning of this year as well. You saw NVDA, you saw SMCI, you saw these big tech companies fly to the moon.
All the while small caps were just kind of, you know, they were the fish lying in the dry riverbed, gasping for air. And the air comes in the form of lower interest rates, which is more capital for growth.
So, I do think it’s gonna be a great time for those stocks.
Mike: That’s great – because they have been much maligned for a long period of time. Small caps have underperformed, but it would be nice to see them back in the driver seat again.
So then, Jason, one final question: You touched on this, since of course it’s on everybody’s mind. The Federal Reserve has their next policy meeting coming up next week. So then, will they or won’t they cut rates? And if so, by how much?
Jason: Well, I think they’re definitely gonna cut rates. There’s no question. I think a lot of people are now asking, is it going to be 25 or 50 basis points? Right.
I personally think, it would be great if it was 50 because we’d get a massive rally. But, I think it’s going to be 25 basis points. I don’t think the Fed wants to be perceived as being totally behind the eight ball – which they are… But if they cut it by 50 points, they’re basically admitting they dropped the ball.
Now, there are several reasons why I think it’s almost certain to cut.
So, the spread between the effective Fed interest rate, which is around 5.33%. You take the middle of five and a quarter, 5.5 is significantly above CPI, which is the preferred benchmark for inflation.
So then, CPI. I think it dipped even down below three for the first time since 2021, right? The Fed’s long-term target, as they said, is 2% inflation. My data says since 1960 – so we’re talking 60-some-odd years here – the average reading for the Consumer Price Index (CPI) is 3.87%. So, we’re significantly below that. And then you want to look at market rates, where the market thinks interest rates should be.
And if we look today, the 10-year bond, which is a great sort of yardstick for the market’s expectation of interest rates, is at 3.7%.
So, the spread between 5.33 and the 10-year bond at 3.7% and the spread between that and CPI… well, the Fed is just way off site. They’re just… you can’t fight market rates for much longer.
The Fed even acknowledged that they’re cutting rates. So, it’s definitely coming. I think it’s 25 basis points in September and even another couple of cuts this year after that.
Mike: Yeah, it is. Definitely. You’re correct. Right on the money saying the Fed is sort of behind the curve here just as they were when inflation started to take off in 2021, they dragged their feet on raising rates. Let’s hope they don’t drag their feet too much on lowering rates back down to more of a neutral rate.
We’ll have to wait and see what they come out with next Wednesday.
Jason: Yeah, it’ll be interesting. I think it’s clear they don’t want a recession. But they are very patient. Wall Street is very impatient. The truth probably lies somewhere in the middle.
Mike: Right. So, let’s talk a little bit about stock market sectors going forward, especially in a rate cut environment.
Some of the cyclical sectors and some of the interest rate sensitive, obviously like financials do well. Financials have been doing well, perhaps anticipating those rate cuts. What is your research and your money flow data particularly telling you are the best sectors to be looking for opportunities right now?
Jason: It’s interesting. We did do a study that showed financials is probably the biggest beneficiary of lower rates. But like you said, rate-sensitive securities like REITs are worth looking at too – you know, in order to legally qualify as a REIT, you must agree to pay between 70% and 90% of your net profits in the form of a dividend? And typically, those are very high yielding stocks.
So as rates are going to collapse…
By the way, we need to bring up the elephant in the room here. Which I will in just a moment, but do remind me about that if I forget, Mike.
Anyway, as rates collapse, people are going to be seeking higher-yield stocks like real estate stocks and utilities, but financials are also going to benefit.
But I guess the elephant in the room – and this is something we’ve been talking about for a long time – is that as of today, there’s $6.4 trillion sitting in money market accounts, collecting 4 or 5% depending on who’s paying. It’s an easy 5%.
Guess what happens when rates cut? When those rates fall, all that cash sitting around earning an easy 5% won’t be doing that anymore.
And we call it something: The Income Heist. Because let’s just say the Fed cuts two full percentage points over the next 18 months, for argument’s sake. And we go from 5.35% to 3.25%. That seems a little fair, right?
That’s a massive 40% drop-in interest rates.
So, imagine you’re sitting earnings income in the form of interest rates in a money market account. Suddenly you’re earning 40% less. That’s going to be flooding into stocks. And specifically, I think those interest rate-sensitive stocks like REITs and utilities are going to benefit. Financials too, of course.
And then these smaller cap value stocks, like we said, when they’re refinancing their debt and they have more money in the bottom line? They’re going to start to zoom too. Yeah, I think it’s a very bullish set up myself.
Mike: Yeah, I totally agree with what you’re saying there. I think you’re going to see the money come out of money markets just as fast, if not faster than it went in, because those rates are going to go down a lot faster, a lot quicker than they went up.
So, I know you’re involved in a new project: Project Greenlight. You talked a little bit about that earlier. Talking about how you can spot some of the stocks that Wall Street is buying. Getting a look at what the algorithmic traders who control most of Wall Street trading these days are doing. Tell us a little bit about that, and what folks can kind of glean from that?
Jason: Well, Project Greenlight is all about putting these algorithms to work. The same ones that we spoke about earlier: identifying unusual money flows into the best quality stocks.
With our tools, you literally get a green bar – like a flash of light in the visualization of these signals. And what we found is over a 34-year history, that track record that you pointed to that we experienced this year, which was great.
We use this process, this Project Greenlight process, to identify when these money flows are moving into the highest quality stocks. We’ve done a ton of back testing, and over 34 years, we win about 70% of the time – and our winners are larger than our losses.
So, this is a repeatable process. The Project Greenlight event’s about going in and talking about how this actually works, what these are highlighting and why it works tomorrow, yesterday, next month, next year.
Really, we’re just following the money into the best quality – and that’s what yields these results. That’s what it’s all about.
Mike: Yeah, that’s what everybody is looking for: repeatable, consistent edge in the markets. And you certainly have that in your Quantum Edge system.
Well, listen, Jason, thanks for taking some time out to catch up with me. I always love hearing your takes on the market andwhat’s coming next.
So just let us know where those green bars are showing up.
Jason: Thank you. I will! That’s what we do. You know, another thing about the green bars is that the machines do it for me, right? I built this as a stock picking system so I wouldn’t have to stare at screens all day, and then I just get this report and it kind of filters out the noise.
You know, one last concept I want to leave you guys with is there was a professor: Hendrik Bessembinder at Arizona State University. He studied the performance of all stocks since 1926, with no survivorship bias. If they went out of business, you lost 100% of your investment, everything.
What he found was… Well, he asked a very simple question: Do stocks outperform treasury bills over that period? Nearly 100 years.
I think everybody knows the answer is yes. You look at the stock market. It went in one direction in 100 years and bonds kind of moved differently, right? Well, what Professor Bessembinder found, Mike, was that only 4% of all listed stocks since 1926 account for 100% of the out performance of stocks over bonds.
Mike: Just 4%? Really?
Jason: Just 4%. So that means 96% of stocks can’t even meet government bonds. So, you really have to be in the right stocks. And that is what we built for the Quantum Edge system. That’s what Project Greenlight is all about: identifying and living in that tiny 4% as much as we can.
Mike: There you go. Well, thanks for sharing that with us. I appreciate it – and we’ll talk to you again soon.
Jason: Thanks for having me. Looking forward to that Panthers lunch!
Mike here.
With interest rates set to fall and the uncertainty of the U.S. presidential election on the horizon, it can be challenging to find the right opportunities to weather the spiking end-of-year volatility. Here at TradeSmith, we take a data-driven approach – but Jason’s Quantum Edge tools are especially powerful in these shifting market environments.
Jason’s tools are doubly useful now, because they evaluate both the fundamentals and the market interest of a stock – an approach all of us here at TradeSmith tend to favor – then combines that with his own Big Money Index. By focusing on only the “best of the best,” and tracking the flow of capital in or out of those stocks, he’s able to select high-quality trades to focus on… just as they catch the attention of the biggest investment funds and institutions in the market.
As part of his ongoing research, Jason has launched “Project Greenlight.” It’s all about how algorithms and AI tools are taking the wheel when it comes to Wall Street’s day-to-day trading – and how to turn that fact into an advantage for you and your portfolio. To learn more about what Jason’s been up to, click here to check out his latest video report.
Good investing,
Mike Burnick
Senior Analyst, TradeSmith