This Forgotten Class of Stocks Is Worth a Second Look

Listen to the audio version of this article (generated by AI).

 

In This Digest: 

• Small caps are leading the market – add these to your watchlist 

• This signal in Reddit (RDDT) points to big gains ahead 

• Why two steelmakers are a key positive sign for the U.S. economy 

Small caps are leading the market once again… 

For the last five years, small-cap stocks have been lagging. 

The Nasdaq-100 (green line below) has climbed close to 100% over that stretch. The S&P 500 (dark blue) is up around 70%. The small-cap S&P 600 (light blue) has trailed both, up a little over 30%. 

That’s no longer true. So far this year, the small-cap S&P 600 is up roughly 22%. Compare that to a 17.6% gain for the tech-heavy Nasdaq-100 and a 13% gain for the large-cap S&P 500: 

Not only are they winning, but they’re also doing it with less drama. 

The biggest loss this year from the S&P 600 has been 8.4%. The Nasdaq-100 has fallen as much as 11.4% over the same stretch.  

And right now, the small-cap S&P 600 index has the highest share of stocks in Short-Term Health Green stocks in our system right now.  

Regular readers know Short-Term Health is our bedrock momentum indicator. It compares a stock’s recent price swings to its own typical trading range, then sorts the result into a Green, Yellow, or Red Zone, depending on whether that momentum is holding steady, wavering, or breaking down. 

Right now, 64.6% of the S&P 600 is in the green. Meanwhile the S&P 500’s is 57.3%. And the Nasdaq-100 only has 39% of its stocks in the green… 

These small-cap stocks are a cut above the rest… 

This morning I pulled up a screen for stocks in the S&P 600 that: 

• Are green on their Short-Term Health status, indicating healthy momentum  

• Have a Business Quality Score – TradeSmith’s proprietary 21-factor fundamentals rating system – above 80 

• And have a Free Cash Flow yield of more than 5% – its cash flow makes up a significant share of its total value 

That cuts the S&P 600 index down to just 47 stocks. Here are the 10 most recent buy signals: 

Sleep apnea research and treatment maker Inspire Medical Systems (INSP) is the freshest signal on the list, just two days into a new Green Zone. It carries a Business Quality Score of 93 and jumped more than 19% over the past month. 

Asset manager Artisan Partners (APAM) has the highest quality score in the group at 98 – along with an 8.6% free cash flow yield and a 19% gain over the last month. 

And keep an eye on Yelp (YELP). It had a rough week, down nearly 5%, but it’s sitting on a free cash flow yield of almost 20% – the biggest on this list.  

The market is full of great small-cap stock ideas, and Short-Term Health is the key momentum filter to use. 

We’ve built a strategy around these Green Zone stocks. Each month, it selects stocks that are in Short-Term Health Green Zones and are bullish on colleague Marc Chaikin’s Power Gauge. 

That second part is key. If you don’t already know Marc, he’s worth getting to know. 

He started on Wall Street in 1966 with nothing but a phone, a notepad, and a drive to understand what actually moves stock prices.  

Since then, he’s built a quantitative system trusted across the industry, working on Wall Street for more than 50 years, surviving 10 bear markets, and building three indexes for the Nasdaq. 

Bloomberg and Reuters carry his Chaikin Money Flow indicator on terminals worldwide, where banks, hedge funds, and other institutional investors use it to track where the big money is moving. Building on that work, Marc later created the Power Gauge – a 20-factor model that evaluates stocks the way institutions do, blending fundamentals, technicals, and real-world money flows into a single read. 

We recently partnered with Marc to combine the Short-Term Health indicator with his own Power Gauge to create a new monthly trading strategy.  

Backtested to October 2019, this strategy grew money at an average pace of 32% a year – more than double the S&P 500’s roughly 14% – with a maximum loss only marginally steeper than the index’s.  

Keith Kaplan and Marc Chaikin walk through the full system – along with one stock they recommend buying and another to avoid – in their Tipping Point research presentation. Get the full details here. 

Lucas Downey just dropped his latest signal study… 

Signal studies help you gain an edge on what’s coming next by looking at the past. 

By isolating specific, rare conditions in stock price movements, you can compare them to what’s historically happened next. 

On Aug. 3, for example, he noted Reddit (RDDT) slid 20% after its earnings report – driven mostly by jitters over its Google AI-licensing deal and a small decline in U.S. daily active users.  

Lucas found 102 prior instances of RDDT falling 20% or more over a similar stretch.  

A month later, the results were close to a coin flip. But three months out, shares were higher 80% of the time, with an average gain of 26%.  

Six months showed that same 80% win rate with an even bigger average gain.  

And a year later? Shares were higher in all 102 instances, averaging a 51.3% gain. 

Lucas called RDDT a buy up to $149. And in just the few days since his recommendation, RDDT has well cleared that level. 

Keep an eye on RDDT in the months to come – because the data is pointing to a recovery. 

And for more data-driven ideas like this, stay tuned here to TradeSmith Daily.  

Keith Kaplan thinks these two steelmakers are a key sign for optimism… 

Over on his X account, Keith Kaplan flagged Nucor (NUE) and Steel Dynamics (STLD) this week – one at all-time highs and the other a stone’s throw away. And according to him, these two steelmakers pushing higher is a reason to be optimistic about the U.S. economy. 

Keith says steel is one of the most cyclical businesses there is, and that makes it a good gauge for the economy.  

Nobody builds a data center, a bridge, or a car factory without buying a lot of it first. So when steelmakers are running hot, that’s usually construction, manufacturing, and infrastructure spending running hot right alongside them. 

Keith flagged Nucor, and our Predictive Alpha model backs up his optimism. 

Predictive Alpha is TradeSmith’s AI-powered forecasting engine. It’s trained on more than 100 billion data points spanning decades of market history to forecast the price of stocks up to 21 days out.  

For Nucor, trading at $272.72, Predictive Alpha’s Prime Projection points to $291.06 by Sept. 3 – a 6.76% move – with a Historical Target Accuracy of 67.19%.  

Nucor also flipped into a Short-Term Health Green Zone five days ago, meaning our momentum read and our forecasting model are both pointing the same direction at the same time. 

Keep an eye on steelmakers, and NUE specifically, over the coming weeks. 

To building wealth beyond measure, 

Michael Salvatore 
Editor, TradeSmith Daily