Your Portfolio “Dogs” Are Set to Start Running

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Last month we shared an important fact about the market…

Most stocks are underperforming at a rate last seen in 2008.

It’s an alarming statistic on the surface. However, we proved how massive relative underperformance tends to forecast market-beating returns.

Whenever the equal-weight S&P 500 trails the regular, cap-weighted S&P by a similar magnitude as today, you should prepare for a catch-up trade for the average stock.

I firmly believe that right now represents one of the best stock-picking environments in years, based on the weak participation under the surface.

Today, we’re reiterating our call for a strong reversion trade coming for the average stock. We’ll offer up another powerful study highlighting why you want to buy into weak breadth markets.

So before you dump your underperformers and pile into popular trades… consider hanging onto those dogs.

Because there’s strong historical evidence that they’re about to get an upgrade.

62% of S&P 500 Stocks Are Below their 50-Day Moving Average

There are a couple of interesting facts about today’s stock market environment.

First, the S&P 500 has steadily climbed to new all-time highs in 2024. At last measure, the index has gained 15.75%.

Second, and more startling, is that earlier this week less than 38% of the S&P’s constituents were above their 50-day moving average.

That’s an incredible statistic when you think about it. It highlights how just a few winners like Nvidia (NVDA) and Microsoft Corp. (MSFT) are holding up the index. They are up 153% and 20%, respectively, this year. (Disclosure, I own MSFT.)

But the reality is most stocks are not holding up. You can feel the weakness across many great businesses including credit card processor Mastercard (MA), cosmetics giant Ulta Beauty (ULTA), and McDonald’s (MCD)… each of which are below their 50-day moving average.

Here’s a look at McDonald’s year-to-date chart, clearly hanging below the 50-day moving average:

For swing traders, this isn’t the ideal setup. They’ve been taught to buy strength and fade weakness.

And there’s been a lot of weakness going around lately.

Here’s a bird’s-eye view of the drastic disconnect in markets lately. The blue line in the chart below is a year-to-date uptrend of the S&P 500 (SPY ETF), and the orange line below it plots the daily percentage of stocks in the index that are above the 50-day moving average.

At the bottom right I point to the recent drop below 38% this month. I also note the low point on April 18 when this reading fell below 26%… right at the market low:

The bad news in today’s piece is that, statistically speaking, you’re almost certainly holding a few laggards in your portfolio.

The great news, though, is that low breadth readings point to market-beating performance coming soon…

Low Breadth Is No Bear Signal

Visualizing data helps investors understand today. But reviewing history helps investors understand tomorrow. This is what’s most important… where the rubber meets the road.

So, let’s look through history and compare the S&P 500’s average performance to this unique situation.

Going back to May 2003, the S&P 500 (SPY ETF) averages a solid 11.1% 12 months after any given day. Not bad.

However, if you were to buy SPY on days when 38% or fewer constituents are below their 50-day moving average, your 12-month average return climbs to 11.4%… so, it’s a tad better. But no game-changer.

Surely there’s a better signal in this data, right?

There is… and it lies in the laggards.

Turns out, betting the average stock will gain is better. When you single out all 38% or lower days and plot the forward performance for the Invesco S&P 500 Equal Weight ETF (RSP), the 12-month forward return jumps to a market-beating 12.7%:

The data is clear as day. There’s a ton of opportunity at the single-stock level.

History points to market-beating gains in the months ahead for the average stock.

And this is how having cutting-edge data at your fingertips allows you to profit.

Betting on an equally weighted basket of stocks, like the RSP ETF, is one way to play this theme. But you can do better… a lot better.

TradeSmith’s software is fine-tuned to spot the top stocks in the market. By using Jason Bodner’s Quantum Score, readers were able to lock in Super Micro Computer (SMCI) before the breakneck rally this year.

It happened again with AI networking firm Arista Networks (ANET)… with that stock soaring triple digits since it was initiated.

I see a similar setup unfolding in the months and years ahead.

The average stock will have better days…

BUT, outlier stocks will have the BEST days.

Focus there!

Sign up for Quantum Edge Pro here.

Regards,

Lucas Downey
Contributing Editor, TradeSmith Daily