An Essential Rotation Play for ‘25 an d Beyond

An Essential Rotation Play for ‘25 and Beyond

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BY LUCAS DOWNEY, EDITOR, TRADESMITH’S ALPHA SIGNALS

Three months ago, stocks were in the value bucket.

The post-tariff chaos smacked the stock market down close to 20%… and reined in valuations along with it.

April’s monthly close saw the average trailing 12 months S&P 500 price-to-earnings ratio at 26.4 – the cheapest since April 2024.

But since those April lows, the S&P 500 has screamed over 25%… And it’s now trading at its highest trailing 12 months price-to-earnings multiple since March 2021.

But even more impressive is the small-cap benchmark Russell 2000, gaining an impressive 27.28% and outperforming the S&P 500 over the same span. That’s put it at around 17.4x trailing 12 months earnings.

With such a violent snapback across the board, and rich valuations in large caps, it’s imperative to be choosy with new additions.

We all can probably recognize that at some point in the future a healthy pullback will ensue…

…and low-quality highflyers will be the last place you’ll want to be overweight.

In fact, small caps’ relative value and strong performance are looking mighty attractive.

Just last week, my colleague Jason Bodner discussed the small-cap revival.

He pointed out reasons why this left-behind group could be a great bet.

In that same vein, I agree.

Given the new policy shifts with the One Big Beautiful Bill Act and impending rate cuts on the horizon, you’re better off focusing on areas that can thrive given these tailwinds.

Today I’ll break down two powerful signal studies that suggest one red-hot, out-of-this-world ETF is due for a cooldown… And another is ripe for big gains in the months ahead.

The winds are blowing strongly into the small-cap sails.

But today we’ll dive deeper and uncover one sector primed in just the same way.

Seeking the small-cap gems in this specific area might be the best play for 2025 and beyond…

But first, let’s talk about a sector that’s flung too far, too fast.

Space Stocks Are Set to Come Back to Earth

If you know me, you know I’m a glass-half-full kind of investor.

I’m always looking for the positives and the upside opportunities. That vantage point has served me well over the years. You only have to look at any long-term stock market chart for the proof.

However, when you look over mounds of data each day, every now and then something pops out and requires further investigation… And in some cases, the odds favor a pullback.

That’s where we find ourselves today with the Ark Space Exploration & Innovation ETF (ARKX).

As the name conveys, this fund bets on companies tied to space.

It currently holds 32 equities including mega-caps like Google (GOOGL) and Amazon (AMZN).

But it also holds smaller, more speculative names like Rocket Lab (RKLB), which has gained an impressive 68% in 2025, and Kratos Defense (KTOS), which has soared nearly 100%.

These big performances have helped send ARKX up over 30% year-to-date, crushing the S&P 500’s 6.6% rally:

Now, I would never suggest shorting ARKX. But if you’re looking to take profits, now could be a great time.

Here’s why…

When you look under the hood at all the holdings in the basket, 81% of the stocks are above their 200-day moving average (200DMA). Turns out, that’s quite a large amount going back the last few years.

Below shows this beautifully. Note that the ETF tends to not have this strong of breadth for long periods of time:

I was able to locate 28 prior dates in history where the percentage of stocks above their 200DMA was 81% or higher.

In most cases and timeframes, the ETF traded lower and the win rate was extremely low with a:

Now, I fully recognize there are some great stocks in this basket…

But let’s also realize that some are likely due for a healthy pullback.

It may make sense to deploy capital into an area primed for more data-driven success.

Fortunately, I’ve found a great one that no one is talking about.

Homebuilders Are Quietly Breaking Out

A lot of negative rhetoric has been said about housing lately.

High interest rates have caused new home sales to decline.

Finding a constructive view of the housing sector may seem silly. But the data suggests this area is exactly the place you want to be building positions in.

The SPDR S&P Homebuilders ETF (XHB) is a basket of 35 stocks levered to homebuilding.

The fund includes popular homebuilders like Lennar (LEN), PulteGroup (PHM), and Tri Pointe Homes (TPH).

It also has allocations to retail giant Lowe’s (LOW) and one company I wrote about recently, HVAC player Trane Technologies (TT).

If you’re looking to get exposure to everything home-related, XHB is the ticket. And as you’d imagine, the fund has struggled this year, gaining just 1.1%:

But looks can be deceiving on the surface.

By studying the number of stocks in the basket that are above their 200DMA, you’ll see this group is building a base… and rising from rock bottom.

As of July 9, the percentage of stocks in XHB that were above their 200DMA was 38.8%. But just a handful of days prior at the end of June, that number was at 13.89%:

Now, we all learn to buy when stocks break out and to follow the trend. However, we can see that below 14% is in the lower bucket of datapoints.

Here’s why it’s a smart idea to bet on homebuilders here.

I went back 10 years and found 280 discrete dates where the percentage of stocks in XHB above their 200DMA was less than 14%.

Big gains tend to follow with:

The win rates at the bottom are all strong too, with a 61% win rate after one month continuing to rise as time marches on.

This is a smart setup just on a pure data perspective.

Now, throw in the fact that rates are slated to fall over the next year… which will unlock the frozen housing market.

It’s only a matter of time before this group finds its former glory.

If you’re looking to pare gains in some of your riskier highflyers… You have my blessing.

Just keep focused on where the money is rotating…

The homebuilders sector hits the target.

Regards,

Lucas Downey
Editor, TradeSmith’s Alpha Signals

(Lucas Downey held a position in AMZN and GOOGL at time of writing.)

Note from Michael Salvatore, Executive Editor, TradeSmith Daily: If you’re looking for another way to profit from small caps’ comeback, the AI space is buzzing with opportunities right now…

From my perspective, most investors are way too focused on richly valued, large-cap tech stocks right now… especially those in the once-Magnificent 7.

Some of these companies are great. But we cannot expect the same kind of returns going forward that we’ve seen since the dawn of the new bull market in 2023.

Instead, the most exciting trades right now are in small-cap AI stocks.

Specifically the mining and materials companies tied to AI chips, robotics, and data centers.

My colleague and 40-year investing legend Louis Navellier found five such companies that are essential for the AI boom. And while those mega-cap tech names are still hogging all the attention, these five names are way cheaper than they should be.

That means investors could potentially see 10X, 50X… even 100X returns if they get into these under-the-radar stocks early enough.

Even better… Louis believes that President Donald Trump is just days away from making a major policy announcement that could send AI stocks soaring.

This historic initiative could begin as soon as July 23 – that’s next Wednesday.

You don’t want to be among the scores of investors scrambling to buy after the announcement. You want to be in now.

So click here to watch a replay of Louis’ special briefing where he explains everything you need to know about Trump’s upcoming announcement and the next generation of AI stocks.

This replay goes offline tonight. So take advantage while you can and check out Louis’ AI event right now.