Small Caps Are So Back By Michael Salvatore, Editor, TradeSmith Daily In This Digest: The most important breakout you missed on Wednesday… A massive market vibe shift post-election… Bitcoin breaks into clear skies… The Fed cuts again but makes a key statement change… Small-cap stocks finally broke out on Wednesday… Most people hear “small caps” and think “Russell 2000.” But the Russell 2000 is still below the all-time high set back in 2021. So what broke out? The S&P SmallCap 600. And the difference between the two has set the narrative for the next four years. To be in the S&P 600, you need to have positive earnings over the past quarter and the past year, and have a market cap between $1 billion and $6.7 billion. The Russell 2000 is just the smallest 2,000 companies in the broader Russell 3000 composite. That makes the S&P 600 theoretically a more conservative bet. But it broke to new highs on Wednesday while the Russell 2000 didn’t. This is just as much a story about the high interest rate era as it is about the Trump presidency. As we’ve shown you, the last Trump administration was a huge boon to small-cap U.S. businesses. And during that admin, the Russell 2000 and the S&P 600 moved basically in lockstep. Today, they’re diverging. And that’s because profitability is a key factor for investors. It has to be in a world where money isn’t free or even all that cheap. It’s not enough to buy a basket of small caps. You have to be in the best ones. Let’s talk about one way to look at those… Every day at TradeSmith, I get a bunch of automated reports from our backend research environment, the TradeSmith Research Lab. That’s where we battle-test our newest, best ideas before deciding if they’re ready for prime time. One of these ideas is simple, but so, so effective. It’s a ranking of stocks with a Quantum Edge Fundamental score above 60 that have also notched a one-month high. The Fundamental score is a composite of factors that focus primarily on earnings growth. And any stock charting a one-month high shows strong short-term momentum. Understand, this list is across the market cap spectrum. But the top 10 after the election was called on November 6 was laden with small caps:
Six of the above 10 stocks are small caps, highlighted in yellow. (Large caps are in green, mid-caps in blue, and micro-caps in orange.) All of these stocks broke out to a one-month high the day the election was called. And all but one of them, Iris Energy (IREN), have positive earnings. If you want to make the most of the next several years, you have to look for stocks like these. Profitable, fast-growing companies of all sizes, but especially small caps, will dominate the market. If you don’t believe me, just look at that last column. The smallest gain among these stocks over the past year is still 66.7%. That gain, seen by Vertiv Holdings (VRT), is still beating the market handily during a period where stocks have returned nearly 40% year-over-year. The market has gone full risk-on… I was sitting on the couch with my wife watching the election coverage Tuesday night. Around 9 p.m., my phone buzzed on the coffee table. Picking it up, I saw a notification that bitcoin had hit a new all-time high. The fact alone didn’t surprise me so much as the timing did. This was hours before the race was called for Donald Trump. But to my mind, it was the first sign he would win. Trump’s made a big show of support for crypto over the last few months as he courted voters. He spoke at a recent bitcoin conference, promising to fire crypto-hostile Securities and Exchange Commission Chair Gary Gensler and proposing a strategic fund for the U.S. government to buy and hold bitcoin. That was enough to get crypto folks on Trump’s side. And so bitcoin’s price has moved along with Trump’s odds, culminating in an election night breakout. No matter the reason, the new high in bitcoin cements the breakout we’ve been talking about over the past couple weeks. We’re in uncharted territory, and it’s clear to me that bitcoin is on its way to six figures. Here’s my latest chart on the BTC price, which has broken out of its parallel downtrend channel. We have to start thinking about where support lives now, and the dashed line below is an arguable idea:
We can see bitcoin has bounced off this support twice over the past couple weeks and traded around it as it worked its way out of the channel. If BTC follows this support line through to the end of the year, we could settle well north of $80,000 per bitcoin. Yesterday’s FOMC meeting was no big shock… Even though it probably should’ve been. The Federal Reserve cut interest rates for the second consecutive meeting, this time smaller – 25 basis points. More interestingly, though, was how the Fed revised its statement. It edited a key line from previous statements, when it said it has “gained greater confidence that inflation is moving sustainably toward 2%,” and instead changed the line to simply say, “The risks to achieving its employment and inflation goals are roughly in balance.” This could mean 2% is no longer the inflation target held by the Fed… or that it simply is no longer confident inflation is heading in that direction. We’ve theorized before that something close to the inflation level we’re seeing now is a “new normal” level. The statement seems to confirm it. Inflation and employment may be the stated priorities for the Fed. But by removing its 2% target from the Federal Open Market Committee statement, and by cutting even as the labor market continues to cool, the Fed’s biggest priority is exposed. And the biggest factor, what we’ve taken to calling the Fed’s third mandate, is the fact that the interest expense on government debt is at an all-time high. That factor naturally has the biggest weight – high inflation and high unemployment will always take a backseat to the solvency of the federal government. To me, this all nets out to the conclusion that rates will probably stay relatively high, along with inflation, for quite a while longer. A federal funds rate floor well above 3% that lasts for years is probably appropriate, and would provide the right mix of relief for consumers and the federal government and tightness for the corporate world. If inflation stays above 2% as I expect, that 3% interest rate still amounts to a real risk-free rate of return… and a high cost to money. This all brings us back to where we started today: with profitable, growing small caps. Doing your homework and only holding quality stocks is as important as it’s been since the 2008 financial crisis. The “free lunch” era is over, and investors aren’t going to trip over themselves to invest in no-growth, pie-in-the-sky ideas when there are plenty of well-capitalized firms actually earning money and outpacing their peers. Stick with TradeSmith, and we’ll help you find the latter in what could prove to be the best small-cap investing environment of our lifetime. To your health and wealth, Michael Salvatore
Editor, TradeSmith Daily P.S. Meanwhile, our colleague Louis Navellier of InvestorPlace has his own big prediction related to Donald Trump winning the election. Right now, seemingly every journalist in America is speculating about what Trump’s first act will be when he returns to office. But even before closing the border or issuing pardons, Louis believes Trump will issue an executive order that will create a second boom for AI stocks… And Louis has six specific AI stocks in his sights that could take off as soon as the mainstream media catches on to this story.
Click here to find out why Louis believes Trump’s election will launch a second boom in AI stocks, and how you can position your portfolio for this windfall. | 