One Bizarre Thing That Makes a Tech Stock Great

By Michael Salvatore, Editor, TradeSmith Daily

In This Digest:

Beating tech is no small task…
We did it anyway, thanks to a strange discovery…
The five stocks in play for a 40% better tech basket…
Robinhood muscles in on the hyper-finance market…
A huge divergence setup from a master pit trader…

Trying to beat “buy-and-hold tech” is audacious…

I talk a lot around here about how mid-cap stocks offer some of the best historical returns of any market cap class. That’s true. Compare the mid-cap S&P 400 benchmark against the small-cap S&P 600 and the large-cap S&P 500, and mid-caps are clearly the ones to own over the long haul.

But when you get sectors involved, even mid-caps have to bow their head to two powerful areas of the market – discretionary and tech.

Discretionary stocks have turned every dollar into $10 since the turn of the century. Tech is a 9x:

I wouldn’t say that puts the mid-cap return of 8.5x to shame, but it certainly shows us where to focus a mid-cap investment strategy.

You’ll remember last week that I shared a work-in-progress stock rotation strategy focused on the energy sector. Where the SPDR Energy ETF (XLE) returned about four times your money over the last 20 years, the strategy we came up with did even better, with a 10x return.

We did this by filtering out the universe of energy stocks down to just those that are the kings of a few key fundamental metrics, adjusting our position size based on the past year of volatility, and cycling in new stocks once the top brass changes.

This week, we did the same thing with tech stocks. (Discretionary stocks are their own puzzle that we’re tackling next.)

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For years, Jeff Clark managed money for some of Silicon Valley’s wealthiest CEOs. He helped them grow their fortune with a little-known strategy he calls “Crossfire.” It generated gains like 388%, 1,263%, and 1,285%… sometimes in as little as two days. Now he’s finally revealing the entire Crossfire system, from beginning to end, in a new video walkthrough. By the end, you’ll have all of the information you need to go for these huge gains yourself. Click here to watch now.

We kept the fundamental policy of holding five stocks at a time, adjusting position sizes based on volatility, and checking the basket every four weeks for new leaders. But as you might expect, the factors that make a great energy stock are not the factors that make a great tech stock.

Tech companies do not benefit from having high free cash flow yield, or high dividends, or even high productivity – which we measure as revenue per employee.

Do you know what makes a great tech trade? Two things – one obvious and one very not obvious:

Price action. For the tech strategy, we looked for stocks with a 52-week price change that was higher than the average tech stock’s 52-week price change plus an added 20%. Translation: any stock in this basket to be trading at least 20% better than the average tech stock over the last year. This sounds like the kind of thing that would work for everything, but it hurt returns on the XLE strategy.
High debt levels. Yes, you read that right. We originally looked for tech stocks with manageable debt levels, calculated as a debt service to net income ratio of less than 1. Almost jokingly, we flipped the “less than” to a “greater than.” No joke: Tech companies that spend more servicing debt than they make in income have been the outperformers over the last 20 years. Consider it another “sacred cow” off to the slaughterhouse.

Those were the only two factors we needed to produce a five-stock rotation strategy that outperformed the benchmark XLK – the second-best-performing sector ETF of all time – by nearly 40%.

With this strategy, every dollar traded turns into nearly $22 vs. about $16 for holding XLK.

Now, there is a price you pay for this outperformance. For one, it takes quite a bit more work. It may take only a few minutes a week, but compared to doing nothing in XLK, that adds up.

It’s also quite a lot more volatile. Check out that spike higher and lower in 2022 – the result of hanging on to a few major bubbly names through the big bust. You suffer some drawdowns when you trade this, so it’s not for the faint of heart.

But if our goal is to see consistent outperformance through bull markets, that’s what this strategy gives us. From the market bottom in 2009, the strategy stayed well ahead of the benchmark, and it’s at just as much of a lead right now.

Just like with the XLE strategy, this too focuses primarily on small- and mid-cap stocks… giving you both that outperformance and that volatility. Here are the current holdings:

Since you all had such a positive response to our first stock rotation experiment, we’re going to keep working at new strategies and sharing them here in TradeSmith Daily. Whenever the stocks change, I’ll include that news as part of the next issue.

The hyper-finance trend keeps accelerating…

Last week, we introduced you to our big idea about hyper-finance. Essentially, we’re quickly hurtling toward a speculative bubble where anything having to do with tokenized financial assets will gain a huge premium over the next six months.

The very same day I first published that idea, we got our first taste of hyper-finance in action with Republic’s listing of tokenized shares of Elon Musk’s otherwise private SpaceX. That was a pretty high-profile example that shows exactly what this technology could be used for.

Well, not to be outdone, Robinhood (HOOD) announced at its showcase in Cannes, France, this past week that tokenized stock trading is now available for EU-based users. And not only that, but Robinhood users can trade SpaceX this way, too, as well as the poster child AI company, OpenAI. From CNBC:

Robinhood stock climbed nearly 13% to an all-time high Monday after the company rolled out tokenized shares of OpenAI and SpaceX to users in Europe as part of a larger crypto rollout.

[…]

The announcement, which came Monday during the company’s product showcase in Cannes, is part of a broader push to expand Robinhood’s crypto footprint globally. The tokenized assets will be available exclusively through Robinhood’s EU crypto app, where more than 200 tokenized stocks and ETFs are now tradable 24 hours a day, five days a week with no commission or spread.

To mark the launch, Robinhood is giving 5 euros worth of OpenAI and SpaceX tokens to every eligible user in the European Union who onboards to trade stock tokens by July 7. The company has allocated $1 million worth of OpenAI and $500,000 worth of SpaceX for the campaign.

If there’s any better evidence that the hyper-finance trend is accelerating, I can’t imagine it.

Day after day, smaller-cap fintech firms are paving the way for a future where everyday investors can take part in equity ownership for previously off-limits companies, while also accessing publicly listed firms via tokens that offer additional utility.

Every fintech out there is looking at this news and scrambling to get a piece of the pie. And they will be for the remainder of this crypto cycle.

As we showed Monday, it’s not too late to get a piece of this action. Own some crypto, own some crypto stocks, and own some upstart fintechs that might join in, and chances are good you’ll catch some big moves through the end of the year.

Jonathan Rose has a new idea for how to trade the short term…

And it involves one of a professional trader’s favorite words:

Divergence.

When stocks that usually move together suddenly break apart, you can make a lot of money betting on them coming back into line again.

Just look at what happened in April.

“Liberation Day” threw the market into chaos…

And not only that – it created massive divergences like the one Jonathan Rose of Masters in Trading spotted between two ETFs: iShares MSCI Mexico (EWW) and iShares MSCI Brazil (EWZ).

Nineteen days later, his Divergence Trader portfolio clocked a 100% gain when EWW/EWZ jumped back in line.

The beauty of it, though, is that these trades don’t depend on market chaos. It’s helpful – but they don’t require you to take big risks.

After all, you’re not betting on a big move, up or down… You’re just waiting for a snapback.

Those snapbacks can take a lot of forms, creating wins ranging from:

322% in 32 days
411% in 39 days
752% in 40 days
805% in 70 days
And 967% in 52 days

But this one breakthrough – stop guessing the direction, start finding the relationships – is the core of Jonathan’s entire trading philosophy since his earliest days at the Chicago Mercantile Exchange in 1997.

To see how it all works, check out Jonathan’s new YouTube video, How I Traded for 27 Years Without Guessing. It’ll prepare you for his full presentation where you can get in on the major divergence forming now.

One Bizarre Thing That Makes a Tech Stock Great