The Risk On rotation I prognosticated in last week’s commentary didn’t take long to come to fruition. That is because once the CPI report came in well under expectations on Thursday, investors quickly grasped that rate cuts will soon be on the way and it’s time to take profits on the Magnificent 7 type stocks and rotate it elsewhere.

This explains the +3.6% gain for the Russell 2000 on Thursday as the S&P 500 (SPY) fell steeply from record highs. This is the healthiest thing to happen to the stock market since the November/December 2023 rally when Risk On investments were previously in fashion.

Let’s spend our time today discussing the specifics behind this move and what it means for our trading strategy and top picks going forward.

Market Commentary

First, an important backdrop. Here is the chain reaction which explains why rate cuts are so beneficial for the stock market:

Rate Cuts > Higher Economic Growth > Higher Earnings Growth > Higher Fair Value for Stocks

This is why we love to say “Don’t Fight the Fed”. Because when they lower rates it boosts the economy and therefore foolish to be a bear in that environment.

Another positive for stocks is that they are often valued relative to the return produced from bonds. This leads to a focus on the “Earnings Yield” which is the inverse of PE (meaning Earnings divided by Price).

Not that long ago we had short term rates above 5% and that is what many investors were earning in their cash accounts. That made it not as necessary to risk money in the stock market to enjoy an attractive rate of return.

This is especially true when the you look at the Earnings Yield for stocks which right now stands at 4.59% ($260 in EPS expected for the S&P 500 divided by the current price of 5,667). Yet as rates drop…and will continue to drop it will make the Earnings Yield of stocks more appealing than cash or bonds driving more dollars to this investment choice. Even more true when economic growth helps pick up the pace of earnings growth also pumping up the Earnings Yield for stocks.

Some of you may be scratching your head and saying that the above equation doesn’t look that attractive for stocks. And you would be correct.

This focus on the S&P 500 is skewed heavily to the Magnificent 7 stocks that have rallied too much and are now priced for perfection. Or simply…overpriced and due for a round of profit taking.

The more investors look at smaller stocks…the more value they will find. That is why the Russell 2000 has erased the loss on the year that existed as recently as July 5^th. Now it stands at +11.67% on the year.

Yes, that means all those gains took place in just the last seven sessions. In that same time the S&P 500 has been positive, but churned a much more modest +1.80% return. That is a better than 6 to 1 advantage in favor of small caps.

This Risk On shift is the healthiest thing that has happened to the stock market since the November/December rally of 2023 when we last saw smaller stocks leading the charge.

But Risk On is not just about smaller stocks. It also calls on investors to consider stocks that have higher earnings growth rates. That certainly includes more economically sensitive groups like transportation, industrials, basic materials and energy.

Financials is another interesting group as lower rates should increase borrowing activity. That includes the appeal of refinancing higher rate mortgages that came on the books the last couple years.

As this Risk On rotation matures investors will become more selective. They will punish companies who flunk earnings season. And will stay away from companies with premium valuations.

All the above says its prime time for the POWR Ratings to shine. Not just because it skews towards smaller stocks, but because the model also evaluates:

• 13 Growth factors seeking consistent growth of not just earnings, but profit margins, cash flow and revenue as well.
• 31 Quality factors that show how well the company operates. Things like ROA, ROE, debt and other key financial metrics. This plus the Growth factors are the most beneficial in finding companies more likely to enjoy beat and raise results when earnings season comes around pushing the share price higher.
• 31 Value factors to find undervalued gems

There is no denying how much the POWR Ratings has helped the Reitmeister Total Return portfolio generate market beating returns this past week since the Risk On green light came on. And really that advantage has been the case all year long with our return about 2X the Russell 2000.

I look forward to more of the same as this Risk On rally continues. The main drivers of that are the stocks highlighted in the section below…

What To Do Next?

Discover my current portfolio of 12 stocks packed to the brim with the outperforming benefits found in our exclusive POWR Ratings model. (Nearly 4X better than the S&P 500 going back to 1999)

These hand selected picks are all based on my 44 years of investing experience seeing bull markets…bear markets…and everything between.

And right this portfolio is beating the stuffing out of the market.

If you are curious to learn more, and want to see these timely 12 trades, then please click the link below to get started now.

Steve Reitmeister’s Trading Plan & Top 12 Stocks >

Wishing you a world of investment success!

Steve Reitmeister…but everyone calls me Reity (pronounced “Righty”)
CEO, StockNews.com and Editor, Reitmeister Total Return

SPY shares fell $0.29 (-0.05%) in after-hours trading Tuesday. Year-to-date, SPY has gained 19.59%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: Steve Reitmeister

Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks. More...

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