Friday, February 23, 2024
Dividend Stocks

Where to Find Big Returns (Spoiler: Not the Mag 7)

Why all three of our analysts like small AI plays … and why they’re cautious about the Mag 7 … what the data say about a small-cap bull market … big wins for Louis Navellier’s subscribers

Small- and mid-cap AI stocks.

That’s what our three experts, Louis Navellier, Eric Fry, and Luke Lango, believe will make investors double- and triple-digit returns in the months ahead.

From Louis:

We’ve had an incredible small- and mid-cap rally since late-October/November that’s continuing… Money is moving, and it’s clearly going to the AI-related stocks.

From Eric:

The Mag 7 stocks led the first phase of what will likely be a multiyear AI-focused rally. But now that Phase II of this rally is underway, I expect the Mag 7 stocks to hand off the baton to a variety of smaller, dynamic AI plays.

From Luke:

We remain exceptionally bullish on the outlook for small- and mid-cap stocks in 2024, or “SMID” stocks, as they are known in investment circles… this interim market volatility is an opportunity to load up on SMID stocks, particularly small AI stocks, before a furious small-cap catch-up rally over the next few months.

This preference for small- and mid-cap AI stocks isn’t the only position shared by our three experts. Each are increasingly cautious on the Magnificent Seven stocks. While not explicitly bearish, they believe your money will be treated far better elsewhere.

Let’s get into the details of what’s happening.

Why small- and mid-cap AI stocks look especially attractive today

For an overview of the opportunity in small- and mid-cap stocks, let’s go to Luke’s Daily Notes from Innovation Investor.

Investors flooded into large-cap stocks in 2023 because they were “on the fence.”

They were hopeful for the potential of AI but remained fearful of a potential recession. So, they bought large-cap stocks that have AI exposure but are also better protected from recession risks than small- and mid-cap stocks.

But investors now are increasingly moving “off the fence.”

Recession risks are abating. AI euphoria is only strengthening. Investor sentiment is therefore becoming markedly more positive and bullish.

This should inevitably lead to investors putting more and more money to work in smaller stocks.

One way to see this money flow into small-caps is by looking at IWM, which is the iShares Russell 2000 ETF.

Below, you can see IWM jumping 27% between late-October and late-December compared to the S&P’s 16% return over the same period.

Source: StockCharts.com

To be clear, IWM is not an AI-focused ETF. It’s engineered to reflect the entire small-cap universe. So, if we narrow our analysis to small caps with AI exposure, the returns accelerate significantly.

For example, below, we look at four small-caps: SoundHound AI, Lemonade, BigBear.ai, and Recursion Pharmaceuticals.

Over the same late-October to late-December period, their returns clocked in at 36%, 61%, 69%, and 103%.

Chart showing a basket of small-cap stocks surging between 36% and 103% at the end of 2023

Source: StockCharts.com

But since late-December, many small- and mid-cap stocks have pulled back, especially in the wake of last week’s Fed meeting – why?

Luke explains that as we entered 2024, it appeared the economy was slowing in a manner that would require at least five rate cuts.

But the economic data are showing a far stronger economy than anticipated. And as more reports roll in, they suggest only three or four rate cuts will be needed this year. Comments from Federal Reserve Chairman Jerome Powell last week supported this more tempered rate cut expectation. But this is less than what Wall Street had been pricing into stocks.

Here’s Luke with the takeaway:

So, the market is resetting.

Investors are revising their rate-cut expectations lower and their economic growth projections higher.

And in the short term, this is having a negative impact on rate-sensitive small- and mid-cap stocks.

But this “negative impact” is creating an enormous opportunity for investors who see what’s coming.

We’ll return to this opportunity in a moment. First, let’s touch on the other half of this shared market positioning from our experts – caution on the Magnificent Seven.

Will the Magnificent Seven underperform the market in 2024?

To make sure we’re all on the same page, the “Magnificent Seven” stocks are:

  • Alphabet
  • Amazon
  • Apple
  • Meta
  • Microsoft
  • Nvidia
  • Tesla

If you weren’t in these stocks last year, you left money on the table. Collectively, they doubled in value in 2023, crushing the S&P’s 24% return.

But our macro expert Eric Fry, editor of Investment Report, suggests that investors hoping for a repeat performance are going to be disappointed.

(For Tesla investors, that disappointment is already in full bloom. They’re down 28% since December 28.)

From Eric:

The chart below shows the rolling three-month performance of the Mag 7 stocks, minus the rolling three-month performance of the other 493 stocks in the S&P 500 Index.

Whenever this line is above 0%, the Mag 7 stocks are outperforming the other 493 stocks in the S&P 500. Conversely, whenever this line is below 0%, the Mag 7 stocks are underperforming.

As you can see on the left side of the chart, the Mag 7 significantly outperformed throughout most of 2023. However, the line has been trending lower and fell below the 0% level shortly before the start of this year.

Less Magnificent

Expect this downtrend to continue as the richly valued Mag 7 stocks lose some of their luster.

To be clear, I don’t expect these stocks to perform poorly this year, just less well than the overall market.

Legendary investor Louis Navellier is more bearish than Eric.

In his Accelerated Profits Special Market Update podcast on Monday, he noted:

I’ll be honest with you, only three of the Magnificent Seven should be held right now.

I highly recommend that you be very, very careful when you invest… You just can’t have all the mega-cap tech stocks hog all the money.

I’ve seen this before in March 2000. 54% of the S&P ended up in seven giant tech stocks. Then that bubble burst and the tail end of the S&P did better for seven straight years.

That’s where we are now.

So, which three of the Mag 7 does Louis like?

Nvidia, Microsoft, and Amazon, with Nvidia as Louis’ clear favorite.

It’s certainly sobering that Louis doesn’t even recommend owning the rest of them. Even more sobering to see Louis referencing March of 2000.

As for Luke, though he’s not bearish on the Mag 7 stocks, he finds the small- and mid-cap AI set-up vastly more compelling. And per usual, Luke provides the data behind this.

What the numbers tell us about this “catch up” rally in small- and mid-caps

The large-cap S&P 500 is barely below its all-time high. Meanwhile, the small-cap Russell 2000 is still in a bear market.

This has never happened before.

But the closest that we have to this dynamic suggests big gains on the way for small-caps.

Here’s Luke with those details:

In the three instances closest to the current situation – where the S&P 500 rose to all-time highs while the Russell 2000 remained >10% off all-time highs – stocks always rallied over the following year and small-caps always outperformed.

In two of those instances, small-caps rallied more than 35% over the next year.

Table showing small-cap outperformance after small-caps underperform large-caps

We think history will repeat.

It is our belief that small-caps will rally somewhere between 30% and 40% over the next year, led by small-cap AI stocks, many of which we think could double over the next 12 months.

So, there you have it.

Be careful with your Mag 7 holdings and look for opportunities in leading small- and mid-cap AI stocks.

If you’re not sure how to find the best small AI plays, all three of our analysts are recommending them in their investment services. But I’ll also point you toward Louis’ free Portfolio Grader tool.

Louis has codified much of his proprietary quant-based market system, and now offers it to the investment community in the form of his free Portfolio Grader tool.

Think of it as a diagnostic that gives investors an instant snapshot of a stock’s financial strength. It focuses the same eight metrics that drive Louis’ stock selection process for all his premium investment services.

To illustrate, here’s how Nvidia looks today through the Portfolio Grader.

Graphic showing Nvidia through Louis Navellier's Portfolio Grader

Click here to give it a spin yourself.

Before we sign off, a quick “congratulations” to Louis’ Accelerated Profits subscribers

They’ve been banking a growing list of 30%+ winners over the last three weeks.

On January 18th, it was a 38% gain from SPX Technologies and a 43% surge from Alarum Technologies.

On the 31st, it was Powell Industries with a 33% gain.

Then last Thursday, subscribers locked in 36% gains from Novo Nordisk.

Profits like these aren’t unusual for Louis’ subscribers at this time of the year. After all, we’re in the middle of earnings season. And given that Louis’ entire market approach centers on fundamental superiority, earnings season often brings major price surges as Wall Street wakes up to the strength that Louis’ quant system identified weeks/months ago.

Here’s Louis speaking to his fondness for earnings season in his Novo Nordisk profit alert:

Congratulations on your profits!

This is why I love earnings season; fundamentally superior stocks are dropkicked and driven high on their strong earnings results… and then we reap the rewards.

If you’re not enjoying the same outperformance in your own portfolio today, Louis just updated his Quantum Cash income-generating system. He’s so confident in it that he’s making what I find to be an eyebrow-raising personal guarantee…

It will deliver at least $60,000 in payable income opportunities over the next 12 months.

To learn more about how Quantum Cash works and the guarantee, Louis provides more details on this free video here.

Circling back to Accelerated Profits subscribers, congrats again on your wins and enjoy the second half of earnings season.

As for the rest of us, give a good look to small- and mid-cap AI stocks today. That’s where all three of our experts are shopping now. And be aware of the potential for underperformance from your Mag 7 holdings.

Have a good evening,

Jeff Remsburg

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