Why Stocks Could Be Ready To Rally

It’s been a painful week for growth investors given significant declines in technology-oriented indexes and exchange traded funds. The NASDAQ 100 ETF (QQQ) fell over 11% from its intraday high this month to its intraday low this week, and returns were worse for software investors given the iShares Expanded Tech-Software Sector ETF (IGV) 12.5% drop from its month-to-date high to low point.

Source: Top Stocks for Tomorrow.

Many individual stocks fared worse. For example, high-flying Tesla (TSLA) lost over one-third of its value and Zoom (ZM), Wayfair (W), and Shopify (SHOP) declined by over twenty five percent.

Since many of the baskets and individual stocks that fell most were also those most extended to their 200-day moving average, it isn’t surprising they took the brunt of the sell-off.

Source: Top Stocks for Tomorrow.

However, our overbought indicator is still extended with over 50% of our 1,500 stock universe trading 5% or more above its 200-day moving average.

Historically, readings above 50% have preceded significant corrections, including the one we experienced this week and ideally, a correction would normalize this reading in the 20% to 40% range. Since we’re still north of 50%, it’s hard to argue all the pain has been felt when it comes to individual stocks.

The market itself could be finding its footing, though. Volatility can remain elevated for weeks following a 3% one-day decline in the S&P 500, but the market usually trades higher at some point within 30-days. In my experience, picking bottoms is more art than science, so it’s best to focus on ranges and be flexible. Ideally, I’d like to see a retest of this week’s intraday low followed by a heavy volume reversal day for confirmation, but as I said, flexibility is key. Many leading stocks may officially bottom before the market, so selectively buying leaders could be the best approach for investors.

Overall, it’s too soon to declare every stock has found its footing, but using down days to buy leaders in strong sectors and industries could be savvier than indiscriminately selling at this point. It’s far easier to proactively and non-emotionally prune portfolios into strength, than weakness, so the best time to raise cash was when we recommended doing it in August, not today.

Top-rated sectors now

Weekly, we rank major sectors so members can see which baskets have alpha-friendly tailwinds. It also helps investors spot emerging positive or negative trends. For example, consumer goods — a defensive group — strengthened throughout August as technology weakened, adding conviction to thinking the market was due for a correction.

Currently, industrials, services, consumer goods, financials and technology are the best ponds to fish in large cap. The top mid-cap sectors are consumer goods, services, and basic materials, while basic materials, services, consumer goods, and industrials are best in small cap.

Because utilities and energy stocks remain weak across all market caps, it’s best to focus elsewhere for stocks to buy.

Source: Top Stocks for Tomorrow.

It can also be useful to track sector strength by market cap. For instance, large-cap industrials score better than small cap industrials, and small-cap basic materials scores higher than large-cap basic materials.

Source: Top Stocks for Tomorrow.

The strongest-scoring stocks now

Our scores provide a systematic and objective way to rank over 1,500 high-quality stocks. Weekly, we run every stock in our universe through a 7-factor gauntlet explained more here. Overall, our model assigns scores based on the following factors:

• Forward earnings growth expectations
• Historical trends in reporting earnings that beat Wall Street estimates
• Insider buying
• Short-term and long-term institutional money flow
• Forward valuation relative to historical valuation
• Contra-trend short interest analysis
• Quarterly seasonality over the past decade

Because stock prices follow earnings over time, insiders buy for one reason; money flow reflects institutional sentiment, and seasonal patterns can rhyme, high-scoring stocks offer a solid source of new ideas.

This week, over 100 top-rated stocks were shared with members, including these 80 stocks. I’ve highlighted the stocks seeing the biggest increase in score for convenience.

Never miss a money-making idea. Get all the ideas we sent to members this week, plus weekly large cap, mid cap, small cap and ADR rankings. Know what sectors, industries, and stocks to buy and when to buy them. Over 400 bps of excess return in the following 52 weeks since 2017. Free trial, special introductory pricing, and you can cancel anytime. Join the conversation. Sign up for Top Stocks For Tomorrow.

Disclosure: I am/we are long IGV, TSLA, SHOP, ZM, AAPL, AMGN, DXCM, INSP, FSLY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.