As readers know, my trading (investment) strategy revolves around medium-long term trades for the S&P 500. Using the Medium-Long Term Model, you can achieve massive returns in the long run by buying and holding the S&P 500’s leveraged ETFs (2x SSO and 3x UPRO). The Medium-Long Term Model helps you avoid the downside by sidestepping “bear markets” and “big corrections”.
However, buying and holding leveraged ETFs during “big rallies” within bull markets has 2 problems. Investing in large cap high growth stocks (which are also “expensive”) solves these 2 problems.
- Leveraged ETFs have some decay/erosion when the market is choppy (see explanation).
- Large cap high growth stocks are the first to recover from corrections in the broad stock market.
I have created a stock picking strategy to solve these problems. I will allocate a small portion of my portfolio to this strategy. It is somewhat similar to the Stock Picking Model. This strategy combines quantitative models and discretionary decisions.
Stock Picking Strategy
When the Medium-Long Term Model is bullish (i.e. the model thinks that the broad stock market’s trend is UP)…
Buy and hold large cap high growth stocks.
When the Medium-Long Term Model turns bearish (i.e. thinks that a “bear market” or “big correction” is about to start),…
Shift into cash.
Logic Behind this Strategy
Stock picking on its own isn’t very useful.
- 99% of individual stocks will tank if it’s a bear market for the entire stock market (remember 2008).
- Most stocks will go up over the long term if it’s a bull market for the entire stock market.
That’s why it’s important to first and foremost predict whether it’s a bull or bear market for the entire stock market. That’s what the Medium-Long Term Model does.
The stock picking component merely helps us predict which individual stocks will outperform when the broad stock market’s trend is UP.
Historically, stocks with the strongest earnings growth tend to outperform AS LONG AS the broad stock market is still in a bull market. This is similar to the concept behind William O’Neill’s CANSLIM strategy for picking stocks. Earnings growth is the single best predictor for a stock’s future performance over the medium-long term.
Contrary to what some people might believe, valuations don’t matter AS LONG AS the broad stock market is in a bull market. In a broad bull market, investors and traders love to buy the hottest growth stocks, regardless of valuations. High-growth stocks almost ALWAYS have higher valuations than low-growth stocks.
*These insanely overvalued stocks will crater in a bear market, but that’s why our various quantitative models predict these broad equity bear markets.
FANG stocks demonstrate this concept. Facebook, Amazon, Netflix, and Google have been consistently “expensive” stocks (high P/E’s) during the past 10 years. But despite these very high valuations, FANG stocks have continued to outperform simply because they have significantly above-average earnings growth.
The current bull market began in March 2009. Look how much these companies have outperformed the S&P 500.
The S&P has gone up 281% in the past 9 years.
Facebook is up 707% in the last 5 years.
Amazon is up 2695% in the past 10 years.
Netflix is up 7938% in the past 10 years.
Google is up 615% in the past 9 years.
Moral of the story: are FANG stocks ridiculously overvalued? Yes. But as long as the broad market is in a bull market, these stocks will continue to outperform purely because they have above-average earnings growth. Investors are willing to pay more for above-average earnings growth.
We can use the economy to predict whether this is a broad equities bull market or bear market. An improving economy = medium-long term bullish for the broad stock market. High-growth stocks outperform when the broad stock market is medium-long term bullish.
This “high growth” strategy applies to all stocks, not just Silicon Valley tech stocks. (It just so happens that in our era, tech is the “high growth” sector).
Another high growth (non-tech) stocks is Visa. Its stock has gone up 956% in the past 9 years (while the S&P is up less than 300%).
Here’s Mastercard, another high-growth stock. It’s up 1277% in the past 9 years.
Why only large cap stocks?
Because earnings expectations are more consistent for large cap stocks. These are more established companies.
Remember, the key to this strategy is that you must buy and hold high earnings growth stocks. Hence, earnings expectations about the long term future are critical.
Long term earnings estimates for small cap companies are wrong more often than long term earnings estimates for large cap companies. This is because the long term future for smaller companies is more uncertain than the long term future for larger companies.
Here’s a simple example. Between Facebook and Twitter, if you had to pick which company will still be around in 20 years time, which will it be? I would pick Facebook. Facebook is a behemoth, and it’s unlikely for this company to disappear. But Twitter is much smaller. Twitter might be gobbled up by a bigger company. Twitter might go bust in the next recession if it doesn’t make enough money. Or Facebook, with its larger resources, might build a competitor that seriously hurts Twitter.
I will hold 10 stocks for this strategy. Diversification reduces risk.
My Stock Picking Portfolio
I will share the stocks in my Stock Picking Portfolio with the Membership Program.
Future proof yourself
There’s one additional benefit to investing in high growth stocks.
The world is constantly changing. Many professions and industries will be wiped out by change (i.e. artificial intelligence). Unfortunately, not everyone can be at the forefront of this change. We all have our individual skills, and not everyone can switch into industries that are “the future”.
So what should you do if you’re working in an industry that will be obsolete in 20 years? Changing careers isn’t always easy, especially if the only thing you’re good at is the industry that will soon be obsolete.
By investing in high-growth stocks, you are future-proofing yourself. If you can’t build the future, at least invest in the future and profit from the future. Don’t let the future destroy your career and livelihood. Benefit from change. Don’t be a victim of change.
For example, truck drivers will soon be obsolete thanks to self-driving cars. So if you’re a truck driver and can’t find employment in other industries, what should you do? Should you just sit by and watch the future endanger your livelihood? Of course not! Invest in high-growth tech companies! That way when the future comes and makes your job obsolete, at least you will have a large investment portfolio to rely on.