🚨Trade Alert 18: One Exit, One Trim, One New Position and Two Top-Ups!
Exiting two positions, increasing an existing position and opening one new position.
For the last two months, the correlation of our portfolio with the S&P 500 has dipped. Thus, most of our gains were pure alpha. In fact, our best day over the last two weeks was one of the worst for both the S&P 500 and the Nasdaq-100.
This is exactly what we aimed for at the beginning of the year.
If you remember, I said we had an extremely imbalanced market in late December and early January:
AI names made up 40% of the S&P 500 market cap.
The market overall was trading near 22x forward earnings.
The equal-weighted index was trading at 17x forward earnings.
Thus, we expected a broadening and avoided buying names that already had outsized weight in the index. Instead, we hunted for opportunities in forgotten sectors and foreign markets.
This strategy played out perfectly.
We have witnessed a smooth broadening as the market-cap weighted index has come down to 20x forward earnings and the equal-weighted index has gone up to 19x:
This led to underperformance of the portfolios focused on the well-known AI names like Nvidia, as it’s up just 4% YTD vs 9% of the index. Meanwhile, we generated substantial alpha from focusing on ignored corners of the markets. Most of our gains came from three buckets:
Foreign markets.
Ignored S&P sectors, like healthcare.
AI plays that were ignored up until this year, like AMD.
In the first 5 months, we observed a portfolio that was still correlated with the broader index moves, though it was weakening thanks to this strategy. Over the last few weeks, we saw a portfolio that positively diverged from the index as broadening was underway.
That broadening is largely complete in my view, as the valuation gap between the equal-weighted and the market-cap-weighted indexes has narrowed down to 0.7x.
The fact is that Mag7’s net contribution to index performance this year is just 28 points, while 609 points came from the rest. This used to be the exact opposite. For reference, Mag7 made up 68% of all gains in the S&P 500 from 2023-2025.
Mag7’s drawdown has also stressed some other top-of-the-funnel AI names, as they are seen as leveraged bets on Mag7.
This created another lopsidedness in the market.
I think the following clearly explains what I mean:
Meta, Microsoft, and Nvidia all have way higher growth expectations than the broader market. However, they are now trading at 18x, 17x, and 15x 2027 earnings, respectively, while the S&P 500 is at 19x 2027 earnings. The market is assigning no premium to the highest-quality businesses.
You may say it’s because of the capex worries, but that doesn’t explain Nvidia.
Indeed, the Mag7 premium to the S&P 500 has collapsed to the lowest level since 2025, and all that premium is basically made up by Apple and Google, if you exclude the inexorbitant valuation of Tesla:
Let me be very straight about it: If this rally continues, money should flow back into these names to some extent and attach them some substantial valuation premium over the index. These are the highest-quality growth in the index, and the earnings growth of the rest will fall short of keeping valuations at these levels.
If we think that money will flow back into these names, we should also see top-of-the-funnel AI names to get some love. These two spaces are where I think opportunities exist now.
Plus, we should also see that the recent rotation was still not broad enough to bring sectoral balance to valuations. Money has largely flowed into healthcare and equipment/industrials. Some other sectors are still ignored, and there are opportunities to capitalize on.
This is the general direction I’ll take today:
Trim one position and totally exit another position.
Buy one new foundational position.
Top up two existing positions.
This way, we’ll be positioned well for the next wave of rotations while locking in gains from our positive divergence so far.
I’ll explain the trades below and add the link to the portfolio spreadsheet at the end of the write-up. I’ll be updating it after I execute the trades.
So, let’s get started.
Here are the exact trades I am making:
The first trade is obvious for us.