Unless you've been living in a cave, you are likely aware that the "Rotation Trade" has been the toast of the town this year. Apparently the powers that be decided that the stock market was going to look a lot different in 2026 than it has over the last several years. You know, where companies that have been growing at remarkable rates have led the way - while the rest of the market's "troops" lagged badly. As in, very badly - for a very long time.

So, as is often the case on Wall Street, the trading desks at the big banks and hedge fund managers decided it was time to flip the script in the new year. Time for a good ol' mean reversion trade. Time to sell the leaders and buy the laggards. I.E. Time to sell megacap tech and buy the old economy, staid, defensive/cyclical/value names such as Walmart (WMT), Procter & Gamble (PG), Coca-Cola (KO), Hershey (HSY), Colgate (CL), Kroger (KR), Caterpillar (CAT), etc.

Such "trades" are not new. No, mean reversion trading has been around for eons. When something is perceived to have "gone too far," traders sell the winners and buy the losers - for a trade. And when the spread between the two themes closes up, so too does the trade. But it is certainly fun while it lasts if you get the timing right.

Right now, the trade appears to be in full swing. If my calculator is correct, all but two of the "Mag 7" stocks are in the red to start 2026 as the Magnificent Seven ETF (MAGS) is down nearly -6% year to date and Vanguard's Growth ETF (VUG) is off -5.5%. At the same time, the value space has been rockin' with iShares Value ETF (VLUE) sporting a gain of +10.7% through the end of last week.

Usually, Rotation Trades Have Limitations

To be sure, I enjoy a good mean reversion trade as much as the next guy. The problem, from my perch, of course, is that these types of trades can only go so far. For example, the value stocks aren't curing cancer or revolutionizing computing, robotics, space, or energy. While this is merely my $0.02 opinion, Colgate can only sell so much toothpaste. Sales of Coca-Cola (KO) and Pepsi (PEP) are not likely to skyrocket. And Walmart (WMT) doesn't have limitless upside. So, at some point, the joyride to the upside in these types of trades tends to end.

While trying to call tops and bottoms of any type of trade is a fool's errand, it is worth noting that an awful lot of the value-oriented stuff is suddenly overbought and overvalued. As in, very overvalued. As in, more overvalued than the big tech names that our furry friends so publicly whine about almost daily.

As my son, Don Moenning, recently opined in his weekly market update, "We now find ourselves with a glut of low margin, low-growth defensive names trading in a parabolic fashion on the charts at P/E's that would make big tech blush." He notes that the current P/E for Walmart (WMT) is 46.9, Kroger (KR) is 64.2, Hershey (HSY) is 51.1, and Colgate-Palmolive (CL) is 36.8. Don suggests we compare those multiples to that of Microsoft (MSFT) at 24.2, Amazon (AMZN) at 28.1, or Alphabet (GOOGL) at 28.8. Don continues with, "the question remains, "but why?"

Why does Nvidia (NVDA), which, according to my favorite LLM, sports revenue growth above 60% (Grok says the 3-yr growth rate is 65%, the 5-yr is 66%, and 2026 projection is 64%) trade at a P/E multiple even with Walmart (WMT) - and well below Kroger (KR) and Hershey (HSY)?

And for those keeping score at home, Nvidia's PEG ratio (P/E divided by its growth rate) is currently around 0.6 - generally, PEG ratios below 1.0 are considered "bargains". Compare this to CL's PEG of 1.6, KR's of 1.44, and WMT's eye-popping 3.37.

For comparison, Walmart has been growing revenues in the 5-6% range, which, of course, is impressive for a company of its size. Colgate's revenues have been growing at a rate below 2%. And while the forecast is looking up for 2026, 3-4% growth is tough for me to get excited about from a long-term investment perspective.

It's Time To Play: Pick The Overvalued Sectors Game

OK, maybe it's time to have some fun with this. So, if you don't mind me getting a little silly here, please read the following in your favorite game show host voice: "Let's all play the Pick the Overvalued Sectors Game!"

"Contestants, using the chart below, press your buzzer when you spot the sector(s) that are the MOST overvalued right now. Ready, set, go!"

(I've circled the really overvalued stuff in red to make the game go faster - you know, so we can squeeze in a couple extra commercial breaks.)

"That's right players, according to the current Forward P/E's of each S&P sector relative to their historical ranges and means, Industrials are the most overvalued right now, with Consumer Staples taking the silver, and Materials capturing the bronze. And sorry to say, if you picked Technology you weren't even close... So, everyone thinking illogically is a winner!"

Silliness aside, what makes this situation a head scratcher is that while Staples and Industrials are both at five-year highs and well above their means, the Technology sector's valuation is closer to its average than its highs. Oh, and the Forward P/E on the Tech sector is actually LOWER on an absolute basis than both Consumer Discretionary and Industrials. Hmmm...

Getting to the point, I believe it's safe to opine that most of the value/defensive plays are not growing at eyebrow raising rates. And as such, do not usually warrant such high multiples.

So, if we apply the same narrative the bears have been using on tech - you know, that multiples are too high and therefore a reset is required - then the next big rotation trade might be to... wait for it... sell the defensives and buy stuff that is actually growing at a high rate. Assuming, of course, there is no recession, no resurgence in inflation, and/or no major geopolitical interruption.

But for now, the traders seem to be enjoying their rotation trade, which appears to be becoming more entrenched each week. So, if you are a growth investor, you may have to grin and bear it until this trade runs its course.

Thought for the Day:

Love never fails; Character never quits; And with patience & persistence; Dreams do come true. -Pete Maravich

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: VLUE, WMT, NVDA, AMZN - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES