Cabot Growth Investor Issue: April 20, 2023

Looking for a Big Positive

Having been around this game for a couple of decades and studied markets going back to the early 1900s, we can say this: Assuming you have solid market timing and stock selection methods, dealing with strong uptrends (heavily invested in strong stocks with big stories, numbers and strong charts) or ugly downtrends (hiding out mostly in cash) aren’t that much of a problem in terms of knowing what to do. But it’s the in-between situations—when things are choppy, mixed and rotational—that are tough, and that’s mostly what we find ourselves in today. Interestingly, the 25-day, 50-day and 200-day moving averages are all within 3% to 4% of each other for most major indexes, indicative of a sideways phase.

The tricky part is that, while things are choppy and challenging, there are many small positives out there: Our Cabot Tides are back to neutral (you could call them bullish if you wanted to) and the Two-Second Indicator is technically positive (by a hair), all while our Cabot Trend Lines have continued to point up for the past two and a half months. It’s a similar story with our Aggression Index (again, positive but not my much) and other secondary measures—especially sentiment, where most are expecting lower prices down the road. More than a few growth stocks act well, too.

These small positives do reflect the fact that, thus far, 2023 has certainly been better than the 2022 mess—and we still believe they tell us the market’s next major move is likely up.

But what the market really needs is a big positive, meaning a big show of buying power that tells us the Fidelity’s, T. Rowe Price’s, big pension funds and large hedge funds are not just trading in and out of a few names but are really building positions—effectively embarking on accumulation campaigns as they look ahead to brighter and more stable times.

If (when?) that occurs, we could floor the accelerator pretty quickly—there are a lot of good-looking setups out there, so if big investors go to work, we will, too.

In the meantime, we’re not ignoring our indicators or the small positives, but we’re also not going to ignore the meat grinder-type environment that exists for growth stocks, where some act well but many potholes appear out of nowhere. All in all, it remains a time for a caution and patience as we manage mostly small-ish positions.

What to Do Now
Remain cautious, but once again, keep your eyes peeled for a character change. In the Model Portfolio, most names act decent, but we haven’t been immune to the recurring dips out there—in yesterday’s special bulletin, we trimmed more of our Shift4 (FOUR) position and tonight we’re placing Allegro (ALGM) on Hold. Our cash position now stands right at 50%.

Model Portfolio Update

On-again, off-again, washing machine, yo-yo, meat grinder—pick your way of describing it, but the fact is that most of the market (and growth stocks more so) remain in a very tricky, challenging and rotational environment, which keeps us in an overall cautious stance.

That said, the evidence today isn’t bad at all, with our Cabot Tides and Two-Second Indicator both shaping up and the setups in many areas (both on individual charts and for the market as a whole) are very high potential, especially as so many investors are bearish. On that basis, there’s a good argument for putting some cash to work.

But right now, very little is sticking—things that act well and make some progress are subject to potholes (some of them extreme) at any time, and the same goes for strong groups, too. All in all, we don’t have much desire to throw more money into the meat grinder (or however you want to describe it) at the moment, as the risk/reward in growth stocks has been sub-par.

That said, we meant what we wrote above: If the market can truly show some real upside power, pushing the many stocks and indexes now setting up to new highs, we could move relatively quickly. That’s how fine an edge the evidence is standing on—right now, caution is key, but so is keeping your eyes open for a clear change in character. After selling one-third of our remaining Shift4 (FOUR) stake in yesterday’s special bulletin, tonight our only change is placing Allegro MicroSystems (ALGM) on Hold.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO is a great example of what we’re seeing in the market right now: Shares got hit hard after a very solid Investor Day, then bounced back to new highs within a few days, before another shake to the 25-day line … and another low-volume bounce back toward its closing highs—and all of this has happened just since the start of April! We’re certainly not complacent, but as we wrote recently, everything is in place here for Academy’s earnings and free cash flow to not just remain elevated, but to expand nicely in the years ahead as the store expansion plan continues (the firm just opened a new location in Lafayette, Indiana—the first new opening of about 14 this year, and part of 130 new openings expected through 2027) and, most likely, a good number of share buybacks, too. As for the here and now, there are obviously recession worries out there; that wouldn’t be a good thing, of course, but Academy’s more value-ish offerings compared to peers should keep most customers coming back (and possibly attract some new clients who are cutting back). As for the stock, we won’t rule out taking partial profits in ASO if the super-choppy action continues and/or we see a break of recent support (low 60s), but at this point, we’re happy to hang on—though we’d prefer to buy some other names that are acting more under control. HOLD

Allegro MicroSystems (ALGM)—Big picture, ALGM continues to look OK, having given up relatively little of its booming breakout action from early February. That said, the up-and-down action from growth stocks and some softness in chip stocks has begun to take its toll, and today’s dip after Tesla’s earnings (Allegro’s growth is tied to EVs and other advanced auto features) took shares down another peg. The true tale will likely be told on earnings (due May 9), though that’s nearly three weeks away—right here, we’re not panicking and still think the story is sound, but with the dip under the 50-day line, we’ll move our half position to a Hold rating and keep our eyes open to see if ALGM can find some support. HOLD

Axon Enterprises (AXON)—In contrast to so many other stocks and sectors, AXON has been a nice change of pace—while there’s been some chop since the earnings-induced breakout a few weeks back, the stock has shown mostly calm trading with higher lows and multiple tests of resistance in the 225 to 230 area, both of which are constructive. Of course, in this environment, air pockets can appear in a hurry, but so far, so good. On the news front, Axon isn’t resting on its laurels and continues to put out better offerings—a few weeks ago, that included the latest generation of Tasers (more range, more shots at the target, better safety features), and now there’s the Axon Body 4, an up to date body camera that comes with better communications abilities (including from both the officer and support teams, as well as a Watch Me button that allows officers to signal for additional support), more points of view, better images and more. The next quarterly report is due May 9, and the results and outlook will obviously be key, but until proven otherwise the rapid and reliable growth story (as well as the big-volume breakout from a two-year range) should keep buyers interested. BUY A HALF

On Holding (ONON)—ONON (along with a couple of retail peers) suffered a valuation-based downgrade earlier this month that brought some brief-but-intense selling. But winning stocks in good (or good enough) markets usually shrug off these types of negative commentary quickly, and so far that’s what we’ve seen from the stock—ONON’s low was that day, and while it’s still choppy, shares challenged multi-month highs today. Fundamentally, the core business of athletic (and trendy) shoes has big potential, but there’s a long history in this industry of going from a few products to expanding into new lines (kids’ shoes, other sports, etc.), not to mention the lifestyle appeal. There are no sure things in this market, but ONON’s combination of newness, rapid growth, big estimates and a ridiculous blastoff on earnings means the odds favor the stock will be nicely higher down the road. Hold on if you own some, and we’re OK starting a position here if you’re not yet in. Should the stock continue to firm up, we could fill out our stake. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—There hasn’t been much fanfare about it, but the S&P 500 recouped all but a half percent of its February-March decline, including the bank panic—given the numerous headwinds, we take that as a positive, as is the fact that our Cabot Tides have improved to neutral and could turn up with any real strength going ahead. Given the market’s penchant for selling on strength (like we saw today), we’re going to stay on Hold—but as we mentioned in the portfolio intro, if the market (and SSO) were to really get moving, we would restore our Buy rating and may even add back some shares we sold a few weeks back. As it stands now, sit tight. HOLD

Shift4 (FOUR)—Shift4 had been retreating normally, and then a report from a short-selling firm that claimed accounting shenanigans caused FOUR to plunge through its 50-day line on huge volume yesterday; in yesterday’s special bulletin, we sold a third of what we had left. As with most of these situations, we’ll simply see how it goes, but we’d note that many big Wall Street banks (including Goldman; 447 funds in total owned shares as of the end of March, up from 369 nine months before) follow the company, so we’d be surprised if the accusations were anywhere near as bad as claimed. Indeed, one smaller name came to defend the stock yesterday with another analyst doing the same today, saying some of these issues were known and, importantly, that the underlying business really is doing great. FOUR finished up off its intraday lows yesterday and bounced well today; if it can close the week in decent shape, this could be a massive-volume shakeout/support week on the chart … though, of course, if it doesn’t, it will be a big intermediate-term break. Sitting with a small-ish position at this point, our game plan is to see how things play out in the days ahead—much more weakness and we’ll likely bail on the rest, but some buying support would be encouraging. Earnings are due May 4. SOLD ONE THIRD, HOLDING THE REST

Wingstop (WING)—WING hasn’t been tearing up the charts, but shares did just reach a new closing high on Tuesday; the relative performance line didn’t confirm that, but it’s still a solid show of strength. The overall picture here hasn’t changed, though, with shares bumping up against all-time highs … which, in this environment, has proven to be very tough resistance to break through. On the news front, Wingstop has inked a deal with a new marketing agency as it looks to expand its brand awareness and keep same-store sales (which have risen an amazing 19 years in a row) pointed up. The quarterly report is due May 3 and will obviously be vital—a very strong few days could produce a legitimate breakout, but for now, we continue to think hold is the appropriate rating. HOLD

Watch List

• Arista Networks (ANET 155): ANET has continued its correction, with a dip to slightly lower lows this week as the 50-day line (now just above 152) catches up. How ANET reacts in the days ahead will likely tell us a lot about the next big move.
• Axcelis (ACLS 125): ACLS continues to chop mostly sideways, giving up very little of its strong January/February gains (good) but also not bouncing much off support in recent weeks (not as good). To us, it’s a new leader that’s still worth watching.
• DraftKings (DKNG 21): DKNG has actually been gaining steam while many growth stocks sag, etching a decent-looking (albeit brief) launching pad. Growth remains in a good place, and like many fallen angels, the top brass is focused on getting the bottom line into the black.
• Duolingo (DUOL 138): DUOL is probably the top name on our watch list right now, with a super-powerful breakout and run during March and a very reasonable rest period so far this month. The red ink is a negative, but as the firm upgrades its offerings (including more AI for explanations and chatbot-like services) subscription revenue should continue to surge.
• Impinj (PI 137): Like many growth names, PI has had trouble punching above resistance since early February, but shares are beginning to settle down and the story seems as good as ever. See more below.
• Intra-Cellular Technologies (ITCI 61): We’re not big on money-losing biotechs, but this company’s drug has huge blockbuster potential in schizophrenia, bipolar I and II, and major depressive disorder. See more below.
• Palo Alto Networks (PANW 192): PANW is one of many names that has tested multi-month highs this week only to fall back. Even so, the stock has been holding near its 25-day line and the outlook looks great—any positive change in character from the stock or market would be tempting.

• Samsara (IOT 22): IOT has actually shown some great accumulation this week, moving to slightly higher highs. Given the environment, that could mean a near-term pullback is due, but the overall action is bullish, as is the story.

  
  

Other Stocks of Interest

Intra-Cellular Technologies (ITCI 61)—Biotech stocks remain hit and miss, but a combination of the sector going nowhere for years (the S&P Biotech Fund, symbol XBI, has made no net progress since early 2015!), some M&A activity (big pharma has tons of cash and little growth, leading to some buyouts) and some real fundamental breakthroughs involving treatments have some names popping. One we started following more than a year ago is the mundane-named Intra-Cellular Therapies, which has the makings of an emerging blue-chip outfit thanks to one potentially massive blockbuster drug. Called Capylta, it was approved back in 2000 for the treatment of adult schizophrenia, a market of about 2.4 million people, and the firm was and is making good progress there, with around 1,750 patients signed up in less than two years. But then came approval for both Bipolar I and II disorders (importantly, the approval label came both for Capylta alone and in concert with certain other drugs—the only treatment with such a label), and that accelerated adoption in a big way, with 2022 seeing prescription volume triple to north of 6,000 people—and with 11 million people in the U.S. alone with some sort of bipolar disorder the potential is obviously giant. (Indeed, the top brass guided for 2023 Capylta sales of $440 million or so, up 75%-plus from a year ago.) But even that market looks like just the tip of the iceberg if some recent Phase III clinical trial results hold: The drug has met primary endpoints as a treatment for major depressive disorder (MDD for short), with statistically significant declines in both symptoms and severity. That’s a monstrous deal as there are 21 million people with MDD, some of which also have bipolar symptoms, too. The bottom line here is that, while Intra-Cellular is still losing money, the upside is big, as analysts see sales advancing from $250 million last year to $444 million this year to $662 million in 2024, with (a) the estimates likely proving conservative, as the firm regularly trashed estimates last year and (b) with much more upside down the road as long as management pulls the right levers. ITCI wasn’t immune to the bear market last year, finally falling to the 45 area in September, October and again in March, but the recent trial results have changed the stock’s character, with the name testing its 2022 (and all-time) highs of late. It could be news-driven in the near term, but it wouldn’t surprise us if ITCI has begun a sustained run. Earnings are due May 10.

Denbury (DEN 93)—In the last issue, we mentioned Civitas Resources, which is one of the strongest oil stocks (albeit a small-ish one) out there, especially among those following the new playbook of limited CapEx and debt and big dividends and share buybacks. Denbury is technically in the same group, but it’s a tiger with different stripes, with big potential in both the old and new energy worlds. Right now, the big earnings and cash flow are coming from black gold, just like Civitas and the rest of the group—last year, Denbury cranked out north of $3 of free cash flow per share (thanks to operations mostly in the Gulf Coast and Rocky Mountains) and returned three-quarters of it via share buybacks (at a price near 61, so very accretive to shareholders). Free cash flow would have been 40% to 50% higher if this was a traditional oil and gas outfit, but the firm is investing to be a next-generation green oil firm, too—Denbury is busy building a carbon capture, utilization and storage network for itself and many others, which it will use in enhanced oil recovery, where it injects CO2 into the ground to drum up oil from hard-to-get-at wells. And, even better, lots of times more CO2 is left in the ground (so-called sequestration) compared to the oil recovered, which allows Denbury to collect tax credits, too. The firm’s Cedar Creek Anticline is a prime example of all this, with 1.4 million tons of CO2 already injected, and with the first oil expected to be “pushed out” in the second half of this year—all with very low operating costs and overall negative CO2 emissions. In total at year-end, Denbury had transportation and/or storage agreements for 22 million metric tons per year of CO2 down the road, and aims to have more than 30 million in place by the end of 2023 … all moving it toward its goal of being the carbon capture and so-called “blue oil” (net negative emission) firm in the future. DEN does loosely follow the oil group, but it’s beginning to separate itself—the stock actually hit new highs last fall, and after a grudging pullback into March, DEN has perked back up to within 11% of its prior highs (and above its 2021 highs, which is noteworthy). We’re intrigued by this one-of-a-kind story—effectively leading the way creating what could be an entirely new (and large) industry. Earnings are due May 3.

Impinj (PI 137)—We admit we’ve been a bit hot and cold with Impinj since we mentioned it on this page about five months ago, as the stock’s had some wild week-to-week volatility and some fundamental factors (like customer concentration—a couple of OEMs combined account for half-ish of the firm’s revenues) increase the blowup potential should something go amiss. Still, at day’s end, it’s hard not to be enticed by the company’s outstanding combination of story, numbers and, more recently, its chart. Impinj is all about connecting trillions of items to a network for better tracking and security—for just pennies apiece, retailers (for instance) can put Impinj’s endpoint chips on any item for inventory management and fraud prevention (which is a huge issue globally), while basically everyone could use them for supply chain logistics and tracking. (There’s also related software, checkout systems and scanners, so the firm provides an entire solution.) Demand has been strong for a long time (a good-sized chunk of it appears to be from one big European retailer), but supply of these circuits has been tight—so much so that the top brass said demand was outpacing supply by 50% for the past many quarters! Even so, supply has been gradually improving (sales up 46%, earnings up 156% in Q4) and that should continue in 2023, with analysts seeing 38% sales growth and earnings up 67% (both likely conservative) and more growth beyond that. Big picture, if Impinj can ink a new deal (or a big expansion of an existing one), the sky’s the limit as it’s captured just a hair of the potential market. As for the stock, PI gapped up hugely on earnings in October and rallied up to the 140 area in mid-January but then started to thrash around in a 25-point range. However, PI has etched some higher lows in recent weeks and is now just shy of a breakout … if earnings, which are due next Wednesday (April 26), please big investors. We’ll be watching.

Wanted: Liquid Leadership

A few months back in early October, the title of our issue was “Wanted: Leadership,” where we wrote about the crystallization of bearish sentiment (the U.K. bond market was having convulsions at the time) and some intriguing upside action (including a super-skewed up volume day, with 20 to 25 times as much up volume as down volume, a historically rare figure)—and so far, that ended up being the bear market lows for the indexes.

But what we really wanted to see—and what the market needs for a sustained advance—was new leadership. Happily, more and more has popped up, and while the going has been choppy, there are many newer names that appear to have begun new upmoves; indeed, there are a lot of IPOs from the past year or two that look like new leaders.

But that gets us to the title above—what the market also needs is not just leadership, but liquid leadership that big investors can really pile into. These are stocks that have great stories and numbers and charts, yes, but they also have tons of trading volume where big mutual and pension funds can buy in size and have the conviction to hold through a few earnings reports. If we had our druthers, we’d love to have most of the Model Portfolio in liquid leaders, but right now that’s a hard pull.

About the only liquid leader we see out there is Nvidia (NVDA), which looks like the rare case where a huge former winner remains a leader following a punishing bear phase. Not only has the stock shown extreme power this year (it rose 13 of the first 14 weeks of the year and has given back zero of that move), it looks like a nuts-and-bolts way to play the AI boom and many other growth-y areas—and the numbers should show it, with earnings expected to grow north of 30% both this year and next, more than making up for last year’s hiccup.

After that, though, the super-liquid pickings are slim; if you dig into most strong names right now (our Model Portfolio, watch list and ideas in Other Stocks of Interest are examples), the vast majority are still in the process of gaining sponsorship. For our part, we rarely buy a stock that trades below $50 million of daily dollar volume (share price multiplied by the average shares traded per day), but liquid leaders often trade $250 million or more … and most of today’s strong names aren’t there, at least not yet. Names like Arista Networks (ANET, $400 million per day) or Palo Alto Networks (PANW, $800 million) could be liquid leader candidates, but the rest are still “growing up,” with names like Duolingo (DUOL, $75 million) and DoubleVerify (DV, $41 million) good examples.

“But Mike—who cares exactly how liquid the name is? If it has the characteristics of a winner, it has a good chance to do well, right?” Well, yes … which is why we own a few of them. But the point here is that if the market’s leadership stocks are mostly borderline liquid or still growing up, then they’ll be subject to more ups and downs as smaller funds can push them around. Along with the news-driven environment, we think that’s one reason we’re seeing so many names get tossed in the surf on a week-to-week basis.

However, the reason we’re writing this is because we’re just getting into Q1 earnings season, and if we’re going to see either (a) some new liquid leaders emerge, or (b) some borderline liquid names grow up, it’s likely to happen after some blowout reports and outlooks. Indeed, that’s how we’ve landed many big winners in the past, from Facebook in the summer of 2013, Ulta in 2014, Twilio in 2020, Baidu in 2010, Shopify in 2017 and tons of others. If big institutional investors are going to find some new favorites to play with, the next three or four weeks will be key.

Lots of Dry Tinder for the Bulls

In the meantime, we’re still stuck with a choppy environment, where strength is still being sold into for the most part—as we wrote in the last issue, trends last for days or maybe weeks but certainly not months—but, while there are some potholes out there, the market and even most leaders tend to find support on dips. We think a reason for the latter is that so many investors are already lightly invested in stocks, meaning there’s less pent-up selling pressure than there would be otherwise.

We see this among both big and small investors. For the latter, consider an offshoot of our Real Money Index—shown here is the 20-week sum of money flows into or out of equity funds and ETFs going back six years. You can see that, as of a couple of weeks ago, that sum hit a multi-year low. Other individual-heavy measures (like the AAII sentiment survey) showed similar extremes a couple of months back.

Then there’s the Bank of America survey of institutional investors that combined manage something north of $500 billion (the last time we checked)—and every month, it seems like there’s another “most underinvested in 10 to 20 years” figure that comes out. This week, the monthly survey showed that, as a whole, respondents were about 45% overweight cash and 10% overweight bonds, while at the same time, they were nearly 30% underweight equities. The net effect has big investors as cautious as they were for much of 2008.

As always, sentiment is secondary, but there’s no doubt that the torrent of bad news out there, including the recent bank panic and resulting plunge in lending activity, has many thinking a bad recession is coming. Maybe it does—but the question is how much of that is already priced in. At this point, there’s little doubt that there’s plenty of dry tinder for the stock market if a few things can go right in the world.

Cabot Market Timing Indicators

As we wrote on page 1, there are many small positives out there, and our indicators aren’t in bad shape overall, with our primary measures and others we watch generally in the neutral-to-bullish range. That said, the on-again, off-again environment for individual stocks keeps us cautious as we wait for the market (and growth stocks) to show some decisive strength.

Cabot Trend Lines: Bullish
From the perspective of our market timing system, the biggest difference between 2022 and 2023 remains our Cabot Trend Lines: Last year, this key long-term trend measure was bullish for less than one month, but this year, it’s been bullish for two and a half months despite the ups and downs, recession worries and banking issues. And the green light looks healthy here, with the S&P 500 (by 5%) and Nasdaq (by 7%) above their respective 35-week lines by a solid amount.

Cabot Tides: Neutral
By the letter of the law, our Cabot Tides are back to positive, as most of the indexes we track (like the NYSE Composite) are above their lower, rising moving average. That said, this is a don’t-leave-your-brain-at-the-door situation: Even the best-looking index (the Nasdaq) is still within a big-picture range, so while the rebound from the bank panic lows is a good thing, we consider the intermediate-term trend to be neutral.

Two-Second Indicator: Positive
Our Two-Second Indicator continues to show improvement, enough for a technical all-clear signal—including today, we’ve seen 10 straight days of 40 or fewer new lows. To be fair, many of those readings were right on the edge (39 or 40), and if today’s weakness spreads, the next few days will be key. But like many measures, this indicator is improving and the action is encouraging since the March break.

The next Cabot Growth Investor issue will be published on May 4, 2023.