Cabot Growth Investor Issue: April 6, 2023

On Again, Off Again

The real money in the market is made when things are trending—the market firstly, and then of course individual stocks and sectors. Of course, there will always be shakeouts and even intermediate-term corrections along the way, but riding a months-long uptrend in a few winners can really make a difference in your portfolio and, ideally, your lifestyle as well.

These days, though, trends are counted in days and sometimes weeks but not in months—the big institutional investors that control the market and are responsible for pushing things up and down over time just aren’t stepping up in any sort of consistent way. Instead of having a few dozen funds in an accumulation campaign, buying a bunch of shares in many leaders over time, the action implies that they’re doing some nibbling here and there but abstaining from big buying sprees until they have more clarity on the economy’s future.

This week, we saw another example of that, with growth stocks and many potential leaders—which had been holding excellently even during the banking panic three weeks ago—meeting with lots of selling, even as we’ve seen defensive stocks rally and economically sensitive stuff get whacked.

Now, while the action is discouraging, we wouldn’t say it necessarily portends something hugely bearish, at least not yet: Most stocks that have taken on water are still above key support, and from a top-down perspective, not much has changed with our indicators (Cabot Trend Lines positive, Cabot Tides and Two-Second Indicator negative). Plus, there have actually been an increasing amount of studies based on market action that, historically, occur before some good-sized market upmoves. (See more later in this issue.)

To us, what the action this week really says is simply that the on-again, off-again environment, both in the general market and within growth stocks, is still in effect. That’s more descriptive than predictive (it can change in a hurry if big investors change their tune), but right now, it reinforces the view that we should be playing lightly and staying nimble—which is what we’ve mostly been doing in the Model Portfolio.

What to Do Now
Remain cautious, but let’s see how stocks react following this rotation. We came into this week with around half the portfolio in cash, and while we have a few stocks on the fence, most are standing right on top of support. Obviously, should the growth stock weakness spread, we’ll be paring back, but as we head into the long weekend we’ll sit tight and see how things play out. Our only change is placing Academy Sports (ASO) on Hold.

Model Portfolio Update

The market remains in a relative no-man’s land, with some improved action since the banking panic a few weeks back, but with tricky conditions persisting—lowlighted by this week’s rotation, which saw many defensive areas (big healthcare, consumer staples) find buyers while growth titles did poorly.

To be fair, growth stocks as a whole are still in halfway decent shape, but the sell-on-strength bugaboo that was with us for all of 2022 is beginning to reappear, with many names poking to new highs late last week quickly rejected. How many names we own and are watching act around key support will be key next week.

Right now, though, given that we’re about half in cash and that nothing has really broken down, we’re going to sit tight, stay flexible and vigilant and see how things progress. Our only minor switch is placing Academy Sports on Hold.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO hosted an Investor Day this week, and we have to say, the near- and longer-term outlook here look very bullish to us: First, the firm reiterated its 2023 outlook from a few weeks back, but it also had many encouraging tidbits when looking out to 2027, including a boost in the store expansion plan (now looking to increase the store count by nearly 50% in the next five years), and all of that will be self-funded (no need for huge borrowings … though the firm has very little debt as it is). Plus, in the very long term, the top brass sees the potential for 800 locations, up from 268 today, so there’s plenty of growth runway ahead. (As for store economics, new openings are usually EBITDA positive after year 1, which is very solid.) All in all, Academy sees sales up in the 8% to 10% range per year through 2027, with earnings totaling $1 billion by then (about $13 per share on the current share count, though there will almost surely be share buybacks between now and then). All that said, the company is not the stock—and the stock sold off sharply on the news, which came after a test of its earnings spike high from two weeks ago. After a run higher in recent months, we do think the action is a yellow flag—we’re switching our rating to Hold tonight—but the overall uptrend is still intact, and obviously the story is solid. If ASO cracks from here, we’ll probably sell some and hold the rest, but for now, we’re sitting tight. HOLD

Allegro Microsystems (ALGM)—Allegro Microsystems is one of the new chip leaders out there, with products that are perfectly suited to the power-hungry demands of many applications, though autos are the main draw—electric vehicles and advanced driver assistance systems in particular. Indeed, at its Investor Day last month, the top brass said it thinks it can grow 7% to 10% faster than the overall auto market (as well as 5% to 10% faster than the broad industrial sector) in the years ahead—and it also bumped up its long-term margin guidance (eventually seeing 25% free cash flow margins down the pike). All in all, the story is very sound, but now it’s a matter of seeing if the stock’s uptrend can hold: ALGM staged a great-looking breakout from a big post-IPO base in early February, and it’s been chopping slightly higher during the past few weeks … though this week’s light-volume decline looks a bit sloppy. Any decisive break of support in the 42 to 44 range would be intermediate-term abnormal, but right here, ALGM is still acting normally and is approaching its 50-day line (near 44), so if you don’t own any and want to nibble, we’re good with it. BUY A HALF

Axon Enterprises (AXON)—AXON is an example of what we’re seeing among so many growth stocks, with a quick wave of selling as big investors let go of shares after last week’s strength, but the stock is also still in decent shape overall, trading above support in the low/mid-200s and holding most of its earnings move. Of course, the story here should remain intact no matter what happens to the economy, with the firm’s Tasers and cloud-based evidence management likely to continue to gain popularity with law agencies in the U.S. and overseas. Like most of our names, if growth stocks really unravel (whether it’s because of a general market decline or more rotation), we won’t hang around with any sort of big loss even on our half-sized position—however, right now, while the near-term will likely bring more wobbles, we’re sticking with what we have and think a small position is fine if you’re not yet in. BUY A HALF

On Holding (ONON)—We wrote that ONON is likely to be hyper-volatile and that’s exactly what we’ve seen, with big up and (yesterday) big downmoves, supposedly brought on by an analyst downgrade (though it was likely more due to the overall environment). Obviously, anything is possible if the market really gives up the ghost, but the odds strongly favor that the stock’s gigantic, earnings-induced breakout, sparked by a terrific forecast (analysts see earnings up 30% this year and 42% next, both of which are likely conservative) should lead to good things down the road. A move all the way down to the 24 or 25 range would be abnormal, but at this point, we’re content to hang on and see how things play out—if you own some, sit tight, and if not (and are willing to give the stock plenty of rope), we’re OK starting a position here. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—The bounce in the S&P 500 over the past couple of weeks has certainly been welcome and a positive surprise, with the index recouping about 80% of its February-to-mid-March decline before pulling in a bit in recent days. As we write about later in this issue, there are tons of big-picture studies that suggest the market’s next big move is up, which, when combined with the solid post-bank-crash bounce and our still-bullish Cabot Trend Lines (and even the fact that interest rates have likely peaked and our Power Index is positive), has us giving our remaining shares of SSO a chance to hold up and (eventually) move higher. That said, we wouldn’t be piling in here, either, with the Tides still bearish and with financial stocks still circling the drain. Long story short—we’re encouraged by the action and are holding on, but when it comes to the overall market, we’re not pushing the envelope given the evidence. HOLD

Shift4 (FOUR)—FOUR looked as good as could be a week ago, but this week’s rotation out of growth stocks and increased fears of a recession (many economic reports have been weak in recent days, even as Fed officials continue to jawbone for higher rates) has brought some selling—not cracking the uptrend, per se, but quickly pulling shares back into their March trading range. As we wrote about recently, a modest recession (if one comes) wouldn’t be good for a payment operator, but Shift4’s move into new industries should cushion any blow, as it did just a couple of years ago—even though restaurant and hospitality are its core clients, the firm actually grew during 2020, and obviously, those sectors are far healthier today while new clients should goose growth. Thus, the story remains excellent, though we’ll be watching the stock’s action: A decisive dip below the 65 area would be a yellow flag and at least have us going back to hold, but at this point the dip is sharp but acceptable, so if you don’t own any we’re OK starting a position here. BUY

Wingstop (WING)—Stop us if you’ve heard this before: WING was looking picture-perfect coming into this week, but some out-of-nowhere selling on heavy volume has knocked the stock down … though it’s still holding onto support. Yes, recession fears likely had a role in Tuesday’s selling, though it’s doubtful a fast-casual place with a cheap-ish menu like Wingstop would be crimped much if the economy goes south. Thus, our view here is very much like most of our other names, as (a) the story is still sound and growth should remain intact, but (b) much more weakness and we’ll potentially prune our position, selling a portion of our shares. At this point, with lots of support in the 165 to 170 area, we’ll sit on our hands. HOLD

Watch List

• Arista Networks (ANET 160): ANET has been jerked around a bit but remains in fine shape, still holding near its 25-day line. To be honest, a bit more weakness would probably be a good thing and potentially set up a lower-risk entry—assuming the market doesn’t cave in.
• Axcelis (ACLS 125): ACLS has dipped right to its 50-day line, technically hitting that key support area for the first time since breaking out at the start of the year. We’re not in a rush to add another chip stock, but if ACLS (and others) bounce strongly from here, it would be an intriguing setup. At this point, we’re just watching.
• DoubleVerify (DV 31): DV has a great story relating to digital ad verification, a new-ish sector that should boom as digital ads become the norm. See more below.
• Duolingo (DUOL 137): DUOL continues to act just fine, holding the vast majority of its moonshot gains from last month. A couple of weeks of calm trading as its moving averages catch up would be a plus. Fundamentally, the firm’s language offerings should lead to years of rapid growth both from new users and from converting current free users.
• Palo Alto Networks (PANW 192): Cybersecurity names are mixed, but PANW looks like the liquid leader in the group, with strong sales, earnings and free cash flow growth. Shares tested all-time highs last week and are retreating normally so far.
• Samsara (IOT 19): IOT is lower priced and volatile, but it’s still within a reasonable consolidation following a big early-year run. We think the firm’s story (software to help firms manage tons of physical assets like truck fleets, etc.) has rapid and reliable growth written all over it.

Other Stocks of Interest

DoubleVerify (DV 31)—The boom in digital advertising, especially if done programmatically (via algorithm behind the scenes; Trade Desk is a leader there), is spawning a follow-on opportunity in terms of ad verification—and DoubleVerify is one of the leaders in that field. In essence, the company’s offerings help make sure a client’s digital ads are shown where they’re supposed to (fraud is up huge since digital ads became more prevalent); are shown in “friendly” places to protect their brands (i.e., can elect that ads aren’t shown next to other ads or content for untoward products); and are actually viewed by customers for at least a couple of seconds (the industry standard). All in all, DoubleVerify says it’s the only verification firm that covers all the top ad-supported connected TV providers (including Roku, Paramount+, Disney+, Hulu and a just-released version for Netflix, too), and it also does big business verifying social media ads and retail media (ads within an e-commerce site or app), plus it’s moving into adjacent categories (like podcast audio ads), too. All in all, the firm provides a single platform for clients to manage, monitor and track their ads, which is a service that will be increasingly in demand due to the growth in digital advertising (DoubleVerify measures about 300 billion daily data transactions) and the desire to make every ad count. There is competition, but at this point, there’s tons of whitespace, with around two-thirds of the deals it’s inking with firms that don’t use any verification or viewability solutions at all. As for the numbers, they’re solid—sales are expected to grow in the 20% to 25% range this year and next, while EBITDA lifts at a slightly slower rate … though these assumptions assume a continued sluggish economy and don’t include much from newer deals, so we’ll see. Just as important are terrific sub-metrics, including a 95% gross revenue retention (100% retention of its top 75 customers over the past four years!) and a 27% same-customer revenue growth rate. DV came public in mid-2021, tanked for the next year and, after a nice summer rally, dipped to a higher low by year-end. But like many names, shares have perked up this year, with shares testing multi-month resistance and giving up no ground this week. We think there’s potential for rapid, reliable growth for many years to come; DV is on our watch list.

Civitas Resources (CIVI 70)—When sectors hit the skids, we usually try to keep an eye on one or two names that are holding up best during the decline—with the idea that, should the sector turn up, they could be the names that lead the way. Civitas Resources is a smaller oil explorer (~$6 billion market cap) that operates in the less-talked-about Denver-Julesberg (DJ) basin in Colorado, controlling around a half million acres and around 1,000 drilling sites that crank out a balanced mix of output (45% oil, 30% gas, 25% liquids) at the lowest cost of any of its peers. The firm is in an interesting position, spinning off almost more cash than it knows what to do with—it has been looking for acquisitions in the area (in fact, the company itself was formed via a set of mergers in the basin), but the top brass has felt acquisition prices have been too high, so it’s been returning tons to shareholders. Last year, with elevated prices, free cash flow totaled about 24% of the market cap, which led to huge dividends ($4.80 per share, not including the $2.15 it just paid at the end of March) and, in January, it executed a one-time repurchase of 5% of the firm’s shares … and despite all that, the company still has more cash than debt on the balance sheet! Now, obviously, oil and gas prices have come down, but even with relatively modest assumptions ($65 oil, $3.50 gas, etc.), Civitas’ free cash flow could be 12% to 15% of the market cap, with a lot of that paid out in dividends and most of the rest used to buy back stock and/or engage in some modest M&A—and, of course, if this past weekend’s OPEC move kicks off a new uptrend in oil prices, even those solid figures could prove super conservative. There are some risks here, including the fact that the firm’s current inventory of wells is probably only five to six years’ worth of new drilling, but there’s far more good than bad here, and possibly most impressive aspect is the chart: Yes, CIVI has been choppy, but while the S&P Oil and Gas Fund (symbol XOP) is still 20%-plus off last year’s peak even after the recent rally, CIVI is just 6% off its own high, knocking on the door of a real breakout. We’re not sure we’ll be playing much in the oil patch, but if you’re interested, CIVI is a smaller name that certainly looks ready to move if the sector decisively turns up.

Freshpet (FRPT 66)—Freshpet is a name we’ve been keeping a distant eye on for a while—the stock had a monstrous advance from 2018 to 2021, but then the bear market (and, frankly, a series of fundamental potholes) sent the stock to the glue factory, with shares imploding 80% over 17 months. What’s interesting to us, though, is that the story and underlying demand have remained excellent—the firm is known for its fresh pet food that it now sells in more than 25,000 locations (and online) and is part of the overall trend of Fido and Whiskers becoming a real part of the family (meaning owners will spend whatever it takes to keep them healthy and looking good). While on the small side, Freshpet looked set to turn profitable a few years back before things went sideways; supply chain and inventory issues, higher costs for inputs and logistics, new plant opening costs and more sent the bottom line deeper into the red and caused investors to bail. Interestingly, though, sales growth remains very strong (it’s actually accelerated of late, up 43%, 41% and 34% during the past three quarters), penetration continues to increase (9.57 million households are customers, up 16% from a year ago; heavy buyers are up 31% from 2021) and the majority of the cost and supply issues look to be in the past. Indeed, Freshpet squeezed out an EBITDA profit last year, and by keeping costs in check and with further expansion, the numbers should continue to improve—analysts see sales up 26% both this year and next, while the top brass sees EBITDA lifting from $20 million in 2022 to more than $50 million this year. As for the stock, it rallied smartly off its low point last year before pulling back again and looked ready to go over the falls after the Q4 report a month ago. But instead, buyers stepped up in a massive way, with FRPT finding support on its second-heaviest weekly volume ever, and shares are now testing multi-month highs. Of course, we can’t say the stock is in an uptrend yet, but it’s a nice setup—and a healthier market and a powerful breakout could see a new sustainable rally get underway.

Playing the Odds

There’s no doubt that the 2022 bear market—and, really, everything since the pandemic—has been something of a rule-breaker environment, meaning many tried-and-true indicators, measures or studies that have usually worked over time have fallen flat. The perfect example of this was many of the “mini blastoff” indicators turned green last year (historically portending great gains) only to see the sellers show up anyway.

That said, we always like to play the odds, and the fact is that more and more happenings are occurring that, in the past, have almost always preceded further gains. (For the coming data, hat tips to Ryan Detrick of Carson Group, Bespoke Investments and Nautilus Research.)

One is the 2-to-1 Blastoff Indicator that flashed on January 12. It hasn’t been great thus far, but the action isn’t completely out of the ordinary—the max loss from the signal of 3.2% on the S&P 500 is actually quite average compared to other signals that came below the 200-day line. Interestingly, the S&P is now back above that signal by nearly 3% despite all the issues out there.

And there are many other studies that are lining up on the bull side of the aisle. First is the fact that the S&P 500 has now closed three straight months above its 10-month moving average; following a 20%-plus decline, such action has always come after the bear market low. Thus, if history holds, that means last October’s market nadir should be the bottom.

Then there’s the old “December low” measure, which simply states that if the market never closes below its December low during the first quarter (which happened this year), it portends good things. Indeed, since 1950, such action has led to gains 92% of the time for the rest of the year with average returns of 11%.

Similarly, you have the fact that the S&P declined last year and then rose in Q1 of this year. Since 1954, that’s happened 10 times, with all 10 bringing gains for the rest of the year with average gains again around 11%.

Then there’s the fact that the Nasdaq’s 21-day (short/intermediate-term) moving average recently closed above its one-year (longer-term) moving average after being below it for at least half a year. Since 1975, that’s happened only seven other times—and a year later, the Nasdaq was higher every time by an average of around 30%, while the S&P 500 was higher every time by an average of 21%!

There are a few others, but you get the gist—the pattern of the past year (a big bear market, a decent rally and a lack of downside since) is one that has almost always led to higher prices down the road. As mentioned above, there are never any guarantees, but the market is an odds game, and seeing a confluence of studies all point in the same direction is something to keep in the back of your mind.

The Sector on the Margin

We’re always focused on what we feel are the market’s leading (or potential leading) stocks—especially any liquid leaders (which, by the way, there aren’t many of today; that’s a fly in the ointment of the recent rally)—as (a) those are ones that can be ridden for big gains over time, but also (b) their action can give you insights into the health of the market and the mindset of institutional investors.

However, when the market is iffy, we also like to keep an eye on a couple of stocks—or sectors—that are leading the way lower. For all of 2022, one example was the Ark Innovation Fund (ARKK), which was the poster child of sorts of the growth stock decline. Indeed, that fund sunk right into year-end … but its rebound (and relative resilience of late) correlates well with the growth stock perkiness until this week.

Now, of course, the market has moved on to worrying about a banking crisis, with the disintegration of SVB and Credit Suisse having many wondering if something’s coming loose in the system. That obviously means financial stocks are the new sector on the margin—and within financials, it’s largely the regional banks (symbol KRE) that are under the most fire.

We won’t go into every detail of the chart here; KRE has obviously crashed, but more important to us, it’s been unable to bounce at all and slipped to new closing lows this week. We’re not saying the market is going to move in lockstep with KRE, but it’s also unlikely a sustained uptrend will get underway with many stocks at the heart of a possible banking crisis under extreme pressure. It’s a tertiary indicator, but in the near term at least, it’s worth keeping an eye on KRE to see if it can at least hold up, if not push out to recent highs (above 48-49).

Cabot Market Timing Indicators

From a top-down perspective, there are still some positives, with the longer-term trend up and numerous studies boding well for down the road. That said, most of the market remains iffy, and the growth stock resilience is fraying. We’re remaining relatively cautious here, though we’re also giving our positions a chance to hold support.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines held onto their buy signal during the market’s banking-related selloff, and the recent push higher has given them some breathing room—as of this morning, the S&P 500 (by 3%) and Nasdaq (by 5%) are solidly above their respective 35-week moving averages. Clearly, it’s not 1999 out there, but with the longer-term trend remaining up, the odds continue to favor higher prices in the months ahead.

Cabot Tides: Bearish
While the big-cap indexes are in decent shape, our Cabot Tides are still negative due to the broader indexes (like the S&P 400 MidCap, shown here) that continue to lag. To be fair, there has been some improvement—if the major indexes can improve during the next week, a new green light would likely be triggered. But we don’t anticipate these things: Right now, the intermediate-term trend of most of the market is still pointed down.

Two-Second Indicator: Negative
Our Two-Second Indicator has taken some steps in the right direction, as there were a few sub-40 readings during the recent bounce and, even on this week’s selloff, we’re not seeing new lows truly explode higher as they did during the banking selloff. Even so, whether it’s this or other measures (less than one-quarter of all NYSE and Nasdaq stocks are above their 50-day lines), the evidence points to the broad market still being unhealthy.

The next Cabot Growth Investor issue will be published on April 20, 2023.