Cabot Growth Investor Issue: August 24, 2023

Decent Snapback—but Still Cautious

In the last issue, we wrote that the market was definitely down but not out, and since that time, we’ve seen the market sink further—from top to bottom, the Nasdaq fell about 9% while the S&P 500 was off nearly 6%, with interest rates perking up near (or in some cases, out to) new multi-year highs. But this week things have generally snapped back nicely (today was ugly but many stocks are well off their lows), led by the tech stocks that were the hardest hit during the past month. Let’s hop right into a few thoughts we have.

First, we’re not obsessed with precedent analysis, but so far this pullback is playing out fairly closely like the ones in 2003 and 2009, each of which pulled back 8% over about a month and then marched higher. It’s a similar story with our Aggression Indexes, too, with the relative strength of the Nasdaq (and equal-weight Nasdaq 100, which we showed in the last issue) compared to consumer staples hanging in there.

Second, we like the fact that the sharp retreat has boosted discomfort by many measures: This week’s Investors Intelligence survey shows the fewest bulls since late March; the 15-day average of new highs on the Nasdaq is at its lowest level since the mid-March banking crisis (see chart); and the NAAIM Exposure Index is at levels not seen since last October!

And third, our Cabot Tides have at least a shot at a “shakeout buy” signal—where every index dips below their 50-day lines for a brief time (usually a week or two) before quickly recouping that key area. Today’s action hurt the cause, of course, but it’s something watch, and if it happens alongside a still-bullish Cabot Trend Lines, such signals in the past have often been powerful.

Thus, we take this week’s bump as a positive first step—yet it’s clearly not decisive: While the Tides have a shot at turning around, they remain negative, so there’s clearly more work to do. Same goes for our Two-Second Indicator, which confirms that the sellers are doing damage to the broad market. And then there are growth stocks—yes, some could be buyable if they power ahead from here, but again, we have to see it happen first.

And let’s not forget what we mentioned above and what’s been a major thorn in the side of stocks for the past two years: Interest rates, which are trending up (we touch on our Power Index later in this issue), with all eyes on tomorrow’s big Fed speech. No, rates aren’t as important to us as the action of the indexes and growth stocks, but if they continue trending higher, it’s a good bet the environment will be challenging.

What to Do Now

Overall, then, we remain cautious, though we’re also flexible—should the nascent rally pick up steam and flip our indicators, we’ll put a slug of cash to work, but another leg down could have us selling more. Tonight, though, we are making one small move—we’re starting a half-sized stake in Noble (NE), which looks like the leading energy driller, and whose stock has traded tightly for a few weeks even as oil has pulled in. That will still leave us with a bit over half the portfolio in cash, which we’ll hold onto until we see further strength.

Model Portfolio Update

The market’s correction started out focused mostly on glamour stocks, with leader after leader cracking support, often after earnings. Then it spread to the Nasdaq as a whole, which knifed below its 50-day line two weeks ago. And finally it took down the rest of the market on an intermediate-term basis, with our Cabot Tides turning red last week and our Two-Second Indicator confirming the weakness as more stocks hit new lows.

Because we were already half in cash when the Tides flipped negative, we didn’t make any huge changes (we sold our small stake in Shift4, mostly because the stock broke down), and are now in a cautious stance—and, for the most part, we’re content to hold plenty of cash until we see the buyers really step up.

That said, we’re still of the mind that the odds favor the market’s next big move being up, and because of that, we’re not sticking our heads in the sand. Tonight we’re adding a small stake in Noble (NE), which could be leading a group move, and if the market can build on this week’s rally, we’ll obviously put more cash to work (we have some new names on the watch list tonight). For now, though, we remain cautious, with around half the portfolio in cash after the NE buy.

CURRENT RECOMMENDATIONS

Celsius (CELH)—Celsius remains one the strongest stocks in the market, not only gapping higher after its Q2 report (a rarity among growth stocks recently) but, so far, holding those gains, with a quick shakeout last Thursday leading to romp back toward new closing highs yesterday. We’ve done a ton of studying of past trades over the years, and one of the factors that correlated best with good outcomes was triple-digit sales growth (and we’re talking about “real” 100%-plus growth, not just because of an acquisition), as Wall Street often has trouble keeping up with the growth story and developments. And seems to be playing out here, where Celsius’ (sales up 95% and 112% the past two quarters) distribution, uptake and margins continue to top expectations (next year’s earnings expectations popped 30% after the Q2 report), and yet the runway of growth appears humongous, with plenty of end markets (food service, casinos, hotels, universities) under-penetrated, and that says nothing about the international opportunity, which should become a 2024 focus. Obviously, none of that guarantees anything if the market has another leg down, but while volatile, investor perception continues to improve as Celsius follows in the footsteps of Monster Beverage 15 to 20 years ago years ago. We’ll stay on Buy, though right now, keep new buys small and aim for dips if possible. BUY

DoubleVerify (DV)—The prospects for DoubleVerify’s business are basically the same as they were a couple of months ago; analysts still see the top line growing in the low/mid-20% range while EBITDA ramps at around the same pace. That said, there’s no question the stock is broken, but following an offering of closely-held shares, we thought it was likely DV could hold support in the low 30s and bounce. And it did just that, with a modest bounce before today’s reversal. All told, we could easily toss the stock out on the way up and look for greener pastures; for now, though, we’ll sit with our small position. HOLD

DraftKings (DKNG)—DKNG was hit very hard after the Penn National/ESPN tie-up a couple of weeks ago, dipping all the way back into its May/June range—though it’s started to bounce and approached its 50-day line yesterday. As we wrote initially, we doubt the ESPN action will dramatically shift market share in the online sports betting sector where DraftKings is a huge player, but the fear is that ESPN will essentially bring back the bad old days of huge incentives and marketing spend—hurting profitability for everyone involved. (Indeed, PENN hit new multi-year closing lows on Tuesday.) That said, we’ll see how it goes—DraftKings’ business is on fire, not just because they’re garnering new users but because current users continue to boost their usage in a big way, and we doubt those players will be switching platforms. If big investors think the ESPN move will have more bark than bite, we’d expect DKNG to continue recouping ground; if the stock sinks from here, though, it’s likely going to take a while to turn around, with big investors waiting for clearer data points on the effects of ESPN throwing its weight around. Right here, we’re holding our half-sized stake. HOLD

Noble (NE)—NE had a big breakout and run in early July, and since then has had plenty of opportunity to give back a chunk of those gains as the market’s selling has spread to the broad market and oil prices have wobbled—but instead, volume has been light, every dip has found support and shares continue to trade in a tight range. Yes, some of the attraction here is the recent upturn in oil prices, but far more important to us is that trends in this space tend to last a long time (you don’t just build a new deepwater rig in a few weeks), and with many drillers avoiding speculative building this time around, too, which means supply should remain tight for a long time, boosting dayrates for Noble’s rigs. And then there are shareholder returns: Similar to oil explorers (like Devon Energy, which we rode higher) a couple of years ago, Noble is aiming to return most of its solid and growing free cash flow to shareholders via both share buybacks (small but steady amounts each month) and dividends (initiated a dividend yielding 2.4% in July, and payouts are likely to grow as free cash flow does)—we’re not income investors, but these moves helped to change perception for the explorers in a big way, and we think that could happen with a firm like Noble, too. We’ll start with a half-sized stake and a stop in the mid-40s, but if the stock and the market get moving, we’ll look to fill out our position fairly quickly. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—We placed SSO on Hold last week to respect the Cabot Tides sell signal, though we’re still holding onto our (fairly big) position. To this point, the S&P 500 pulled back a maximum of 5.9%, which is a reasonable retreat after a persistent advance, and there remain a ton of longer-term positives, ranging from our own Cabot Trend Lines (firmly bullish, as they have been since late January) to the continued big-picture positives (one margin debt-related study just turned positive, which in the past has led to an average 29% gain in the S&P 500 a year later!). Thus, in our view, the odds still favor this being a normal correction—though the near-term is much more of a coin flip. We’re willing to go in either direction: Should the market cave in further (likely because interest rates continue to squeeze higher), we could trim our stake in SSO, though should the buyers return in a big way (Tides turn positive, etc.), we’ll likely restore our Buy rating. Tonight, though, we’ll stay at Hold. HOLD

Shift4 (FOUR)—Shift4 was sold last week as the stock cracked support, and there’s been no bounce since. Just looking at the story (the firm continues to sign up new names; deals inked a few months ago should start to kick in soon) and numbers (analysts see earnings of $2.63 per share this year, with free cash flow larger than that), the stock seems like a major bargain—but FOUR’s own action (and that of its peers) is clearly singing a different tune, with big investors either expecting a major slowdown or something other negative. If things clear up, we could always go back into FOUR, but we gave our small remaining position plenty of rope, so shares would need to improve in a major way before being ready to run. We think there will be better names to own in the next upmove. SOLD

Uber (UBER)—UBER pulled into its 50-day line of late as the market weakened, but unlike most stocks (65% of names in the S&P 1500—big, mid and small cap—are currently below their 50-day lines), this one has held up and begun to rally. There’s been nothing much new since the Q2 report, which was excellent and continues to bolster the case for continued huge EBITDA and free cash flow growth (some see $4 billion of free cash flow next year) in the quarters to come. All in all, we still think UBER acts like a “new” liquid leader of sorts, with a dominant position in two areas that have a long runway of growth, not to mention the firm’s newer ventures (like taking orders for certain places via its apps and then handing off the order), so we’re optimistic shares can move nicely higher if and when the market kicks into gear. We’ll stay on Buy, but as with most everything in this environment, we advise keeping it small. BUY

Watch List

• Axcelis (ACLS 170): ACLS pulled back 22% from high to low, which is very reasonable given its moonshot in the first half of the year, and it’s started to bounce back. See more later in this issue.
• Boot Barn (BOOT 90): BOOT has given up its earnings pop, which is par for the course these days, but it’s holding above the 50-day line. The combination of a post-pandemic turnaround, a long-term cookie-cutter story and a reasonable valuation have us optimistic the next big move is up.
• Confluent (CFLT 32): Granted, it’s sloppy, but we continue to think CFLT’s correction is normal at this point—though we’ll need to see some decisive upside action before thinking about buying. Fundamentally, we enthuse about the story, as Confluent looks like the key player in allowing data to be instantly integrated into both front-end (consumer facing) apps and back-end operations.
• CrowdStrike (CRWD 145)—CrowdStrike has always had emerging blue chip written all over it, and it’s finally set up a tight-ish sideways phase ahead of earnings next week. See more below.
• Freshpet (FRPT 73): FRPT has retreated some, which is no surprise given the environment, but it remains in solid position as the short-term numbers improve and the long-term outlook remains excellent. Our only rub is the stock remains a bit thinly traded for our tastes, but we’re thinking it could “grow up” in the near future.
• Monday.com (MNDY 164)—We don’t usually jump right back into stocks we were forced out of, but MNDY reacted well to earnings two weeks ago and (while still very volatile) has held up well since. Sales and earnings continue to crush estimates and sponsorship is growing quickly. See more later in this issue.
• Pure Storage (PSTG 36)—PSTG’s move to storage-as-a-service is progressing nicely and demand should accelerate as the AI boomlet continues. Shares were hit today but remain within shouting distance of all-time highs. See more below.
• Samsara (IOT 25)—IOT’s story is fantastic, the stock has finally stabilized somewhat and earnings are due out next Thursday (August 31). We’re watching for a powerful upside reaction.
• Vertiv Holdings (VRT 35)—VRT is a fresh leader that few have heard of, but its thermal management solutions look like they’ll be in giant demand as big firms fill up data centers with new, more powerful computing equipment—all while the firm’s supply chain issues are easing, boosting margins.

Other Stocks of Interest

Freshworks (FRSH 21)—We’re always keeping an eye on cloud stocks—they haven’t been in favor for a while (even during the May/June run-up), but the innovation is so pronounced in the sector that it becomes a breeding ground for future winners. Freshworks looks like a potential new winner in the group, but the story here isn’t some brand new idea, it simply revolves around having a better mousetrap: The firm goes up against big boys like Zendesk and Salesforce in CRM and sales and marketing offerings, and Atlassian and ServiceNow in IT service management, but those firms have added on to their offerings so many times they’re mostly geared toward big clients, which means user experiences are mixed and the total cost of ownership is large (fine for an enterprise, not as great for small- and mid-sized clients). Freshworks, on the other hand, has been built from the ground up to be easier to use and build off of, with more rapid onboarding and with a lower price point, too. That’s attracted users of all sizes from a variety of sectors (American Express, Blue Nile, Honda, Toshiba, Nielsen, Marvel, Coupa, Riverbed, Discover, TaylorMade, Sotheby’s, StitchFix, etc.), many of which start out with small purchases and grow; right now, Freshworks has north of 65,000 total clients (up 10% from a year ago), though 19,105 pay at least $5,000 in annualized recurring revenue (up 17%), with 2,186 paying more than $50,000 annually (up 32%). All of that is to the good, and is a big reason why the company is growing steadily (sales up 19% and 20% the past two quarters), is already profitable (in the black the past three quarters), and has positive free cash flow (interestingly, it has north of $1 billion in cash and securities, or about 16% of the market cap, with no debt). However, the future could be even brighter thanks to Freshworks’ moves into AI: It just released a new customer service suite with its Freddie AI system that includes things like smarter bots to help customers find answers on their own, gives agents next-best-action recommendations and provides insights into problems and can generate reports using conversational prompts—all while remaining easy to use for the average employee. Management was bullish on the potential here during the conference call, so we’ll see how it goes, but all in all Freshworks looks like a successful outfit with attractive products, and AI could provide a kicker to growth. FRSH crashed during the bear, spent months bottoming out and then broke out decisively above resistance after earnings, and it’s held the move. It’s still growing up (~$60 million of trading volume per day, 261 funds onboard), but we’re intrigued.

CrowdStrike (CRWD 145)—We fully admit that, for us, cybersecurity player CrowdStrike is a bit of a binky—we follow it from a distance and read through its quarterly reports even when the stock is acting poorly because we think the story has emerging blue chip written all over it, similar to a younger ServiceNow or Salesforce.com. While it’s obviously not the only new-age cybersecurity player out there, CrowdStrike has been building out its AI-enabled platform for more than a decade, and probably more important, it’s been accumulating massive amounts of data (trillions of events per week; the firm says its dataset is in the petabytes) that the platform sits on, making it “smarter” and yielding better models and automation to prevent threats, even before they occur. In management’s words, CrowdStrike has a “sustainable data advantage, the most powerful and unique set of correlated human and machine-generated data across [the] entire industry.” (Ironically, AI will probably lead to more cybersecurity threats, as hackers will use it to develop more complicated attacks.) CrowdStrike now has 23 different modules, everything from threat intelligence to identity protection to cloud security to observability to endpoint defense, providing an all-in-one, top-notch solution to giant enterprises, government agencies and other big organizations (education, etc.) across the globe. To be fair, the slowing tech environment is providing a bit of a headwind to capturing new business, but even so, the numbers and sub-metrics are up there with anyone: Revenues lifted 42% and earnings 84% in the April quarter, while the gross retention rate was 98% (been 97.5% or higher since the start of 2020!) and same-customer revenue growth was a very enticing 25%. And this is being driven by the players with the deepest pockets, as 15 of the 20 largest banks, 271 of the Fortune 500 and 70 of the Fortune 100 are all customers (total client count is over 23,000, up 41% from a year ago). Plus, this is all happening as CrowdStrike has become a good-sized outfit (annualized recurring revenue is north of $2.7 billion, up 42%) and free cash flow is much larger than earnings ($2.80 per share last year vs. $1.54 in earnings, with something approaching $4 per share possible this year). Now, none of those numbers guarantee anything—the stock fell nearly 70% during the bear phase—but shares are set up nicely ahead of earnings: CRWD rallied to the 160 area by the end of May and has hacked sideways in a reasonable range (140 to 162, give or take) ever since. Earnings are due next Wednesday (August 30), so a positive reaction would be tempting.

Pure Storage (PSTG 36)—Pure Storage was a first mover in the storage space to deliver high-grade, flash storage for big enterprises (management here sees zero hard disks sold within five years!), and the firm has had solid growth for years (58% of the Fortune 500 are now customers)—though for whatever reason, the stock has never really had more than a brief run; relative to the market, the stock’s peak was back in mid-2018. But we’re thinking that perception of the firm could finally change for the better for a few reasons. The first is Pure’s continued march toward not just being a one-time seller of storage equipment, but leading the transition to a storage-as-a-service model, which is a fancy way of saying Pure has a handful of offerings (dubbed Evergreen) where it provides its state-of-the-art equipment and software, and keeps them up to date, all for a regular subscription or consumption-based payment (which should grow over time). Then there’s the AI angle, with Pure likely being a big winner in the soaring storage needs as AI takes hold at firms large and small; the firm’s new Flashblade/E looks like a hard disk drive killer, allowing massive data storage at low operational and energy costs (Pure claims 40% lower total costs than huge disk drives over six years; the product’s pipeline growth was the best for any new Pure product ever). The only issue is that the non-subscription side of the business, which still makes up half of revenue (ballpark), has been sluggish (total revenue in the quarter ending April was up just 5%), but the writing is on the wall for better times ahead: Pure’s annualized recurring revenue from Evergreen and other offerings was $1.16 billion, up 29%, while remaining performance obligations rose to $1.8 billion (up 26%) and free cash flow is much larger than earnings (about 40 cents in the April quarter vs. 8 cents of earnings). And with the AI boomlet, it seems all but a sure bet that demand for Pure’s offerings should grow markedly in the quarters and years ahead. The stock seems to agree—it was dead as a door nail in May, but the surge in AI stocks and then the firm’s own quarterly report shot shares back to their old highs. And, impressively, PSTG has traded in a modest range for weeks, even including today’s sloppy action. The next quarterly report is due next Wednesday (August 30), and a positive reaction could be buyable.

Money Goes Where It’s Treated Best

Just over a month ago we wrote about interest rates, the Power Index and the Fed—and sure enough, rising Treasury rates have continued to be a thorn in the market’s side, likely playing a big role in the Nasdaq correction and blow-ups seen in many growth stocks. And today we’re mentioning rates again for two reasons.

First, as an update to our Power Index(es): All are now negative, with the six-month rate of change in everything from shorter-term two-year Treasury notes to longer-term 10-year Treasury notes now clearly negative; the yields on both instruments are about 10% higher than they were six months ago (meaning up from 4.5% to 4.95%, etc.). When looking back, rates did spike nearly six months ago, so maybe that affects the Power Indexes a bit, but it’s pretty obvious market-based rates have been rising.

Second, more important than any indicator is simply the longer-term charts, both of which are nosing above multi-month resistance—the two-year note is testing its March high, which itself was a hair above the October high, while the 10-year note is also testing its multi-year highs (last October), just before the Fed’s Jackson Hole speech tomorrow.

All of this matters mostly because of the title of this section: Money goes where it’s treated best. Yes, some of that pertains to individuals (there are likely many that are content to grab a shorter-term CD at 5% or what-not), but think of outfits like big pension funds that have to balance allocations between equities and fixed income. A couple of years ago, buying high-grade corporate bonds might get you 3%; today, that may be 6% to 7%, which can entice more money out of the market and into bonds.

Of course, we always favor the market’s primary evidence—if the major indexes start to soar and growth stocks explode higher, we’ll be buying aggressively no matter what interest rates are doing. But we’re also not leaving our brain at the door given the impact rates have had on stocks during the past couple of years. A decisive move lower (double top on the charts) in yields would be encouraging, but a big upside breakout would likely continue to hamper the market.

Starting to Look for Tennis Balls

It’s about this time in a pullback—the Nasdaq topped six weeks ago and the major selling started four weeks ago—when we start to look for resilience among individual stocks. It’s not that we’re predicting any sort of low—our Cabot Tides and Two-Second Indicator aren’t acting well, so for all we know another downleg is coming—but you want to be prepared should the market kick into gear.

Some of what we hunt for is simply stocks that have refused to go down much, and we wrote about two of those earlier in this issue: Pure Storage (PSTG) and CrowdStrike (CRWD) have remained relatively calm during the Nasdaq’s quick 9% retreat, and both have earnings next week. Powerful gap-ups could be tempting to nibble, especially if the market is perking up at the time. In the Model Portfolio, Celsius (CELH) is obviously one, as it’s refused to give up much ground despite being extended to the upside.

Beyond that, though, is the hunt for tennis balls, meaning stocks that did break intermediate-term support (most growth stocks did) but didn’t truly implode, and now are showing at least some signs of life, like big buying volume or quickly recouping a chunk of the recent decline. A good example here is a name we were forced to sell during the market’s dip—Monday.com (MNDY) fell about 20% in less than a month, but reacted nicely to earnings two weeks ago (sales up 42%, earnings of 41 cents per share obliterated estimates by 24 cents), recouping just over half of the prior decline before some recent ups and downs. A strong advance from here would be very encouraging, and while we usually don’t jump right back into stocks we got whipped out of, MNDY is back on our watch list. WATCH

Another potential tennis ball in the making is a name that’s already on our watch list—Axcelis Technoloiges (ACLS), which is the cleanest way to play the boom in SiC chips (mostly for electric vehicles). After a monstrous run, the stock fell 22% from high to low, which is reasonable, but it’s begun to bounce, recouping as much as 50% of the decline before pulling in today. WATCH

We’ll see how it goes with these and others—it’s still early, but at this point it pays to keep your eyes open for high-potential growth stocks that are resisting the messy action.

Cabot Market Timing Indicators

This week’s bounce has been fairly solid, and we’re not ruling out a quick turnaround as was seen in some prior precedents. That said, we always go with the here and now, and today the intermediate-term trend is still down and the broad market is unhealthy, so we’re staying cautious—but are flexible should this week’s strength continue.

Cabot Trend Lines: Bullish

The recent correction took some steam out of the market, but it hasn’t come close to changing the longer-term trend: Our Cabot Trend Lines remain firmly bullish, with both the S&P 500 (by 5%) and Nasdaq (by 9%) holding well above their respective 35-week moving averages. The fact that this indicator was positive throughout the spring muck was a good sign the next major move was up—and the longer it remains positive during this retreat, the greater the odds the market has another leg up coming down the pike.

Cabot Tides: Bearish

Our Cabot Tides, however, have turned bearish, with all five indexes we track (including the NYSE Composite, shown here) trading under their lower (50-day) moving averages. Should three of the five indexes power above their 50-day lines in the days ahead, that would be a “shakeout buy signal,” which have a history of being fairly powerful. As always, though, we’ll take it as it comes—right now, the intermediate-term trend remains down until proven otherwise.

Two-Second Indicator: Negative

Our Two-Second Indicator has definitely worsened: Today was the ninth straight day of greater than 40 new lows on the NYSE, which confirms the weakness in the broad market. To be fair, the readings aren’t exploding higher—there have been no 100-plus readings so far, and while that’s not “good,” it doesn’t appear the bottom is falling out of the broad market. Either way, the bears are certainly making headway, and we’re looking for a quick and decisive dry-up in the readings to tell us the selling has passed.

The next Cabot Growth Investor issue will be published on September 7, 2023.