Cabot Growth Investor Issue: December 1, 2022

Not Perfect, but Improving

Since the last issue, there hasn’t been that much that’s officially changed, either with the market’s action and our indicators, or what investors are keying off of. Our Cabot Tides remain positive, which is certainly a plus, but that’s about all there is on the bullish side of the ledger when it comes to market timing. And with individual stocks, especially growth stocks, we continue to see plenty of ups and downs, with few names really taking off on the upside for more than a few days before being reeled in.

Because of that, we’re sticking with the same main thought from our last issue—that there’s no huge rush to pile into growth stocks, as few are leaving us behind and, in fact, we’re still seeing a decent amount of air pockets out there, with good looking stocks going bad in a hurry. Today’s action was another example of that, with stocks that are near their highs mostly meandering while the worst performers perked up. That’s why we continue to hold a lot of cash.

And yet, the market does operate in shades of gray, and when you look at some of the details out there, it’s hard not to see improvement. From a top-down point of view, our Cabot Trend Lines are within striking distance of a green light, while our Two-Second Indicator has seen a shrinkage in the number of new lows (today’s reading was excellent)—and if this post-Fed rally can continue, we could get an all-clear signal from the broad market.

And for individual stocks, it’s obviously not great, but we’re definitely seeing indications of waning selling pressure. When names are rejected by resistance, they do fall for a day or two … but many have then found support and perked up again. Those that gap up huge on earnings or other news do pull in … but many have been pulling back normally and grudgingly instead of giving up the ghost.

Ever since the market’s repair phase started in late September, and after the indexes got moving following some encouraging inflation data last month, we’ve thought that the longer the market could hold itself together, the greater the odds that growth stocks would eventually come under control and kick into gear. We think we’re starting to see a little of that improvement—but now it’s a matter of the market building on it, with real leadership emerging.

What to Do Now

Overall, we’re remaining very cautious given the growth stock environment—though with the evidence having crawled in the right direction, we are going to do a little buying tonight: We’ll start a half-sized stake in Dexcom (DXCM), and we’ll buy another half in Wingstop (WING). That’ll still leave us 70% of cash on the sideline, so we’re open to doing more buying if the buyers can step up their game, but for now, we’ll stick with these two moves.

Model Portfolio Update

There continues to be a gradual improvement in the overall market’s tone, with yesterday’s solid Fed-induced pop keeping some of those good vibes going. Our Cabot Tides remain positive and some other things (like the Two-Second Indicator), while not positive, are within striking distance of flipping.

When it comes to growth stocks, though, the story hasn’t changed much over the past two weeks: Unless you’re trying to trade in and out of names every few days (which is like picking up nickels in front of bulldozers), things remain very hit-and-miss, with a good number of potholes and blowups and relatively few stocks in meaningful uptrends.

Even so, all of that is descriptive and not predictive. The longer the market can hold itself together, the greater the chance that growth stocks will eventually break through resistance and get moving—and we’re open to the idea that such a process could be in the early stages of playing out.

All told, we need to see more to really get bullish … but we do think the evidence is gradually improving, so we are putting a little more money to work tonight. We’re going to start a new half-sized stake in Dexcom (DXCM) and buy another half position (averaging up) in Wingstop (WING). That will leave us with around 70% on the sideline, and if the market’s action steadily improves, we’ll aim to steadily increase our line.

Current Recommendations

Albemarle (ALB)—ALB has had a very sharp dip from its highs, and shares even got clonked on the half day after Thanksgiving, all due to fears that the lithium market is easing up as supply comes online and demand overseas (especially China) for electric vehicles will fall short given the never-ending shutdowns over there. Frankly, though, we think it has just as much to do with the market environment (failed breakouts, etc.), as some of the quoted prices of lithium show a minuscule decline after a more than doubling of the price in the past year, with the decline far smaller than the modest pullback seen in the spring. Because of that the fundamentals remain in great shape, but the chart is clearly throwing up warning signs—double tops (or failed breakouts) with huge volume down have been pretty reliable red flags over the years. All told, if ALB can basically march higher from here, we’re OK giving it a chance, but it’s on the tightest of leashes; another bad day or two or a close back in the mid-260s would likely have us pulling the plug. Hold for now. HOLD

Dexcom (DXCM)—We’ve followed Dexcom for a few years now, and owned it a couple of times with good or decent results. The firm’s continuous glucose monitoring systems remain popular, with its G6 device still selling well and some other offerings (like Dexcom ONE, a tiny device that gives up-to-date glucose readings to your phone, available in Europe) making headway—all while Medicare looks set to expand coverage for CGMs, effectively broadening Dexcom’s potential market. As we’ve written recently, the stock has a history of resting for a year or more, either during difficult markets and/or ahead of new product introductions, and the past year seems to be following that script as the next-generation G7 launch gains steam overseas and, next year, in the U.S. Management sees a multi-year stretch of 20%-plus top-line growth ahead, with Q3’s results (sales up 18%, earnings up 27%, and those figures were actually hurt by a strong dollar) the first step in that direction. We like that the stock bottomed in May (well ahead of the market), and the huge October upside (first on reports of the likely Medicare expansion, and then after earnings) was certainly bullish. And the last month has seen a well-controlled consolidation before some upside after the Fed this week. (We also like that pump maker Insulet (PODD), which actually uses Dexcom’s technology in its products, acts similarly—i.e., the diabetes group as a whole could be coming into favor again.) We’ll start with a half-sized position, use a stop just under the century mark, and will ideally average up on decisive strength from here. BUY A HALF

Enphase Energy (ENPH)—ENPH’s recent movements are something we’re beginning to see more of: Shares continue to hit a wall any time they test the 320 to 325 area, but instead of sliding sharply after these failed attempts, the stock dips modestly for a couple of days before perking up again; it’s a modest sign of waning selling pressures as we wait for buyers to show up. Fundamentally, we’re encouraged that ENPH and solar names in general have held their own despite weak oil prices; historically the groups would move somewhat in tandem, but it’s good to see solars dance to their own drummer given the demand trends in the U.S. and overseas. All in all, we think this stock can help lead the next uptrend in growth stocks—we’ll hold onto our half-sized stake (if you’re not yet in, we’re OK starting a position around here), and will look to average up on any decisive upside action along with a more solid market environment going forward. For now, we’ll stay on Buy a Half. BUY A HALF

Halozyme (HALO)—HALO is another stock that certainly looks like a winner if the market can truly enter a more bullish environment—shares followed through nicely this week, tagging new high ground on good volume after an analyst offered encouraging words. Possibly the most important thing the analyst opined on was saying the worries over potential patent expiration issues (which wouldn’t be an issue until 2027 anyway) are overstated, with his own analysis showing many products and pipeline with protection into the mid-2030s, and that doesn’t take into account any actions Halozyme could take to extend protections, either. Besides, big investors are likely to key off the next couple of years, which should be great: Earnings are likely to leap into the $2.60 per share range in 2023 and advance from there as Enhanze-enabled drugs see increased sales (and more hit the market), driving royalty revenue up. Throw in the long-term breakout after Q3 earnings and we think HALO has a bright future. We’re looking to fill out our position, but given the sell-on-strength activity that’s still the norm, we’ll practice a little patience and see if we can average up after a normal digestion. BUY A HALF

Wingstop (WING)—WING continues to act constructively—yes, its move to new multi-month highs two weeks ago didn’t hold (again, that’s par for the course these days), but instead of coming under distribution, shares retreated grudgingly on low volume, and now they’re bouncing nicely. Moreover, the lack of selling stands in contrast that to the big buying sprees seen in July, late August and especially after earnings in October (which brought the biggest one-day volume total since September 2020). Translation: It certainly seems like the buyers are in control, or at least that the sellers have left the building, and when you combine that with the great underlying growth story, we think this is a decent area to fill out our position—we’ll average up, adding another half-sized stake (5% of the Model Portfolio) tomorrow, which should leave us with an average cost in the mid 140s. We’ll start with a mental stop for the entire position in the upper 120s in case things take a turn for the worse, though we’re obviously optimistic here, thinking WING can hold up should the market have some further wobbles and eventually get moving should the market kick into gear. BUY ANOTHER HALF

Watch List

• Academy Sports & Outdoors (ASO 50): ASO pushed to new highs last week, but as is the norm, shares have sagged back under the breakout level in recent days. Still, the setup is great, and if next week’s quarterly report (December 7) is pleasing, we think the stock can decisively get going—and we’d be interested in buying. We’ll be interested in hearing how the store expansion plan is going; since late September it’s opened five new locations, with bunches more on the way.
• Arista Networks (ANET 139): Net-net, ANET is basically unchanged from the Nasdaq peak in November 2021, which is obviously a huge sign of relative strength. The buying from the cloud titans for the firm’s super-fast networking gear has been more pronounced than expected, which has growth continuing to accelerate and estimates for 2023 headed higher.
• Axon Enterprises (AXON 184): AXON is acting great, holding nearly all of its post-earnings gains. The valuation is up there, but investor perception is coming around to the view that the firm’s tasers, body and in-car cameras and cloud offerings (for evidence sharing and management) could be the standard in the sector, which should keep annualized recurring revenue (up 39%), same-customer revenue growth (20%) and contracted revenue (up 56%) growing rapidly.
• Celsius (CELH 111): CELH is getting very intriguing—shares had a sharp dip early last week, but came storming back to within a few points of new-high ground. The numbers are a bit messy due to some moving parts with the transition to Pepsi’s distribution channel, but there’s no question that move will be a good thing.
• Impinj (PI 128): Impinj is an IoT company that’s seeing huge demand (far larger than supply) for its endpoint ICs that allow firms to effectively connect every product and item to the cloud for better tracking and data. See more below.
• Neurocrine Biosciences (NBIX 127): NBIX has been acting properly for months, with investors looking favorably on the prospects for higher Ingrezza sales in the years ahead, and anticipating positive Phase II data readouts for its pipeline in the weeks ahead.
• Schlumberger (SLB 52): Oil prices and stocks have taken hits of late, though as expected, service names have been far more resilient—SLB’s dip of late looks fine, and the firm’s well-rounded arsenal of offerings should remain in big demand barring an implosion in the energy market.

Other Stocks of Interest

Inspire Medical (INSP 242)—Inspire was high on our watch list earlier this year before the bear market got its claws into it in the spring, but shares have shaped up somewhat and the story has actually improved from back then. The big idea here surrounds sleep apnea, which is usually either left untreated (with severe health consequences, including twice the risk of stroke or sudden cardiac death) or treated with CPAP machines, which work pretty well but have a huge non-compliance factor (one- to two-thirds of patients) due to the cumbersome mask and noise. (Invasive surgery is an option, too, but even that has mixed results.) But for the 17 million in the U.S. that suffer from moderate to severe apnea, Inspire has a better mousetrap: Via a 90-minute outpatient procedure requiring two small incisions, doctors can implant the firm’s sensing lead, a neurostimulator and a stimulation lead that acts to open the obstructed airway during sleep; the device is controlled by the patient (turned on every night) and there’s an 11-year battery life, too. It sounds a bit futuristic, but studies covering a few thousand patients have shown huge reductions in key metrics such as the severity of a patient’s apnea (65%-plus improvement), better oxygen levels (70% higher) and far less sleepiness (45% less) and snoring. And, in May, one of the hitches in the story was fixed—the FDA approved patients to be able to have full body MRI scans with Inspire’s offering implanted (before that only head, neck and extremity MRI scans were allowed), which takes down a barrier to adoption. Being a medical device firm, Medicare and reimbursement rates are worth watching, but everything appears smooth on that front, with plenty of coverage (selling prices were up 2% in Q3 vs. a year ago). Sales growth has been fantastic here, with eight straight quarters of 70%-plus growth, though to be fair, earnings remain deep in the red as the cost of sales and marketing (less than 40% of sleep doctors in the U.S. are referring for Inspire; it’s also doing TV advertising to broaden awareness) is big as Inspire expands into new territories. Even so, there’s little doubt Inspire is likely to get a lot bigger in the years ahead as it tackles sleep apnea in the U.S. and overseas. As mentioned above, INSP held up well early this year before going over the falls, but it etched a higher low in October and is challenging multi-month highs after a solid post-earnings run. Like most things, there’s still plenty of overhead resistance, but the longer it can hold up around here, the better the chance shares have started a new uptrend.

Impinj (PI 128)—Impinj is placed in the chip stock basket, but the real theme here surrounds the Internet of Things (IoT), with the firm’s offerings allowing businesses to connect basically everything (potentially trillions of items) to the cloud. The benefits here are potentially huge, ranging from inventory and fulfillment visibility, loss prevention for checkouts at retailers, far more efficient supply chain operations and much more. The firm is best known for its radio identification (it dubs it RAIN) endpoint ICs, which cost just pennies, are battery free, can work without a line of sight and can be read at rapid speed (1,000 items per second at 10 meters). Impinj also offers readers, gateways and software, too, including a new Authenticity platform that can authenticate everyday items (counterfeiting is a huge issue globally). All in all, the firm says it’s the leader across all its product lines, having sold well north of 60 billion (!) endpoint ICs and plenty of its other offerings, too. Supply has been an issue here, but we’re not sure that’s a bad thing—according to management, demand for its endpoint ICs has run at least 50% higher than what Impinj can supply for six straight quarters (!), and the firm sees some easing of supply restraints coming up. And even before that happens, business is picking up, with endpoint IC revenue (which makes up three quarters of the total) hitting its fourth straight quarterly record in Q3, rising 19% from the prior quarter, with another sequential increase expected in Q4. The overall numbers are just as impressive: Sales growth is accelerating (17%, 27% and 51% the past three quarters), while earnings took off in Q3 (34 cents a share, up from a loss a year ago and double estimates), with analysts looking for a big bottom-line gain (up 40%) in 2023. Now, there are some potential customer concentration issues here (it sells to OEMs, and a couple of them make up nearly half of revenue), which, combined with supply worries, does raise the risk of a pothole if the top brass doesn’t execute. That said, they’re on record saying demand should remain strong into 2023, and Wall Street sees great things ahead: PI made a huge comeback in the summer, pulled back reasonably into the fall and then exploded higher on earnings in late October—and, impressively, has held those gains and even nosed to new highs since then. It’s sure to be volatile but we’re intrigued; PI is on our watch list.

Ollie’s Bargain Outlet (OLLI 61)—Our cup of tea is obviously a new-ish, great growth story, but given the year-long bear market, we’re also on the lookout for some growth-oriented turnaround situations—stocks (and companies) that went through the wringer because of the market and other reasons, but the underlying growth story is starting to reassert itself. Ollie’s Bargain Outlet was a big winner from 2016 through 2018 as its closeout retail model was a hit—the firm has a huge buying team that has deep relationships with many top brands, allowing them to get overstocked, irregular or older products for very cheap, and pass along the savings (often 50% to 70% or more) in things like pet supplies, snacks, appliances, sporting goods, flooring and much more. (It recently bought a whopping $100 million of stuff from Target on the cheap, and should the economy slow, more opportunities should arise.) There was always a great cookie-cutter aspect to the story as well, with 10%-ish growth in the store count most years. However, the firm had some convulsions after its large advance, with the sudden death of its CEO in 2019, then with the pandemic briefly helping business (overstocked goods were everywhere, allowing its buying team to go wild), but then, as the virus eased, inventory issues popped up as business slowed again. All in all, sales and earnings shrunk for more than a year and the stock lost more than two-thirds of its value. Now, though, it appears the tough times are over and investors are focusing not just on an upcoming turnaround, but years of solid growth ahead: Q3 saw revenue and same-store growth turn positive (up 9% and 1%, respectively), with further gains likely going forward, while analysts see earnings surging 54% (more than making up this year’s declines) next year, bolstered in part by new store openings (north of 40 should open this year, just south of a 10% growth rate). The stock bottomed back in March, rallied nicely into July and is now five months into a reasonable (32% deep) base-building effort. Earnings are due December 7—a well-received report could kick off a sustained run.

A Surprising Area of Resilience: Bull Market Stocks

Our system is all about finding growth stocks, and so the vast majority of time we’re digging around in sectors like software, networking, cybersecurity, retail, medical, e-commerce, green energy and the occasional “new” sector (in fact, those can be the biggest winners as they’re inventing something totally new—think XM Satellite Radio back in 2003, etc.).

However, there are two “non-growth” areas we do keep a distant eye on. One is aerospace, which might seem surprising; the sector doesn’t have many players, and uptrends in new orders will often last for many years, which can lead to fairly big and persistent moves when the time is right (which is not now).

The other area is what we call Bull Market stocks, which are companies whose businesses (and stocks) thrive in bull markets, such as asset managers, brokers, exchanges and the like. If things line up, we’re not afraid to buy one early in what we think is a new bull move, as perception increases in a big way as the market’s trend turns up.

What’s interesting, though, is the group is acting pretty well right now, at least relative to the market. Yes, some of that is due to the fact that interest rates are up, which will help many firm’s interest income. But many firms that are leveraged to higher rates saw their stocks pull in sharply in recent weeks when inflation came in less than expected (fewer Fed hikes expected down the road), and yet the Bull Market group overall has held firm.

One way to measure the sector is the Broker/Dealer Index, shown here, which etched a much higher low in September compared to June, is well above its 40-week line and actually hit seven-month highs as of three weeks ago. All in all, it’s less than 10% off all-time highs, which isn’t bad considering the Fed’s stance and the market’s plunge this year.

And then there are individual stocks. The granddaddy of the group is Goldman Sachs (GS), which looks a lot like the index itself, and the recent, big-volume rally has left it just 7% off its peak from late last year. After a 2021 moonshot, earnings are way down this year but should stabilize soon and bounce into 2023.

Then there are trading outfits like Charles Schwab (SCHW) and Interactive Brokers (IBKR)—again, higher rates will help the bottom line, but the underlying business at both outfits has held up well and each stock is holding well above its 200-day line—IBKR, in fact, is near all-time highs!

Finally, we have Raymond James (RJF), a good-sized wealth manager (two-thirds of revenue come from private client group assets), which actually leapt to new highs in early November before backing off. Analysts see earnings up 29% next year.

They’ll never be the core of our portfolio, but we’re intrigued by the action of the group in what’s a still-iffy environment—it’s a small positive when evaluating the overall market, and while we’d prefer to find some smaller, faster-growing firms in the group, a blue-chip name could do well if and when the bulls decisively retake control of the market.

When the Nasdaq Lags, it’s Bad for Growth—and the Market

We’ve written a bunch about our Aggression Index in recent months because the indicator has offered one of the clearest explanations of the under-the-surface action this year and in recent months especially—not only is the growth-oriented Nasdaq underperforming most other indexes, it’s also underperforming defensive stocks like consumer staples, which are practically the definition of safe and steady names. We don’t have any hard-and-fast statistics surrounding the indicator, but it didn’t take more than a cursory glance to see that past occasions when the Aggression Index was under major moving averages correlated to times the Model Portfolio struggled, and vice versa.

Of course, that leaves open the possibility that a bunch of other stuff (cyclical names, etc.) could do well, and that’s always possible —but as it turns out, it’s far better for everything when the Nasdaq is in the lead.

That’s the big lesson from an article we read that concerns a “broader” Aggression Index, if you will. The article comes from a firm called Quantifiable Edges (Twitter: @QuantifiablEdges, Web: quantifiableedges.com), and they studied the market’s performance when the relative performance line of the Nasdaq compared to the S&P 500 was above and below its 10-week moving average, with the study going all the way back to 1971.

It turns out that when the above measure was positive (when the Nasdaq was leading), the S&P 500 advanced at a 7.6% annual rate, while the Nasdaq rose at an 11.3% clip annually. Pretty solid.

But the real story occurs when the Nasdaq was lagging (when the ratio was below its 10-week line), as the returns were negative across the board—the S&P 500 returned -0.2% annually, basically no gain, while the Nasdaq fell 1.8% per year. Said another way, all of the market’s net gains (and then some) during the past 50 years occurred when the Nasdaq was leading, even when looking at the S&P 500!

To be fair, this study is a bit more theoretical than tradeable—oftentimes the indicator can flip from positive to negative and back again a few times when things are choppy, which can chew you up. Plus, averaging things over 50 years can gloss over a lot of details (not saying that’s the case, but in our experience it’s possible). We’re intrigued, though, and we’ve begun a study of our own using some longer-term averages to see if there’s anything usable for our purposes.

Either way, though, the broader point is pretty straightforward: Whether looking at our own Aggression Index or an offshoot of it like this one, the market as a whole often has trouble making any big headway when stodgy and safe sectors are the ones leading the way—as they continue to do today.

Cabot Market Timing Indicators

On the positive side of things, the market has done a good job of hanging in there of late, with the intermediate-term trend remaining up and other measures improving. But we still haven’t seen buyers truly show up in a sustained way, with few growth stocks pushing ahead and with many potholes out there. We’re putting a little money to work, but need to see more to floor the accelerator.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines have been bearish for the past 10 months, since late January, and that remains the case today—but like many indicators, there’s definitely been improvement. Coming into today, the S&P 500 was actually 2% above its 35-week moving average, though the Nasdaq is still 2% below its own trend line. We need both indexes to close out two straight weeks north these moving averages for a green light, so the market still has still some work to do, but we’ll obviously be watching closely.

Cabot Tides: Bullish
Our Cabot Tides have done a good job of holding onto their buy signal during the past couple of weeks despite a few ups and downs—all five of the indexes we track are positive, with broader measures (such as the NYSE Composite, shown here) still well above their lower (50-day) moving line. Granted, the Tides are the only green light from our batch of indicators, but it’s a plus that the intermediate-term trend has remained positive.

Two-Second Indicator: Negative
The Two-Second Indicator has improved in recent weeks, and the readings haven’t been bad—lots of days with new lows in the 50s, 60s and 70s—so that a few strong days from here could finally produce some low (bullish) readings. (Today was a good start.) However, like so much in the market nowadays, we need to see it happen first; a string of sub-40 (preferably sub-20) days would be very, very encouraging, but at this point, the sellers are still active in the broad market.

The next Cabot Growth Investor issue will be published on December 15, 2023.