Cabot Growth Investor Issue: December 29, 2022

Better Times Ahead

I started at Cabot back in June 1999, and the first eight months here were like a printing press, with growth and Internet stocks going wild as the Nasdaq soared above 5,000 to its bubble peak—but since then, there’s been 9/11, three big bears, many small bears, a financial crisis and housing collapse, numerous wars and a pandemic, all while interest rates, the dollar and oil prices have zig-zagged. And after each one of many “never seen before” events, the bulls have returned and driven a new batch of winners much higher.

I wanted to start with that cheery take even as we’re finishing up a horrid year, especially for growth stocks—the Nasdaq is off 35% or so since its top, many popular mega-cap stocks like Meta and Amazon are off 50% to 70% and tons of emerging growth stocks that we normally traffic in are off 80% or more. Certainly ugly, and certainly a “major” bear if you’re a growth investor.

And today the evidence remains negative, which is keeping us in a highly defensive stance: The intermediate-term uptrend ended, and growth stocks remain on the outs, especially compared to defensive stocks. We’ve had about three-quarters of the Model Portfolio in cash for weeks now, and it could go higher if the extreme Nasdaq weakness (down 12% in the 11 sessions before today) continues.

However, as we roll into 2023, our main thought is that better times are ahead—we can’t say exactly when, of course, but as mentioned at the outset, no matter how bad things seem or how bad the news gets, a new bull is coming around the corner. Beyond that, we have some optimistic thoughts for you to chew on.

Fundamentally, the U.S. economy remains surprisingly resilient despite a hawkish Fed, which bodes well for a soft (or at least not-super-hard) landing; China’s recent re-opening (if it remains on track) should boost the global economy; any end to the Russia-Ukraine war would likely help cool inflation in Europe and elsewhere; and the Fed itself is saying that it’s likely nearing the end of its hiking cycle. As for the market, we think it’s important to note that despite all the bad news, recession worries, interest rate hikes, housing slowdown, crypto implosion and more, most major indexes are no lower today than they were seven or eight months ago and more stocks are clearly resisting the bear’s downward pull.

What to Do Now

As has served us well all year, we’re not going to jump the gun—we’ll wait for the buyers to show up before making any major commitments—but now that we’re nearly 14 months into this bear phase, it’s important to keep your head up and eyes open should investor perception change. In the Model Portfolio, we have no new buys or sells, though we’re keeping Enphase (ENPH) on a tight leash after solar stocks were hit this week.

Model Portfolio Update

The year is ending a lot like it started, with the indexes weakening and (more important to us) growth stocks under pressure, which you can see by watching individual stocks, growth funds or our own Aggression Index (shown below), which is nosediving to new lows as the Nasdaq sinks even as defensive stocks firm up. Throw in the fact that the Cabot Tides buy signal has fallen by the wayside and we’re continuing to hunker down for the most part.

Given the late-year holiday trading (light volume and exaggerated moves, plus some tax-loss selling), we’ve been trying to give our remaining positions some leeway. Enphase (ENPH) is on the edge here and clearly weak, but we’ll hold for now and see if the late-December selling pressures reverse, which isn’t unusual to see.

As has been the case for weeks, our main focus is on honing our watch list for when the market turns up—and despite all the bad news and action, it could turn up if, when looking ahead three to six months, it sees some brighter times ahead. There’s little doubt that more and more names are resisting the decline—the percent of Nasdaq stocks below their 200-day lines has fallen from 90% in May/June to 84% in September to 72% today, even as the Fed has been on the rampage and many names have blown up. We’ve also seen a positive divergence in the number of stocks hitting new lows on the Nasdaq (max of ~1,200 in September vs. max of ~550 this week), a sign more names are resisting the selling.

That said, as we head into 2023, our plan remains the same: Hunker down mostly in cash until the bulls decisively retake control, but spend time building our watch list and possibly nibbling on a potential fresh leader or two if opportunities arise. We have no changes tonight, but we’ll be on the horn in the New Year if we do.

CURRENT RECOMMENDATIONS

Dexcom (DXCM)—DXCM looks like a lot of growth names of late, slipping and sliding as the Nasdaq caves in, and dipping a bit below obvious support (50-day line, etc.) earlier this week. Even so, today’s rally was nice and the stock is still basically in the same general position as it has been the past seven weeks, consolidating its huge October upmove that came on news of expanded Medicare coverage for CGMs and then the Q3 report and outlook later that month. There hasn’t been much on the news front, though Dexcom did partner with others to offer G6 users in Canada access to personalized diabetes management support earlier this month. Still, the real question to us is whether the firm really is on the cusp of two or three solid years of growth, as management alluded to in the Q3 call—Wall Street sees earnings up 38% next year (on top of a 20% gain in 2022), and if that proves conservative and initial details regarding the G7 U.S. and Europe launch are positive, we think shares will eventually surprise on the upside. Back to the here and now, we could go to Hold if the market’s dip continues and DXCM falls further, but today, we’re OK picking up a few shares if you’re not yet in. BUY A HALF

Enphase Energy (ENPH)—This year has been one of rolling selling, meaning a few nooks and crannies get hit, and then a few weeks later, the sellers move on to some other pasture. After holding up well, one of the latest targets has been solar stocks, with Enphase and others hitting the skids. We doubt there’s anything wrong fundamentally here, though an important question will be 2023 earnings growth—as 2022 has boomed, analysts see “only” a 23% gain next year, which is almost surely conservative but could factor into some buy/sell decisions. Plus, the implosion in Tesla and other green stocks isn’t helping the cause in terms of investor perception. As usual, we’ll just play it by the book: ENPH’s action is certainly poor, but there’s some support in this area (260-265); if shares can bounce early in the New Year, we’ll hold on, but otherwise we’ll likely move to cut the loss. Hold for now. HOLD

Halozyme (HALO)—HALO has remained a port in the storm, holding its 25-day line and staying close to all-time highs even as other growth stocks sink. While nothing is for certain, early January could bring some 2023 guidance from the company (it offered some in early January 2022), which will obviously be key and could include expectations for the Enhanze launch of Argenx’s potential blockbuster efgartigimod for autoimmune diseases; analysts see that drug potentially bringing in $3 billion of revenue by 2026, and the Enhanze version has an FDA decision date of March 20. Back to the stock, there’s always the possibility that HALO (along with some other still-resilient biotech names) could be the next to come under pressure; the 50-day line is down at 53 (rising steadily), so some sort of shakeout can’t be ruled out. But the longer HALO can hold up, the greater the chance that December rest period will result in a continuation of the powerful October breakout. Hold on if you own some, and if you don’t, you can nab a small position here or on dips of another couple of points. BUY A HALF

Wingstop (WING)—With fears of recession growing and with some analysts releasing cautious 2023 outlooks for restaurant spending, Wingstop and many peers (CMG, DPZ) have been skidding for much of December. As we’ve written before, we think some of that is overstated for a firm like this, with cheap takeout options that can be in demand around sporting events (NFL playoffs, etc.); overall, we think the underlying growth story is back on track and the stock can do well if the market can ever find its footing. Even so, we have to go with what we see—we placed WING on Hold last week as it nosed below its 50-day line and the market remained weak, and now the stock has eatne a bit more into its earnings gap. We’d like to give this and our other stocks a chance given this week’s super-light volume action, so we’re holding for now, but our mental stop is in the low 130s should the market keel over and drag everything down further. Hold for now. HOLD

Watch List

• Academy Sports & Outdoors (ASO 52): ASO has dipped back toward its breakout level, which is acceptable so far—all in all, the stock’s giant launching pad, relative strength and the firm’s huge earnings, share buyback program and cookie-cutter story mean ASO’s next major move should be up.
• Axon Enterprises (AXON 167): AXON has dipped to its 50-day line of late, which is normal action given its huge run before and after earnings in October/November. We think the company’s economically-independent story, huge markets (basically all law enforcement agencies in the U.S. and in many other countries) and recurring income story can keep buyers interested.
• Celsius (CELH 104): Not surprisingly, CELH has backed off in recent weeks, though it’s not imploding (north of its 50-day line) as it continues to etch a new launching pad. The firm has been quiet on the news front since the Q3 report, but any updates on the Pepsi distribution deal in the weeks ahead could spark buying interest.
• Impinj (PI 108): Chip stocks have been nailed since the Fed’s announcement this month, which has weighed on PI—though we’re not overly worried, as shares are holding their earnings gap from October. We think this little-known story (revolving around endpoint ICs) can go very far.
• Las Vegas Sands (LVS 47): China continues to open up its economy, deciding to deal with an increase of Covid cases as they come, and that bodes well for many turnaround situations over there. (A giant spike in cases could change perception, but so far so good.) LVS is our favorite idea from China given the increase in travel, gaming and entertainment spending that’s likely coming after a severe nationwide case of cabin fever.
• Planet Fitness (PLNT 79): Even though PLNT is still 15% south of its pre-pandemic high, business is better than ever and the outlook for the next three years is solid. And now the stock is beginning to perk up. See more below.
• Shift4 (FOUR 56): FOUR is probably at the very top of our shopping list, with outstanding numbers, estimates, a huge story and a stock that actually moved out to multi-month highs today, which is very encouraging. We may add a half-sized stake if the Nasdaq finds its footing, though for now we’ll just wait.
• Super Micro Computer (SMCI 82): Super Micro has some unique offerings in the server space that have led to a huge gain in market share and giant sales and earnings growth. See more below.

Other Stocks of Interest

Planet Fitness (PLNT 79)—There’s no question investor perception for the fitness sector has changed tremendously since the pandemic hit, with many swearing off gyms forever and others opting for a variety of in-home options (like Peloton). But, ironically, the pandemic probably has put Planet Fitness—the nation’s only national fitness center, known for low prices (as low as $10 per month but most pay low/mid-$20s to access any location and get some perks), quality equipment and a non-muscle-head workout environment—in a better position, with 25% of gyms (nearly all of them small businesses, sadly) permanently closed during and after the pandemic. Indeed, even before the virus, Planet Fitness accounted for seven of every eight new gym members country-wide in the 2010s, and with the firm continuing to expand in recent years, it’s poised to gobble up more and more of the industry’s members (especially younger ones that value a healthy lifestyle more) as the virus slowly fades from memories. Really, despite the fact the stock is still shy of its pre-pandemic peak, the company is doing just fine: At the end of September, membership totaled 16.6 million, up 9% from the start of the year and up 15% from the end of 2019, pre-virus, thanks in part to the cookie cutter aspect of the story (2,353 locations, up 4.4% from the start of the year; management sees the potential for 4,000 in the U.S. alone) while already-open locations perform well (same-store sales up 8.2% in Q3) thanks in part to price hikes. Bigger picture, a November analyst day saw the top brass predict steady (albeit not amazing) growth for the next three years, with sales up in the low/mid-teens annually, EBITDA up in the high teens and earnings per share likely up faster than that. Interestingly, PLNT tested its pre-pandemic high late last year, but then the bear market got its claws into the stock and pulled it down in a couple of waves, with September bringing the low. But shares have improved since then, rallying above the 200-day line and tightening up in recent weeks just south of resistance. Big picture, Planet’s growth story looks back on track, and the easier competitive environment could result in a longer, smoother expansion than previously thought. A decisive move above 80 would be interesting,

TransDigm (TDG 627)—We always keep at least a distant eye on the aerospace sector because (a) the group’s uptrends tend to last a long time once they get going—new jet orders tend to rise for years as airlines expand and replace older jets, while any new plane design from the likes of Boeing gooses this trend; and (b) the sector is relatively concentrated, with a few big players supplying most of the key components (from engines, chassis and wings to seats and toilets) and getting most of the money when times are good. We’re not huge fans of 600-dollar stocks, but TransDigm has always been one of our favorite names in the group as it’s the poster child for the factors above: The company makes pumps, valves, actuators, batteries, cockpit security systems and much more. While that may sound mundane, about 90% of its offerings are proprietary (obviously a good thing) and it focuses on areas that have big aftermarket businesses (leading to years of steady demand and generally higher margins, too); more than three-quarters of its cash flow comes from these aftermarket orders, though that was boosted a bit by Covid (fewer new plane orders = more repairs and refurbishments of older ones). It also does a good-sized business with defense, and after a couple of rough years due to the virus and supply chain issues, TransDigm’s business is back on track (earnings were up 41% in the fiscal year that ended in September) and management is forecasting more good times ahead, with double-digit sales growth (commercial-related revenues up mid-teens; defense up mid-single digits), EBITDA up 15% and earnings up 25% in the year ahead – and that’s very likely conservative as it assumes no acquisitions (TransDigm has $3 billion in cash and a history of small buyouts) and says nothing about some special dividends (it had an $18.50 per share special payout earlier this year). And the stock seems to be smelling good things: TDG has been consistently capped by the 650 to 680 area since the virus hit, but has tightened up nicely in recent weeks, and some other aerospace names (RTX, HWM, etc.) are doing the same. A decisive breakout would be interesting, especially if confirmed by other members of the sector.

Super Micro Computer (SMCI 82)—Most nuts-and-bolts technology stocks are on the outs this year, but Super Micro Computer has been a standout situation. On the surface, there doesn’t seem to be much special here, as the firm’s offerings (mostly server and storage systems) come in a highly competitive space, but Super Micro is taking massive market share and posting ridiculous growth numbers (sales up 51%, 53% and 79% the past three quarters, while earnings were up at triple-digit rates each quarter) for a couple of reasons. First, as of a couple of years ago, Super Micro switched its focus from providing parts to selling entire solutions, meaning complete rack systems with servers, storage and software, along with security, providing more of a one-stop shop to clients. Plus, the firm’s products have a “building block” architecture, meaning clients can replace components without replacing the whole system and it can create better optimized offerings for specific customers. Plus, Super Micro is also focused on very energy-efficient setups, which decrease the total cost of ownership (which has been a big factor this year as electricity prices have leapt). All of that has led to the rush of demand and growth mentioned above, but management is thinking this isn’t a short-term thing: In the November conference call, the top brass sees revenues rising to nearly $7 billion this fiscal year (ending next June), up 35% from the prior year, with the early fiscal 2024 outlook of $9 billion and continued growth to $20 billion in the “near distant future” (whatever that means). Of course, we wouldn’t hang our hat on long-term projections in this sector, but there’s little doubt the company is going to get much bigger; after leaping from $2.48 to $5.65 last year, Wall Street sees earnings of around $10 per share in the current fiscal year. The stock has been wild this year, but is clearly showing relative strength, with huge upmoves in July/August and again October/November—and the latest pullback has so far found some support near the 50-day line. It’s on our watch list.

Is This a New Secular Bear Market? Unlikely

I’m just starting to prep for my annual January webinar where I look at the year ahead (should be on January 19—our marketing team will give you a heads up if you want to attend or get the recording), and one thing I like to touch on for a few minutes is the “mega-picture view” of the market, sometimes called the secular trend: As it turns out, the market tends to move in 15- to 20-year cycles up, followed by a decade or two of going mostly sideways as valuations adjust. Of course, even during those sideways periods there are plenty of opportunities during sustained uptrends, but it’s a good piece of background information to know.

Right now, given the huge post-2008 advance and this year’s plunge in the Nasdaq, we’re hearing more voices saying a secular top is in place. Could that be true? Sure, anything is possible. But if you look at a few breadcrumbs, it becomes less likely—said another way, the odds favor the market hitting higher highs once this bear market finishes up.

I’ll dive into more details in the webinar, but the fact is secular tops have occurred after long runs and after the market has posted huge gains during the prior 10 or 15 years. One simple way to look at it is via this chart from dshort.com, which looks at the rolling 15-year annualized after-inflation return of the S&P 500 going back to the early 1900s. You can see the major peaks (1929, 1937, mid-1960s, 2000, etc.) all saw returns in the 13% to 16% range—whereas this time the return never got to 10% and now stands below 6%.

The reason for these so-so returns is because the market emerged from the prior secular bear phase a few years back—the S&P 500 made no net progress from 2000 to 2013, while the Nasdaq did nothing from 2000 to 2016! Those arguing we’ve hit a secular top are saying the Nasdaq did nothing for 16 years, then went up for five (2016-2021), and now will do nothing for another decade or so. Again, is it possible? Sure. Is it likely? Not in our book.

To us, this feels more like a “reset” phase that the market actually has experienced many times in recent years—the indexes actually made no net progress for stretches of a year or two (2011-2012, 2015-2016, and 2018-2020) during the past decade.

Honestly, all of this is a bit theoretical—secular top or no, nothing will change with how we go about things in the weeks and months ahead. If our market timing indicators turn green and growth stocks start to break out, we’ll be buying some potential leaders, and if they don’t, we’ll stay mostly on the sideline. But to us, some of the talk of a long-lasting market top is simply a function of the action of the past year; it’s easier to be pessimistic in the midst of a tough bear phase, but usually that just means the ensuing bull move will be even more rewarding.

Individuals May Finally be Throwing in the Towel

As the year has gone on we’ve seen rolling waves of pessimism among sentiment indicators, the latest of which is a series of measures from Bank of America’s monthly survey of institutional investors that shows near 20-year highs in cash levels, expectations of a recession and ownership of defensive stocks (and underweight growth).

However, one piece has been missing, which has been some puke action from individual investors, but now we might be seeing that. Below is a chart of our Real Money Index, which is simply the five-week tally of inflows (or outflows) to equity funds and ETFs. Generally speaking, this is a contrary indicator—when money is gushing into stock funds, it tends to be after an advance and near a top, while very low readings indicate some level of panic as everyone hits the sell button.

Indeed, the most extreme readings on the upside on the chart came in mid-December 2017 (the market peaked a month later), early March 2021 (just after the top for most growth stocks and growth funds) and early January of this year (you know what happened after that). Conversely, the spike lows of December 2018 and March 2020 were within a couple weeks of major lows, while other low areas (June 2019, July 2020, and May, July and September of this year) preceded decent rallies.

And that makes the recent action intriguing—according to Lipper, investors have yanked $68 billion from equity funds during the past five weeks, resulting in the most extreme reading of the year and third biggest since the fall of 2017, a good sign that investors have had enough of the bear and that the latest Fed-induced selling wave has caused many to throw in the towel. Sentiment is always secondary to price, volume and the market’s trend, but this data is a good sign more weak hands are being washed out.

Cabot Market Timing Indicators

The year is ending much like it began—by going down, led for the most part by growth stocks, which argues for a cautious stance. We’re keeping our eyes open to see if things change once the calendar flips, but the onus remains on the bulls to arrive, turn the market’s trends up and create a few breakouts among new leaders.

Cabot Trend Lines: Bearish
The Cabot Trend Lines sell signal in late January was the first major clue that 2022 could go up in smoke, which proved to be the case—and this long-term trend measure (our most reliable indicator) has remained clearly bearish ever since. After the latest weakness, the S&P 500 is still without shouting distance (2% below) of its 35-week line, though the Nasdaq (8% below) is further behind. The next buy signal should be a great one, but until then, caution is warranted.

Cabot Tides: Bearish
The green light from our Cabot Tides has vanished during the post-Fed selling, with four of the five indexes we track (including the S&P 600 SmallCap, shown here) dipping below their lower (50-day) moving averages. To be fair, the damage isn’t awful, and a few good days could change things—but at the very least, the intermediate-term trend isn’t up, which is another reason to keep most of your powder dry.

Two-Second Indicator: Negative
The Two-Second Indicator has been in the triple digits on most days this month, especially after the selling picked up two weeks ago. Interestingly, we did see a legitimate positive divergence in the Nasdaq new low figures (that index retested its fall lows this week), which is a ray of light. But the bottom line is we need to see a string of sub-40 readings on the NYSE to signal a change in character, which isn’t in the picture yet.

The next Cabot Growth Investor issue will be published on January 12, 2023.