Cabot Growth Investor Issue: February 23, 2023

Fed Back in Play

In recent years we’ve seen a few major-ish bottoms, like late 2018 and early 2020, never mind the mother of all lows in 2009, and each time when the bottoming process was complete, the market exploded out of the gates. In those instances, the Fed was dovish, so once some macro worry (China trade war, pandemic shutdowns, financial crisis) was digested and the market looked ahead, the buyers went wild.

But today, the Fed remains in play—and that leads to a news-driven environment, with every week’s economic data picked over for clues as to the economy’s health and the Fed’s next move. That’s certainly what we’ve seen in the past couple of weeks, with some higher-than-expected inflation reports re-ratcheting up expectations of further Fed rate hikes, and in turn, pulling the market lower.

We have a few thoughts, of course. First, while we and everyone else is paying attention to the Fed, remember that (a) the Fed is almost certainly in the last couple of innings of its tightening phase, and (b) the market can definitely get going before the Fed finishes up. There have been many prolonged rate hiking cycles that saw the market do well when the economy remained resilient. Just a heads up.

As for the market action itself, we’re putting the past two weeks in the “tedious but acceptable” category, at least for now. When we look at our key market timing indicators, all have shown degradation … but all have also remained positive to this point, which is the most important factor. The same goes for most potential leaders we own or are watching. Losing altitude? Yes. Breaking? So far, not much of that.

There are many examples of this, but the IBD Mutual Fund Index—a straightforward reading of how many top active growth managers are faring—is as good as any: You can see the recent pullback is sharp, but the Index still stands above the 50-day and 200-day lines.

At heart, given all that’s transpired the past few months (months of bottoming action, crystallization of bearish sentiment, 2-to-1 Blastoff Indicator, great breadth, etc.), we’re optimistic that the buyers will step up—and if they don’t, that we’re still in the midst of a major bottoming process as we wait for the Fed to call off the dogs.

What to Do Now

However, we always go with what’s in front of us, which today, means sitting tight, but it also means keeping some names on tight leashes. In the Model Portfolio, we’re holding onto our positions tonight, as well as our 35% cash stake, and will simply follow the market’s lead—if the rally resumes, we think there could be some great buying opportunities, but if the sellers swarm, we’ll pare back. Tonight, we have no changes.

Model Portfolio Update

No one said emerging from a bear market would be easy, especially with the Fed still in play and every economic report (over)analyzed by everyone to guess at the future path of interest rates and liquidity—which in and of itself creates a choppy, news-driven environment. While just about all of the key evidence turned positive in January, the sellers have been at it this month as fears of a more aggressive Fed (and what that might do to the economy) take hold.

To this point, the evidence has basically done a 180 direction-wise in the past week or two—but not enough to actually trigger any sell signals, with our key market timing indicators still positive and most (not all) potential leaders holding just north of support. That said, most stuff is also right at key intermediate-term areas; another bad day or two and we’ll be trimming, though not selling wholesale.

Bigger picture, we remain optimistic that, while there could be stops and starts, we’re gradually leaving behind the bear phase of 2022 and transitioning to a new bull phase. That said, we always go with what we see: Right now, with our indicators still OK, we’re holding what we have (including our 35% cash position), but will stay flexible and use the market’s action as a feedback mechanism going forward. We’ll be on the horn if there are any other moves in the days ahead.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO has been riding the bucking bronco of late, with a nice breakout and upside move, followed by a dip back to support, then a nice snap back last week—only to again hit turbulence this week. Still, our thoughts here really haven’t changed: Academy’s earnings should remain buoyant thanks to a still-strong consumer, a big share buyback program and its store expansion plan, which is just starting to rev up (one so far this year but many more to come). And the stock, while tedious, has closed above its 50-day line every day since mid-November, with the 25-day line acting as support more recently. Earnings are likely out in mid-March, which will probably tell the tale—in the meantime, a dip below 55 would be a yellow flag, with a plunge all the way into the lower 50s possibly having us pulling the plug. Right now, though, while choppy, the path of least resistance remains up, so we’ll stay on Buy. BUY

Las Vegas Sands (LVS)—LVS remains cool, calm and collected during the market’s latest retreat, pulling in a few points on light and decreasing volume before perking up a bit. The risk here is that the China reopening runs into trouble for some reason, but there’s no sign of that yet, so barring poor execution there should be little standing in the way of Sands seeing booming (and, eventually new highs in) cash flow in the quarters ahead as Macau visitation picks up. Indeed, January saw Macau as a whole post an 83% hike in gaming revenue (doesn’t include room and food revenue), which is great ... but also still less than half of January 2019 (the historical January high-water mark), so there should be plenty of growth ahead. If the market was acting fine, we’d look to fill out our position in LVS here; given the recent action, though, we think it’s prudent to wait. If you don’t own any, though, we’re fine picking up a small position here. BUY A HALF

Inspire Medical (INSP)—INSP broke out nicely on earnings and pushed a bit higher after, but as has been the case with most everything of late, shares have turtled somewhat due to the market’s retreat. Still, big picture, everything seems in order here, both technically (starting to emerge from a two-year rest period) and especially fundamentally—yes, the sales growth here is important and very solid (70%-plus each of the past six quarters; analysts see 40% growth this year, which is very likely conservative), but even more enticing is the overall potential, with Inspire thinking the U.S. annual market for its solution to be something like 500,000 patients a year, which translates into a $10 billion annual opportunity—and that says nothing about people using CPAP properly that may want to switch, or those undiagnosed with moderate apnea, or anyone overseas. Inspire has been adding more than 60 new centers per quarter over the past couple of years, with plenty more to come. Back to the stock, we bought a half-sized stake last week and are willing to give it some rope; a drop below 250 would be a yellow flag and probably coincide with a crack in the market, but right here, we’re sitting tight and think you can grab a small position if you don’t own any. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—SSO has taken a hit with the S&P 500 in recent days, which is now sitting right on its 50-day line. As we wrote in the last issue, we built a good-sized position in this leveraged long index fund because the evidence and indicators lined up in the right direction after a bear phase last year—but, obviously, if some of that evidence falls by the wayside (it’s getting close), we’ll change our tune. Still, our main thoughts here are, first, we don’t anticipate signals, and so far our indicators are positive; if that changes, we’ll likely sell a portion of what we own, but at this point the retreat is still acceptable. Second, big picture, it’s hard to ignore the bottoming action last year, the pervasive pessimism out there, the 2-to-1 Blastoff signal and the near-two-month stretch of positive readings from the Two-Second Indicator—all of which occur at the end of bears/beginnings of new bulls. That doesn’t mean we’re complacent (again, we’ll pare back if we see much more weakness), but we still think the market could be in a (longer than hoped for) bottoming process even if we do crack. Back to the here and now, the S&P 500 tested its 50-day line today and bounced, while our Cabot Tides are still positive. Thus, we’ll stay on Buy but will be watching closely. BUY

Shift4 (FOUR)—FOUR was really one of the first legitimate growth stocks to get going late last year and was looking just fine until late last week, when a turn in the market and (more importantly) a poor outlook from peer Toast (TOST) took the stock down sharply over a couple of days; with the crack of the 50-day line, we moved to Hold and have shares on a relatively tight leash. That said, at heart, we’re optimistic, as Shift4 has all the characteristics of a winner, including real profits and cash flow (unlike Toast), not to mention a lower valuation (half the market cap, give or take) and, of course, a bunch of new markets that should begin to crank out payment volume and revenues in the months ahead. That said, as always, we’ll take it as it comes: FOUR’s break came on big volume last week, which is certainly negative, though we can’t say the overall uptrend is over. We’re OK holding on with a stop three or four points below here, though earnings (due February 28, next Tuesday) will be key. HOLD

Uber (UBER)—UBER has been hacking around, but like many names, it looks fine in perspective, giving back just a small fraction of its rising-volume ramp so far this year. To us, if the market can get moving, we think this stock is poised to do very well—demand is strong thanks to the overall global economy and the booming travel sector, and management’s renewed focus on cash flow is resulting in that figure accelerating each quarter. After eight weeks up in a row, a rest could be in order, but we think Uber can be a magnet for institutional investors should the market/economy get moving. We filled out our position last week and are sitting tight, and while a drop down to 29 or 30 would be abnormal, right here we think UBER’s path of least resistance is up. We’re holding onto our position, and if you don’t own any, you can buy some here or on dips of another point or two. BUY

Wingstop (WING)—It’s all systems go fundamentally for Wingstop, which just reported another very solid quarterly report, with system-wide sales up 29%, domestic same-store sales up 8.9%, earnings of 60 cents per share up 150% (topping by 19 cents) while EBITDA was up 72%. And while the firm didn’t give exact guidance for 2023, it reaffirmed its three-to-five-year plan for mid-single-digit same-store sales growth and expects 240 new openings worldwide this year, which would be a 12.2% bump in the restaurant count. (Some positive commentary on the firm’s chicken sandwich, which the top brass thinks can be a multi-year sales driver and diversify away from wings and wing costs, was very good to hear.) That led to a rush of buying initially, but in this environment, strength is still being sold into, especially for stocks that are extended to the upside (25-day line here is 161); the result is that WING gave up much of the earnings pop during the past couple of days. That’s not ideal, and of course we won’t stick around if the stock melts down from here, but to us the action looks much more like profit taking than any major distribution to this point. We’ll stay on Buy, though if you want to add shares, we advise keeping it small here or looking for further dips. BUY

Watch List

• Airbnb (ABNB 126): ABNB’s earnings move is losing altitude, so shares might need more time to set up, but the story reminds us of Uber in the sense that it’s an emerging blue chip and profits are now booming after years of red ink. See more below.
• Allegro Microsystems (ALGM 44): Allegro’s chips are in giant demand for auto and industrial applications (EVs, clean energy, industrial automation), so much so that the firm has a backlog of over a year as it rushes to fill demand. Shares recently broke free from a huge post-IPO base and have been very resilient since.
• Axcelis (ACLS 125): Axcelis looks to have the perfect chip equipment (its Purion line) for the coming boom in making high-performance chips for the EV sector and other power-hungry devices. The stock is holding up great despite a huge breakout and run so far this year. See more later in this issue.
• Axon Enterprises (AXON 195): We thought AXON was kaput a couple of weeks ago, but we’re impressed with its quick rebound and steadiness of late. In fact, shares are holding very nicely just south of all-time highs, part of a two-year-long base. Earnings, due February 28, will tell the tale.
• On Holding (ONON 21): Shares have been all over the place since the start of February, but the chart looks intact—there’s no set earnings date yet but we’re really looking for a strong gap up to signal the start of a fresh uptrend. Fundamentally, everything looks on target here.
• United Airlines (UAL 51): You might think that tough Fed talk (and related fears of economic weakness if they continue hiking) would be crushing airline stocks, but most are acting normally, and UAL is the best of the bunch—analyst estimates continue to crawl higher (up to $8.22 per share for 2023), and that’s still short of management’s $10-plus forecast a month ago. We’d prefer to see UAL (and the market) show some real strength before taking a swing at it, though.

Other Stocks of Interest

Airbnb (ABNB 126)—We’ve written about the travel boom, which is really a mix of strong demand for all types of travel from millions that didn’t go anywhere for a couple of years—but, for the firms in the industry, the story is also about some structural issues that are keeping supply in check and prices elevated, which in turn is leading to great earnings and cash flow. Despite them being the farthest thing from traditional growth, we’re still eyeing some airline stocks, but Airbnb might be the growthier way to play the move. The company, of course, is the preeminent vacation rental firm out there, with 6.6 million listings (up 900,000 from the start of 2022), and it’s continually making it easier for new hosts to sign up (including getting free one-on-one consults with “superhosts” for advice, better guest identity verification and moving into the apartment space for long-term rentals). Not surprisingly, business has been solid, both within the U.S. and across borders—indeed, while Q4 bookings were up 20% from a year ago (26% on a currency-neutral basis), cross-border bookings rose a whopping 49%, and guests are staying longer when they go, with stays of more than a week up 40% compared to Q4 2019 (pre-pandemic). Thus, business is good, and as opposed to a few years ago, it’s leading to big earnings—the bottom line totaled $2.79 per share last year, though free cash flow was much bigger (nearly $5 per share), which actually led to $1.5 billion of share buybacks during the year. In a way, we look at Airbnb in a somewhat similar way as Uber—a dominant firm in a growing, established sector that’s already gone through the wringer but is seeing solid growth (probably 15% to 20% top-line expansion in 2023) that’s leading to big earnings and cash flows. And big investors are taking notice: ABNB was whacked early last year and had a shakeout below its summer low in December, but quickly recouped ground and briefly tagged nine-month highs after its earnings gap last week. Shares have pulled in with the market in recent days, but we have the name on our watch list if it can steady itself.

Revance Therapeutics (RVNC 34)—We’re not big on speculative stocks at most times, and that’s especially true when the market is still battling Federal Reserve-related headwinds like now, but Revance is a biotech outfit with a simple story that could go very far. While the firm gets some revenue these days from a series of dermal fillers for wrinkles (probably $110 million or so last year; Q4 results are out Februray 28), the big idea here concerns Daxxify, which is the firm’s neuromodulator (cosmetic injection to counteract wrinkles) that got FDA approval for in September for frown and lip lines. If that sounds like it would compete with Botox, that’s because it will, opening up a gigantic market—Botox garnered about $2.6 billion in revenue last year for giant AbbVie, and the excitement is that Daxxify seems like a better treatment: It contains no human or animal byproducts (it’s stabilized using a novel peptide), and more important, the effects lasted longer in trials, with Daxxify’s injections holding up for six-ish months, which is longer than the three to four months (in practice, many reportedly see effectiveness wane after three months) with Botox. And, in trials, it works just as well, with 98% of people saying they had little to no wrinkles after injection (with no side effects, either). Like Botox, Daxxify could also have other, off-label applications, including possibly for people with muscular disorders, but clearly, investors are focused on the core wrinkle market, as grabbing a big chunk of the market would be huge. Very early results have been good; Revance rolled out the product selectively late last year to just 400 practices, resulting in $11 million of revenue—and management said it’s all systems go for a full launch in late Q1 or early Q2 (and the firm should have enough cash to get things off the ground, too). The bottom line is still deep in the red, of course, with the early read from analysts that 2023 revenues could rise 75% to $230 million, though we’d take those figures with a grain of salt, as a strong launch phase could see money pour in. The stock is certainly acting like good things are ahead: After months of wild up-and-down action, shares exploded higher in early January on the positive tidings from management, rallied to multi-year resistance in the mid-30s and have tightened up since despite the market’s wobbles. It’s a high-risk, high-reward play, but there’s no doubt the potential here is big.

Agilon Health (AGL 21)—Everyone knows the incentive structure when it comes to doctors and patients is out of whack—with seniors (Medicare) especially—in that payments are based on visits and tests, as opposed to health outcomes. Starting a few years ago, though, there are now incentives to turn things in the right direction, and a handful of companies (including Oak Street Health, which was recently bought out by CVS for more than $10 billion) like Agilon are leading the value-based care industry—partnering with thousands of primary care physicians (PCPs), providing them with capital, data, payor relationships and technology. Doctors get a fixed payment and then, if costs per patient come in lower than expected (meaning fewer hospital admissions, re-admissions, ER visits, etc.), the insurer will share those savings with Agilon, which then passes some on to the doctor. That’s exactly what’s transpired with Agilon’s PCP base, with most metrics 30% better than the Medicare benchmarks, leading to shared savings. It’s a bit convoluted, but it’s clear the sector is moving toward value-based care, with CVS’ recent move into the industry certainly helping perception. At this point, Agilon is up and running in 25 markets in 12 states; at the end of last year, there were likely about 1,600 PCPs onboard covering 360,000 total patients, and those figures are expected to have another big increase in 2023 (to 2,200 and 500,000, respectively). Revenues have been clipping ahead nicely (52%, 34% and 58% the past three quarters), and while earnings are still in the red, EBITDA was about breakeven last year and should improve from here. The stock still needs to show more strength (and more trading volume), but we like the fact that it’s new (public April 2021), found support in the 15 area repeatedly last year and is seeing more funds jump onboard (422 at year-end vs. 312 nine months earlier). The Q4 report is due March 1, and a big gap up could be interesting.

Chip Stocks Strong—and with New Leadership, Too

As we wrote in the last issue, one of the characteristics of the rally so far is that leadership has been somewhat slow to come on board; the number of stocks hitting new highs was only so-so even at the recent peak, and anecdotally, there aren’t a ton of growth leaders (especially big, liquid leaders) out there just yet.

However, the good news is that the chip sector has shown definite strength and relative performance. While individual names can be tricky (most chip names are a bit down-the-food-chain stories, which means demand can pick up or vanish in a hurry depending on a few large customers), the sector itself is a good growth “tell,” and the fact that the group is perking up and holding firm is a plus.

Granted, much of that move has been caused by either off-the-bottom names (such as stalwart Nvidia (NVDA) or Ambarella (AMBA), both of which were destroyed last year) or older names that had a big run in the last cycle, (Onsemi (ON) is a good example of this). We have nothing against these stocks, but new leadership tends not to come from old leaders or those that fell 75%, etc.—usually, they’re newer firms with products that, especially in the semiconductor area, are in huge demand from newer growth industries.

Today, there are two that we’re very high on. The first is Allegro Microsystems (ALGM), which is a chipmaker that focuses on magnetic sensors and power integrated circuits (ICs) which are are used in a variety of products. However, the big drivers today and for years to come are automobiles and industrial applications, where its offerings seem to have something special for clients. Industrial applications include things like clean energy and industrial automation, and growth there is fantastic, rising 60% in Q4 and likely to boom for a long time to come.

Autos could be even bigger: Today, they make up 70% of revenue, and within that, e-mobility (Allegro’s term), which includes advanced driver assistance systems and the electrification of vehicles, is growing like mad—making up 30% of total company sales and growing at 54% in Q4. With the number of electric vehicles on the road set to boom (price cuts in the sector could help Allegro, as it’s sales are tied to EV output), and with the firm’s sales opportunity 60% to 100% greater in an EV than a regular car, the top brass is looking at many years of big growth.

Sales and earnings have been catapulting higher for many quarters (revenue growth is accelerating and was up 33% in Q4), and the firm has a backlog of greater than one year (!), 20% of which is actually past due as it continues to work to boost capacity and fix supply chain issues (it’s making progress). To be fair, analysts expect a slowdown in the quarters ahead with the chip sector as a whole, but big investors don’t seem to believe that—ALGM tightened up in December and broke out of a two-year post-IPO base three weeks ago and has continued higher since.

Then there’s Axcelis Technologies (ACLS), which (if management makes the right moves) looks like the next Applied Materials. This firm makes ion implant equipment that’s benefiting from the increasing complexity of chips (more complexity = more implants), and again, a lot of that is coming from the EV boom: Its various Purion lines of equipment appear to be the best-in-class for silicon carbide chips (SiC for short—they can operate far more efficiently at higher temps than regular silicon, which is needed in EVs and other power applications).

In the words of management, Axcelis is “the only ion implant company that can deliver complete coverage for all power device applications” and “is considered by power device customers to be the technology leader—providing the lowest-risk path to high-volume manufacturing to support aggressive [production] ramp plans.” Translation: Axcelis has the best offerings for what should be a multi-year boom in SiC production, which is expected to double every three years for the next decade!

Unlike Allegro, this company has been around for a while, but sales and earnings growth has been pristine and ACLS actually broke out before ALGM (back on January 9) and has been smoke up a chimney since, with only a little wobble during the market’s recent correction. While Wall Street sees some slowdown this year, management believes the firm can crank out free cash flow of $325 million (nearly $10 per share) within two to three years.

Both ALGM and ACLS quack like new leaders, though admittedly, both are extended here and are still growing up, sponsorship-wise. Both are on our watch list—we could add one on further weakness, or potentially add half positions in both and treat it like one “full” semiconductor position. Either way, the story, numbers and charts for both (as well as the sector’s positive action) is very enticing. WATCH

Cabot Market Timing Indicators

After most key measures turned positive early this year, the evidence has waned in recent days as fears of more aggressive rate hikes come back into play. We’re not ignoring that—but we’re also not ignoring the fact that, to this point, all of our indicators are still positive. We’re on guard in case the selling continues, but for the moment we’re standing pat.

Cabot Trend Lines: Bullish
The Cabot Trend Lines are still positive, but like everything else, bears watching—at this point both indexes are a smidge above their respective 35-week lines (by 2% or so for both the S&P and the Nasdaq), so a down week or two could flip the script. But we don’t anticipate things, and today this important long-term measure still offers encouragement for the bulls.

Cabot Tides: Bullish
Our Cabot Tides have also taken on water, with one index (the NYSE Composite) slightly below its (50-day) moving average. But the other three we track, including the S&P 400 MidCap (shown here), look fine, with a reasonable retreat to this point. A decisive dive below the 50-day lines on most indexes we track would reverse the buy signal, but so far, the intermediate- and longer-term trends remain up.

Two-Second Indicator: Positive
Not surprisingly, the broad market has weakened some (especially on the Nasdaq, where new lows have picked up). That said, our reliable Two-Second Indicator is still in good shape—yes, new lows have increased somewhat, but (a) that’s not a death knell when it comes two-plus weeks after a peak, like now, and (b) new lows are still coming in under 40 every day (yesterday’s 34 was the largest figure of the year), which is a healthy figure. If the readings continue to increase, that would be iffier, but right here the broad market remains healthy.

The next Cabot Growth Investor issue will be published on March 9, 2023.