Cabot Growth Investor Issue: January 25, 2024

Be Bullish, but Keep Your Feet on the Ground

Just over three months ago, the world looked pretty dour. Interest and mortgage rates were standing at multi-decade highs, three-quarters of stocks were below longer-term moving averages, next to nothing was hitting new highs and even the famed mega-cap stocks were struggling. Of course, the market is a contrary beast, so when things began to take off, it presented a high-odds situation.

Today, the situation has reversed: Instead of 75% of stocks below their 200-day lines, 70% are above those long-term averages; instead of few new highs, there are hundreds nearly every day; and instead of growth stocks being on their knees, they’re leading the way higher, including the mega-cap names but also tons of others, too.

Thus, it doesn’t take a proprietary timing system to realize the market’s had a good intermediate-term run, that a lot of the world’s worries have been forgotten/ignored and, if you’ve been buying some leaders, many are clearly extended to the upside (which can be measured in a variety of ways).

Throw in the fact that earnings season is revving up and interest rates are testing key levels (see more on that later in this issue), and now’s a good time to remember to keep your feet on the ground—just as we didn’t get overly pessimistic near the lows, it’s best not to start high-fiving each other right now, instead being relatively selective when doing new buying and not being afraid to hold some cash as we look for better entry points (possibly during earnings season).

Of course, we said the market’s had a good intermediate-term run that it may need to digest. Bigger picture, the evidence remains almost uniformly to the good—are our key market timing indicators in this issue are still bullish, and our Aggression Index, after a bit of sluggish action, has again roared ahead, telling us growth has the upper hand.

Combined with the overall setup (nearly three sluggish years for growth stocks), we’re optimistic last November launched a real sustained advance that can take the market and many names much higher than most expect.

What to Do Now

However, even the strongest markets don’t see leading stocks go straight up, so right now we’re holding a chunk of cash, trimming positions if needed and being selective on the buy side. Since the last issue, we sold half of Duolingo (DUOL) and one-third of Nutanix (NTNX), though tonight we’re averaging up on Elastic (ESTC), filling out our position. The portfolio’s cash position will now be around 23%.

Model Portfolio Update

We’re certainly bullish overall and have been writing about the fact that we may have entered a “real” bull move last November following two years in the muck (nearly three years for glamour stocks)—and that means stocks that look “too high” can eventually go a lot higher if all goes well. When it comes to the primary evidence, it’s hard to argue with those thoughts, as the market’s key trends are up, leading growth stocks look good and, after a brief scare, even the broad market has found some support.

Thus, we advise holding all (or most of) your strong, profitable stocks, giving them a chance to develop into big winners. Of course, some won’t keep going; that’s the nature of the market. But a couple of outliers can make a big difference to your portfolio.

All that said, we’re also students of the market, and the difference from three months ago (when very few stocks were hitting new highs and the investor worry level was elevated) to today (tons of leadership that’s extended to the upside, etc.) is glaring, and even the Nasdaq itself is sticking up in the air. Combined with earnings season, near-term risk is elevated for new buying, with a pullback or some sharp rotation possible.

Put it together and we’re picking our spots on the buy side, moving slowly and not afraid to hold some cash given the relative lack of great entry points out there. Tonight, we’re averaging up on Elastic (ESTC), buying another half-sized stake, but sticking with a 23% cash position as we see how earnings season plays out.

CURRENT RECOMMENDATIONS

Arista Networks (ANET)—ANET has been one of the names at the heart of the tech rally, with more and more big investors coming around to the view that, though there may be a lull for two or three quarters in purchases from hyperscale clients, Arista is well positioned for the AI investment boom, which could last a few years and be absolutely massive; some of the industry-wide numbers being thrown around, like $200 billion to $400 billion spent on AI chips alone, give you a sense of how big the spending spree could be. Like many of the strongest names, our thoughts on this stock are two-fold: Near term, shares have been running for nearly three months, have enjoyed a solid move and are somewhat extended to the upside (14% or so above the 50-day line), so don’t be surprised to see some wobbles, especially with earnings coming up soon (February 12). That said, bigger picture, assuming the market doesn’t completely keel over, ANET’s strength (including months on end of withstanding the rough growth stock period of the past two years) and fundamental positioning bode well. We’ll stay on Buy, but if you want in, aim for dips of at least a few points. BUY

CrowdStrike (CRWD)—CRWD remains a homesick angel, surging more than 60 points since the start-of-January pullback, now challenging round-number resistance around 300—though, like many names, there’s been some selling on strength up here as profit taking sets in. For whatever reason, there seem to be many more cyberattacks going on these days—Microsoft of all firms recently said a state-sponsored organization hacked some emails of senior leaders—and when you combine that with disclosure regulations, it’s almost surely leading to a big bump in business for CrowdStrike, both for initial forensics and, after that, for signing up big outfits for some of its services. That said, for the stock, our thoughts are almost exactly the same as for Arista—CRWD has had a huge run and a lot of good news is out, while shares are extended to the upside. Big picture, that is a sign of strength, but near term, it may mean that some turbulence is dead ahead. Right now, we’ll keep our Buy a Half rating—a controlled pullback for a few sessions could provide an opportunity—but we’re watching things closely should the sellers really step up. BUY A HALF

DraftKings (DKNG)—DKNG has been a hard stock to handle, first with its tedious summer and fall drop last year, and then more recently, when it gave back all of its post-breakout gains this month. The good news, though, is the stock has once again pulled itself away from the cliff’s edge, roaring back to its prior highs on good volume, partially thanks to some positive analyst reports that suggest ESPN’s new venture, while off to a good start, isn’t likely to grab much market share from the leaders like DraftKings and FanDuel. Also helping the cause this week were reports that the firm is likely to tie up with Barstool Sports, which used to be a partner with Penn National before they decided to throw in with ESPN. All told, we obviously like the snapback, and if you didn’t own any and wanted to start small, we wouldn’t argue with you—but we’re simply going to hold what we have, partially because the relative performance (RP) line (not shown) is still lagging, and partially to avoid chasing our tail in this volatile name. HOLD

Duolingo (DUOL)—DUOL saw some lagging action at the very start of the year and then, last week, suffered a sharp decline on two separate days, pushed along by an analyst downgrade that cited the unknown effects of AI on education-related apps like Duolingo. This same worry popped up last summer and management did a very good job dispelling it—if anything, the company is a leader in using AI to its advantage, making its learning platform “smarter” and more productive for users. That doesn’t mean we ignored the action, though—given the selling, we pared back, selling half our shares—but we’re willing to give DUOL a little wiggle more room here to see if this is yet another big, 20%-plus shakeout that gives way to fresh move higher, something the stock has done a few times in the past year. Hold your remaining shares, though we’re keeping a close eye on the situation. SOLD HALF, HOLDING THE REST

Elastic (ESTC)—While many tech-related names look extended, we think ESTC is fresher—having decisively broken out in early December on earnings and showing some power (it recently ramped to new high ground) of late as money has flowed back to AI-related names. (Not to delve too deeply into the chart, but the weekly chart during the past couple of months shows only low volume on the down weeks, while the breakout and thrust last week came on big trade; even yesterday’s sloppy action occurred on quiet volume.) Bottom line, we think Elastic’s story (its search platform could be the foundation that many AI models are built on) and overall pattern are excellent, so while a pullback is possible if the Nasdaq fades some, we’ll fill out our position here, buying another half-sized (5% of the account) position, and use a mental stop near the century mark for the entire stake in case things go awry. BUY ANOTHER HALF

Nutanix (NTNX)—NTNX remains super strong, with some bullish analyst commentary (especially involving the likelihood of the firm taking share from VMware, which was just taken over by Broadcom), a strong market and lingering M&A rumors propelling shares to all-time highs on big volume. That’s obviously great to see—though we decided to book some partial profits last week, taking advantage of the strength to put some money in our pocket while still holding onto a good-sized position. As we explain later in this issue when we write about partial profits more generally, that wasn’t about picking a top—it’s more about portfolio management, feeding the ducks while they’re quacking so to speak, and then giving our remaining shares plenty of rope to ride out a major uptrend that, ideally, will last for many more months. SOLD ONE-THIRD, HOLDING THE REST

ProShares Ultra Russell 2000 Fund (UWM)—Whether you’re looking at small caps, mid-caps or equal-weighted indexes, the broad market has basically been marking time (or worse) in January, even as the big- indexes lift—indeed, even as of today, the equal-weight S&P 500 is actually down a half percent this month while small and mid-caps are also in the red. With that said, we don’t consider those statistics bearish, per se( it wouldn’t surprise us to see some rotation back into the broad market sometime soon), but it is what it is at this point. UWM had a tough pullback and has bounced a bit of late, which is good to see—given all the longer-term positives, we still think this fund can surprise on the upside down the road. But given the current tenor of the broad market and our loss, we’ll stay on Hold and watch for signs the buying pressures are spreading. A meaningful drop below the recent low near 33 would probably have us looking for greener pastures. HOLD

PulteGroup (PHM)—Pulte and other homebuilders have finally hit some turbulence, with blue-chip builder D.R. Horton the culprit—that company reported results this week, and while the metrics were solid (new orders were up 38% in dollars!), big investors sold the news, driving the group (and PHM) lower. Our thoughts: Short term, after a very good run, our guess is PHM has some consolidating to do, especially as interest rates are testing key levels on the upside (see more on that later in this issue)—that said, a couple of down days doesn’t make a trend (the 50-day line is still down below 98), and the underlying positives we’ve written about remain in place. All told, we’ll stay on Buy as the odds favor higher prices over time, but next week’s earnings report (due January 30) will probably tell the intermediate-term tale. If you own some, we advise hanging on, and we’re OK buying a small stake on this dip if you’re not yet in. BUY

Shift4 Payments (FOUR)—Shift4 Payments isn’t part of a strong group (PayPal took another wallop today after a presentation), but the firm has a very long history of making the right moves (including M&A that expands its markets and bolsters its offerings) and the firm’s track record of growth (earnings expected to rise ~30% in 2024 after doubling in 2023) should continue to attract buyers. Interestingly, Shift4 is handling the payments in both stadiums hosting this weekend’s NFL Championship games (one in Baltimore, one in San Francisco) and it will do the same for the Super Bowl (in Las Vegas) two weeks later, all of which is a clear sign the firm’s move into new verticals (in this case stadiums and ticketing) is working. The stock has been futzing around on low volume but looks fine overall. We own a half-sized stake and are sitting tight tonight. BUY A HALF (P.S.: As an aside, we know it’s not always possible as people have busy schedules, but you should try to avoid placing overnight market orders to buy a stock—market makers will often mark up the price early and then feed those buyers shares, leading to a pullback after the open, which is what we saw last week. To be clear, FOUR still looks fine overall, but just a heads up that you’ll often get a better price by logging into your account sometime during the next day and grabbing shares. Just something to consider.)

Uber (UBER)—UBER has earnings in a couple of weeks (due February 7) and, maybe as important, the firm will hold a virtual update session (sounds like a mini Investor Day) with the top brass a week later (February 14), where it’s possible the firm will have some updated multi-year EBITDA and free cash flow targets as well as tidbits concerning the progress of some of the firm’s newer ventures (such as advertising, delivery partnerships and the like). Some analysts have been sounding valuation alarms of late, but those tend to be hit or miss—indeed, the stock actually kissed new price highs today, although the relative performance (RP) line (not shown) isn’t doing the same. All told, we still see UBER as a liquid leader in two giant, growing fields (ride-sharing and delivery) and think the odds favor higher prices ahead. We’ll stay on Buy, but as with everything, try to enter on a bit of weakness, especially with earnings coming up in two weeks. BUY

Watch List

• Celsius (CELH 53): CELH was starting to perk up but got walloped on big volume late last week, and even news of international expansion this week hasn’t brought in buyers. Shares are in an area of support, so we’ll watch a bit longer and see if last week’s dip can morph into a shakeout.
• Eli Lilly (LLY 628) and Novo Nordisk (NVO 105): We usually don’t watch stocks endlessly, but in our view, both LLY and NVO are still setting up properly—the stocks have nosed to new price highs but the relative performance (RP) lines are still working their way back. Both firms report earnings soon (Lilly February 6; Nordisk January 31).
• Expedia (EXPE 152): EXPE is doing its own possum imitation, trading in a tight 10-point range during the past month after a 60-plus-point run. While not a hyper-growth outfit, the top line should grow 10% or so this year while earnings lift 27% and free cash flow is both big (likely $13 to $17 per share for all of last year) and growing at a solid clip. Earnings are due February 8.
• GitLab (GTLB 70): We already have a bunch of tech exposure, but GitLab quacks like a new leader, with a platform that makes it easier to develop, test and secure new software. And since software is key to just about every big company these days, tons of big enterprises (half of the Fortune 100) are already clients. The stock recently experienced a mini-volume cluster as it moved to higher highs.
• KKR (KKR 85): KKR had a big, persistent, seven-week run in November and December and has now etched a very tight six-week range. If the market really can run for many months, it’s close to a sure bet that KKR will thrive as money flows pick up and the assets it owns surge in value. Earnings are due February 6.
• Neurocrine Biosciences (NBIX 141): NBIX continues to act like a leader in the resurgent biotech group, and we like its combination of strong current sales and earnings growth as well as upside potential from a new drug approval in early 2025 or sooner (which the stock is likely to discount ahead of time). Earnings are out February 7.
  

Other Stocks of Interest

Academy Sports & Outdoors (ASO 65)—We owned Academy Sports & Outdoors for a while last year, but like so many names, the stock’s great-looking breakout fizzled in the summer and fall. And while the market definitely had something to do with it, part of it was an elongated post-pandemic hangover—the firm is one of the larger players in the sporting and outdoor equipment field (thanks mostly to its 280 locations in the south and southeast U.S.) and business went wild during the cabin fever days of the pandemic, but a variety of factors have led to a long, slow scale back of sales as the world has turned right side up. Indeed, while weather was a factor, Q3 saw same-store sales down a big 8%. That background masked what was—and still is—a very enticing story: Operations-wise, the firm has a few key differences from its peers (unique assortment of name-brand and private-label offerings; everyday value pricing; surveys show higher customer loyalty, etc.) that have led to some eye-opening metrics (sales per square foot, EBITDA per store, etc.) that not only are better than direct competitors, but are among the best in all of retail. And then there’s the growth angle, with same-store sales expected to halt their decline and with the top brass aiming to be the big dog in the group—Academy opened 14 stores last year and expects to open 130-ish new locations in total through 2027, bolstering the store count by 50% or so, sales by more than 60% and spinning off huge amounts of free cash flow during the next few years. (The firm is already active on the buyback path; the share count was down about 5% in the first nine months of the year.) Obviously, a lot will depend on execution and if the post-pandemic retrenchment in outdoors-y items stops, but if things go even partly right, Academy’s bottom line (which has been hovering in the $7 to $8 per share range since the pandemic) should advance steadily for the next few years. As mentioned above, the early 2023 rally fell flat, but after a big correction, ASO moved all the way back toward its highs before resting for the past month. We’ve been looking for some non-tech names, and if ASO can confirm its uptrend, we could take another swing at it.

TransMedics (TMDX 86)—TMDX doesn’t have the type of chart that usually interests us—we actually wrote up the stock six months ago, but shares completely unraveled after earnings a few weeks later. But then came a ridiculous gap up on earnings and TMDX has been acting like a totally different, more bullish animal ever since … all while the company sports a true one-of-a-kind story with massive potential. That story starts with the firm’s organ care systems (OCS), which are complex machines that are able to mimic real-life environments for organs, helping hearts, lungs and livers “stay alive” much longer than the current standard (cold storage), which allows for just a few hours of time. That not only dramatically increases the number of organs available for transplant, but patients have far fewer severe post-transplant issues (43% to 65% fewer severe complications depending on the organ). In and of itself, that’s a gigantic, revolutionary change for patients (and, frankly, it helps providers and hospitals, too, boosting procedures and revenue), but TransMedics isn’t satisfied just with selling the machines: It’s building an entire network that includes logistics and procurement to make it as seamless as possible to get organs from donors to patients—it’s even building an entire aviation division (!), hiring its own pilots and buying its own fleet that can transport and OCS-support organ from one place to another (80% of transplants occur in just nine states, so the focus is on getting organs to big city centers from all over the country). With all that investment, it’s not a surprise that the bottom line is in the red, but revenues have been growing like mad (up 159%, 156% and 162% the past three quarters); analysts see that slowing to “only” 45% in 2024, though our guess is that will prove very conservative. Back to the stock, it has rallied back into an area of resistance, and the stock is a bit thinly traded, too—thus, like many names these days, some sort of rest or retrenchment wouldn’t be surprising. But there’s no question the upside is big, and if the top brass pulls the right levers, we’d guess this small-cap name will grow up in a hurry.

Super Micro Computer (SMCI 476)—We remember back in the late 1990s when the Internet bubble really started to go wild, we recommended Yahoo!, which was one of the first to hit new highs coming out of the short, sharp bear market of 1998. (It actually hit new highs a few weeks before the end of that mini-crash, but we digress.) Shares went on a massive run and staged a classic blow-off top in early 1999—eight times out of 10, that would have been it and the stock would have topped out. But, in the market, it’s always important to pay attention to unusual happenings, which often tell you something big is occurring—and as it turned out, after a multi-month rest, Yahoo! went wild yet again in late 1999 and early 2000 into the final market top. That long prelude leads us to Super Micro Computer, which has for years been a solidly profitable, though relatively unexciting, maker of various types of servers and racks and everything that goes into them; half of the firm’s employees are engineers (!), and it’s known for both its customizable solutions, being fast to market, and its lower power consumption (using liquid cooling solutions), the combination of which provides big clients a much lower cost of ownership. That helped the firm take market share while the industry itself was growing due to greater computing demands—and now, of course, the AI movement is supercharging that demand and Super Micro’s bottom line. Indeed, the firm’s fiscal year earnings (ending in June) went from $5.65 in 2022 to $11.81 in 2023, and some analysts see another near-doubling in fiscal 2024 (possibly to north of $20 per share) after Super Micro goosed its outlook last week—for the December quarter, earnings are expected to be around $5.50 per share (up nearly 70% from a year ago), well ahead of estimates, and some analysts see continued big demand for the next few quarters at least. Back to our comparison above, SMCI went absolutely bananas during the market’s spring/early-summer rally last year, but the stock quickly fell 37% after earnings in July and stayed rangebound for months, even when the market got going late last year—it certainly looked like it had seen its best days. But the guidance hike changed all that, bringing another breakout on its heaviest weekly volume ever (and this week’s volume is every heavier). SMCI clearly isn’t in the early innings of its overall advance, but like Yahoo 20-plus years ago, it’s looking like it has another run in it. A shakeout (possibly on the official earnings release next Monday) could be tempting.

Having Your Cake and Eating It, Too: The Importance of Partial Profits

The rally that kicked off in November has a different feel to it—as we’ve written before, the ducks seemed to be lined up for a real, sustained uptrend where trends persist and leading stocks act “as they should.” Indeed, looking at a weekly chart of the IBD 50 Index (a collection of growth stocks with solid fundamentals and relative performance—which is the pond we fish in) going back three years, it appears our universe of names could be emerging from a long bottoming effort. Obviously, there are never any guarantees, but we’re optimistic that 2024 will see more winners emerge.

The question, however, is how you want to approach handling those winners—the market, remember, is a game of outliers, so a big winner or two (or, conversely, some huge losers) is what tends to drive performance over time. One way to handle your stocks to simply hold a stock no matter what, thinking a good story will eventually win out. But we don’t recommend that; if investing were that easy, we’d all be rich. The growth stock graveyard is littered with good stories.

Another option is to hang on but trail a stop—and in most cases, that is indeed what we’ll do. However, it’s important to realize that even the biggest winners will usually have two or three good-sized corrections—20% to 25%, sometimes a bit more if you’re talking about a very volatile stock—that also slice below intermediate-term support (like the 50-day line). In other words, (a) you’ll have to use a loose stop and be willing to give up a big chunk of your gains, and (b) even if you’re able to hold onto the stock, there’s no guarantee that stock will recovery powerfully after the dip.

Of course, some of those are risks you have to take in the market; there’s no way to get upside potential without any downside. But if you run a concentrated portfolio like us, sometimes you can have your cake and eat it by taking partial profits. The idea here is two-fold: First, of course, you’re booking some profit, but second, because of your gains and a slightly smaller position size, you’re able to give your remaining position plenty of wiggle room to keep motoring higher. All told, then, you have a better chance of holding onto a big winner—and if the stock flames out, at least you put some profit in your pocket along the way.

In terms of guidelines, it’s mostly about common sense—if you have a good profit (not just 5% or 10%), the stock is extended in both price (10% or more above even short-term moving averages) and, importantly, time (it’s been running for at least a couple of months, if not three or four), you can consider lightening up. That’s especially true if you see a few potential yellow flags in the market (like interest rates—see below).

To be clear, we won’t be banging out partial profits on every winner we have—it will still be something we do only here and there. But after we booked some of Nutanix (NTNX) last week, we received a good number of questions about it, so we wanted to share our thoughts. In sum, it’s not about picking a top, but about portfolio management and, over time, giving us a better chance to ride a potential longer-term winner.

Interest Rates are at Key Levels

There’s no question that, during the past two years, interest rates and everything related to them (inflation reports, Fed actions) have been the tail that’s wagged the stock market. In a sense, it’s similar to what was seen in the two or three decades prior to 2000, after which rates become less of an issue as they remained near zero for most of the past 20 years.

Of course, we’ll always put more emphasis on the primary evidence, but we’re also keeping a close eye on the intermediate-term trend of interest rates—the Interest Rate Tides, in a sense. Shown here are charts of the five- and 10-year Treasury yields; we’ve inverted the chart so that going up means lower rates (a bullish thing).

Both measures saw big declines starting in late October (right before the market low) but have retreated during the past three weeks—and are now testing their key 50-day moving averages. A decisive break below those lines would almost surely be a market headwind, though it’s not unusual to “test” these key areas and resume the trend. Right now, the trend in rates remains down, but this is certainly something to watch closely in the days ahead.

Cabot Market Timing Indicators

It’s hard to argue with the primary evidence out there, as the trends of the major indexes are firmly up while the action of leading growth stocks is impressive. That said, we also think it’s important to keep your feet on the ground—holding your best performers, yes, but also picking your stocks and entry points more carefully as many names have had good runs and earnings season is revving up.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines don’t give signals often—but that’s a big reason why they’re so reliable: Today, the indicator has been bullish for a year, and the signal is as strong as it’s been during that time, with both the S&P 500 (by more than 8%) and Nasdaq (by 11%) clearly north of their respective 35-week lines. Further wiggles are obviously possible, but the there’s no doubt the market’s longer-term trend is up.

Cabot Tides: Bullish
Despite some topsy-turvy action under the surface, our Cabot Tides remain bullish, with all five key indexes we track (including the NYSE Composite, shown here) holding above their lower (50-day) moving averages. To be fair, the broader indexes (NYSE Composite, S&P 400, S&P 600) are lagging a bit, and a sharp retreat from here could put the green light into question. But we don’t act what may or may not happen—right now, both the intermediate- and longer-term trends are pointed up, so we remain mostly bullish.

Two-Second Indicator: Positive
Our Two-Second Indicator was looking like a fly in the market’s ointment, with four days of plus-40 new lows during the broad market’s weakness, but now we’ve seen four sub-40 readings this week. It’s best not to get too close to the readings, which can gyrate; at this point, the broad market remains healthy, though it’s still lagging the big-cap measures.

The next Cabot Growth Investor issue will be published on February 8, 2024.