Cabot Growth Investor Issue: January 26, 2023

Steps in the Right Direction

Nobody is going to argue that there aren’t still issues when looking at the market’s evidence. The long-term trend, which by our measures has been down for a full year at this point, is still bearish. The intermediate-term trend remains effectively neutral, with most indexes stuck within two-month ranges. And growth stocks are hit or miss, especially ones that have held up well—while some names that were crushed last year are bouncing, many near their highs are having trouble finding buyers.

We’re not going to gloss over those facts, especially the point about individual stocks—as we’ve written countless times, the #1 “tell” of the bear market has been in the inability of potential leaders to turn into actual leaders by breaking out on the upside and having big investors pile in. So far, that type of action is the exception to the rule with growth (and most other) stocks.

However, we also don’t want to let the perfect be the enemy of the good. Right now, we’re only about three weeks into the market’s attempted change of character, and we’re continuing to see steps in the right direction: Our Two-Second Indicator remains very encouraging, with new lows under control even when the market gets nailed on bad news; the indexes have been able to shrug off a couple of recent bear raids; and our own Aggression Index (shown on the next page) is starting to turn up after a punishing decline last year.

Adding all of that to the 2-to-1 Blastoff Indicator (we dive into more detail later in this issue) and the crystallization of bearish sentiment out there—individuals (huge money outflows from equity funds and ETFs since early November), institutions (most underweight U.S. stocks since 2005!) and economists and CEOs (highest percentage predicting a recession in decades) are all leaning in the bearish direction—and we’re optimistic that the bulls are wresting control from the bears.

That certainly doesn’t mean we’re advising you to floor the accelerator, nor to become complacent given the lack of leadership out there. But the game plan is to steadily take steps back into the market’s water should the evidence improves, and so that’s what we’re doing tonight.

What to Do Now

In the Model Portfolio, we only started coming off a giant cash position in the last issue, so we’re still holding 75% or so on the sideline. Tonight, though, we’re going to take another couple of steps in the bullish direction by filling out two of the positions we recently added: We’ll average up on ProShares Ultra S&P 500 Fund (SSO) and Shift4 (FOUR), bringing our cash hoard down to around 65%. Details below.

Model Portfolio Update

After getting knocked out of a couple of small positions early in the year, we listened to the improvement in the broad market in the last issue and began putting a little money to work. As usual, the game plan is to take things step by step, especially given the fact the market is trying to come out of a bear phase—while you occasionally see a straight-up move when the turn comes, things are often herky-jerky as the market (and individual stocks) work to chew through overhead resistance.

The goal is to be “pulled” into a more heavily invested stance as the market and stocks we own/are watching act bullishly. As we wrote on page 1, there are still plenty of things left to be desired at this point, and we’re certainly not looking to cannonball back into the pool. But continued resilience in the broad market, the 2-to-1 buy signal and improvement in our own Aggression Index (see below; note the 10-week line is starting to turn up) is enough for us to put a little more of our still-giant cash hoard to work.

Thus, tonight, given that the broad market is pretty much the best looking thing out there, we’ll fill out our positions in ProShares Ultra S&P 500 Fund (SSO) and Shift4 (FOUR), which is probably the best looking true growth stock out there. That will still leave us with 65% in cash (nearly two-thirds of the portfolio); we’re hoping to add more new names soon if earnings season goes well, but we’ll take it as it comes.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO is in good position longer term, as the stock rests in a tight base that’s sitting on top of the prior year-long consolidation; and near term, shares have held in there pretty well of late, north of its moving averages and firmly in its recent range. (The weekly chart also showed some tightness in December, a constructive sign.) That said, like so many names near their peaks, ASO is also not going up (yet), as it gets pushed and pulled by the market’s ups and downs. We certainly think the stock can do very well if the environment truly improves, with the combination of elevated earnings, a cheap valuation, a solid buyback program and (most important to us) a major store expansion plan that’s just getting underway (30%-ish store growth over the next five years) that’s likely to push earnings higher and keep buyers interested. A powerful move into the upper 50s (along with a stronger market) would probably have us averaging up (buying another half to end with a full position) and thinking a sustained upmove is underway—though a dip into the mid/upper 40s would have us thinking the opposite. Right now, we’re OK standing pat, and think it’s fine to grab a half-sized stake if you’re not already in. Earnings aren’t likely to be out until early March, as Q4 doesn’t conclude until the end of January (like most retailers). BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—There’s a confluence of resistance for the S&P in its current area (long-term downtrend line; near the 200-day line; early December resistance), and that’s bottled up the index over the past two weeks, which has obviously had the same effect on SSO. Still, while that’s not ideal, we’re very encouraged by the under-the-surface evidence: The broad market remains healthy, with new lows very tame—in fact, we don’t remember a time when new lows dried up this long and this deeply after a huge bear phase that didn’t lead to good things. Moreover, the downside since the 2-to-1 Blastoff Indicator flashed (max of 2.5% on a closing basis) is well within the bounds of normal activity; throw in an improving Aggression Index and the fact that recent selling raids haven’t gained much traction (either with the index or the broad market), and we’re thinking positively here—we’re going to fill out our holding in SSO, adding another half-sized (5% of the portfolio) stake here, and use a stop for the full position in 42 to 43 area, which is just under the December lows and should be plenty of wiggle room if the S&P needs to spend more time gathering strength before moving ahead. BUY ANOTHER HALF

Shift4 (FOUR)—FOUR has been jerked around by the market and some analyst moves during the past week; an upgrade last Friday helped the stock recover from its initial dip, though some peer downgrades this week (of Toast and Square/Block) pulled the entire group lower. Still, nothing has really changed here: FOUR remains above even its 25-day line, recently tagged nine-month highs and the business momentum remains intact; the company recently inked a deal to be the payment provider to Utah’s major league soccer team, both in-stadium and for ticketing (through an integration with Seat Geek). Sports and entertainment have been a big growth area for Shift4 as its offerings are great for campus-like environments; as of late last year, Shift4 was the payment provider in more than 120 stadiums (up from 77 a year before), as well as ticketing solutions for many zoos, aquariums and the largest theme park in the U.S. In total, FOUR’s recent wobbles look to be normal shake-the-tree action after a solid run from early December, and the overall chart (above all its moving averages and a real uptrend) and fundamentals are about as good as it gets in growth land. We’re going to fill out our position by purchase another 5% stake, with a mental stop in the 50 to 52 area for the combined position. BUY ANOTHER HALF

Wingstop (WING)—WING has had a couple sharp dips during the past month, but we’re impressed with the stock’s ability to snap back, albeit on light volume. There has been talk about tight supplies of onion rings and fries this year, which, of course, could add to cost pressures even as labor markets remain tight, but in the big picture, wing deflation should be a bigger, positive push for Wingstop. A dip back to the December lows (low 130s) would be iffy, but overall, WING’s 24% correction and consolidation since mid November looks like a normal, more proper base-building effort that should lead to good things if the market shapes up. We’ll stay on Hold for now, but like so many things, a bit more strength would be bullish and likely have us restoring our Buy rating. Earnings are due February 22. HOLD

Watch List

• ASML Inc. (ASML 684): ASML is top player in the chip equipment industry, with a monopoly on the highest-end machines that make the highest-end chips. Q4 results were solid (sales up 21%, earnings flat-ish and better than expected), and the top brass boosted guidance for 2023 with sales likely to rise 25% and with margins up a bit, too. The stock is hitting 10-month highs.
• Axon Enterprises (AXON 192): AXON has been toying with a breakout all week long, though it’s been unable to break free. Overall, we like the look of both the latest tight rest and the longer launching pad, and of course, the business should crank ahead consistently for many years regardless of what happens with the economy.
• Celsius (CELH 102): CELH continues to have trouble breaking free from what is effectively a five-month rest period—that’s par for the course right now, but the number of sharp selloffs is becoming a bit iffy. For now, it’s OK to watch, with a major breakout above 120 being tempting.
• Impinj (PI 125): PI has been all over the place of late, but is still in decent position overall. The stock does have some boom-bust to it, but there’s little doubt demand for its endpoint ICs is giant, as the bullish Q4 pre-announcement revealed. Earnings are due February 8.
• Inspire Medical (INSP 254): INSP changed character after its earnings report in late October and we like the tightness of late—not to mention the rapid sales growth as the firm’s sleep apnea solution has a massive opportunity ahead of it. The trick here is the stock trades thinly at times and earnings are due out February 7.
• Las Vegas Sands (LVS 58): Sands’ Q4 wasn’t great, but that was because travel to Macau was just 14% of pre-pandemic levels, while travel to Singapore’s main airport (near the firm’s casino) was off by about one-third. So the turnaround story is still very much intact—a shakeout would be tempting.
• Schlumberger (SLB 57): SLB reported a fine Q4 (sales up 27%, earnings up 73%), and analysts see more of where that came from in the quarters ahead. Shares aren’t powerful but are clearly trending higher.
• Uber (UBER 30): UBER has built a decent bottoming base since its massive-volume lift in early August. The key will be earnings (due February 8)—a big gap-up combined with the firm’s new cash flow growth story could be a great opportunity.
• United Airlines (UAL 49): Airlines are about as far from growth stocks as you can go, of course, but we think this is one of those (very) rare times when the group may be starting a move as earnings are out of this world. See more later in this issue.

Other Stocks of Interest

Gitlab (GTLB 50)—We’re mostly of the mind that the leading sectors of the last bull phase, like software, are unlikely to be super performers this time around ... but that doesn’t mean there won’t be a select few that work, especially newer issues. Gitlab is a name we keep coming back to (and have written about a few times), as the more we look into it, the more we think the fundamental story has real juice. Whereas other software firms have offerings for a specific purpose (data management, cybersecurity, payment management, etc.), Gitlab’s platform is about helping every firm develop and improve the software it’s using faster and more efficiently—called DevOps, it replaces the practice of implementing different, one-off, third-party solutions, which is becoming a bear given how many of these patches are needed every month and year. All of this means the industry is looking for a platform to make better software and in a shorter amount of time, which in turn allows clients to crank out better (often revenue-generating) apps and updates to their client base. Granted, this isn’t something that’s easy to touch and feel, and most out there will never hear of Gitlab, but every quarter that goes by reinforces the view that the firm is going to be a big technology infrastructure provider to tons of giant and mid-sized companies around the world. The numbers have been excellent, with rapid revenue growth (69%, 74%, 75% and 69% the past four quarters), huge customer growth (up 59% in total to 6,469) and same-customer revenue growth north of 30%; the bottom line is still in the red but losses are shrinking and cash flow looks better than earnings, too. The early look for 2023 is for 40% revenue growth, though our guess is that will prove conservative as Gitlab’s solutions actually save time and money for its clients. Of course, the stock hasn’t been immune from the destruction in the software sector—after a brief IPO pop, shares imploded from 137 to 30 by March of last year. But that was the low, with every foray down to that area finding support, including the ridiculous-volume buying week after earnings in early December. There’s work to do on the chart (first up is getting over the 40-week line), but if it can gain some momentum, we think GTLB can be among a new batch of tech leaders.

On Holding (ONON 22)—Nobody is going to confuse me with a fashion-forward guy (I’ll keep wearing the same comfy jeans for a few years, thank you very much), but there’s no doubt that many of history’s winners are retail firms with a new offering that, while initially targeted for a specific use, end up becoming lifestyle-type brands. Lululemon is the classic example, with its yoga wear eventually creating the athleisure category in large part; Crocs and Under Armour are also examples. Today, On Holding, a Swiss shoe firm, may be next in line. The company was founded in 2010 and went public in 2021 in large part to make a better running shoe—and they did, with its various higher-end offerings providing runners with a softer cushion on the way down but better “spring” on the way up. The firm has broadened its target market to more fields (including tennis, where Rodger Federer created his own On shoe; there’s also trail running and more), and it’s also getting into apparel—but the bigger opportunity is that On is now a popular choice for many who want to walk around in a pair of $150 to $200 comfy sneakers. The combination of both legitimate improvements in performance and a broader fashion pull has led to outstanding growth; the top line likely came in around $1.25 billion in 2022, with analysts seeing another 36% gain in 2023, which is likely conservative. And, with supply chain issues mostly fixed and with more automation in its production facilities, margins could easily reverse their recent slide (a weaker U.S. dollar doesn’t hurt, either, given how much business is overseas)—as it stands now, analysts see earnings up 28% this year but we’re thinking that’s low. The valuation is certainly up there ($14 billion market cap), but a lot of steam has come out of the stock—from above 50 in late 2021, ONON crashed to 16 in July, but that was basically the bottom, with a few more retests in the months that followed … and now shares have lifted a few weeks in a row above their 40-week line. Like GTLB, we want to see more upside momentum, but it looks like the sellers are losing control and that the story has big potential in the years ahead.

Valaris (VAL 75)—We’re still intrigued by oil service names like Schlumberger, but Valaris has also caught our eye. It’s one of the largest offshore drillers out there, with around three dozen ships of various capabilities on the water and another 11 or so relatively new rigs that have been stacked (sitting idle) along with options to buy two new builds. The story here is extremely straightforward: Offshore drilling was very hot in the mid-2010s when oil was elevated for years, but with the sector taking on too much debt, it was ravaged from 2014 through 2021, with dayrates collapsing and many firms declaring bankruptcy … including Valaris! (In fact, the company was formed in 2019 by the merger of Ensco and Rowan but filed for Chapter 11 a year and a half later.) Still, from today’s viewpoint, those bad times and the bankruptcy have sown the seeds for a likely multi-year boom: The company now has more cash than debt, and with other costs cut to the bone, rising dayrates as the market tightens are driving earnings through the roof—earnings likely came in near $2 per share last year (after big losses the prior few years), with analysts looking for $3.70-ish per share in 2023. And there should be some certainty here, too, with a big backlog of nearly $2.4 billion (compared to trailing revenues of ~$1.5 billion), and that figure doesn’t even count Valaris’ 50% ownership in a joint venture with Saudi giant Aramco (which has another $1.5 billion in backlog). All that is good, and Valaris should do fine if conditions remain solid. But the real candy will come if oil prices really get moving and drive dayrates higher: At modest pricing and utilization, the company believes its EBITDA can total about 12% of the current market cap (pretty good), but if prices just come within 10% to 20% of 2014 levels, EBITDA could be 50% of the current market cap! Granted, dayrates aren’t likely to soar right quick, but the point is that if industry conditions improve—which they should—most of it will fall right to the firm’s bottom line. VAL had a great run into last June, then had a big correction, but has mostly been trending higher since July, including a push this year to new all-time highs. There will undoubtedly be potholes, but the path of least resistance is up.

2-to-1 Blastoff Indicator Speaks—Will the Market Listen?

On Thursday, January 12, when we went to (digital) press, the Advance-Decline Line on the NYSE reached rarefied air: Over the prior 10 trading days, the number of advancing stocks averaged more than twice the number of decliners, triggering the 2-to-1 Blastoff Indicator. Along with the 90% Blastoff Indicator (which hasn’t flashed yet but could if broad market strength persists), the 2-to-1 measure is one of two very old-school measures of sudden strength in the market that have a sterling history of portending big market gains.

We’ve written about the reasoning behind these indicators many times, so we won’t rehash all of it here. But, in a nutshell, it all comes down to what Walter Deemer—who basically invented the 2-to-1 measure decades ago—says: “The market gets most oversold near a low, but gets most overbought near the start of a new advance.”

Thus, the 2-to-1 and 90% measures point out times when the overall stock market has shown sudden strength … which, really, means there’s been a sudden change in investor perception. And that tends to have ripple effects for many months, with the market posting solid gains going ahead—in fact, many of the 2-to-1 signals occurred near the beginning of major bull markets, such as early 1975, autumn 1982, early 1991 and early 2009.

Altogether, looking strictly at initial 2-to-1 signals and taking out “repeat signals” (those that happen six to nine months from one another; we’d rather just go with the first green light, since that’s what we act on), there have been just 12 prior signals since 1960, with superb results: The S&P 500’s average maximum gain within three, six and 12 months has been about 12%, 17% and 25%, respectively.

Meanwhile, the average maximum loss from the signal has been just 2%, with many simply rallying straight up from the signal. However, there is a “but” with that statistic: When the 2-to-1 signal occurs at a time that the S&P 500 is below its 200-day line, as this one did by a hair, then we did tend to get some shaking and baking, with a 4% average maximum drawdown from the signal, including one instance that retested the low. (For reference, the S&P’s max pullback since the signal thus far is about 2.5%.)

So, with all that history in tow, what does it mean? Well, you don’t want to ignore signals like this, as they have a pristine history and, besides, what’s the point of following something if you’re not going to act on it? That said, it’s one measure—and last year did see some briefer, less-broad thrusts fail in the bear market.

Translation: The 2-to-1 Blastoff Indicator is a definite positive for the market, especially coming after such a prolonged bear phase. That said, we still want to verify that the strength is leading to good things, and on that front, there is some good (Two-Second Indicator, Aggression Index), some OK (Tides still neutral) and some iffy (growth stocks still stalling at resistance). We’re optimistic and are putting a bit more money to work because of the “good,” but we need to verify that the buyers are taking control before getting heavily invested.

Welcome to the “New” Travel Boom

One pattern we’ve seen play out a few times since the pandemic, usually in cyclical areas, is the following: Conditions in a certain industry rapidly improved, causing players to show outrageous earnings growth which helped the stocks have a run. But then the stocks petered out (at best) or were hit hard (at worst), as investors figured the earnings bump would soon disappear as conditions returned to normal … but then it turned out conditions did not return to normal, with earnings and cash flow remaining huge and helping the stocks enjoy another leg higher.

Today, this is playing out in what we look at as the “new” travel boom, with what could be a multi-year increase in travel and experiences as (a) travelers make up for a couple of years of pandemic-induced cabin fever, (b) people emphasize good times with their family instead of saving money, and (c) some potentially structural changes in the sector that will keep capacity limited and prices elevated. Indeed, many hotel and airline firms are still in a catch-up phase compared to pre-pandemic activity levels—and we think they could blow through that in the quarters to come, which, combined with cutbacks during the dry times of 2020/2021, should lead to even higher earnings than what’s been seen so far.

Hyatt (H) looks like the strongest major hotel stock, and for good reason: In the first nine months of 2022, the firm cranked out EBITDA that was a whopping 40% greater than the same period in 2019 (pre-pandemic comparisons), and that’s with revenue-per-available-room up just 2% from three years ago; that’s thanks in part to Hyatt remaining in expansion mode (its purchase of Apple Leisure Group in 2021, with its set of all-inclusive resorts, looks very promising). Plus, a possible surprise is business travel: As of October, Hyatt had booked 30% more in group business in the Americas at 17% higher rates vs. 2019! The stock has been bobbing and weaving for two years but is now tagging all-time highs.

Then there’s United Airlines (UAL), which has posted three quarters in a row of huge earnings and is thinking there’s much more to come—in the Q4 conference call, the top brass said it believes the industry (which is still shy of 2019 activity levels as a whole) will struggle to expand capacity as much as hoped, meaning it could take years for supply to meet up with demand. The CEO is targeting earnings north of $10 per share this year, and while Wall Street isn’t as optimistic (nearly $8), the point is the next few quarters at least should be massive. Shares are flirting with year-long highs.

While travel names will never be the core of our growth-oriented portfolio, we do think there’s at least an intermediate-term opportunity here—again, everyone seemed to assume the big second-half 2022 numbers would fade due to the recession, but instead, the fundamentals seem to be accelerating to the upside.

Cabot Market Timing Indicators

It’s not perfect, especially when it comes to individual growth stocks, but the market as a whole continues to reveal more positives, with the broad market remaining in good health, the intermediate-term trend close to turning up (not there yet) and even our trusty Cabot Trend Lines showing improvement. Earnings season will be key, but we’re doing a bit more tip-toeing into the market’s waters tonight.

Cabot Trend Lines: Bearish
The Cabot Trend Lines remain bearish, but we’re now clearly in watch mode: As of mid-day, the S&P 500 was 3% above its trend line, while the Nasdaq was a smidge above its own. That said, what counts is the weekly close: If both close above their respective 35-week lines this week and next week, the longer-term trend will turn up—that said, there’s a long way between here and there, and we never anticipate signals. Like we said: We’re watching closely, but nothing to report quite yet.

Cabot Tides: On The Fence
Our Cabot Tides remain in an interesting position—most indexes are positive by the letter of the law, but for now, we still consider the intermediate-term trend to be neutral (on the fence) as just about everything is still within its trading range of the past couple of months. That said, it’s close: As you can see with the S&P 600 SmallCap here, a good couple of days could do the trick. We’re optimistic, but let’s see if the buyers can really show up and produce a durable Tides green light.

Two-Second Indicator: Positive
There isn’t much in question with our Two-Second Indicator—it’s positive, with the number of new lows at tame levels every day since the calendar flipped. (The largest reading came on Tuesday of this week, due to the NYSE glitch at the open, with readings declining after that.) Combined with the 2-to-1 Blastoff Indicator, the broad market certainly looks to be in good shape, which is something that usually occurs early in a sustained run.

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