The market’s slow, steady improvement continues, with our Cabot Tides turning positive last week and some more stocks starting to shape up. That said, we still think it’s best to go slow here, partially due to more time being needed for setups to emerge, and partly because so many names we’re watching actually report earnings in the next week or two; the reactions will go a long way toward telling us if this rally has legs. Right now, we’re cautiously optimistic--we have no more buys tonight but could in the days ahead if things go well.

In tonight’s issue, we write about our new additions, review some other top ideas (including one that’s shown repeated huge-volume buying over the past many months) and remind you that the market is very capable of getting going despite the bad economy.

Cabot Growth Investor Issue: July 28, 2022

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Tiptoeing Back In
During the last few years, we’ve seen a couple of very sharp market downturns—one in the fourth quarter of 2018, when the Fed was hawkish and the U.S.-China trade war was getting extreme, causing the major indexes to slid 20%-plus in three months; and then pandemic crash, with the major indexes plunging 35% in a matter of weeks—and both turned around very quickly. There actually were some quick positive divergences seen in the 2020 crash (new lows peaked more than a week before the market), but for the most part, the market went from really bad to really good, really quickly.

But those really were the exception to the rule, as bottoms are almost always a process, not an event, and that’s especially true of prolonged (greater than three month) bear phases. We relate it to injuries—if you’re riding your bike and fall off, you’ll have some nasty scrapes and bruises, but a few bandages and couple of days off and you’ll be back out riding. But if you fall off your motorcycle going 45 mph, you’re headed to the hospital and looking at many weeks of recovery.

Thus, in our view, the market’s action during the past many weeks has been about what you’d expect if things are turning around: Growth stocks (the “leaders” of the bear market) mostly stopped going down in May; the market began to hold up on bad (awful) news in the weeks that followed; some growth names continued multi-month bottoming processes; and, last week, our Cabot Tides turned positive, telling us the intermediate-term trend was turning up—and we’ve seen some positive tidings since then, too.

Understanding that things like this take time is a big reason why (unlike so many investors out there) we’re not dumping on the rally … but it’s also why we’re not advising anyone to cannonball back into the pool yet, either. Individual stocks are working hard to repair the huge damage from recent months, but most still have lots of overhead to chew through, which means choppy (if any) progress and sudden potholes are to be expected.

Indeed, to this point, few stocks are hitting new highs and stocks trying to leap above resistance are still being met with sellers (though, to be fair, those sellers aren’t crushing the stocks, just repelling any advances). Ideally, that changes during earnings season (one name on our watch list has gone bananas), but going with what we see, we think tiptoeing into the market makes the most sense—and then taking things as they come from there.

What to Do Now
With the Tides positive, we advise putting a little money to work—but just a little, as we wait for further confirmation from our indicators (including our Two-Second Indicator and Aggression Index) and, more importantly, from potential leaders. In the Model Portfolio, we added Bumble (BMBL) and Shockwave Medical (SWAV) last week, and we’re close to putting on another small position; tonight, we’ll hold off, though we’ll be in touch if that changes.

Model Portfolio Update
We’ve obviously been highly defensive for a while in the portfolio, but we put a morsel of our giant cash hoard a few weeks back as things seemed to be stabilizing, and after last week’s Cabot Tides green light, we dipped another couple of toes in the water. Since then, the action has been OK (not amazing), but the nascent intermediate-term uptrend is still intact and a few more stocks are rounding out.

The question in these situations is how aggressive you should be. In our view, what we’ve mostly seen so far is a drying up of the selling pressures, while buyers are still hesitant—to be clear, that is completely normal (most bottoms or bottoming processes start with sellers drying up; buyers come in later), so we’re not implying anything negative. But it’s a fact that very few stocks are in clear uptrends at this point, and that argues for going slow. (More than 75% of all stocks remain south of their long-term 200-day lines.)

Going forward, the two things we’re watching closest are, for market timing, green lights from our Aggression Index and Two-Second Indicator; those would logically be the next to flip and tell us the bulls are wresting control from the bears. (Both have improved but haven’t quite turned positive, similar to other times this year.)

The second is the action of individual stocks—simply put, we need to see more names leap to multi-month or all-time highs, ideally on earnings, as opposed to simply watching the leaders of the last bull run flop up and down.

This week, we did see one name that we’ve been following closely break out on earnings—Enphase Energy (ENPH), which we could add but would like to see it settle down a bit in the days ahead. Whether it’s ENPH or something else, we’ll be on the horn if we put any more money to work.

Current Recommendations

Bumble (BMBL)—The very best leading stocks often create an entirely new industry for themselves—for instance, when we rode First Solar to huge gains in 2007/2008, there was no solar sector, and further back, XM Satellite Radio pioneered that industry from scratch. That said, there are also winners that simply take a big, existing area and put a new spin on it; Amazon is the classic example there (changed bookstores, and then everything else), as was Keurig (single-serve coffee). As we’ve written before, we think Bumble could effectively have a new, better offering in the large and growing online dating realm, where most meetups occur these days—it’s consistently gaining users (Bumble app users were up more than 30% in March from a year ago) due to the unique rules here of women having to make the first move, along with its better policies on ghosting and fewer bots. And there’s potential in some of its higher-end services (like Beeline, which enables users to sort by closest connection), its friend finding service (Bumble BFF for those that want to simply meet some new people), as well as virtual goods (popular among the Generation Z cohort). Less talked about is Bumble’s international app, dubbed Badoo, which has been shrinking of late mainly due to the Russian invasion but should have a solid runway of growth ahead after the initial shock of users in Ukraine, Russia and Belarus cancelling. All in all, we think Bumble can be the go-to way to find a match (or a friend) as the world reopens post-Covid, and the stock may be sniffing that out—shares bottomed out way back in March with a massive-volume earnings surge, and then rallied again after retesting that low in May. Now BMBL is acting well, as it’s been north of its 50-day line since mid May and today marked its highest close since early December! Next up is the quarterly report, due August 10: A solid gap up could kick off a real uptrend, though we have a loss limit in the upper 20s should things go in the wrong direction. Right here, we’re optimistic and are fine buying a half-sized stake if you’re not yet in. BUY A HALF

Devon Energy (DVN)—DVN tested the 50 area twice earlier this month, but it and many peers have finally bounced some even as oil prices meander in the mid $90s, though we wouldn’t say the bounce has been overly impressive, at least not yet. As we write about in our mention of Chesapeake Energy (see Other Stocks of Interest), the big question in our minds is whether the positive change in perception for the group that was in place for much of the past year—due to the new playbook of huge cash flows even at mid-cycle energy prices—has vanished or is just taking a hiatus. As with most everything else, DVN’s intermediate-term future will probably come down to the quarterly report, which is due out next Monday; it’s a good bet the dividend will be huge, though more important will be management’s cash flow outlook at various energy prices, as well as any update on the buyback program. We’ll see what comes, but right here, we’re happy to follow the stock higher, but we continue to have a mental stop (now in the 50 area) should the sellers reappear. HOLD

Halozyme (HALO)—HALO remains in fine shape, with the typical sell-on-strength and choppy action seen in most high relative performance stocks of late. Still, last week’s dip was controlled and shares have generally bounced back and remain perched in the vicinity of all-time highs. Earnings are due out August 9, which will obviously be key; analysts see the bottom line down from a year ago, but (a) that’s likely conservative, and (b) that’s almost solely due to a one-time step up in the tax rate this year. More important is the fact that royalty revenue should still leap about 50% this year (obviously any updates on that estimate will be key), and given that we’re about to push into August, this is about when Wall Street starts focusing on next year’s earnings, which are expected to leap 39% as the royalty story gains steam and the tax burden stays level. Stepping back, a factor here will be the action of the biotech sector in general—it showed great promise in June, though has actually stalled out since the first week of July even as the market as strengthened. It’s something to watch, but we want to be careful not to overanalyze things—HALO acts well and the story is as good as ever, though as always, we’ll take it as it comes after earnings. Hold on if you own some, and we’re OK buying a small position here or on dips of a couple of points. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—Our patience has paid off with SSO, as the S&P 500 has rallied somewhat and, of course, our Cabot Tides have turned positive. We’ll take it, and we’re happy to hold our small position as we see how this rally develops; having a stake in a leveraged long fund early in a new upmove can help, especially when individual stocks are still in stop-start mode. That said, we’re not advising new buying quite yet—if some upside confirmation occurs (Two-Second Indicator, Aggression Index, or ideally, some blastoff indicators), we could restore our buy rating, but at this point SSO’s chart is more in the “stopped going down” category instead of the “really going up” column. Sit tight, but we’d favor taking a stab at some fresh potential leaders at this point. HOLD

Shockwave Medical (SWAV)—Like many stocks, SWAV is still being stymied by resistance (in the 215 to 220 area), though stepping back, we’re far more impressed with the stock’s upmove after its huge May shakeout-and-reversal, with very little selling pressure since that time; the only pothole came when the market imploded in June, and the stock’s relative performance line (not shown on this chart) is sitting near all-time highs. As with everything else, the upcoming quarterly report (due August 8) will be vital; analysts are looking for sales growth north of 90% while earnings leap to 44 cents per share, though expectations are probably even higher than that given that Shockwave has trashed estimates in recent quarters. Further market strength and a decisive push above resistance after earnings would almost surely have us averaging up, but right here, we’ll stick with our half position and see if buyers continue to step up. BUY A HALF

Watch List

• Celsius (CELH 87): CELH remains in good shape, buoyed in part by rumors Pepsi will become either a partner (distribution deal) or suitor. The longer the stock can hold above support in the low 70s, the greater the chance it can extend higher. Earnings are likely out in mid August.
• Duolingo (DUOL 95): DUOL is very volatile and we’d prefer it grow up a bit (only 171 funds own shares), but the story is great (it dominates online language learning), the long-term potential is big and the stock has been etching a low since January. Earnings (on August 4) will tell the tale.
• Enphase Energy (ENPH 274): ENPH reported another great quarter, with sales growth accelerating nicely (to 68%) while earnings more than doubled and (importantly) margins actually expanded nicely. The stock responded by booming back toward its old highs, and then got another lift today after news that Congress could pass a green energy-friendly bill. If ENPH settles down a bit, we could start a position.
• Intra-Cellular Therapies (ITCI 54): On one hand, ITCI has been a bit sloppy since mid May, endlessly chopping sideways. On the other hand, a couple of good days (and a move above 60) could kick off a big run due to its bi-polar drug that has blockbuster written all over it.
• Pure Storage (PSTG 28): It’s not on many people’s lips, but we continue to think Pure has the story and numbers to drive a sustained advance during the next bull market—and, as we write later in this issue, the repeated huge-volume buying weeks during the past year are a good clue that the buyers are really in control here.

Other Stocks of Interest

Chesapeake Energy (CHK 93)—As we wrote about in last week’s update , we’re very interested in seeing how the energy sector plays out in the weeks and months to come. For more than a year, the sector saw a gradual rise in perception—yes, rising prices helped, but even before things went crazy on the upside (like, say, when omicron was the big fear in late 2021), energy stocks kept outperforming as the “new playbook” in the industry was adopted (less CapEx, huge cash flows, dividends and buybacks even at modest energy prices), attracting more value and income investors. Now, though, that seems to have changed—which brings up the intrigue: Despite a hawkish Fed and recession worries, energy prices remain elevated, and that’s especially true for natural gas, which has nearly recouped more than 70% of its recent decline, and at $8.40, would result in ridiculous cash flow for a firm like Chesapeake Energy. This company has one of the best sets of gas-heavy acreage of any energy outfit, with its stakes in the Marcellus, Haynesville and Eagle Ford having well over a decade of high-return inventory even if gas prices fall to $3.50! As for cash flows, even a modest $3.50 gas and $70 oil price during the next five years would see Chesapeake averaging $1.8 billion of free cash flow annually (15% of the current market cap), with the dividend yield averaging more than 7% and the firm buying back about 16% of the market cap by year-end 2023—and if prices stay up at current levels, who knows how big the numbers could get (possibly 50% to 75% larger). Now, as we’ve written a bunch, we’re not income investors, so our question is whether these resilient cash flow figures (again, even at much, much lower gas prices) are going to keep big investors interested following the inevitable corrections that occur. We’re seeing some early signs that may be the case: CHK had a solid run to 105 in late May, fell to 73 during the energy stock wipeout, but held its 40-week line and has recouped nearly two-thirds of its decline, retaking its key intermediate-term moving averages in the process. The next quarterly report (and dividend announcement) is due next Wednesday (August 3)—we do think the energy sector (and CHK) likely need some time to repair the chart damage, but we’re open to the possibility that a reiteration of the buoyant forecast and a big Q2 payout could supercharge the current bounce.

Olaplex Holdings (OLPX 17)—We like a new, revolutionary medical device or technology gizmo as much as the next investor, but we’ve had just as much success with the retail growth stories, which tend to grow slower (though still at solid clips) but have a much longer shelf life, which in turn gives big investors confidence to build big positions. That’s why we’re keeping an eye on Olaplex, which we wrote about a couple of months ago: The firm’s product line-up is anything but sexy, consisting of a variety of haircare products, but there’s actually some real know-how here—the company’s products all have a patent-protected (more than 100 patents with more than 13 years left) hair bond-building active ingredient (bis-aminopropyl diglycol dimaleate) that protects, strengths and repairs bonds that break when hair is damaged. The skeptic could say “so what?” but the firm’s dozen offerings are a hit, with Olaplex having the #1 bond-building brand among professionals (who account for 43% of total revenue; specialty retail is 29% while direct-to-consumer make up the rest) as well as the #1 haircare brands on both Amazon and Sephora. As Olaplex says, it’s the pioneer in the “skinification” of haircare, where many are choosing to pay up for beauty; 90% of users say the firm’s offerings make their hair healthier, and the average customer buys around four of their products, egged on by stylists (35% of buyers were referred to the products by professionals). Long-term, there’s plenty of runway here, with global haircare sales of $82 billion (the top three firms in the sector have been losing market share in recent years to upstarts like Olaplex), and long-term, the firm has expressed interest in launching skincare lines, which would open up another gigantic market. As for the here and now, growth is terrific—in Q1, sales lifted a huge 58% from a year ago while earnings rose 44% and, thanks to a CapEx-light business model, the after-tax profit margin nearly touched 50%! Granted, analysts see growth slowing to “only” 26% next year (earnings up 22%), but odds favor that’ll prove very conservative. OLPX came public last September and hit the skids with everything else a couple of months later, but the stock effectively began bottoming out in March, with consistent support in the 13 area and, more recently, a pop to five-month highs. Our only rub here is the trading volume—despite mutual funds consistently picking up shares (333 owned shares at the end of June, up from 179 nine months ago), OLPX only trades around $36 million per day; our usual cut-off is $50 million and we much prefer $80 to $100 million or more. Still, we think Olaplex has rapid, reliable growth written all over it for many years to come. We’re keeping a distant eye on it; a coming out party after earnings (August 9) would be very tempting.

Five9 (FIVN 98)—Five9 was one of the sneaky, lesser-known big winners of the past few years, with its low popularity mostly stemming from the fact that the stock was relatively thinly traded—fundamentally, though, the story has always oozed long-term growth. It revolves around customer contact centers, which traditionally have been labor intensive and pretty inefficient (can’t scale easily), and believe it or not, tons of them are still using outdated methods and technologies. But Five9 (and some others, including Twilio) have a much, much better way, using technology, automation and AI to allow customer service reps to communicate via a variety of methods (phone, chat, email, etc.), and to even allow technology itself to aid agents (getting information in real-time using speech-to-text capabilities) or even take up some functions itself (virtual agents). (AI and automation revenue has been cranking ahead at twice the growth rate of the overall business during the past couple of years.) And, of course, the top brass can monitor everyone’s productivity and quality control, which clearly helps. Really, it’s a very straightforward, almost old school story—using technology know-how to dramatically boost efficiencies—but the market is in the tens of billions of dollars, especially as Five9 moves overseas and emphasizes large enterprises (who make up north of 80% of revenue). The proof of the upside potential came from an attempted acquisition last year—Zoom Communications offered to buy Five9, but the deal eventually fell apart as shareholders rejected it. But that should be a good thing, and Five9’s top brass is highly bullish: At its Investor Day late last year, the firm sees a clear path for revenues to expand at a 30% annual clip through 2026 as its same-customer growth rate remains north of 20% each year and, of course, more big players sign up. And while there are some big investments going on today (earnings up just 6% this year), the firm is solidly profitable and should see earnings begin to kite higher in 2023 and beyond (estimated to rise 41% next year). The stock got knifed starting last July, imploding from 211 down to 80 in March—but that was the low, with a couple of retests since then holding up and the stock steadying itself in recent weeks. Yes, there’s still work to do on the chart, but let’s see what earnings—which are due out tonight—bring. A big gap up would go a long way toward advancing the stock’s bottom-building effort.

The Economy ≠ The Stock Market
Just this morning it was reported that the GDP for the U.S. economy shrunk for the second straight quarter—while not technically the definition of a recession, most think we’re in one or will be soon. And that top-line number follows some weak numbers seen from housing, consumer confidence and even manufacturing of late, not to mention the high-profile warning from Walmart this week. And all this is happening while the Fed hiked rates another 0.75%!

What do we think of that bushel of bad news? Not much, at least when it comes to the market. As it turns out, decades worth of data show the market actually does better when the economy is modestly bad compared to when things are very good. It’s true.

Consider that from 1960 to 2022, when GDP growth (year over year) was below 0.8%, the S&P 500 actually advanced at a 16.7% annual rate; when GDP was up between 0.8% and 6.1%, the S&P moved up at a 7.1% annual clip; but when GDP was up more than 6.1% from the prior year, the S&P … actually fell 4.3% annually! (FYI, after today’s report, the current year-on-year real GDP change is about +1.5%.)

Using more advanced statistics, many have looked at the correlation to quarterly GDP growth and stock market performance. What they found was the correlation was effectively zero—no correlation at all.

One more example: When the University of Michigan’s Consumer Sentiment Index (one of the popular consumer confidence measures) falls by at least 10 points per month—that is, people are becoming much more pessimistic—the S&P 500 averages a 7.4% gain during the next six months. What about when the Index rallies at least 10 points in a month, indicating a surge in optimism? The forward six-month return averages less than 3%.

None of this means you should be buying because the economy stinks, or that we suggest basing your trades on economic data. Instead, it’s important to remember that the market predicts the news, not the other way around—the market’s horrible performance this year forecasted the bad economy of today, but the bad news of today doesn’t preclude stocks from getting going if they want to. Just stay focused on our tried-and-true indicators and you’ll be there for the next big move.

Keep Your Eyes Open for Skyscrapers
We’ve written before about one chart indicator we look for called “double skyscrapers”—which simply looks for a stock that’s overcoming key resistance on two straight weeks of giant volume. Many big winners were launched with this, including Yahoo! back at the major bear bottom of October 2002 and Facebook when it began its run in 2013. Seeing a couple of these during earnings season would obviously be bullish.

However, beyond just double skyscrapers, we also keep an eye open for repeated big-volume buying weeks over a period of many months. Take a look at Roku (ROKU) during the few months after the pandemic crash; we saw five huge-volume buying weeks from April through August, which was a big reason we recommended it around then—and shares went on to have a big move during the next few months before topping out.

Despite the bear market, we’re seeing a similar situation play out in Pure Storage (PSTG), which was a stock we took a half-sized swing at back in March but the market pulled it lower. Even so, look at the huge amount of skyscrapers on the weekly chart, dating back even to last summer—with the latest one after earnings in June being the largest of all of them! Not surprisingly, fund ownership has been kiting higher consistently in recent quarters despite the market’s bear phase; 573 funds owned shares at the end of June, up from 548, 491 and 417 funds the prior three quarters.

Pure has the best-in-class storage solutions for enterprises in the cloud era, but even better than that is the fact that the firm has a burgeoning storage-as-a-service business (it sells and updates storage systems for a subscription), which should lead to more reliable growth. Indeed, sales growth has actually been accelerating in recent quarters (up 50% in Q1) while earnings boom.

PSTG still has work to do on the chart, starting with a push above its 200-day line, but the story and numbers are excellent, and the multiple weeks of accumulation by the big-money crowd looks like a tip-off that the stock wants to head higher once the market is ready to get going. WATCH

Cabot Market Timing Indicators
It’s been so far, so good for the rally attempt, with the market acting resiliently during a spate of bad news in June and early July, followed by a Tides buy signal last week. Our other key measures (and the action of potential leading stocks) are still neutral or bearish, though, so we’re dipping a couple of toes in the water and seeing how things progress from here.

Cabot Trend Lines: Bearish
The market is giving it a go here, which is obviously a good thing, but there’s no question a lot more work needs to be done for the longer-term trend to turn up. Our Cabot Trend Lines remain clearly bearish, as even after the recent lift, both the S&P 500 (by 5.5%) and Nasdaq (by more than 8%) are still stuck well below their 35-week moving averages. It’s not a death knell but it’s a good reminder to go slow and remember there’s plenty of overhead for the market to chew through.

Cabot Tides: Bullish
Our Cabot Tides are acting decently since their green light of last week, when all five of the major indexes we follow (including the S&P 400 MidCap, shown here) held above their lower (25-day), rising moving average. Growth funds are in a similar position, too, so intermediate-term, most things are in gear. Obviously, we’re just taking it day to day and would like to see further strength develop, but going with the here and now, the Tides buy signal is a reason to put a little money to work.

Cabot Two-Second Indicator: Negative
If this rally is for real, one of the next indicators to flash should be our Two-Second Indicator, which is one of the best measures of selling pressure in the broad market. So far, there’s been improvement, but it’s been a close-but-no-cigar situation—we’ve seen just one sub-40 reading during this rally (though lots of readings in the 40 to 50 area), so a bit more broad market strength could do the trick. As always, we don’t anticipate, but we’re watching closely.

The next Cabot Growth Investor issue will be published on August 11, 2022.

About the Analyst

Mike Cintolo

A growth stock and market timing expert, Michael Cintolo is Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader. Since joining Cabot in 1999, Mike has uncovered exceptional growth stocks and helped to create new tools and rules for buying and selling stocks. Perhaps most notable is his development of the proprietary trend-following market timing system, Cabot Tides, which has helped Cabot place among the top handful of market-timing newsletters numerous times.