Cabot Growth Investor Issue: June 1, 2023

Getting Better—but More Work to Do

We’ve been waiting seemingly forever for the market to show some true power, and last week provided an interesting piece of evidence—following Nvidia’s earnings, a batch of AI-related stocks (mostly technology infrastructure, like chips and networking) went to the moon. Really, it was the first time we’ve seen growth-y stocks in any sector let loose on the upside in such a big way since early 2021 and certainly is a mark on the bullish side of the ledger when it comes to the overall evidence. (We write more about the AI boomlet later in this issue.)

The problem, so to speak, was that outside of that handful of names, the rest of the market didn’t go along for the ride, and the other bugaboos that are out there are still in place. In particular, the narrowness of the market is getting more extreme—the latest “wow” stat was that the S&P 500 eked out a small gain in May even though 75% of stocks in the index were down. And coming into today, nearly 60% of the S&P components are below their 200-day lines!

More important is that our market timing indicators remain in the same less-than-encouraging situation—our Cabot Trend Lines remain positive and are a beacon of hope, but our Cabot Tides are neutral (and are actually close to turning outright negative) and the Two-Second Indicator reflects the weak broad market. In other words, the bulls still have plenty of work to do.

And yet, as the title says, we do think things have taken a step or two in the right direction, and not just because of the AI move. In general, leading growth stocks are improving—yes, the chop factor (selling on strength) remains in place, with lots of two steps forward, one (or one and a half) steps back action. But there are two areas where we see rays of light.

The first is that, outside of AI names, many leading stocks lifted off nicely in early May (either on earnings and/or snapping back after quick shakeouts), pushing to new price and (often) relative performance highs … and while many eased lower after, the action has been normal, with many starting to perk up again. Second, we’re simply not having trouble filling up our watch list week after week—even after accounting for the occasional blowup we’re seeing out there.

All in all, a lot of growth names look similar to the equal-weight Nasdaq 100, shown here—still choppy and battling with some resistance, but many have a solid base-building effort in place and there’s also been some recent power. Throw in the fact that defensive stocks (consumer staples, etc.) have hit the skids, and it certainly seems that the big, institutional investors are starting to get more aggressive.

What to Do Now

Of course, it’s far from a buying stampede, and given our indicators, we’re not going to hugely change our stance. But with the Model Portfolio overloaded with cash, we’re going to throw another couple lines in the water after this recent rest in most leaders—we’ll add half-sized stakes in two old favorites, Celsius (CELH) and Inspire Medical (INSP). That will still leave us with a little less than two-thirds in cash, which we’ll ideally put to work if more names kick into gear.

Model Portfolio Update

Beyond the boomlet in AI stocks, the story remains mostly the same for the market—it’s as narrow as can be, with most equal-weighted (not market cap-weighted) or broader indexes stuck in no man’s land and—more important to us—most growth stocks, sectors, indexes look OK but are having trouble really getting going on the upside.

All of that is true and is reason why we still favor an overall defensive stance—and yet, we’re adding some exposure tonight. Why? Honestly, our main reason is that our watch list continues to grow, which we’ve found to usually (not always) to be a good sign. And, while few of these stocks are racing to the upside (the chop factor and selling on strength is real), many did show great action earlier in May and have since calmed down normally, if at all.

Granted, if the market falls apart from here—always possible given the weak action of the broad market—we’ll take a couple more paper cuts, which won’t be fun. But at day’s end the evidence isn’t telling us it’s 2008 out there, and there are a growing number of good-looking stocks, so we’ll drop a couple more lines in the water tonight, adding half-sized (5% of the account) positions in Celsius (CELH) and Inspire Medical (INSP). Ideally, if leading stocks start lifting off in a real way, we’ll be able to quickly put money to work, but as always we’ll take what comes.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO was sold the day after our last issue, when a poor earnings report from Foot Locker (FL) caused the group to move lower—and shares have fallen all but one day since (that one day was up eight cents), even dipping back below their breakout level from late last year. To be fair, many retail-related names have been hit, as it seems the market is pricing in a retrenchment in consumer spending, but whatever the case ASO’s normal pullback in late April and even early May has morphed into a sharp downtrend. Earnings are out soon (June 6), so maybe that will turn the tide, but there’s no question the sellers are in control here. SOLD

Celsius (CELH)—We nibbled on CELH last summer but the timing obviously wasn’t right, but we’ve been watching it since and believe it’s finally ready for a real run. Most of the time, such a huge winner from the prior cycle doesn’t have the juice to have another big run, but (a) so far in this nascent rally attempt, a fair number of “old” leaders are acting well, and (b) Celsius’ distribution deal with Pepsi last year certainly has the potential to drive business significantly higher (and into more channels) than was possible before. After being rejected by the 120 area many times over many months, CELH leapt to new highs after the Q1 report started to show the power of the Pepsi deal (sales up 95%, earnings more than quadrupled); the stock did rest for the next three weeks, but today’s big-volume buying tells us that, at the very least, there are buyers under here, and ideally, that shares are ready to run. CELH is very volatile (today’s big move “only” brought it back to the highs of its three-week range), so we’ll start with a half-sized stake and use a looser stop in the 115 to 120 range. BUY A HALF

Inspire Medical (INSP)—Inspire is another name we’ve toyed with before, grabbing a small position earlier this year but having to kick it out when the market keeled over in February and March. Even so, the story never changed—the firm’s sleep apnea solution is taking massive share but has only scratched the surface of its potential, having performed 41,000 surgeries compared to two million annual CPAP prescriptions in the U.S. And, while there are no sure things in this market environment, the stock’s recent action looks better than what we saw earlier this year: After a pre-earnings shakeout, INSP moved to new all-time price highs, but also new relative performance (RP) highs, which it did not do earlier this year. The stock has retreated since then, but has held above its 25-day line and is beginning to perk up. If the market falls apart, we’ll use a stop in the 260 range, but right here we think INSP is presenting a solid entry. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—While things have improved some, the S&P 500 and SSO (which moves 2x the S&P on a daily basis, percentage-wise) are still suffering the same chop problem as has been the case for months, with the 4,200 level on the S&P (call it 53 or so on SSO) still providing resistance, at least for now. (Today’s move again tested the top of the range.) Meanwhile, though, more big-picture positives continue to show up—last week saw the relative performance line of the semiconductor sector vs. the S&P 500 hit an 18-month high for the first time in over a year; the prior eight times (dating back to 1992) that happened, the S&P 500 was higher a year later each time by an average of 13%-plus. (Hat tip to Quantifiable Edges, @QuantifiableEdges on Twitter, for that study.) If the market can truly kick into gear—including a real improvement in our Cabot Tides—and the S&P 500 can clearly punch out to new highs, we’ll likely average up here given the many longer-term positives in place and our bullish Cabot Trend Lines. However, as always, we’ll simply take our cues from the market itself: So far, SSO remains range bound, so we’ll hold what we have and look for confirmation buyers are showing up. HOLD

Shift4 (FOUR)—FOUR has sagged back after testing its 50-day line from below, continuing the base-building effort of the past few weeks. Fundamentally, though, the firm continues to make moves: Recently it announced a technology integration with OpenTable, one of the big restaurant reservation systems, that allows clients to combine booking data with Shift4’s spending data, which should give clients a better view of customers and where to focus marketing (to get repeat customers). The obvious risk is that most things retail-related are weak, with fears rising that the Fed’s forever-tightening campaign will eventually crimp consumers; we’d note that big names like Visa (V) and MasterCard (MA) have hit multi-week lows in recent days. Still, the story and numbers (including estimates) for Shift4 remain fantastic, and while there have definitely been some wobbles, FOUR showed solid support in April and has held above that area since. Our thoughts here remain the same: We’ll cut bait if necessary, but with a small position, we advise giving shares a chance to firm up and resume their overall uptrend. HOLD

Uber (UBER)—We added a half-sized position in UBER last week, and like most of the market, it’s eased lower since, dipping on low volume to its 25-day line. As we wrote when we added it, we’re optimistic the third time is the charm for the stock in terms of investor perception, as the firm is delivering (and exceeding) EBITDA and booking expectations quarter after quarter, with a possible hike to the firm’s $5 billion EBITDA target for next year coming soon. As with most everything, economic fears are ever-present—it seems like until the Fed calls off the dogs (another rate hike is expected next week) there will be some worries the bottom will fall out of the economy. Still, there’s always something to worry about, and UBER’s long bottoming action (dating back to last August) and decisive upside before and after earnings give it good odds of heading higher over time. If you don’t own any, we’re OK starting a position here. BUY A HALF

Wingstop (WING)—WING continues to slowly drift lower, nosing below the 200 area this week as the 50-day line (near 194) has caught up. Thus, the correction has been normal so far (importantly, it’s held above the prior all-time highs in the 190 area), though we’re getting close to the fence—having already sold some, we’re willing to give shares a bit more rope, but a decisive drop from here would likely be abnormal. We’ll see how it goes—deep down, we think the cookie-cutter story here has a very long way to play out, and while same-store sales are likely to slow some, they’re coming off huge levels (20%-plus) so any double-digit gains should keep Wall Street happy. We’ll stay on Hold for now and watch the coming action closely. HOLD

Watch List

• Axcelis (ACLS 162): ACLS has taken off with chip stocks—it’s not really an AI play, but its Purion line of chip equipment machines should remain in huge demand as chip firms ramp production for power-hungry devices (mostly EVs but many other applications, too). The next pullback or shakeout should be buyable.
• DoubleVerify (DV 35): DV is yet another name that shook out in a big way about a month ago but stormed back before and after its recent earnings report, with shares making new price (and testing new RP) peaks. We like this long-term story and a fresh setup would be intriguing.
• DraftKings (DKNG 24): DKNG is still OK but has been subject to the chop factor, with a nice pop a week ago leading to a retreat right back into its 25-day line, and then a nice rally today. We like the story here—both the long-term increase of sports betting but also this firm’s improvement in EBITDA, which should turn positive in Q2—and if the stock can settle down we could take a swing at it.
• Duolingo (DUOL 154): DUOL continues to act well, holding all of its snapback gains last month and looking peppy. We think growth will remain solid for a long time to come; if the market and growth stocks hang in there, this could be our next purchase.
• Mobileye (MBLY 45): Mobileye is one of the leaders in advanced driver assist systems (ADAS) in many current automobiles, and it’s leading the charge toward autonomous driving down the road (with a few models already going live with it). Shares seemed done-for a few weeks ago but have stormed back. See more below.
• Monday.com (MNDY 182): Monday.com has a work management software platform that looks like a leader in the “no-code” movement, where everyday workers (not programmers or IT types) can use it to set up powerful workflow systems. Business is booming and profits are coming much sooner than expected. See more below.
• Palo Alto Networks (PANW 217) and CrowdStrike (CRWD 158): As we write later in this issue, we’re seeing more “old” leaders come to life than is usually the case, and if that holds, some cybersecurity names like PANW (already out to new highs) and CRWD (good support after earnings last night) could reassert themselves.

Other Stocks of Interest

Mobileye (MBLY 45)—While the potholes among potential leading stocks are just as numerous as they have been, we’re seeing more and more names snap back in the weeks after nosediving—basically making the prior plunge look like a big shakeout of the weaker hands, which in turn paves the way for the stock to head higher. Mobileye is a good example, with shares setting up nicely near the end of April but then having a wicked plunge on earnings (as low as 30!) before turning around and, this week, rallying all the way back to its old highs. While a technology company with many different products and metrics, the story here has always been simple and straightforward: Mobileye is the top way to play the current trend toward more and better advanced driver assist systems (ADAS), with camera- and lidar-based sensors that improve driver safety and awareness (adaptive cruise control, lane departure alerts, blind spot detection, automatic emergency braking and more). But even more important, it’s one of, if not the, main player in pushing toward partially- and fully-autonomous vehicles via its SuperVision driving system, which aims to allow hands-off navigation capabilities and can handle standard driving functions on many road types. (SuperVision uses 11 cameras to give it a full surround HD view, as well as detailed maps and advanced chips.) A big Chinese car maker has already deployed SuperVision in one model of high-end EVs, with another set to launch in Q4, and because the industry looks ahead, orders are piling up—in 2022, the firm booked business that should result in a total of $6.7 billion of revenues through 2030, and it said in May that the pipeline of design win opportunities was larger this year than last; one brokerage firm thinks SuperVision revenues could soar to the $3 billion mark within five years and possibly twice that if things take off. (Mobileye hinted toward the potential for a SuperVision design win with a big U.S. outfit in the second half of the year.) However, the near-term looks more challenging—Mobileye’s Q1 report that said Chinese demand was lower this year than expected (providing the impetus for the aforementioned shakeout), with sales expected to rise just 13% this year while earnings fall (partly due to heavy R&D). But the writing is clearly on the wall here, as it’s a matter of time before sales and cash flow soar to much higher levels (2024 revenues are expected to rise 32% with earnings following suit). MBLY is still a new, volatile issue and it’s run right back into resistance, which usually means some selling is on the way. But we’re placing it on our watch list—as the market looks ahead to 2024, we could see the post-IPO advance resume, with added upside should a big SuperVision deal or two be announced in the months ahead.

Monday.com (MNDY 182)—Software stocks were the big leaders in the last prolonged bull cycle, so it’s not a total surprise that the group has been hit-or-miss of late. That said, we still think some newer names could emerge should a real bull market get going; Procore Technologies (PCOR) is one, which we discuss below. And Monday.com (based in Israel) is another, and it plays in a field we first sniffed around a couple of years ago. Dubbed work management, Monday is one of a few players (Asana (ASAN) is another) that’s aiming to help firms in the new age of mobile and at-home work better stay in touch, complete projects, share data and the like. It sounds simple, and to some extent it is, but what appears to make Monday unique is that it effectively can be used by everyone, with a low-code (or no-code) approach that lets everyone in an organization (don’t have to be a techie) to “build” a customized workflow tool and system using drag-and-drop tools, virtual whiteboards, synced messaging, easy data sharing and much more. The end result is a more centralized, shared system. As one analyst puts it, the functional equivalent of many top-selling software products (think Zendesk) can be built on Monday’s platform by the average Joe or Jane; given that nearly two-thirds of all app development is estimated to occur via this “low-code” method as soon as next year, the firm is playing in a huge market. A couple of users can sign up for free, but of course, Monday then upsells them into higher tiers and new add-ons (their CRM product is growing five times as fast as the overall business right now). Growth has slowed a bit but remains rapid (up 50% last quarter, down from 57% and 65% the prior two), and the bottom line has been in the black each of the past three quarters (14 cents per share in Q1) while free cash flow was a ridiculous 24% of revenue in Q1; all in all, 2023 will be profitable, two years ahead of schedule. The sub-metrics are all great as well (same-customer revenue growth north of 15%, and north of 25% for its largest clients). Bottom line, it looks like Monday.com is a leader in taking the work management space to a new, easier to use, more customizable level for the work masses, which is very enticing. The stock was taken apart during the bear market and, after a rally into February, suffered another sharp pullback into May, but the pre- and post-earnings action (straight back up to new highs; all-time heaviest weekly volume in mid-May) is a major clue. The one fly in the ointment is that MNDY is only owned by 200 mutual funds (not a lot of sponsorship), but it certainly seems like that may be changing—the stock is on our watch list, and a little exhale would be tempting.

Procore Technologies (PCOR 62)—We don’t play favorites when it comes to the stock market, but we admit there are a few names we will regularly keep our eye on over many months, especially during a tough market period, thinking that eventually, the stock will start a move. Little-known Procore Technologies is one of those, and it has a very simple, straightforward story that should carry it to years of excellent growth if management makes the right moves. On the surface, Procore is a cloud software stock, which is old hat, but it’s addressing an industry that’s as big as any—the firm’s platform makes it easier for large construction projects to get every stakeholder (architects, general contractors, subcontractors, builders, owners, suppliers, financiers, you name it) on the same page, sharing information and updates to dramatically boost productivity. It’s really not a tough pull, as the industry has seen horrid gains in labor efficiency for many years and digitization in the sector is way behind the times, with all of that meaning most projects going way over budget (by 80% on average) and of course taking longer than expected (20 months longer). Procore entices adoption by going with a volume-based pricing model (based on how much construction volume is managed via its platform), with no per-user fees. All in all, Procore is easy to adopt and use, boosts communication, saves time and money—and is the best-in-class in the field by a big amount, with modules addressing project management, quality and safety, financials and some newer fintech offerings (like helping clients get insurance for a project, which is a huge headache). Now, given the nature of the construction industry (huge and slow moving), Procore isn’t going to double overnight, but even with the iffy macroeconomic situation, management says its clients have healthy backlogs and the biggest issue remains finding labor (not something you hear when things are weakening). Revenue growth, deferred revenue and remaining performance obligations all rose north of 30% in Q1 and the firm continues to add clients (601 new ones in Q1; up to 15,089 total). Growth is slowing a bit more given the environment, but it certainly seems like Procore is going to get much, much bigger over time as the construction industry is just starting to digitize in a big way. As for the stock, it bottomed a year ago, hit a higher low in early January and is now in the midst of a 14-week launching pad as more big investors (391 mutual funds own shares, up from 273 nine months ago) start positions. PCOR still needs some work but, eventually, we think it will enjoy a sustained advance.

The AI Boomlet

We have numerous rules and tools when it comes to identifying leading (and potential leading) stocks, from sales to earnings to margins to chart patterns and volume clues. But overall, one of the first things we always look for is simply this: Does the company in question have a new product or service that changes the way we work, live or party? Not only have the majority of big winners had this fact in common, but many major market moves were at least in part driven by a big advancement that changes people’s lives for the better.

That, of course, leads us to the recent artificial intelligence (AI) boomlet, which simmered a bit earlier this year but has boiled over during the past couple of weeks; it looks like investor perception is rapidly shifting to the point that AI could be transformative. To be clear, this isn’t about being able to ask ChatGPT some silly questions—the market is excited about the potential for this to become the next big productivity driver for businesses, with AI offering better predictive capabilities, improved inventory and supply chain operations and lots of automation for many tasks. As it progresses, it should positively impact more and more.

What do we think? Well, for the most part, we think what the market thinks—our aim here isn’t to argue with the market. Other than that, though, our main thoughts are that (a) yes, we may be at a tipping point for AI to start dramatically affecting the operations of businesses, though (b) it’s still very, very early, with very few firms really diving into this field headfirst at this point. It’s the top of the first inning, with a lot of outfits testing the waters.

Where there is a lot of strength today is in the infrastructure plays—the firms that will be getting orders for new, specialty equipment that will power AI advances. Nvidia (NVDA) is clearly the top dog here—it reportedly has nearly three-quarters of the AI accelerator market, which is specialized hardware or an entire computer system that accelerates machine learning, neural network tasks and more, which in turn allows data to be classified at rapid speed. NVDA’s recent earnings report was a coming-out party for the entire group.

While a higher-priced stock, Broadcom (AVGO) is also a major player in the AI accelerator area (supposedly 10% to 15% market share)—and it doesn’t hurt that the firm recently inked a multi-year, multi-billion-dollar deal with Apple outside of AI. The stock broke out of a giant launching pad last week and went vertical, though it definitely met some selling earlier this week.

Outside of chips you have servers: Super Micro Computer (SMCI) has boomed in recent days, as it does a lot of business with Nvidia and is releasing new products integrating Nvidia’s chips. Old friend Arista Networks (ANET), a leader in networking switches and equipment, should see business get a boost as data center and network campus spending is likely to surge as firms pour money into AI; and, for software, there’s C3.ai (AI), a (much) more speculative outfit that’s developed a software platform that allows enterprises to build their own AI apps on top of it. (Shares were hit today after earnings but this comes after a massive move.)

So, what, if anything, is the hitch? Well, first, many of these stocks are short-term and even intermediate-term extended; we’re not predicting anything, but some shaking and baking is likely on the way. Second and more important to us, while the charts and stories here are solid, the third element we look for— good growth numbers, both current sales and earnings as well as estimates—is lacking on many of the names that have popped. That’s not totally surprising (again, it’s early days here), but buying hopes and dreams—especially in a questionable market—isn’t usually a good strategy.

Even so, what we wrote above holds sway: New, potentially revolutionary movements are always something we keep an eye out for, and the overwhelming buying seen in a handful of these names is notable. We’re not opposed to a nibble here or there if you want in, though, for our part, we’re looking for higher-odds entry points and expect to see more AI-related leaders emerge down the pike if this move is the real deal. Stay tuned.

Watching Some Old Cybersecurity Favorites

Historically, after big bear markets, the next bull move is mostly led by new leadership, which makes sense—the old leaders are usually bigger (hard to grow quickly), are owned by nearly everyone and, in most cases, might have seen their products and services overtaken by new, young upstarts.

However, as we’ve written before, there’s been a distinct lack of liquid, well-traded potential leaders that mutual funds, pension funds and the like can pile into; it’s no secret that many of the good-looking names out there these days are a bit down the liquidity ladder, which makes them subject to wild action. Thus, as the market tries to firm up, we’re seeing an unusual number of former, well-known names attract buyers, like Nvidia (NVDA) and even ASML (ASML) in the chip group and, of course, the mega-cap Apples (AAPL), Microsofts (MSFT) and Metas (META) of the world.

That has us looking at the cybersecurity group, which remains in a major growth phase—and could accelerate as the need for protection grows stronger as AI investment booms. Similar to other areas, two former leaders look interesting: Palo Alto Networks (PANW) has its hands in both legacy conversions and in zero-trust, with buoyant sales, earnings and cash flow—and a stock that recently lifted to all-time highs.

Then there’s CrowdStrike (CRWD), which to us, has always quacked like a future blue-chip name; its endpoint security platform (dubbed Falcon) takes in trillions of events per week, learns from them and then automatically applies those protections to all clients. And it’s moved steadily into newer, faster-growing fields like log management, cloud workloads and much, much more. Growth is slowing a bit but remains rapid—in the just reported quarter, sales and recurring revenue rose 42%, earnings were up 84% (both topping estimates) and the stock recovered nicely after an initial dip.

There is one smaller, newer name that we’re intrigued by—SentinelOne (S)—that may have a more automated solution than either PANW or CRWD, though it has earnings tonight so we’ll see how it goes.

While we’re always biased toward newer names, if the market is going to run with some old leaders, our bet is that one or two (or more) cybersecurity names from the last run will join in. Right now, PANW and CRWD are our favorites (and on our watch list), but we’ll see how things develop.

Cabot Market Timing Indicators

We’re seeing some improvement in leading stocks, both in AI and beyond, which is why we’re adding a bit of exposure tonight. But the market as a whole remains in the same stance as before—our solidly-bullish Cabot Trend Lines are very encouraging, but the intermediate-term trend is sideways (at best) and the broad market is unhealthy. Thus, we’re overall cautious, though we’re keeping our eyes open should the buying pressures spread.

Cabot Trend Lines: Bullish
The biggest bullish change in character when it comes to the market this year has come from our Cabot Trend Lines—last year, they were negative from late January through year-end, but in 2023, they turned positive in late January and remained bullish throughout the spring slop. And now they’re in great shape, with both the S&P 500 (by 5%) and Nasdaq (by 12%) well above their 35-week lines, which themselves are starting to turn up (very bullish). It’s not the only factor that counts, of course, but having the long-term trend pointed up means a lot.

Cabot Tide: Neutral
Our Cabot Tides, however, can’t get in gear—while the Nasdaq soars and the S&P 500 tests the top of its multi-month range, the other major indexes (including the S&P 400 MidCap, shown here) continue to languish, chopping around near their recent lows. At day’s end, the market’s overall intermediate-term trend remains neutral, but at this point, it’s closer to turning down than turning up. That doesn’t mean the rally is doomed, but it’s a descriptive thing—the advance to this point remains narrow and many stocks and sectors are still walking through minefields.

Two-Second Indicator: Negative
Our Two-Second Indicator is also in the same boat it’s been in, telling you the broad market is iffy—while the figures can change quickly, to this point the number of new lows on the NYSE (and the Nasdaq) remains elevated, a sign that there are plenty of sellers/not many buyers for wide swaths of the market. New bull moves usually see great breadth as well as lots of leadership; we’ll be watching closely to see if these figures can dry up in the near future.

The next Cabot Growth Investor issue will be published on June 15, 2023.