Cabot Growth Investor Issue: March 23, 2023

Broad Market Weak—but Growth Holding Up

When the Federal Reserve is in an aggressive tightening campaign, stocks often sour, but it’s not just a direct effect of the rate hikes—yes, higher money market yields do suck some money out of stocks over time, but the bigger fear is that the Fed breaks something, either in the general economy (bringing a recession) or the vast financial sector, which has the potential to be really bad if it spreads.

Obviously, the past couple of weeks shows the hair-on-fire tightening cycle has caused the latter, with SVB going belly up, another NY bank being taken over by the Feds and long-time zombie bank Credit Suisse getting sold for pennies on the dollar—and now it looks like various office real estate plays are in trouble, too. Basically, the fear is that dozens of banks could be in trouble as deposits flee for the safest places.

Of course, what counts to us isn’t the news, but the reaction to the news, and on that front we have two thoughts. The first is that the reaction to SVB’s collapse decisively cracked the good-looking intermediate-term uptrend that was in place: Our Cabot Tides are clearly negative and the broad market is quite weak, both according to our Two-Second Indicator as well as some broader indexes (small- and mid-caps, etc.) that fell off a cliff and haven’t bounced at all (some probed new correction lows today). Because of that, we’re holding plenty of cash, staying mostly safe to see how this plays out.

Our second thought, though, is more optimistic: The relative strength we saw from the Nasdaq and from many growth stocks for the first couple of months of 2023 is still with us, which is another mini-sign of a character change—every major retreat we saw since the bear began was basically “led” by growth stocks, but now they’re holding up well, which can be seen in the indexes (including our Aggression Index, which is actually still positive; see more later in this issue on that) and individual stocks. Indeed, we’re seeing more good-looking growth names today than we were a couple of weeks ago.

That leaves us with a bit of a split tape—we’re certainly not going to ignore the recent market timing sell signals and the horrid action in the banks, but we’re also not going to ignore the increasing amount of growth stocks and indexes that are looking peppy, not to mention the fact that it’s becoming more likely that interest rates may be starting a new downtrend (again, see later in the issue for more on that).

What to Do Now
Thus, we’re playing along with the evidence by sticking with a large cash stake but also doing a little nibbling tonight in a couple of resilient names. In the Model Portfolio, we’ve cut bait on Las Vegas Sands (LVS) and Uber (UBER), and trimmed a bit more from our ProShares S&P Fund (SSO) position since the last issue. Tonight, though, were starting half positions in Allegro Microsystems (ALGM) and On Holding (ONON), which will leave us with around 53% on the sideline.

Model Portfolio Update

The market continues with its volatile ways, with the banking crisis-induced plunge cracking most indexes and sectors on an intermediate-term basis, followed by a decent bounce, only to see the sellers reappear after the Fed meeting and some unfriendly comments from Treasury.

At day’s end, we have our Cabot Tides and Two-Second Indicator now firmly in negative territory, while the vast majority of stocks (about 78%!) are below their 50-day lines, effectively confirming that the prior intermediate-term rally has gone up in smoke. On the other hand, the long-term trend hasn’t yet broken, the major indexes are still (for now) firmly within their ranges of the past 10 months or so and growth stocks—which usually lead the way lower in downlegs—have been holding up great, with many actually hitting new highs in recent days.

Thus, we’re not aiming to add too much exposure, but given the under-the-surface growth stock positives, we’ll do a little nibbling tonight on two fresh potential leaders, Allegro (ALGM) and On Holding (ONON). That will still leave us with plenty of dry powder (just over half in cash), so we’ll see how things go from here.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—ASO was the latest of our holdings to react well to earnings after a fine report last week. As expected, sales were down a smidge (off 3%), though better margins and the share buyback program helped earnings per share to rise 27% and easily top estimates. Better yet was the outlook—the post-pandemic unwinding will continue to some extent (gross margins last year were five percentage points higher than in 2019; some of that will stick but not all), but same-store sales are expected to level out and, after opening nine new locations last year (the first new openings since 2019), the firm expects around 14 new locations in 2023 (about 5% growth in the store base) as it continues on its multi-year, cookie-cutter growth plan. All in all, analysts see another year of flat-ish (though elevated) year of earnings at $7.65 per share, but given Academy’s history of trashing estimates (and the fact that it could attract more consumers as people look for better values, which the firm is known for), it’s likely that will prove conservative. The stock isn’t running away on the upside, but after testing its 50-day line, ASO popped on earnings and has held its gains even in this news-driven environment. With the uptrend and story intact, we’ll stay on Buy, though aim for dips if you want in. As a heads-up, the firm will host an Investor Event on April 3^rd and 4^th, which could cause some near-term volatility. BUY

Allegro Microsystems (ALGM)—ALGM is one of the new leaders in the chip space, and it’s held up amazingly well during February correction and again during the bank selloff. While we’re not an expert on the chip technology, Allegro has chips that are perfectly suited for more power hungry applications; electric vehicles are the main attraction (the price wars and competition there should be a good thing, leading to faster adoption and more chips), though advanced driver assist systems are also big. All in all, the firm’s opportunity in each EVs is about much larger than the amount in a gasoline vehicle, and demand has been soaring; at year-end, the firm’s backlog was more than a year’s worth of sales, and as supply chain issues have eased, Allegro should be able to catch up with client needs. To be fair, analysts see growth slowing in the year ahead, but the stock doesn’t believe it: After a huge three-day breakout on earnings in February, the stock gave up zero ground in recent weeks and is now perched near its highs. Yes, pullbacks could come, but we’ll start with a half-sized position (5% of the account) and use a stop in the low 40s. BUY A HALF

Las Vegas Sands (LVS)—We cut bait on our half position in Sands for a similar reason to INSP (in the last issue) and UBER (written about below): When the market is caving in and our indicators are flipping to negative, we don’t stick around too long with losing positions. That said, let’s see how it goes—LVS has bounced back some (peer Wynn Resorts (WYNN) is a bit stronger), and if this dip turns out to be a shakeout for both the market and Macau-type stocks, we may revisit one of these plays. Right now, though, odds favor more time will be needed to digest the heady October-March gains in these names, and of course, the market still has a ways to go before returning to health. We sold our half-sized stake in LVS last week and are holding the cash. SOLD

On Holding (ONON)—We wrote up On Holding a couple of months ago, as it was a new issue with a solid bottom in the chart and a growth story that could go far. To recap, On is a high-end sports shoe outfit (many go for $150 or more) geared toward runners and (as it expanded its offerings) other activities (trail running, hiking) and sports (tennis) as well as apparel. And, as opposed to most peers, the firm does seem to have something different, as years of research have led to offerings that really are better for athletes, with softer cushion when landing but some spring when pushing off, leading to better performance. That’s all definitely a good thing, as On continues to take share—but the bigger opportunity, and one that looks to be playing out, is that On is joining the Lululemon’s of the world and becoming a lifestyle brand, with many sort-of-athletes buying the shoes simply to wear around due to their comfort and because it’s a “hot” brand. Both of those factors combined have the firm growing like mad—in Q4, local currency revenue (On is based in Switzerland) rose 92%, with strength seen in direct-to-consumer (up 76%), wholesale (up 104%) and with in-person sales up 80%-plus in every region around the globe. Better yet, gross margins remained unchanged despite cost pressures, which helped EBITDA lift more than five-fold, and the top brass sees sales for 2023 up nearly 40%, which could prove conservative now that much of the early-2022 supply chain issues have been fixed. After a long bottoming phase, ONON set up nicely into earnings and has gone ballistic this week on monstrous volume. Yes, it’s extended, but we view this multi-day move as one big earnings gap; it’ll be volatile, so you may be able to catch the stock a couple of points lower, but we’re going to start a half-sized position (5% of the portfolio) and use a loose leash. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—Big picture, we continue to think the action of the S&P 500 is not abnormal: During the past 10 months, we’ve seen numerous (often large) Fed rate hikes, hundreds of billions of dollars of quantitative tightening, wild swings in energy prices and, now, banking shenanigans that took down a top 20 U.S. bank, a good-sized NY outfit (Signature Bank had $110 billion in deposits) and kneecapped Credit Suisse, too … and yet the index is basically unchanged during that time and still well above its lows from last fall. Now, none of that is reason to ignore the here and now—with the Cabot Tides negative and the broad market weak, we’ve trimmed our SSO position in two stages, leaving us with just over 40% of what we had three weeks ago. But we’re willing to give our remaining shares room to breathe—and if the market really improves, we could add a few shares back to our holding. For now, though, sit tight. HOLD

Shift4 (FOUR)—FOUR has calmed down of late, which is fine by us after its shakeout-and-snapback action before and after earnings. The risk here is that a sharp economic recession becomes the consensus view, leading investors to anticipate Shift4 will suffer because of it. There’s solid reasoning there, but interestingly, in 2020, even as many restaurants and hospitality joints (the core of Shift4’s business) closed, the firm still posted growth. Moreover, the many quarters of work expanding into new industries is just starting to pay off—just in February, the firm began processing ticketing for a few pro teams (New Orleans Saints and Pelicans and Arizona Cardinals) and should go live with BetMGM by the end of March, plus there are many other previously inked deals and new ones as well (Baltimore Orioles and Ravens, Florida Panthers, Cleveland Cavaliers, etc.) that should kick in later this year. The bottom line is that there aren’t many outfits that should grow earnings 50%-ish both this year and next, but Shift4 is one of them and barring a complete economic collapse, there’s little doubt it will get a lot bigger over time. We’ve been on Hold for a little while now, and we’ll stay there tonight, but we remain optimistic the next major move is up. HOLD

Uber (UBER)—Honestly, we’re still keeping an eye on Uber, as all of the fundamental positives we wrote in recent weeks are as true as ever—EBITDA and free cash flow are soaring and should continue to do so for a long time to come as the company increases its lead over the competition (go look at a chart of Lyft (LYFT) for perspective) and focuses on the bottom line. That said, there’s no doubt the stock is struggling here as the name trades along with the economically sensitive swath of stocks. We cut our loss a couple of weeks ago and UBER hasn’t done much since—if the stock was able to power ahead on big volume (and the market was lifting), we could give it another look, but at this point, we’re happy to have the cash and will be looking for the best of the best of new buys when the market does finally turn up. SOLD

Wingstop (WING)—WING isn’t a go-go stock in the best of times, with lots of stops and starts even during its uptrends, so it wasn’t surprising that the stock’s solid earnings gap faded (especially considering that there were a handful of analyst downgrades during that time). But more important to us is the recent action, with the stock finding support where it “should” (just above its 50-day line) and racing to new closing highs even as the market wobbled—in fact, WING is now banging on the door of its all-time highs from mid-2021! There’s been nothing new from the company since the Q4 report, but the thesis we’ve been writing about for months—that the underlying growth story is back on track after the boom/bust convulsions caused by the pandemic—is playing out. A drop back below the recent low would be a yellow flag, but we’re obviously optimistic given the action; we’ll stay on Hold due to the market, but we wouldn’t argue about a nibble on any minor weakness. HOLD

Watch List

• Agilon Health (AGL 28): The value-based care movement is huge in the healthcare industry, with one major player (Oak Street) getting taken over (by CVS). Agilon is another major player, and it’s been growing rapidly and signing up tons of new doctors and practices—and, of course, seeing better health outcomes for the patients, too. After a long bottoming process, shares are perking up and testing major resistance in the upper 20s.
• Arista Networks (ANET 170): It’s hard to have a better chart than ANET right now, with a big-volume breakout last week from a 14-month zone along with a string of buying (up nine of the past 10 weeks) since the start of the year. We will say that the firm’s growth is expected to slow markedly later this year, but big investors don’t seem to believe it.
• Axcelis (ACLS 131): ACLS has been choppy but strong in recent weeks, with each wobble quickly finding buyers. While Wall Street sees earnings leveling out this year, (a) the stock acts like that will prove conservative, (b) the valuation (24x trailing earnings) isn’t insane and (c) the top brass sees free cash flow of around $10 per share in two to three years.
• Axon Enterprises (AXON 216): AXON’s recent dip has been very well controlled following its huge-volume breakout on earnings three weeks ago. See more below.
• Duolingo (DUOL 135): DUOL continues to act great, ignoring the market’s recent dip and surging to new recovery highs this week. It’s a leader in a unique business, and growth should remain strong for a long time to come. We like it.
• First Solar (FSLR 210): Solar stocks have mostly been disappointing, but FSLR remains in a bull market of its own, with orders having gone bananas in the past few quarters. See more below.
• Samsara (IOT 18): IOT has pulled normally to its 25-day line following its super-powerful coming out party on earnings a month ago. The one-of-a-kind software story—serving large outfits and organizations with tons of machines and trucks—should keep growth humming for a long time.

Other Stocks of Interest

Axon Enterprises (AXON 216)—We touched on this last issue, but Axon Enterprises is one of the few stocks out there these days that’s really pioneering its own theme or industry: It’s making police departments and law enforcement agencies actions less lethal and more efficient through a variety of offerings that crank out tons of recurring revenue. The firm’s electrical weapons are still a huge part of business; in Q4, this segment was still around 40% of revenue, and that figure may grow thanks to the release of the Taser 10, which comes with more probes and a longer range, increasing the odds of a successful “stun” and also cutting the odds of lethal force against an officer. Interestingly, about 60% of Taser’s are sold as part of bundle package (holster, cartridges, battery pack, targets, etc.). But the real growth story is all the other stuff that Axon has added to its offerings that are gradually being adoped. There’s Axon Body and Fleet, which are in-car and on-person cameras that effectively put eyes on the scene of any stop; Axon Air, which is a drone platform with live streaming; Axon Respond, a software offering providing real-time situational awareness; Axon Dispatch, a centralized dispatch solution; and, most important, Axon Evidence and Records, which allow agencies to store, share, edit and report on all the evidence caught by the aforementioned devices—and most of these are sold via subscription, again adding to the recurring revenue totals. In effect, Axon has molded its Taser weapons with software and platforms into various solutions that dramatically help law enforcement do a better job in the field and get more convictions and save time in the courtroom. Axon’s annual recurring revenue increases each quarter and totaled $473 million at year-end, up 45%, while total future contracted revenue (often going out many years) was $4.65 billion, up 66% from a year ago and up 25% from Q3. With many quarters of steady growth, the top brass is looking ahead, seeing annual 20%-ish top line and 30%-ish EBITDA growth through 2025 with strong free cash flow as well. And the stock is responding: It got nailed early in the bear, came all the way back in the months that followed and then spent three months chopping around—but after Q4 earnings, AXON has lifted above two-plus-year resistance and has held up even as the market has fallen off. The longer it can hang in there, the greater the chance that AXON’s starting a new run that will continue to attract more big investors.

First Solar (FSLR 210)—We wrote about the setup in Shoals in the last issue, but an ill-timed offering and then the market’s weakness ruined that. But the liquid leader in the group has been First Solar, and it’s been doing just fine; we won’t say it’s in the first inning of its move, but it’s the top dog in the solar space and certainly looks like it wants to go higher. The story here isn’t fancy, but its powerful: The company is one of the big players in solar panels, with higher-quality and generally higher-yielding output than most competitors (especially Chinese firms) especially in hot, humid conditions. Business has been up and down for years, and some sector issues early last year caused another pothole in 2022. However, demand began coming back early in the year and the green energy bill (which evens out the firm’s higher prices vs. those of foreign competition) has changed the landscape—the firm booked 48 gigawatts of bookings last year as a whole, nearly triple that of the year before, and even though the company is busy expanding capacity (both at existing and new facilities), management said on the Q4 conference call that it’s sold out through 2025 and is now taking orders for delivery in the 2026 to 2029 (!) time frame. All of that, combined with some tax credits from the federal bill, should see the bottom line go wild in the quarters ahead—Wall Street sees First Solar earning $6.60 per share this year (management actually guided to $7.50 in February, so Wall Street could be conservative) and then galloping to $12.50 in 2024! Now, as mentioned above, the stock did initially kick off last summer, so the move is more mature than nearly all others in the market these days—that said, the Q4 report broke the stock out of a four-month period of no progress on outstanding volume, and the resilience since then has been impressive. It probably won’t run for another year, but FSLR has the story, numbers and chart to keep chugging if the market doesn’t implode.

DraftKings (DKNG 17)—One very old long-term stock pattern we used to write about was the three phases of a growth stock’s life—first was the Romance phase, which came when the firm was newer, growing rapidly and goes bananas as investors fall in love with the story (and overlook any warts); then comes the Transition phase, when the stock becomes more widely followed and loses steam over many months or years; and finally you have the Reality phase, where the stock tends to be judged on cold, hard facts and details. (Stocks can have multiple Romance phases, FYI, though it usually comes because the firm has a new product or growth avenue.) That preamble brings us to DraftKings, one of the leaders in the online sports betting market (as well as online casino action) that had a huge Romance phase into March 2021 as the legalization trend gained steam and the company took share. The problem? With intense competition, marketing dollars were flying out the window and incentives to sign up were gigantic (sometimes up to $5,000 vs. generally a few hundred nowadays) and losses were massive. But the bear market has woke the company up on many fronts, all of them positive: Costs have been cut, with more than $100 million coming off the books last year alone even as it continued its expansion into new markets (Massachusetts just went live), while marketing spend per customer is also down, and yet customer retention and the effective take-rate is up (more parlays and a bit of luck on outcomes have helped; the take percentage rose from 6.5% in 2021 to 7.7% in 2022). As an example, for the states it entered in 2018 and 2019, not only did revenue surge (up 50% last year even in these mature areas) last year but gross margins rose four percentage points while marketing was off 15%, showing that initial investments to grab customers don’t have to be repeated endlessly. To be fair, the bottom line is still deep in the red, but that should soon change—revenues soared 81% in Q4 (analysts see 34% growth this year, likely conservative), and the top brass expects EBITDA to turn positive by Q4 of this year. The stock was destroyed early last year, but bottomed in May and held up in the 10 to 12 area many times through year-end. Then came the early-year rally, and now we see DKNG stage a reasonable, lower-volume retreat into the 10-week line. It’s still volatile, but it;s possible DKNG is entering a Reality phase where solid expansion and improving profit metrics will attract more big investors.

Follow-Up: Power Index Flashes Buy Signal**

When we wrote about our old Power Index in the last issue, we didn’t realize the stock and bond markets were about to go haywire. But they have, and it’s brought up an interesting situation: When looking at either the two-year or five-year Treasury notes (both shown below), the recent plunge in yields has taken both below the yield levels they had six months ago … telling you the trend of interest rates have turned down after what was a huge, prolonged uptrend.

That constitutes a buy signal of sorts, telling you the market anticipates easing financial conditions, which are usually bullish for the market.

Of course, you’ll notice the two asterisks in the title above. The first is that, as we wrote in the last issue, the Power Index a secondary indicator that we’re still working on; this was our go-to measure in the 1970s, 80s and into the 90s, but it didn’t work for the past couple of decades when rates (and inflation) were generally low. So we’re still in the process of noodling things around to see if there’s anything actionable there.

And that leads to the second asterisk: Rates have obviously moved quickly of late, which means any normal bounce up in yields could put them back above where they were six months ago (effectively erasing the signal). We’re not predicting that, just saying the six-month rate of change could bounce around near-term.

Even so, the reason we mention it is the overall message here: Higher interest rates likely sucked a lot of money out of stocks in recent months both directly (investors looking for some safe yield) and indirectly (fears of recession), so any sustained dip in rates is likely to reverse that process ... and at the very least it’s looking like a top for market rates is probably in. It’s sure to be news-driven and volatile, but as a background measure, the recent plunge in interest rates should be a longer-term plus for stocks, and especially for growth stocks.

The Market’s Biggest Character Change Remains Intact

The banking crisis and worries over the next domino to fall have changed a lot with the market’s outlook—our Cabot Tides and Two-Second Indicator are now negative and many sectors, especially cyclical ones, have fallen apart on an intermediate-term basis.

However, there’s a key indicator that represented the most important character change in the market during recent months that hasn’t flipped to bearish. It’s our Aggression Index (and other similar measures), which spent most of the past year or more in the doghouse but has changed its tune this year—and is holding up well even during the market’s mini-meltdown of late.

The following few charts are good examples; all look at the relative performance line of the equal-weighted Nasdaq 100 (symbol QQQE; it evens out the huge weightings of Apple, Microsoft, Google and the like) compared to a variety of sectors and indexes (consumer staples, utilities, as well as the equal-weight S&P 500 and Dow Industrials, etc.). You can see that in each case, QQQE was clearly underperforming for 2022 (and in some cases, well before 2022)—but bottomed out for a bit, perked up in January and has either held or extended those gains during the past couple of weeks.

Now, in this news-driven environment, you can’t assume the pattern will continue to play out. Maybe the sell-off intensifies and the next leg down takes with it all resilient growth stuff—or, maybe, the broad market finds support but money rotates into beaten-down areas (financials, oil stocks) and out of growth. You can’t rule anything out.

But as we like to say, it’s good to be aware of what could come—but it’s best to always go with the evidence in front of you. And the fact that after a big bear phase growth stocks are starting to outperform even in the face of a banking mess and weak broad market is definitely noteworthy.

Cabot Market Timing Indicators

From a top-down perspective, the evidence has definitely taken a turn for the worse, with our Tides and Two-Second Indicator pointed in the wrong direction. That said, the Cabot Trend Lines are still positive and, most encouragingly, growth stocks are looking pretty good. We’re nibbling a bit tonight, though are still hanging onto a large cash position, too.

Cabot Trend Lines: Bullish
It was close, but our Cabot Trend Lines remained bullish as the resilient Nasdaq Composite closed above its 35-week line last week, and so far has rallied further this week. Obviously, no one will argue we’re in a powerful uptrend at this point, but the Trend Lines are our most reliable indicator—they were negative for more than 90% of last year’s disaster, and the fact they’re remaining bullish now is a definite plus.

Cabot Tides: Bearish
Our Cabot Tides turned negative during the initial SVB selloff, and they remain so today, though it’s an interesting situation. The broader indexes (like the S&P 400 Midcap, shown here) look sick, having fallen off a cliff and they’re still sitting well below their moving averages—but the Nasdaq itself is actually back above its moving averages and the S&P 500 is close. Overall, though, most of the market has seen its intermediate-term uptrend go up in smoke.

Two-Second Indicator: Negative
After holding up pretty well in February, our Two-Second Indicator has taken it on the chin, as the broad market has fallen sharply in concert with the banking worries—most days of the past couple of weeks have seen new lows over 100. As always, this can change quickly if the bulls reappear, but at this point there’s little doubt the broad market is under pressure.

The next Cabot Growth Investor issue will be published on April 6, 2023.