Cracks Starting to Emerge
The biggest story of the past few weeks has been the Fed’s renewed jawboning for higher-for-longer interest rates, with the Fed Chief even saying hikes could re-accelerate this month (0.5% instead of 0.25%, etc.) if economic data remains too hot. Indeed, since the start of February, Treasury rates have risen an average of three-quarters of a point or more, while futures are starting to price in another 1.25% of hikes this year, up from 0.5% expected just a month ago. Translation: A lot of rate-hike worry has been priced in during the past few weeks.
And how did the market take all of that? Well, higher rates weren’t good, but the market was still keeping an eye on the pot of gold at the end of the rate hike phase. Yes, the indexes sagged, and yes we saw some indicators fall off somewhat, but no real red flags emerged. Coming into today, we had relatively neutral intermediate-term trends from a top-down perspective while the broad market bent but didn’t break.
More encouraging was (and still is) the action of the growth side of the ledger. Our Growth Tides are a bit stronger than the major indexes (interestingly, the Nasdaq is now the most resilient major index we track, the first time that’s occurred in months), our Aggression Index is still hanging in there (defensive areas are some of the weaker things around) and it’s hard not to notice tons of individual stocks that look like they want to go higher … but keep getting reeled in by the market.
In recent days, however, some cracks are beginning to emerge. First and foremost, our Cabot Tides, while close, tipped to the bearish side of the fence today; a strong rally could change that, but today’s action left many indexes in a precarious position. We’re also starting to see the number of new lows pick up steam, financial stocks really get hit (which is rarely a good thing) and some potential leaders come under pressure.
Don’t get us wrong: Overall, many stocks, sectors and indexes are still holding up fine despite interest rate and now economic fears, which is a definite plus; if this was 2022, there’s little doubt the market would be in complete shambles at this point. At heart, we remain optimistic the next major, sustained move will be up as the market looks over the horizon to cleaner times.
However, we also aren’t going to ignore the action, either. In January, as the evidence improved, we put money to work in a step-by-step fashion ... but then stopped buying when the market stopped going up. And now that we’re seeing a few cracks (not a ton) and our Tides are negative, we’re paring back a bit and will see how it goes. We still think a strong rally from here could pave the way for very bullish things, but it’s prudent to trim a little here and stay in gear with the evidence.
What to Do Now
Do a little selling, but also stick with names that are acting normally and keep your eyes open should this news-driven environment turn back up. In the Model Portfolio, we came into this week with 38% in cash, and many of our stocks act decently, but we will pare back tonight by selling our half position in Inspire (INSP) and selling one-third of our overall position in ProShares S&P 500 Fund (SSO), boosting our cash to 47% or so. We’ll also place Uber (UBER) on Hold. Details below.
Model Portfolio Update
The market’s five-week, interest rate-driven correction hasn’t so much crushed the major indexes or cracked a ton of potential stocks, but as we wrote above, we’re starting to see a few cracks emerge, with our Cabot Tides tilting negative and a few potential leaders slicing through support. That said, it’s hard to ignore the many growth-y names that, while not doing great, are holding up pretty well given all that’s gone on in the past few weeks.
Because of that, we’re managing the portfolio in the same way—holding a good chunk of cash and adjusting when need be, but also sticking with a group of (potential) leaders that look like they want to go higher if the market allows them, and keeping our eyes open for some potential (likely small) buys should things firm up. Ideally, if this is part of a longer bottoming process, we’d like to position ourselves in more fresh leaders and then add more if/when the market gets going.
That said, you know us: We always deal with what comes, and tonight that means trimming. We’re going to sell our half-sized stake in Inspire (INSP) and one-third of our overall position in ProShares S&P 500 Fund (SSO), while also placing Uber (UBER) on Hold. Our cash position will now be around 47%.
|Stock||No. of Shares||Portfolio Weightings||Price Bought||Date Bought||Price on 3/10/23||Profit||Rating|
|Academy Sports & Outdoors (ASO)||3,091||10%||59||1/13/23||61||3%||Buy|
|Inspire Medical (INSP)||345||5%||267||2/10/23||243||-9%||Sell|
|Las Vegas Sands Corp. (LVS)||1,590||5%||58||2/3/23||57||-3%||Buy a Half|
|ProShares Ultra S&P 500 Fund (SSO)||4,818||13%||49||1/13/23||46||-6%||Sell One-third, Hold the Rest|
Academy Sports & Outdoors (ASO)—ASO was looking a bit worse for wear earlier this week, but shares have stabilized after peer Dick’s Sporting Goods (DKS) reported a solid quarter—earnings for that firm were down some as the boomerang effect of the pandemic boom continues, but figures were better than expected and caused the stock to pop. Of course, Academy has its own quarterly report next week (March 16), which will obviously be vital, as not just the numbers but updates on the store opening plan will be dissected. (The firm did just hike its quarterly dividend, though the annual yield is just 0.5%.) We’re optimistic given the resilient earnings figures (this year’s estimate continues to creep higher, up to $7.80 per share now) and potential for upside as new stores open, but we’ll play it by the book—a positive reaction will certainly bode well, but any selloff into the lower 50s could crack the uptrend. Right now, ASO looks fine, so we’ll stay on Buy, but keep any new purchases on the small side this close to the quarterly report. BUY
Las Vegas Sands (LVS)—The recovery in Macau is going as planned, and that’s keeping the path of least resistance in LVS pointed up, albeit with plenty of choppiness. Gross gaming revenue in China’s gambling conclave rose 33% from the year before last month, and through February, year-to-date revenues were up a strong 55% compared to 2022’s tally. One analyst sees the area’s revenue rising to north of 90% of 2019 levels (pre-pandemic) by the end of 2023, which would obviously be a big boon to Sands’ cash flow. Back to the stock, the failed mini-breakout attempt last week isn’t ideal, though as we wrote above, it’s hard to argue the overall trend has changed at all. We’re still aiming to fill out our position, but given the environment (including some weakness in China names of late) we think it’s prudent to hold off buying more. However, if you don’t own any, we think the dip in recent days offers a decent entry point, with a stop in the lower 50s. BUY A HALF
Inspire Medical (INSP)—INSP is our weakest stock at the moment, giving up its post-earnings gains during the past few weeks and, over the past couple of days, slicing its 50-day line and filling the (small) earnings gap from early February. We don’t think there’s anything fundamental going on—just a weakening overall market, a sector that’s had some issues (medical and biotech names have sagged in general) and a more thinly traded stock that got caught in the line of fire. If we had a big profit we might sit tight, as the chart is hardly a mess, basically back in an area of support from December/January. But looking at the entire picture, INSP is one of the first potential leaders to crack support and it’s showing us a loss. We’ll cut bait here on our small stake and hold the cash. SELL
ProShares Ultra S&P 500 Fund (SSO)—As we wrote on page 1, we still don’t think the market’s action from a big-picture point of view is all that bad considering the bullets being fired from the Fed in recent weeks and, now, economic worries as fears mount of issues in the financial area. Even after today, we don’t consider the action of the S&P 500 (or other indexes, not to mention many stocks and sectors that are holding up pretty well) to be particularly abnormal, and in this news-driven environment, one Fed speech or economic report could cause a change in investor perception. However, we’re never one to argue with the market, and while the setup was excellent in January (we’d take the trades again if they presented themselves), the idea was always to trim back on SSO should the intermediate-term uptrend crack—and that looks to be happening now, with our Cabot Tides tilting to the bearish side of the fence after today’s drubbing. Thus, tonight, we’re going to sell one-third of our position and hold the rest; if this selloff gains steam, we’ll pare back further (or sell outright), though we’re happy to hold on to our remaining stake if the buyers arrive, as a few good days could change the market’s tenor. SELL ONE-THIRD, HOLD THE REST
Shift4 (FOUR)—FOUR remains a port in the storm following its fantastic Q4 report, which clearly puts it in a different class than other payment operators. (See more later in this issue on that topic.) Analysts are now looking for 50%-ish earnings growth both this year and next as its core restaurant and hospitality sectors continue to grow while newer industries kick into gear. On that note, Shift4 is continuing to ink new deals in new spaces: Last week it signed up with Cordish Companies to power the payments in a variety of its entertainment districts that firm runs that include restaurants, gaming and sports activities; and this week it teamed with Premier Productions (a top 20 global promoter, producing north of 600 events each year) to run that firm’s online ticketing operations. We trimmed our position ahead of earnings, but the powerful reaction (biggest weekly volume since November 2021) and resilience since then tells us FOUR wants to head higher … if the market can get out of its own way. Right now, though, we’ll sit tight with our position and give the stock room to breathe. HOLD
Uber (UBER)—Like a lot of stocks (and even the market itself), Uber’s big picture looks bright, thanks in large part to many company-specific factors at play: Management has said that, due to higher cost of capital, competition is coming down, while the firm has focused on the cost side of the equation (delivery costs per transaction down 20% year over year last quarter; overall EBITDA margins headed up). Then there’s supply, with more drivers coming on board (Q4 driver count in the U.S. was up 30% from a year ago), many of whom signed up in part to offset some inflation pressures in other parts of their lives. All in all, the top brass says there’s been more positive factors than negative ones since the firm put out its 2024 EBITDA goal (i.e., they should be on track to meet or exceed their $5 billion goal), including the fact that they’ve gained share in seven (Delivery) or eight (Rides) of their top 10 markets of late. All of that is to the good—but, the company is not the stock, and like it or not UBER often trades in concert with many economically sensitive stocks, with fears of recession (and less travel/business) hitting shares in recent days. We’re not panicking here, but given the market and UBER’s dip, we’ll go to Hold and see how things play out from here. HOLD
Wingstop (WING)—WING’s action hasn’t been inspiring of late, with a promising earnings rally finding sellers right away and fading back to the highs of its November-January base. To be clear, the evidence is hardly ugly, as shares are still near their 25-day line and the fundamentals look to be on track, and this has never been a go-go name, with plenty of fits and starts along the way. Really, our thoughts on WING are similar to our thoughts on many stocks we own and are watching: If the market can snap out of its funk, we think WING can perform well as the cookie-cutter story plays out and Wingstop’s own innovations (especially on the menu, which broaden appeal and lessen reliance on wing costs) help cash flow. Right now, though, we placed the stock on Hold last week given the failed breakout attempt and think that’s the appropriate rating as we wait to see if the environment can shape up. HOLD
- Allegro Microsystems (ALGM 45): ALGM remains cool as a cucumber, trading under control even as the market goes a bit haywire. Analysts expect growth to slow (mostly industry pressures) going ahead, but that’s looking conservative given the year-long backlog the firm has for its chips that go into EVs, ADAS systems and power-hungry industrial applications.
- Axcelis (ACLS 130): Axcelis had a wicked shakeout when Tesla said it may have a way to decrease the silicon carbide chips needed in its cars, but the weakness lasted for just a couple hours before the stock snapped right back. Until proven otherwise, demand for its Purion line of equipment should remain in big demand as SiC chip production should soar for years to come.
- Axon Enterprises (AXON 218): AXON spent three-plus months hacking around just shy of all-time highs, and the Q4 report finally did the trick, as the company reported not just solid top-line numbers (sales up 54%, earnings up 52%) but another round of higher recurring revenue (up 45%) and future contracted revenue (up 66%). We like that the firm is basically pioneering an entirely new sector (increasing safety and efficiency of law enforcement) and should have years of growth ahead.
- Duolingo (DUOL 121): Duolingo has the leading education app out there that’s being used by millions of people—and it should see huge growth ahead as it converts more of its giant free user base to paid subscribers and attracts new users, too. See more below.
- On Holding (ONON 21): It’s taken some time, but ONON now has a nice setup after months of bottoming action and some ups and downs since the calendar flipped. There’s still no set date for earnings, but we’re on the lookout for a decisive rally (hopefully in concert with strength in the market) to tell us the trend is turning up.
- United Airlines (UAL 52): Airlines are a bit more mixed, but UAL is the leader of what still looks to be a solid group move as earnings not only go through the roof now but are likely to remain very elevated for a while due to structural supply limitations (and still-strong demand) in the industry.
Other Stocks of Interest
Duolingo (DUOL 121)—We wrote about Duolingo on a couple of occasions last year, but like most everything, the timing wasn’t right, with the still-weak market corralling most recent IPOs (the firm came public in mid-2021). But the firm always had a great story in a huge, underappreciated market, and now the stock itself is starting to let loose on the upside. The firm isn’t a household name, but it’s the hands-down leader in online education, mostly for language learning—in fact, it’s the top-grossing education app on both the Apple and Google app stores, and it claims many-fold more people Google “Duolingo” than “learn English” or “learn Spanish.” The secret to its success looks to be two-fold: First, the app is built to be fun and almost video game-like, even including things like quests to complete as you learn; and second, it uses a freemium model, so millions can sign up and get started learning a language they want (they do see some ads, though that’s a small-ish part of revenue) with the opportunity to upgrade ($7 per month paid subscription; no ads, lessons after mistakes, etc.) for a better experience. And with new improvements coming out all the time (management talked about its AI program, which should cut content creation costs and enable a higher-level subscription, which it’s just beginning to test), the approach is clearly working—at the end of the year, Duolingo had 16.3 million daily active users (up 62% from a year ago) and 4.2 million paid subscribers (up 67%), while engagement is up (more users are on Duolingo every day) and the base of users is very broad-based (all ages, all over the globe, etc.), leading to an enormous opportunity. But the best is yet to come for investors, with the top brass seeing the top line up 33% or so this year, while it’s aiming to keep expenses in check, allowing EBITDA margins to rise to 11% or so, up from just 4% in 2022. (Earnings are in the red but free cash flow is solidly in the black.) That news has helped the stock completely change character: After testing and holding the 60-65 area many times last year, shares perked up with the market in January, pulled back in February and went bananas after earnings, catapulting to 15-month price highs on its heaviest-ever weekly volume, and has continued higher since. This looks like the stock’s coming out party—we have DUOL on our watch list, and a reasonable rest or shakeout could have us entering.
Samsara (IOT 20)—So here’s a very big idea: Samsara is a software firm whose platform is built from the ground up to help outfits with large physical operations—think truckers, farmers, even transportation departments of cities and states—better manage their assets and see huge cost savings and efficiency improvements. For example, one big freight carrier uses the platform to get real-time data for its entire fleet (including telematics), video-based safety apps that offer in-cab alerts (reducing accidents and even exonerating drivers from false insurance claims against them) and reduce idling time (less gas), not to mention many of its drivers are now inputting reports digitally, eliminating paper-based nonsense. One state transportation department uses Samsara to help manage its 11,000 assets, using diagnostic data to be preemptive when it comes to servicing its fleet, which lengthens the lifespan of the vehicles. And taming insurance premiums is a big draw, too, with the company’s AI models able to analyze driver behavior and road conditions and proactively alert drivers to reduce the chances of an accident—and, importantly, record all the data so insurance firms can better underwrite the entire fleet. Given the size of the market, the possibilities are huge, and Samsara is just starting to ramp and land some “big fish” deals: In Q4, revenues of $187 million were up 48% from a year ago, while customers spending at least $100k a year with the firm rose 53%. Cash flow is still in the red but should hit breakeven by year-end 2023, and revenues are expected to rise 30% or more each of the next two years—which we think could prove very conservative should Samsara continue to reel in some bigger clients. As for the stock, IOT is a bit thinly traded for us, but it’s hard not to notice the recent action, with shares up nine weeks in a row and with last week’s earnings report seeing the stock gap up on 13 times average volume (a clue that historically leads to very good things). We’re not chasing it here, but it’ll be on our “back burner” watch list; a bit more liquidity and a bit of rest would be intriguing for this young stock.
Shoals (SHLS 23)—Solar stocks have been mixed at best in recent months; in fact, really only First Solar (FSLR—definitely the liquid leader of the bunch) has continued to make progress, while most stagnate, and some have fallen off a cliff. That said, given all the orders pouring into the sector (First Solar alone saw orders triple in 2022, thanks in large part to the green energy bill that passed last summer), we’re keeping an eye on the area with the idea that some secondary players are going to get moving at some point. Shoals remains one we’re keeping an eye on, and while the stock needs to show some strength, it does have a decent setup. And the story is enticing as well: The firm is the clear leader in electrical balance of system (EBOS) components and installation for solar arrays, which are required for every single solar project. While the products are mundane, the secret sauce here is the firm’s installation methods, which lead to huge time and cost savings: It doesn’t require licensed electricians, has more above-ground work and leads to less maintenance because there are 83% fewer connection points between all the different modules, boxes, gears and what-not. That’s why it’s the top dog and still taking share, and it’s only scratching the surface of its potential as it expands in the U.S., overseas, into battery storage and moves into EBOS for EV chargers, too. As it stands now, business is great and is expected to soar for many quarters—Q4 saw sales (up 97%) and earnings (15 cents a share up from a penny and six cents above estimates) come in red hot, with the backlog up 43% from a year ago (and 31% larger than 2022 revenues) and the 2023 outlook (revenues up 50%, EBITDA up 58%, analysts see earnings up 59%) very healthy. SHLS itself has been up (big earnings reaction last November) and down (convertible bond offering) since last summer, effectively going nowhere for seven months. That said, it’s still futzing around (a non-dilutive share offering this week hit shares), but if it can continue holding its 40-week line, it may not be far off from a sustained rally. A move over 30 and/or some decisive upside volume could be the sign that big investors (surprisingly, 599 funds own shares already, up from 403 nine months ago) are adding to their stakes.
Separate the (Usually New) Wheat from the (Old) Chaff
With more individual stocks starting to resist the market of late, now’s the time to really home in on the leadership stocks—not just in the market as a whole, but also within a particular theme. Of course, if the market keels over again, everything will come down to some extent, but our experience shows that the early leaders are often the ones that can have big, long-lasting runs as institutions build positions, so it’s always worth keeping a list.
Clearly, a big part of determining leadership comes down to examining the fundamentals, growth numbers and projections and overall story; doing that will usually eliminate the vast majority of pretenders out there. But beyond that, you can learn a lot by the stock’s own actions—the wheat will separate from the chaff over the weeks to tell you which names big investors are hesitant to sell and accumulating on every dip.
We wrote in the last issue about how chip stocks were looking solid, and how one of them, Axcelis Technologies (ACLS), looked like a fresh leader in the chip equipment space; that still appears to be the case despite a tough shakeout last week (after some Tesla-related news). A good way to see that is to compare the stock to another fundamental (and more well-known) name in the space that we had on our watch list a few weeks ago: ASML Inc. (ASML) looks OK, and will probably do well if chip stocks continue higher, but there’s no question the buying pressures are much stronger in ACLS.
Then there’s payment stocks—we’ve long believed that Shift4 (FOUR) could be the next leader in that space, which is why it was one of the first names we added to the Model Portfolio when the market’s clouds began to part in January. Meanwhile, you have Toast (TOST), the other upstart in the sector and competitor in the restaurant industry, but it’s fallen flat after a so-so Q4 report and outlook.
Even when you’re looking at homogenous groups—i.e., sectors that usually swim closely together—it’s usually best to look for the strongest name. Take the big airlines, for instance: Delta (DAL) and American (AAL) look solid, but United (UAL) certainly looks stronger on both a near-term (testing new recent highs) and intermediate-term (tagged 16-month price highs last Friday) basis, which makes us think it’ll be the one to own if the market firms up.
A couple of final points. First, our favorite stocks are really part of a theme of their own—inventing new industries or sub-sectors—so they’re not necessarily part of an existing sector. Axon Enterprises (AXON) is like that today, as it’s the only major player in safety and efficiency offerings for law enforcement. So that’s something to always keep your eyes open for.
Second, of course, there is never any surety in the market—maybe one of the new, fresh leaders tumbles on earnings while the old stalwart kicks into gear. It can always happen, but investing is an odds game, and the odds favor the fresher, stronger situations having a better chance at morphing into bigger winners should the market really take off.
Return of the Power Index?
Back in the 1970s, 1980s and early 1990s, our best market timing indicator was called the Power Index. There were a couple of varieties of it over the years, but the underlying theme was that it measured the rate of change in short- to intermediate-term Treasury yields over a few months—effectively using the market itself as a “tell” as to what (if anything) the Fed was going to do. When rates were heading higher, it was bearish, while lower was bullish. (One of the indicator’s best calls was a sell in the summer of 1987, even as the market was ripping higher—a few months later came the historic crash.)
Of course, during the past couple of decades, the Fed wasn’t a big driver of things, but that’s changed in the past year … and might mark a return to the time when interest rates were a bigger factor in market trends. To be fair, we’re not quite there yet—and even if we were, we’d still favor using the primary evidence (trends of the indexes, action of leading stocks, etc.). But it’s something we’ve been noodling around in case the environment really has changed.
Below is a chart of the yield on the five-year Treasury note, a length of time that embodies Fed expectations but also includes market expectations of what’s to come. Near the bottom of the chart is the 125-day rate of change (basically six months of trading). You can see that the peak in that yield so far came in October, but the six-month figure (the Power Index) never crossed the zero line; it came close in December and again in January, but the latest backup in rates keeps the Power Index negative, so to speak, with rates higher than they were six months before.
We’ll be keeping an eye on this measure (along with some other rates, like the two-year and 10-year notes, etc.)—a move above the prior highs (near 4.25% on the five-year) would likely be iffy for the market, but a decline back toward the early-year lows would not only be good to see, it would likely push the six-month rate of change negative … a buy signal for the Power Index.
Bigger picture, while we probably won’t be trading directly off these measures in the near term, we think the old Power Index could be a worthwhile arrow to have in our market timing quiver in the years ahead.
Cabot Market Timing Indicators
The five-week slugfest between the bulls and bears has started to take its toll on the evidence—our Cabot Tides are now negative and our Two-Second Indicator is on the fence, though the Trend Lines are bullish and the action of individual stocks (including growth titles) is still encouraging. Overall, we’re paring back a little but are also holding resilient names.
Cabot Trend Lines: Bullish
It’s not the strongest of uptrends, but our Cabot Trend Lines remain bullish, as both the S&P 500 (by 1%) and Nasdaq (by 2%) hover just above their respective 35-week moving averages—which, honestly, is solid action with interest rates ratcheting higher and, today, financial stocks giving it up. Obviously, if the nascent green light falls by the wayside, it wouldn’t be good, but so far, the fact that the major indexes are holding above longer-term moving averages is a plus.
Cabot Tides: Negative
It’s close, but today we’re calling our Cabot Tides negative, as four of the five indexes we track (including the S&P 400 Midcap, shown here) have stretched below their lower (50-day) moving averages. As always, we’ll take it as it comes; a big upside reversal from here would obviously be a good thing. But right here the intermediate-term uptrend has fallen by the wayside.
Two-Second Indicator: Neutral
Like everything else, the Two-Second Indicator has weakened of late—it’s now seen six days of plus-40 readings, and the figures are expanding a bit of late (today was near 80). Even so, the plus-40 readings started three weeks after the recent high (not usually what happens in a meltdown) and are still relatively tame compared to the readings last year. All in all, the broad market is taking on water but not cracking quite yet.
The next Cabot Growth Investor issue will be published on March 23, 2023.