Cabot Growth Investor Issue: October 19, 2023

The Setup Is There, but Need a Spark

Let’s start with the facts of the case, which haven’t changed much of late: At this time, the sellers remain in control of the major indexes and most stocks and sectors, too. Our Cabot Tides are clearly negative, our Two-Second Indicator tells us the broad market is weak, while the usual suspect of the past two years—interest rates—continue to head in the wrong direction. Shown here is the chart of the five-year Treasury yield, which lifted to new highs today along with the 10-year and 30-year yields.

Because of that, our advice and actions remain the same—we’re holding tons of cash (ideally in a good money market fund paying out a few percent annually) and waiting patiently for a turn, content to remain in a cautious stance until we pick up on signs that the Fidelity’s and T. Rowe Prices of the world have decided to start big accumulation campaigns that turn some of our indicators positive.

However, when taking a step back and looking at the big picture (see more later in this issue) or simply the past three months, we actually think the market has a solid setup: The July-October correction so far has been reasonable and led to a lot of normal-looking launching pads during that time. You had growth lead the way lower in July (horrible earnings season), but more recently, many growth titles are resisting the torrent of bad news out there—indeed, when the market perked up a smidge two weeks ago, we saw many resilient stocks push higher, with most holding their gains.

Then, of course, you have horrid sentiment with well-known worries (especially interest rates), as well as scary headlines (Middle East potential war)—all of which is fairly classic three months into a grinding correction.

To be clear, setups in the market are like getting a good pitch to hit in baseball—it’s good to see, but the batter still has to swing, make contact and drive the ball to the outfield to make good on it. In market terms, that means we still need to see upside breakouts (preferably on earnings as quarterly reports start to hit the tape) and a real uptrend in the indexes and leading stocks to make good on it.

The bottom line is that, if something can actually go right in the world—if any Middle East war is averted or minor, if inflation starts to cave in, if the uptrend in interest rates crack—we think the market could surprise on the upside and there could be a good number of stocks that get going right quick, and many more in the weeks ahead as all the bears out there change their minds and put money to work, and as the market looks ahead to brighter times six to nine months from now.

What to Do Now

Thus, we’re spending more time than ever honing our watch list and keeping an eye on the action of the market and potential leading stocks. But we still need to see that spark before putting any meaningful money into what remains a meat-grinder environment. In the Model Portfolio, we trimmed one-third of our position in Uber (UBER), leaving us with 68% cash, which we’ll hold onto tonight as we look for a change in character.

Model Portfolio Update

As we wrote on page 1, we feel like the setup is there for the market and many stocks—there are many launching pads out there that are much tighter (under control) than what was seen last year, and this comes even as most investors are very bearish and we head into a potential catalyst (earnings season). It’s a reason to keep attentive and not lose sight of the fact that, after a couple of tough years, there are many big-picture positives (see more later in this issue) that could lead to the sustained advance we’re all waiting for.

That said, setups are good to see—but to really floor the accelerator, we need to see those setups bloom into something. And on that front, not much has changed during the past two weeks, with our Cabot Tides, Two-Second Indicator and Power Index (trend of interest rates) all negative, and with the number of stocks hitting new highs remaining tiny even when the market perks up a bit.

The positive news is that, through pruning our laggards and holding (some or most of) our resilient names, we still think all of our stocks could help lead the next upmove. But, as always, we need to see the buyers show up before putting much money to work—right now, the Model Portfolio is holding a huge 68% cash position, which we’re maintaining tonight.

But stay tuned: We remain flexible, so if earnings season goes well and a bullish spark can be lit for the market, we could be putting money to work soon. For now, the bulls still have more to prove.

CURRENT RECOMMENDATIONS

CrowdStrike (CRWD)—CRWD is certainly one of the top liquid leader candidates among growth stocks should the environment turn for the better, with the story, numbers (including honest-to-goodness earnings and free cash flow growth), liquidity and chart (new relative performance line peak yesterday) that points to it being a magnet for institutional money—and, as we wrote last week, it’s a plus that the cybersecurity group as a whole is acting well, with names like Zscaler (ZS) and Palo Alto Networks (PANW) coming alive. There hasn’t been much new on the news front, though some are picking up on a couple of good-sized insider sales; we’re aware of that, but historically speaking, insider sales (which can occur for a variety of reasons) are not a great predictive tool for a stock—what counts most is the perception of big investors, and right now, that crowd is thinking positively. Earnings here won’t be out until around Thanksgiving, which reduces some event risk. All told, we’re holding onto our half-sized stake and we’ll be eager to fill out our position—if the market kicks into gear and the stock remains a top actor. Right here, we’ll stay with a Buy a Half rating, thinking those who don’t own any can grab a small position here or (preferably) on dips of a few points. BUY A HALF

DraftKings (DKNG)—It’s been a tedious stretch since the Penn National/ESPN announcement in early August, but given the market, DKNG is still doing its best to hang in there, with a strong snapback into mid-September and, even after today, a higher low compared to late September. In other words, this is still one of the reasonable (12 weeks long, 26% deep) launching pads we see out there, so if the market and earnings (due November 2) go well, the stock is still in position to break out and move. It’s worth noting that ESPN Bet is still in the works and reportedly will launch by Thanksgiving, so that could have an impact on DKNG, good or bad, depending on any initial numbers that come out. All in all, the big-picture outlook here is positive, but with the stock in the middle of its three-month range, we’ll play it by the book—a break toward the August low could have us bailing, but any sudden show of strength could get things finally moving on the upside. For now, we’ll sit tight with our half-sized stake. HOLD HALF

Noble (NE)—NE has been struggling, with it (and most offshore drilling peers) seeing its share price languish even with oil prices rebounding back toward their highs. Still, today’s support after an early dive is a positive sign, and longer term, we do think the group will do well. And as the leading player, Noble will thrive—but the company is not the stock, and with a loss we’re not willing to give the stock too much more rope. We sold one-third of our holding before, and we’ll hold the rest for now, albeit with a very tight mental stop in the 46 to 47 area. HOLD

ProShares Ultra S&P 500 Fund (SSO)—The S&P 500’s early October bounce ran into a wall south of its 50-day line, though to be fair, it’s holding up fairly well in recent days given the fears of a Middle East war and continually rising interest rates. The longer it can hold above the lows, the better the chance it can move higher and have a chance at turning the intermediate-term trend up, especially given the positive longer-term trend and some of the big-picture positives out there. But at this point, you know the drill: We’re OK holding onto our small-ish position here, but a dip below recent lows (and below the longer-term 200-day line in the S&P 500) could have us trimming some or all of what we have left. HOLD

Uber (UBER)—In the last issue we wrote about how UBER was one of a decent number of stocks that had been etching higher lows, even as the major indexes were doing the opposite—but that pattern changed last week when the stock dipped below its August low, which prompted us to sell one-third of our position. Supposedly, the decline could be attributed to a lawsuit in France from taxicab drivers, though we doubt that given that the firm has faced numerous suits and regulatory actions over the years—but either way, the weakness had us trimming the position. Now, to be clear, the chart is far from a horror show, as UBER stands just 13% or so below its recent highs with even the “sharp” selling coming on average weekly volume. Thus, we still think the next big move could be up given the fundamental positives (earnings, due November 7, will have a big say in that) and are OK giving the rest of our shares some more wiggle room—though we also want to see some support show up soon to indicate big investors are buying the dip. Having sold some, we’ll hold the rest here and see what comes. HOLD

Watch List

While little has let loose on the upside, many stocks are still doing their best to hang in there, resulting in longer launching pads being formed. If the buyers really show up—a big if—we think there could be some breakouts in relatively short order, but as always, we have to see it first before acting on it in a major way.

• Eli Lilly (LLY 591): Lilly is obviously a giant pharmaceutical blue chip, which makes growth a challenge—but it looks like its weight loss drug (along with Novo Nordisk’s (NVO) offering) has the potential to be one of the biggest sellers in history, which could drive the bottom line significantly higher in the years ahead. To be fair, the story is becoming well known, but the potential is giant. See more below.
• Gitlab (GTLB 47): GTLB is now 14 weeks into a 24%-deep consolidation, holding above longer-term support. While there’s competition, the firm’s DevOps platform seems best in class for many functions, with 30%-plus top-line growth for a long time to come while profits have just arrived.
• Nutanix (NTNX 37): NTNX is one of the best-looking growth stocks out there, with a fresher subscription story and longer-term outlook of booming free cash flow for years to come. We’re tempted to start a small position on a bit more weakness given our cash hoard.
• Procore Technologies (PCOR 65): We’ve followed PCOR for more than a year as it’s etched a series of bases as business cranks ahead—and with construction spending going nuts, its cloud offering should continue to sell well. See more below.
• Remitly (RELY 27): After a dip with the market late last week, RELY held its 50-day line and lifted back to higher highs (including a new high today) on a pickup in volume. It’s still a bit thin, but the story and relative strength are impressive. Earnings are due November 8.
• Vertiv (VRT 37): VRT’s recent breakout has faltered, but we’re not willing to say the overall uptrend has failed despite the market-induced dip of late. AI should be a boon here, but it comes in concert with an easing supply chain, both of which should drive margins much higher; analysts see earnings next year of $2 per share. The Q3 report is due October 25.

Other Stocks of Interest

Eli Lilly (LLY 591) and Novo Nordisk (NVO 98)—It’s been a challenging year in the market for the vast majority of stocks, but what’s interesting is we’ve seen a couple of real potential fundamental game changers. The first, of course, was AI, a movement that definitely has legs and will likely boost demand for specific chips, storage solutions, networking gear and more—not to mention helping to boost productivity of those outfits that use it. However, now we’re seeing a second potentially revolutionary offering, this time concerning health: Both Eli Lilly (drug called Mounjaro) and Novo Nordisk (symbol NVO; drug will be marketed as Wegovy) have treatments that look like they’ll provide breakthroughs on weight loss, with studies showing 15% (by Wegovy) to 27% (Mounjaro, though this included some lifestyle intervention, too) average weight loss over one and a half to two years (the weight stayed off with people who stayed on one of the drugs). It does so by activating certain receptors in the body that boosts insulin secretion, changes the rate at which your stomach empties and thus makes you feel more full, suppressing appetite. Of course, this isn’t just about looking better—the potential health benefits are real, too, with one study of Wegovy showing a 20% drop in the risk of certain cardiac events; data like that is one reason why insurance companies are likely to hop on board, feeling that even the high cost of treatments (Wegovy is $16,000 per year) will be offset by lower payouts for deadlier diseases down the road. (Amazingly, many medical device and other stocks have been hit as the market is starting to discount less need of these types of services down the road; yes, it could be an overreaction, but it tells you about the wide-ranging potential here.) Right now, both are taken daily by injection, though studies are underway for a daily pill, too, with early signs showing similar positive results. Right now, both drugs are on the market for diabetes, but Wegovy is FDA-approved for long-term weight management, and demand is so strong that supply is limited; the firm just upped its 2023 sales guidance (up 35% vs. a prior view of 30%) mostly on strong sales of the drug. Mounjaro from Lilly is likely to be approved officially for weight loss later this year (though it’s already being prescribed off-label), and given all the evidence, expectations are huge—a couple of investment houses think 10 million Americans might be on one of the drugs by 2026, with a potential of $100 billion in sales for these treatments (!!!) by 2030. Both Lilly and Nordisk have been showing excellent growth, and estimates call for 20% to 30% earnings growth expected (likely conservative). Both stocks broke out powerfully in early August, and after a tough September shakeout, LLY and NVO stormed back to new highs on big volume as the pressure briefly came off the market. Now, one word of warning that comes from a history of big drug launches—oftentimes the best part of the move happens before the approval (the Romance phase, so to speak); we remember Pfizer (PFE) had years of bullish performance into early 1998, but the stock effectively topped soon after the actual launch of Viagra despite massive uptake soon after. Even so, given the market has been mostly on its knees for a couple of years and the recent action from both LLY and NVO, we’re intrigued—of the two, we slightly favor LLY, mostly because it’s an American firm (less foreign currency impact on results, more sponsorship) and the trial results seemed a bit better, too, but both are moving nearly in lockstep. While we do think a good entry point will be key, we have LLY on our watch list; both of the companies’ earnings are due November 2.

Procore Technologies (PCOR 65)—We’re anything but macroeconomic people, but one of the things holding up the economy in the face of many headwinds is a boom in construction activity: It’s not reported much, but after-inflation manufacturing construction spending is up north of 50% during the past 12 to 18 months, while high-tech-related construction spending (chip facilities, etc.) is up something like 2.5-fold during the same time. Near term, that should continue to play into the hands of Procore Technologies, which is one of our favorite IPOs of the past few years that’s come through the bear phase and could be primed to get going. (We’ve written the stock up three other times since we started following it more than a year ago.) The firm is a cloud software operation built from the ground up for the gigantic construction industry, helping every phase of a big project operate more efficiently—before the project starts, it can help with bid management and pre-qualification; during the project, it allows the myriad stakeholders (owners, architects, financiers, general and specialty contractors, etc.) to be on the same page where they can easily share information, adjust timelines and input/share the never-ending change orders to save time and money, while also automating much of the financials, invoice management and accounting. (There’s even some newer insurance offerings and a payment service allows the massive amount of money that needs to be funded and paid to be managed in one place.) Importantly, the platform doesn’t charge a per-user fee, encouraging everyone to hop on board, instead making money based on the size of the project. It’s working, with the firm now having 15,704 customers (up 4% sequentially), with a 94% gross retention rate in Q2, and those clients are using the platform in a big way, with more than 400,000 monthly app users and more than one million monthly web users. Procore is the clear leader here, and while the economy can have some impact, the top brass has said the projects it’s mostly used for are huge and long-term, so a soft spot isn’t affecting things much. As for the numbers, growth is slowing a bit as Procore becomes a good-sized outfit (revenues of $229 million in Q2, up 33%), but the bottom line has nosed into the black the past two quarters and margins should expand at a quicker pace if revenues slow further. As for the stock, it’s a great example of what we’re seeing in many nooks and crannies out there—the initial bottoming base last year was 37% deep, while the springtime rest was 25% deep, and now the latest launching pad has been just 21% deep. Earnings are due November 1, and a breakout could finally prove to be the green light for a sustained advance.

Wanted: New Highs

It’s been more than 30 years since we started following the number of stocks hitting new lows closely—in the early 1990s we came up with the Two-Second Indicator, and while no measure is perfect, it continues to do a great job of telling you in real-time the health of the broad market. When the readings are elevated day after day, it means the odds of a sustained advance are low given that the sellers are in control of much of the broad market.

Conversely, a rapid and persistent dry-up in the readings will often be one of your first signs that the sellers have run out of ammo and the buyers are taking control. Long story short, when it comes to market timing (especially after a long down/sluggish period as we’ve seen), our Two-Second Indicator is a must-watch.

The number of new highs, on the other hand, is usually contrary—very few numbers of new highs day after day, for instance, is a sentiment sign in and of itself, in fact, that could be a good sign when looking out a couple of months: As we’ve written a few times, there have been very few stocks hitting new highs during the past couple of months, so much so that we’re approaching levels seen near prior major lows.

Still, while we’re all for encouraging secondary indicators, the reason we’re writing this today is because given where the market stands, we think a pickup in new highs will be vital for flagging a truly healthy advance. For much of the past two and a half years, we’ve seen consistent selling on strength with stocks that are trying to get going. We saw a respite from that in May and June, but the readings never got huge, and the past few months have seen a return to the same-old selling pattern.

The good news is that the July-October decline has seen a lot of names (including some we own or are watching) correcting and consolidating normally after getting off their duffs in the spring. Hence the new high figures: If and when we see the market getting moving, seeing the number of new highs jump quickly from their bone-dry levels will not only confirm the market’s move but tell you that leadership (not just junk stocks that are down 50% to 75%) is kicking into gear. We’ll be watching closely.

Many Reasons for (Long-Term) Optimism

If you’ve been investing, there’s no question the past couple of years—and really back to early 2021 for growth investors—have been a grind, with lots of false rallies, plenty of air pockets, huge rotations in the blink of an eye and more news-driven moves (often due to Fed speeches or hints) than you can count. And, frankly, after the promising spring upmove, the last three months of correcting and consolidating have been tedious as well.

We’re not ones to trumpet sunshine, obviously; we’re holding a ton of cash right now and have been cautious for most of the dry times. But we firmly believe now isn’t the time to get down in the dumps—there are reasons for optimism out there.

The first involves the market itself: At the end of last week, the Nasdaq had made no net progress in 33 months (since January 2021!), and of course, during that time many former glory names have been taken out and shot months ago—all of which means we’re not in the second or third inning of this process, but likely the seventh, eighth or ninth. We’d say the same thing if growth stocks had been chugging ahead and acting well for nearly three years—you’d be later in the cycle.

The second reason is all that goes along with the long dry spell: Big-picture sentiment, including things like consumer confidence, money flows and longer-term averages of market exposure, is horrible, in some cases on par with other long bear phases. That makes sense given the scare-you-out action in 2022 and, in large part, the wear-you-out action for much of 2023.

Then there are the numerous big-picture studies we’ve written about before. We’re not going to rehash them all, but whether it’s sentiment or the market action (big bear, big bottom, and some upside earlier this year), it portends bullish things in the months ahead. Here is a chart from SentimenTrader.com that shows one of them—when the yearly change in margin debt dips to a minus 25% and then returns to 0%; it’s not a common occurrence, but when it happened, it always did before or during prolonged rallies.

Next comes something we mentioned in the section above: While the past three months have been no fun, tons of stocks are etching “normal” launching pads, as opposed to falling-off-a-cliff action seen in 2022 and even earlier this year. Earnings season is a wild card, of course, but it wouldn’t take weeks’ worth of strength to get many names to new high ground.

Finally, there are the fundamentals itself—we don’t trade off economic reports or data (the reason: It doesn’t work well), but it’s fairly obvious that the Fed looks to be finally done (or nearly done) with its tightening phase, that inflation has calmed down and should fade further and that the economy overall is still fairly resilient. (Granted, Treasury rates seem peppier than we’d like, so that is a fly in the ointment.)

The market is a tricky animal that forces you to often carry two thoughts simultaneously. Right now, that means listening to the iffy evidence and remaining cautious—that’s most important. But it’s also important to keep in mind some fairly straightforward longer-term positives so we’re ready to pounce if the market kicks into gear and earnings season launches some fresh leaders.

Cabot Market Timing Indicators

Many stocks are set up nicely as we head into earnings season, but the actual supply/demand balance hasn’t shifted—while the longer-term trend remains stubbornly up by our measures (a very encouraging sign given all that’s been thrown at the market of late), the intermediate-term trend is down and the broad market is still on the outs. We’re OK with a nibble or two, but we’re staying cautious until the buyers prove something.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines turned bullish back in January, and despite a ton of worries and iffy technical action, they remain positive today, with the mini-test two weeks ago holding so far; today the S&P 500 is right on its trend line and the Nasdaq (by about 1.5%) is above its 35-week moving averages. That doesn’t guarantee anything, but the longer the Trend Lines can remain bullish, the greater the chance that the next big move is up.

Cabot Tides: Negative
Our Cabot Tides, on the other hand, are still clearly negative, with all five indexes (including the S&P 400 MidCap, shown here) in a bearish stance. Looking ahead, the lower 25-day moving average is dropping off days from mid-September, so we’d need to see a 4% to 5% upmove from here and/or a couple of weeks go by for that moving average to turn up, which would trigger a green light. Right now, though, there’s no question the intermediate-term trend is down.

Two-Second Indicator: Negative
Our Two-Second Indicator could only see one day of fewer than 40 new lows during last week’s market bounce before the readings came on again. A small positive is that the recent new low figures (340 or so today) are much less than what was seen earlier this month (450!). Thus, we have very short-term resilience, but like so many other measures, now it’s a matter of seeing if the market can truly build on it.

The next Cabot Growth Investor issue will be published on November 2, 2023.