Cabot Growth Investor Issue: October 5, 2023

Tide Still Going Out—but Stay Alert

You can talk about rates, the economy, the Fed, the U.S. dollar, oil prices and political shenanigans, and we admit that with information more easily accessible then ever, we peruse our share of interesting—albeit often complex and tertiary—data points.

But in the market, it’s usually best to keep things simple. And today, thanks in large part to skyrocketing interest rates, the market’s tide is still going out, and that holds true whether you’re looking at the indexes (all of them clearly below their 25-day and 50-day moving averages), individual stocks (87% of the S&P 1500 firms were south of their 50-day lines coming into today) or just about any other measure of the broad market (yesterday saw the fewest combined new highs since July 2022!).

Translation: The sellers are still in control, and so we’re sticking with a cautious stance—we’ve been holding north of 40% cash for weeks, had more than 50% since the last issue and pruned further earlier this week, resulting in nearly two-thirds of the portfolio on the sideline. We’re determined to stay very close to shore as long as the market is dishing out punishment.

With that said, we still see more than a couple of reasons to stay alert. First, despite all the damage that’s been done, the longer-term trend remains up for the big-cap indexes, which is noteworthy. Second, the reason for the decline (mainly rates) is very, very obvious, contributing to horrid sentiment. Third, that sentiment is producing some truly extreme oversold readings, which aren’t our favorite measures, but serve as “alerts” should the market start to meaningfully turn up. (See more later in this issue.)

And fourth and most important to us, we’re still seeing a good amount of resilience from growth stocks as the days have passed—a number of individual leaders (or potential leaders) have held above their August lows, unlike the major indexes, and even the Nasdaq itself has been holding its own against most other areas, be it defensive stocks or big-cap indexes like the S&P 500 and Dow Industrials.

Obviously, we’re not acting on these factors right now, as good-looking stocks can go bad in a hurry in bad markets. But the point is to stay alert—should the market kick into gear (October is often a month of bottoms), a sustained rally could finally be upon us given all the worries out there. Thus, the game plan is to be cautious for now—but ready to move if the market changes character.

What to Do Now

Right now, we’re respecting the market’s extreme weakness and staying mostly in cash, though we’re also trying to hold onto some or all of our stakes in stocks that are resisting the decline. This week, we sold the rest of our small position in Celsius (CELH) and one-third of our position in Noble (NE), leaving us with 65% cash. Details below.

Model Portfolio Update

The Model Portfolio has been in a cautious stance for weeks and has had more cash than stocks since the last issue, which has been a good thing—but the market’s relentless, interest rate-induced decline has left nowhere to hide, with nearly every nook and cranny of the market coming under pressure.

These situations are always tough from a portfolio management point of view—with a good amount of cash, we prefer not to sell down to the nub and be left with nothing if the market rallies, but “holding and hoping” is rarely a good idea, either. Thus, we’ve been pruning while and trying to give our resilient names (we have three by our measures) some rope.

The sale of the rest of our small CELH position and one-third of NE leaves us with 65% on the sideline, which we think makes sense here. We’ll pare back further if the selling pressures reassert themselves in a big way, but frankly, given some big-time oversold readings, pessimistic sentiment measures and our cash hoard, we’re not ruling out a nibble as we think the wheat may be separating from the chaff at this point in the downturn (see more on that later in this issue). Tonight, we have no further changes as we remain mostly patient for the sellers to run out of ammo.

CURRENT RECOMMENDATIONS

Celsius (CELH)—We’ve been highlighting the giant potential for Celsius going forward now that the Pepsi partnership is in full swing, and our thoughts on that haven’t changed one bit—we think the deal with Pepsi effectively gave Celsius a fresh leg to its growth story, similar to how an entirely new product line would to another company. That said, the company is not the stock, and while not a total horror show, CELH has fallen apart in short order after a big run, including some sharp follow-on selling this week (as opposed to some other, sturdier growth names). That doesn’t mean the stock is set to get cut in half, but even if it does find support, shares will likely need plenty of time to consolidate the prior move. As we wrote at the outset, the growth story here is rare and next year’s move deeper into international markets could supercharge results; we’d also say that, while not in the same category as toilet paper or toothpaste, energy drinks have shown resilience even in tough economic conditions. Thus, if CELH can round out in the weeks/months ahead, we definitely could revisit it—but we have to deal with the here and now, so given the market environment and the stock’s action, we decided to throw the rest of our shares overboard on a special bulletin earlier this week. SOLD

CrowdStrike (CRWD)—With 90% of stocks below their 50-day lines and broader indexes looking awful, there’s not much at all that’s truly “strong” in this market. But CRWD is fighting the good fight, testing new high ground (and registering a relative performance (RP) peak) on Monday before falling back; overall, the stock’s been etching higher lows during the past few weeks, in contrast to the major indexes and most stocks and sectors. (See more on identifying relative strength in today’s market later in this issue.) Of course, good stocks can go bad in a hurry in bad markets, so we’re not complacent, but it’s hard not to be encouraged, especially given the fact that the top brass only recently upped its longer-term margin targets, essentially saying it expects to be far more profitable than previously thought in the years ahead even as top-line growth remains solid. We’re trying to give CRWD room to maneuver given its resilience—we’re holding onto our half-sized stake. And if you aren’t yet in (and have plenty of cash in your portfolio), we’re not opposed to picking up a few shares on the current dip. BUY A HALF

DraftKings (DKNG)—DKNG continues to thrash around, and two or three more points on the downside could damage the chart and have us selling, taking a small profit and holding the cash. But, despite the volatility, the stock has been hitting higher lows since August and looks like one of many charts out there that, if it sees a few good days (a big “if,” of course), it wouldn’t be far from a legitimate breakout. In the meantime, all signs are that business remains in good shape—in fact, the Taylor Swift/Travis Kelce hookup has drastically boosted online prop bets on Kelce (a dynamic tight end for the Kansas City Chiefs) the past two weeks, while opening for business in Kentucky late last month should help the cause both near term and over time. The bottom line is that the story and numbers are there for a sustained rally after the past two months of base building, but we have to see if the market will allow DKNG to get moving. We’re sitting tight with our half-sized position for now. HOLD HALF

Noble (NE)—NE is another example of “the company is not the stock,” as oil prices are still north of $80 despite a recent dip, the demand for offshore rigs is set to outpace supply next year and Noble’s earnings, free cash flow and shareholder returns (2.5% current yield, but should be raised as business improves) are all almost sure to increase in a big way in the quarters ahead. Despite that, the stock has stagnated and, this week, broken through some support, which had us selling one-third of our position in a special bulletin on Wednesday. Now, overall, the chart isn’t a horror show, with shares “only” 13% off their highs and the relative performance (RP) line even closer to new high ground; thus, we’re OK giving our remaining shares a little more rope, seeing if the dip morphs into a shakeout. But we do have a relatively tight leash in place so we won’t ride NE down the chute in case the trend in oil stocks is truly cracking. SOLD ONE THIRD, HOLDING THE REST

ProShares Ultra S&P 500 Fund (SSO)—After the post-Fed market breakdown two weeks ago, we sold one-third of our stake in SSO—and a couple of trading days later we sold a third of what we had left, leaving us with about 45% of what we had. And, really, we might sell the rest soon … but we’re holding on for the moment. The reason is that (a) we’re already north of 60% cash, and we’re not eager to simply sell everything, as well as (b) the S&P 500 is both very oversold (see more later in this issue) and near support (200-day line). There’s no surety in the market, of course, but given that we just sold more than half our stake, we think taking a breath and seeing if SSO can bounce (and if it does, how well it bounces) makes sense. HOLD

Uber (UBER)—UBER remains tedious, slipping periodically when the market sells off, but so far, it’s another one of our names that’s been holding above its August low. While there hasn’t been much news from the company in recent days, management’s bullish tidbits about business (relayed at some conferences in September) certainly helped investor perception and boosted the view that official EBITDA and free cash flow targets (released many quarters ago) should prove conservative in 2024. If the stock falters from here, we could trim our position (UBER is one of the few we haven’t trimmed), but right here, we’re sitting tight. HOLD

Watch List

There’s no question a lot of damage has been done to the market, but we’re still finding a good number of growth-y titles that are holding up decently and, should things turn, could be ready for breakouts fairly quickly. We’re not going to jump the gun in any big way—but we’re continuing to fine-tune our watch list so we can pounce when the next uptrend begins.

• Axcelis (ACLS 159): To be fair, ACLS needs to find some support soon or else the action of the past few months is going to look like a major top. Right now, though, this looks like a normal base-building effort after a big run, and there’s no sign that demand for its Purion line of chip equipment (perfect for SiC chip production) is suffering.
• Duolingo (DUOL 164): DUOL continues to impress as the stock has etched much higher lows during the correction and even nosed to new highs last week before pulling back in—it certainly looks like the prior few months of correcting and consolidating wiped out the weak hands, with investors looking ahead toward surging free cash flow growth. See more later in this issue on DUOL’s relative strength.
• Nutanix (NTNX 35): NTNX looks like another basketball underwater, with the stock refusing to pull in at all. The firm is a core IT infrastructure player and, with its move to a subscription model complete, free cash flow should soar for many years to come. See more below.
• Nvidia (NVDA 447): NVDA is the flag-bearer of the AI group, which has clearly taken on water of late, but this stock is still holding up very well and estimates are out of this world. We’re keeping an eye on it as the past few months of ups and downs could be enough to recharge the stock’s batteries. See more later in this issue.
• Remitly (RELY 26): It’s still a bit thin, but RELY has been a port in the market’s storm, not even dipping to its 50-day line and trading calmly and under control. There is some competition, but the firm is one of the leaders in bringing the remittance industry into the 21^st century. We think there’s huge upside potential.
• Vertiv (VRT 38): VRT is now five weeks into a very modest rest period given its monstrous run earlier this year. The demand picture for its various data center offerings should accelerate, and a modest valuation doesn’t hurt the cause.
  
  

Other Stocks of Interest

Nutanix (NTNX 35) — We wrote a bit about Nutanix a couple of issues ago in the context of its business model transition—the move to subscriptions has taken a while but is just starting to produce growing free cash flow and lower expenses (especially around renewals; sales and marketing expenses have plummeted as a percent of revenues during the past three years), and that’s a big attraction. Indeed, Splunk, which we mentioned in that same write-up, got bought out by Cisco soon after our mention; we’re not predicting any takeovers, but the story here is great as well and the firm’s latest Investor Day last week revealed some bullish long-term projections. What we like here is the broad applicability of Nutanix’s offering: The firm’s cloud platform powers a client’s entire IT infrastructure (it can power basically any IT deployment), including all apps, data and workloads (including AI and machine learning), allowing them to easily run and to be moved between different cloud environments (including private, public or multi-cloud situations)—as management says, they have one software platform for all apps and data, anywhere. The result is that all of a client’s apps/programs are run where they should be for much lower cost; independent studies show a 43% lower total cost of ownership over five years and a payback of just 12 months. Not surprisingly, tons of firms have signed up (24,550 clients, up 9% from a year ago), including a slew of giant ones (2,183 pay more than $1 million per year; 359 pay more than $5 million annually), nearly all stick around (90%-plus gross retention rate), all of which is leading to very solid recurring revenue growth (up 30%). And now that the move to a subscription model is well underway, the top brass sees rapid and reliable growth for a long time to come: The firm sees its annualized recurring revenue doubling during the next five years while revenue grows a total of 75% and free cash flow expands nearly four-fold (and comes in at around 24% of revenue). As always, longer-term outlooks are far from sure things, though it’s worth noting that Nutanix released some projections two years ago and actual results have been miles ahead of those despite the tough tech environment. All told, then, you have a firm that’s very well-situated in a huge and growing market, and earnings and free cash flow are set to really take off. NTNX had a big off-the-bottom move in the second half of last year before etching a long nine-month launching pad—but the August quarterly report gapped the stock to 21-month highs and, so far, shares are holding up extremely well. NTNX is on our watch list and we think it could be a magnet for institutional money once the market gets going.

Braze (BRZE 46)—In the old days, marketing was limited to TV ads, bulk paper mailings and even inserts in newspapers, but obviously the move to email, smartphones, tablets and even digital watches has made consumer engagement a sector of its own. Braze is positioned to be one of the leaders here, with a broad-based platform that helps tons of big brands stay in touch and prompt users with real-time, personalized content. Of course, Braze isn’t the only one aiming to do this, but one of the big differences is that the competition is mostly focused on single-channel solutions (meaning the product helps only with email, etc.), which creates disjointed marketing programs. Braze, though, covers all channels (in-app messages, in-browser messages, email, texts, notifications, WhatsApp messages and more) using its proprietary processing system that takes in first-party data (information collected directly from users) and reacts/responds immediately. For example, Venmo might alert a user in-app or via email about a new product, use an email to let them know a new card is on the way, have a phone notification encourage them to take advantage of a deal and prompt them (again, in-app, email or text) about completing their profile if need be; the result is greater customer engagement and likely sales, and it’s all easily done with Braze’s platform. The numbers here are solid (revenues up 34% last quarter, which was a slight acceleration from the prior quarter; total clients up 22% from a year ago; 20% same-customer revenue growth), but what’s more eye-opening is the client list, which includes big names across a variety of sectors, including Venmo, HBO Max, Burger King, 1-800 Flowers, DraftKings, FanDuel, Grubhub, Nascar, KFC, Samsung, IBM, Pizza Hut, the NBA, Peloton, Shake Shack, CVS, Stubhub, Ralph Lauren, Etsy, GoFundMe, Stubhub and tons more. Big picture, it’s likely every consumer-facing firm will want a multi-channel marketing offering like this, so if Braze can stay in the lead, there’s no reason it can’t continue to collect more huge accounts. BRZE bottomed about a year ago, picked up steam in the spring and, unlike most everything else, sprung to higher highs in August (after a solid quarterly report) and the dip since then has been more than reasonable. It’s a bit thinly traded for our tastes right now, but sponsorship is picking up in a big way (245 funds owned shares at the end of September, up from 123 three months ago) so that may change soon.

Inari Medical (NARI 66)—We first dug into Inari Medical back in early 2021, near the glamour stock peak, and sure enough the stock is much lower today even as the company has grown steadily and recently turned profitable. But the story remains sound and the firm has only scratched the surface of its potential; we’d go as far as to say Inari could be an emerging medical device blue chip of sorts if it keeps on the right path. The big idea here revolves around the difference between clot removal in arteries (higher flow and pressure and softer clots) and veins (harder clots, lower flow and pressure)—and yet most veinous clots are either treated with drugs (which are higher risk, expensive and don’t work great in general) or, when it comes to surgery, use re-purposed arterial devices. Inari, though, has focused solely on innovative veinous clot devices and removal systems (led by ClotTriever and FlowTriever), which allow for quick procedures with minimal blood loss and, for the hospital, no big capital equipment buys or ICU stays are necessary. Importantly, Inari is thinking big, aiming to change the entire standard of care for veinous clots, which it believes is an $8 billion market opportunity in the U.S. alone. Patient outcomes are much better, and as the products have become more proven and as Inari has boosted its sales force, sales have cranked ahead—in Q2, sales were up 28% while the bottom line leapt into the black for the first time (operating income was breakeven while interest income helped), with analysts seeing earnings lifting off in 2024, with estimates likely conservative given the history of huge beats (Q2’s earnings of four cents per share topped by 17 cents). Throw in more new products and the fact that the firm is just getting going overseas ($5.2 million of overseas revenue in Q2, up 187%) and there should be a long runway of growth ahead. As for the stock, it was basically cut in half from early 2021 to mid-2022 and had a never-ending bottoming process, with retests in February and July of this year. But NARI reacted well to earnings in early August and, while it hasn’t put on a great show, it’s held up since then. A powerful move above 72 or so with a fresh market upturn would be bullish.

A-B-C Relative Strength

About the only good news about a market correction is that you usually get to see the wheat separate from the chaff—you can more easily spot the stocks that big investors are hesitant to sell and/or buying on dips, compared to the stocks and sectors that they’re aggressively selling on any minor bounce. While most look for the beaten-down “bargains” during a correction, if you’re more of a position trader (intermediate- to longer-term, etc.), you’re usually better off staying focused on the stocks holding up well.

Many times the stocks that are holding up well are defensive-type names, so you still want to look for great numbers and stories. Still, there’s no confusion about that today, with even defensive areas like consumer staples (XLP) being some of the worst performers in recent weeks.

When it comes to spotting relative strength during a downturn, it’s best when the major indexes have etched two or three different short-term lows. That’s what we’ve seen during this downturn—there was the leg down into mid-August, and after a rally, we’re in the midst of another leg down to lower lows. And, even after a mini-bounce late last week, the sellers have come on again, with most indexes again hitting lower lows.

That sets up an A-B-C relative strength test—simply put, you’re looking for growth stocks that (a) didn’t get completely taken apart in August, and (b) have been etching higher lows at the September October lows. (The more important part is holding the August low—a lower Sept./Oct. low is good to see but not a strict requirement.) Of course, sometimes things that are holding up well today fall apart in a few days; that’s part of the process. The key is to keep up the list so that, when the market finally turns up (which it will), you’re on top of the most resilient names—many of which will take off in a hurry.

A perfect example of this is Duolingo (DUOL), which we’ve been following for months and wrote about in the last issue. The stock actually corrected for a couple of months into its August low near 120 and then had a huge rally—so that the September shakeout occurred at much higher levels (148 or so). When the pressure came off the market, the stock again spiked late last week, and this week’s dip as found support at much higher levels than last month (157). The longer this pattern holds, the greater the odds that DUOL is a loaded spring ready to move up—it’s near the top of our watch list. WATCH

AI flag bearer Nvidia (NVDA) is another example—the low in August was around 403, and the stock actually rushed to new highs near Labor Day (obviously much stronger than the indexes). The September low area was near 410, and so far, this week’s dip hasn’t come close to that level. If the stock continues to hold up in this horrid market environment, it likely has more gas left in the tank despite what’s already been a great year. WATCH

Other names like this that we’re watching include Nutanix (NTNX, written about earlier in this issue) and Vertiv (VRT), and in the Model Portfolio, CrowdStrike (CWRD), DraftKings (DKNG) and Uber (UBER) have adhered to this pattern—again, things could change, but so far, it’s a good sign for these names. And more broadly speaking, this sort of straightforward relative strength analysis should point you toward leaders of the coming sustained advance.

Getting Climactic

When we started our career, we paid a lot of attention to oversold-type indicators, even coming up with a couple of our own to help us lean against the wind when stocks were near a low point. However, over time, just about everyone in this business realizes these indicators have some use, but oversold can often (and in bad declines, usually does) become more oversold.

Thus, we look at oversold indicators only when, first, they’re truly extreme, and second, we view them as “alerts,” meaning they could prove actionable—if the market confirms them by taking off on the upside.

We’re clearly not filling that second criteria at this point, but we are beginning to see some true extremes when it comes to breadth—which makes sense given how weak the broad market has been. One is the percent of S&P 500 stocks above their respective 50-day lines: On Tuesday, the figure slipped below 10% (less than 50 out of 500 stocks closed north of their 50-day lines), which is rare even in bear environments.

In fact, even in 2022’s bear market, there were “only” 14 trading days that saw fewer than 10% of S&P 500 stocks close above their 50-day lines, with the readings coming in two clusters—mid-June, and late September/early October. Both preceded good-sized rallies. And it’s a similar picture going back further, with March 2020, December 2018, October 2015/January 2016 and more all seeing sub-10% readings, and all giving way to either good rallies or powerful sustained advances.

Hence the title of this section: With the well-known bond market meltdown, the latest plunge in stocks seems to be getting climactic—so, as mentioned above, that’s something of an alert to keep your eyes open. If the market can show some upside power, these types of readings can lead to a big move, but as always, you want to wait to see confirmation first.

Cabot Market Timing Indicators

There will be a sustained rally at some point, likely when interest rates back off, helping fresh leaders to skyrocket—but that time is not yet there, as the vast majority of evidence (both market-wide and among individual stocks) is negative. Don’t stick your head in the sand, but a continued cautious stance remains appropriate.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines are still bullish, but the market’s waterfall decline has even this indicator on the fence—as of this morning, the S&P 500 is actually below its 35-week line by a fraction of a percent, though the Nasdaq is above its own trend line by 2%. We would need to see both indexes close two straight weeks below their respective 35-week lines for a sell signal, so that’s not right ahead of us. But the next week or two will be vital.

Cabot Tides: Negative
Our Cabot Tides are clearly negative, with all five indexes (including the S&P 500, daily chart shown here) below both of their moving averages. Near-term, the indexes are stretched to the downside, so we’ll see if yesterday’s bounce gains traction—we’re obviously all for it if it happens. But we don’t anticipate what comes next: There’s no question the intermediate-term trend is down for all indexes, not to mention most stocks and sectors, so keeping things light and holding plenty of cash is advised.

Two-Second Indicator: Negative
Our Two-Second Indicator has been negative for a while, and the post-Fed slide in the market has seen new lows really expand—on Tuesday of this week, the figure rose to 443, which is the largest reading since the fall of 2022. The “good” news is it’s possible we’re seeing a selling crescendo (panic) that can lead to a sustained rally—at this point, though, the broad market is clearly under the gun.

The next Cabot Growth Investor issue will be published on October 19, 2023.