April 21, 2022

Under the surface, there does remain some encouraging signs for the overall market, which is a good reason to keep your antennae up for a change in character. But at the end of the day, what counts most is the action of the market and potential leading growth stocks, and on that front, there’s no question the trends are down and the sellers are in control. Thus, we remain cautious, holding 60% of the Model Portfolio in cash, and while we’re not anxious to sell wholesale, we won’t hesitate to sell more if stocks continue to crack.

In tonight’s issue, we review some key measures that show just how severe this selling wave has been in recent months--and why, once it’s over, it should lead to a fresh bull market in growth stocks. We also highlight some new ideas in commodities and elsewhere while we continue to fine tune our watch list.

Market Overview & Model Portfolio Update

A Few Positives—but Need Much More Than That
A while back I used to play Pinochle—a card game with some bidding and tricks; it’s sort of like an easier Bridge—with a group of people, most of whom were older (and better at playing the game) than me. In the game, Aces are high, but it turns out the second highest cards are 10s, then Kings, Queens and so on. Anyway, one time, early in my playing career, I made a big bid and thought I could win a bunch of tricks thanks in part to a few 10s I was holding. That was … incorrect, and my older/wiser partner and I went down in flames.

When the hand was embarrassingly over, she looked at me with a questioning face and I said “Well, I had a bunch of 10s …” But she cut me off, replying simply “10s are for losers!”, implying that Aces, of course, are for winners.

That’s overstating it for this comparison, but I’ve been thinking about that when looking at the overall evidence in recent weeks. When you dig below the surface, there are still a few encouraging signs, the biggest one being that the peak in selling pressures (measured by new lows, percent of stocks below moving averages, etc.) came back in late January, even after today’s plunge. Heck, even most indexes and some growth funds are unchanged since that time despite a dumpster fire news environment including war, inflation and skyrocketing interest rates. Indeed, investor sentiment has become horrid, and beyond that, we’re even seeing a few growth names hold up.

Still, all of that encouraging secondary evidence is like having a bunch of 10s. It’s nice, and for the market, it does provide a decent setup—these sorts of measures can often provide early heads-ups to a change in character. But at the end of the day, it really doesn’t do much for you in and of itself.

Instead, what really counts is the primary evidence (Aces)—the price, volume and trend action of the major indexes and leading (or potential leading) growth stocks. While there have been a few rays of light from these indicators here and there, most have been bearish since the mid-November top—and they remain that way today, with nearly every little rally attracting sellers and some old winners imploding

The way we’d put it is the market has a decent setup here—lots of pessimism, obvious reasons for the decline and plenty of measures showing that that fewer stocks are participating on the downside. Thus, our antennae are up ... but until buyers really take control, the risk of doing much buying is far greater than the potential reward.

What to Do Now
Remain cautious. In the Model Portfolio, we already have lots of cash but we’re willing to cut bait if something falters. During the past couple of weeks, we’ve sold Dutch Bros. (BROS) and CarGurus (CARG), leaving us with 60% in cash. We have no changes tonight, but we have tight stops on a couple more names and continue to fine tune our watch list should the buyers step up.

Model Portfolio Update
Investors and the media can talk about the why all they want—from inflation, to higher interest rates, to valuations, to economic worries—but when it comes to the Model Portfolio, we focus on the what, and the bottom line is that, whatever the reason, growth stocks topped in mid-November and have trended lower for most of the time since then, so we’ve held an average cash position north of 50% over the past few months (currently at 60%).

Of course, we did put some money to work when the Tides flashed green in March, but we’ve been forced to back away from that as a few names have cracked. It’s not fun, of course, but keeping losses under control (and using half-sized position, which again keeps risk in check) makes the damage manageable—something that can be made up during the next upmove relatively quickly.

Going forward, if we get a shakeout in commodity areas, we’re not opposed to adding a second name in that space. And market-wide, we have our antennae up due to the many encouraging secondary indicators out there. But overall, the trends are clearly down, so don’t want to be too exposed when the wind is in our face—once this correction/bear phase is over for growth, there will be tons of early-stage opportunities, but now remains a time for caution.

Current Recommendations

Arista Networks (ANET)—On one hand, ANET has been hit hard since approaching its old high earlier this month just as the latest market (and growth stock) leg lower started, raising the prospects of an ominous double top. On the other hand, the stock currently sits near its 50-day line, well above its February/March lows and just 18% off its peak, which is far better than most every other growth stock out there. (The average Nasdaq stock is something like 40%-plus off its peak, even with the index being well off its low.) As for the story, there isn’t much new, though the company did just announce an extension of its software offerings to support media and entertainment clients, which should be a nice add-on opportunity. Overall, growth here should be excellent this year and solid for many years afterwards, and combined with the stock’s resilience, we still believe ANET can be a winner in the next market upturn. That said, we own the stock and not the company, so the next few sessions will be key--shares are back down to key support from the past few months, so we’ll hold tonight and use a tight leash. Earnings are due May 2. HOLD

CarGurus (CARG)—CarGurus has a new growth business (CarOffer) to go along with a stable core business, which leaves the stock with a reasonable valuation (23 times this year’s earnings) despite its big growth expectations (sales expected to rise 98% this year and 33% next, though earnings will be flat-ish due to investments) even after its humongous earnings move in late February. It’s a solid combination, but in this market it wasn’t enough—CARG looked great at the start of the month and was still OK coming into this week, but sellers then took over and caused the stock to break badly on Wednesday, leaving us with no choice but to cut the loss on the half position via a special bulletin. Similar to BROS (below), we think the underlying story is very much intact, so if the stock can shape up down the road (not just bounce for a few days) and the market turns the corner, we could revisit it. But at this time, it’s clear the market’s headwinds are too much for the stock. SOLD

Devon Energy (DVN)—DVN remains in good shape, though we wouldn’t say it’s tearing up the charts and, like many names in the group, volume has been tapering off during the past few weeks. As we’ve written before, it wouldn’t shock us if the group hit a deeper pothole at some point, as the advance among oil (and all commodity) names has become very obvious (the obvious rarely works for long in the market with some shake-the-tree action) and oil prices, while elevated, have done more chopping around than advancing of late. Frankly, if we see some true abnormal action (if today’s selloff carries on), we could shave off some more shares from our position. However, looking at the here and now, the evidence remains in good shape—oil and natural gas prices from Q1 should result in the next quarterly dividend (paid at the end of June) being solidly higher than the $1 per share seen from Q4 and still leave a bunch of money for either share buybacks or debt reduction. And, despite the day-to-day gyrations, those prices have actually been higher so far in Q2 (granted, it’s early), especially with natural gas, which recently hit multi-year highs. (Given that oil inventories are 15% below the five-year average, prospects there remain buoyant, too). All in all, we continue to like our position—we sold half of our stake a few weeks back for a big profit and think riding the remaining portion makes sense. We’ll be on the horn if we have a change, but for now we continue to think sitting tight is the right move. HOLD

Dutch Bros (BROS)—We punted BROS over a week ago as the stock dipped below its 50-day line (we don’t want to play around with too many losses until the environment turns bullish), though to the stock’s credit, it’s actually crawled higher since then. As we wrote when we let it go, we’ll be keeping an eye on BROS, as the powerful cookie-cutter story should launch a sustained advance at some point—but given the recent failed breakout and the fact that shares are stuck in the lower end of their post-IPO range, there’s a lot of proving to do before concluding big investors are truly building positions. We sold our stake and are happy to hold the cash in this environment. SOLD

Palo Alto Networks (PANW)—In a world where growth funds are down huge from their highs (QQQJ off 24%, IWO down 27%, IPO down 47%, ARKK down 60%!), any stock that’s within 10% or so of its peak is a rare bird—and, even after today’s wallop, PANW fills that bill. We’ll see what happens after today, but the stock has seen buyers show up in recent weeks after every day or two of selling, likely because the firm offers rapid and reliable growth due to its next-generation products, because of a bullish industry backdrop (the Russian invasion is expected to see cybersecurity spending accelerate) and the not-crazy valuation (about 27 times free cash flow for the year ending in July) doesn’t hurt, either. Of course, in a sour market, sometimes it’s the ones that are holding up best that eventually get hit, so it’s always possible today was the start of a more severe selloff. But looking at the overall picture, the fact that PANW is still in decent shape increases the chances that shares will have a good run once the pressure comes off the market. Hold on if you own some, and if not, we’re still OK buying a half position assuming you have plenty of cash already on the sideline. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—Nobody will argue that the last three weeks in the market has been pleasant, but when looking at the S&P 500 (and, hence, SSO), the action still appears to be normal, at least in the sense that this could easily be part of a bottom-building process that began in late January. Obviously, with the way the market is acting, it’s possible the selling that’s mostly been focused on growth stocks could spread to other areas, hitting SSO in the process—and if it does, we’ll probably pare back. But given the entire picture (new lows slowly drying up, horrible investor sentiment, Four-Day Frenzy signal from mid-March, S&P 500 above its 50-day line), we’re still cautiously optimistic the next major move for the S&P 500 will be up. Sit tight if you’re already in, but if you’re not and have a lot of cash, we think you can start a position in SSO around here. BUY

Pure Storage (PSTG)—PSTG has been caught up in the latest growth stock selling wave, essentially reversing its prior earnings-induced upmove—though, unlike many stocks, this name has held near its 50-day line and prior support support, even including today’s drop. Will PSTG muster enough resilience to hold firm despite the environment? We certainly think it can, as the fundamental story here is powerful, with the company offering not just best-in-class storage products but also moving to a storage-as-a-service subscription business (now making up more than a third of revenue and growing quickly) that will boost client retention, cash flow and margins. A good day or two here would do wonders, and we’re willing to give the stock a little more wiggle room, but the bottom line is PSTG needs to hold support and show some upside for it to stick around. Hold for now. HOLD

Watch List

• Halliburton (HAL 39): Our main thoughts with HAL after its Q1 report is (a) the spending cycle for oil & gas operations is just starting what’s likely to be years of strong expansion, but (b) the stock itself is stretched in the intermediate term and beginning to correct. A controlled dip to its 50-day line (now at 36 and rising) would be tempting.
• Inspire Medical (INSP 239): INSP looks like it’s putting the finishing touches on a 13-month structure, while its sleep apnea offering continues to gain traction. See more below. Earnings are due May 3.
• Halozyme (HALO 44): We can’t say the chart is quite ready yet, but it does seem like HALO has turned the corner, with investors beginning to look ahead to many years of rapid, high-margin (60% after-tax profit margins in Q4!) growth thanks to its burgeoning royalty stream. Earnings are likely out the second week of May.
• Nutrien (NTR 208): NTR is in a similar position as HAL—we think it’s effectively a big-cap leader of the commodity run, but we also think the risk is rising for a shakeout or correction, possibly toward the 50-day line (way down at 94 but rising quickly). Earnings, which are due May 2, could tell the tale.
• Shockwave Medical (SWAV 189): SWAV has futzed around the past two weeks, which is more than acceptable given the continued growth-stock bleeding that’s taken place. Frankly, another couple of calm weeks could result in a buyable setup to the multi-month pattern.
• Wolfspeed (WOLF 107): WOLF still has work to do on its chart, but it’s holding up well given the destruction of many chip stocks, and the near- and longer-term story (written about in the last issue) is compelling.

Other Stocks of Interest

PDC Energy (PDCE 75)—As we write later in this issue, we favor commodity-type names that are following the “new playbook” in the industry—harvesting cash flows, minimizing spending and returning boatloads of cash to shareholders, thus making them somewhat less sensitive to the daily movements of commodity prices. PDC Energy is a name that few have heard of, but thanks to a recently announced acquisition, the firm’s next few years should be almost hard-to-believe good. Part of the reason it’s been overlooked might be where it operates: PDC drills mostly in the Wattenberg Field in Colorado (part of the DJ Basin), and it’s set to be a dominant producer there thanks to the takeover of a big private operator—expected to close in Q2, the $1.3 billion deal will boost its acreage by 30%, bring with it 315 operated, liquid-y locations (67% liquids) and be very accretive to all key metrics. (Even at $50 oil, all of the acreage areas it’s buying will see well returns north of 50%!) The firm is going to do some spending, adding a second drilling rig, and it does anticipate a good amount of cost inflation this year (resulting in up to $1 billion in total spend), but even with that the cash flows here look enormous: At $75 oil and $4 natural gas (miles below today’s prices), PDC thinks it will see free cash flow totaling $27 per share or so in 2022 and 2023 combined, with $17 of that returned via dividends and share buybacks. In fact, on the buyback side, the company expects to complete a $1.25 billion program (16% of the current market cap) by the end of next year! To be fair, the firm’s debt load is increasing a good deal, but there should be plenty of money to go around (40% of free cash flow will be retained). Beyond just the numbers is the stock itself—while most oil explorers have been just decent of late, PDCE has been thrusting higher since February, with a strong angle of ascent as all dips to the 25-day line have been gobbled up. Pullbacks of a few points would be tempting. Earnings are due May 5.

Inspire Medical (INSP 239)—Medical stocks remain one of the few resilient areas among growth stocks, and we’ve been writing about a few of them (including HALO and SWAV in the last issue). We like them all, but Inspire might have the best chart setup, and the story is big: Inspire has a better way to deal with sleep apnea, which to this point has been treated mostly via either giant, clunky CPAP machines that come with big masks and pumps (it’s so uncomfortable that only 35% to 65% actually use it as they’re supposed to), or via invasive surgeries (which involves risk and has so-so success rates). Inspire’s system is a game changer, with three components implanted (via two small incisions in a 90-minute outpatient procedure) that stimulate a nerve to keep the airways open at night, with both trials and real-world experience (20,000 patients and counting!) showing higher oxygen levels, less sleepiness, far less snoring and the like. It’s been a hit, and the firm continues to make progress on both reimbursement and in training sleep doctors on the system—in Q4, Inspire activated 81 new implant centers in the U.S., bringing the total to 684, but it sees that expanding by 185 or so this year alone. Because of the expansion in sales and training, the bottom line is in the red, though losses have been shrinking while revenues are expected to grow in the high 30% range this year (likely conservative). Big picture, there’s little reason why Inspire can’t capture a large share of all the non-compliant CPAP users, a market estimated to be in the $10 billion range (many millions of patients in the U.S. alone). As for the stock, it hit a 252 in March 2021, has been as low as 160 and as high as 285 since then, but today it sits almost exactly where it was 13 months ago. We like the low-volume dip of the past three weeks, with any decisive strength—possibly on earnings, due May 3—potentially kicking off a new run.

Freshpet (FRPT 189)—Given that so many growth stocks have imploded 50% or more, we’re keeping an eye open for fallen angels that have great business momentum, and whose stocks have shown many weeks of healing; should the environment turn decisively healthy, they could embark on solid runs. Freshpet is one such name, with a dependable and easy-to-understand story: Pets have become family, and those people (especially higher-end customers that aren’t impacted by the economy much) are increasingly feeding Fido and Whiskers better food (at a premium price). Freshpet is the leader in this movement, with food made from 100% natural meats and fish, garden veggies and fruits, and steam-cooked to preserve nutrients, all of which is shown to boost pets’ health and well-being; about 4.2 million households are customers, but the firm believes it can boost that to 11 million by 2025. Sales growth has been impressive for a long time, and the figures have actually accelerated a bit in recent quarters, but it could have done even better—the stock topped last year after a massive run, not just because of the market but also due to supply chain issues and inflation eating away at margins. In response, the firm spent a bunch of money boosting capacity and hiring staff at a new production plant; it’s now keeping 15% buffer capacity to ensure it can meet demand, and it implemented price hikes in recent months to cover higher costs (absorbed well so far; again, these are generally higher-end clients). Bottom line, it’s likely that Freshpet’s long-term growth story is going to get back on track in 2022: Management anticipates another year of accelerating sales growth (up 35%), with EBITDA up 28% (would be up much more if not for the buffer capacity), with years of growth (and expanding margins as the new production plant ramps) going forward. FRPT fell 57% from high to low, but effectively bottomed in early January, retested that level a handful of times through March and recently rallied to five-month highs. (The RP line, not shown here, has 15 weeks of positive momentum, a good sign.) Yes, the chart still needs work (resistance near the 40-week line here), but it looks like investor perception is perking up after the stock’s big reset. Earnings, due May 2, will be key.

Selling Pressure on Nasdaq: Prolonged, Intense and Easing (So Far)
While every investor knows the market has been down this year, after flipping through some big picture charts, we can say for a fact that:The broad market on the Nasdaq has already seen one of its most intense selling waves of the past couple of decades—and those selling pressures have actually been easing, at least in recent week.

Let’s take a gander at three charts. The first is from Grant Hawkridge of All Star Charts: It’s a bit hard to see, but if you examine the lower panel, it shows that we’ve now seen 21 straight weeks where the number of new lows on the NYSE and Nasdaq have outnumbered new highs. Sure, that was eclipsed in 2008-2009, but it matches the streak seen in the 2000-2003 bear market and was basically on part with that seen in the 1990 bear phase (first Gulf War).

The second chart takes the percent of Nasdaq stocks north of their 50-day lines each day, and then smooths that out with a 200-day moving average. Basically, it asks “on average, what percent of the Nasdaq’s broad market has been in an intermediate-term uptrend during the past nine months or so?” Interestingly, you can see this moving average has dropped to around 35%, which is again above the 2008 nadir but below just about everything else in the past 20 years.

The bad news: As we wrote on page 1, right now, this doesn’t mean too much; secondary indicators are nice, but until confirmed by the market itself, there’s nothing that says these measures can’t just get more extreme.

So why write about it? Two reasons. First, when you see selling pressures last this long and be this intense among growth-oriented stocks, it represents a true wipeout—growth stocks have been in a bear phase during the past five months, so the next major move should effectively be a fresh bull run that features lots of stocks early in their overall runs.

Second, it’s still noteworthy that we’re seeing a gradual easing of those selling pressures over time. Here’s a near-term version of the net new highs (new highs less new lows) on the Nasdaq. While the figures have been a horror show (just three days of positive readings in the past six months!), notice how they’ve gotten less extreme even as the Nasdaq itself has been wallowing.

Long story short, we’re not predicting a bottom or whistling past the growth stock graveyard, but on the other end of this horrid downturn will be a big bull move—and we continue to see secondary indicators that tell us the sellers are losing power. That’s no reason to turn bullish, but it’s telling us to keep our antennae up amidst the bad news and sharp selloffs.

Separating the Wheat from the Chaff in the Commodity Realm
Commodity stocks have obviously been hot, though there’s also no doubt that the moves, at least in the short- to intermediate-term, have become obvious; everyone “knows” that inflation and prices are high and going higher, which raises risk.

Long term, commodity issues have been out of favor for so long we believe there could be solid upside, but it’s important to (a) aim for weakness if you want in and (b), most important, to focus on the names in that space that are following the new playbook, with CapEx minimized, debt slashed and shareholder returns (dividends and share buybacks) prioritized. While every stock in this space will bob and weave with the underlying commodity price, those that are simply riding the trends will be more subject to going down the chute when prices ease.

Oils are an area we still favor, with many following the new playbook. Devon (DVN) continues to act well, while PDC Energy (PDCE), a mid-cap written about earlier in this issue, is another example. That said, if we were going to own another energy name, it’d probably be in the services space—and Halliburton (HAL), while not a new name, has cut costs to the bone and should see earnings kite higher for years to come.

Outside of oils, we still think drybulk shipping—firms that transport grains, iron ore and the like overseas—has a bright future, as shipping rates are elevated now and the order book remains at multi-year lows. Starbulk (SBLK) has been a volatile stock (it’s somewhat thinly traded), but it holds plenty of cash and has been reducing debt, and the dividends have been enormous—in Q4 alone, it paid out $2 per share! That level isn’t likely to be repeated, but payouts should still be very healthy going forward, especially as the firm’s CapEx will be next to nothing after mid-year.

Then there’s the steel area, which admittedly gets pushed and pulled a bit more based on macro factors—there was a massive shakeout earlier this year (a good thing) and the action has been great since. Nucor (NUE) is our favorite in that space, with earnings that were out of this world last year ($23 per share) and will probably match that this year and still be huge even looking out to 2023 ($9). Again, the key here is that the firm is returning a lot of that money via a big share buyback program; in this morning’s quarterly report, the share count was down 10% from last year.

Again, we still favor trying to enter these types of names on dips (NUE went vertical today) following their recent moves, but we also believe focusing on cyclical and commodity names that are using the new playbook will increase your odds of finding a winner.

Cabot Market Timing Indicators

Most of the evidence is still on the negative side of the fence, especially when it comes to growth stocks—hence our big cash position and cautious stance. That said, we’re keeping our eyes open, as you can cut the bearish sentiment with a knife and some secondary measures are hopeful. But for now, it’s best to be mostly on the sideline.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines haven’t budged since their sell signal in January. At this point, the S&P 500 sits about 1% below its 35-week moving average, but the Nasdaq is still more than 8% south of its own trend line—since we need to see both indexes close two straight weeks above their respective 35-week lines for a green light, the bulls still have some heavy lifting do before the longer-term trend turns up.

Cabot Tides: On the Fence
Our Cabot Tides are effectively neutral here, as most major indexes (including the S&P 500, daily chart shown here) are hanging a bit above or below their lower (50-day) moving averages. More important to us is that the intermediate-term uptrend that tried to get going in March has clearly run into trouble—and our Growth Tides are negative at this point. We’re keeping our eyes open, but we need to see some sustained buying pressures to turn the trend back up.

Cabot Real Money Index: Neutral
Some investors have finally started to hit the exit button from equity funds and ETFs, with our Real Money Index dipping to its lowest level since last October, thanks in part to a big outflow last week. While not technically positive yet (the five-week sum is still north of zero), the bad news has some investors throwing in the towel—if it goes on for another week or two, it could set up a great contrary signal.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on May 5, 2022.