In addition to a detailed explanation of the market’s moves and our portfolio’s holdings, we write about the puzzling failure of the average investor to take part in the equity rally and how to handle stocks around their Initial public offerings.
Cabot Growth Investor 1372
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Nice Recovery, But Earnings Will Be Key
When Cabot analysts come into office each day, we like to look at the market’s big picture so that we don’t get bogged down in the day-to-day news that affects most investors. The good news is that the big picture remains very bright—we’ve been steadfastly bullish on the longer-term outlook all year, and that continues today, as our Cabot Trend Lines, 7.5% Rule and numerous longer-term studies point toward higher prices down the road.
The real question in recent weeks was whether the June downturn in the Nasdaq and leading growth stocks was the start of a deep correction or more of a short-term blip on the way to higher prices. Two weeks ago, it looked like the former—more cracks were appearing in the bullish wall and many growth stocks were testing key support.
Encouragingly, though, last week saw the Nasdaq and a ton of stocks (including most of the stocks we own!) lift higher, with a few leaders shooting to new highs on good volume. It’s been a nice recovery, and we responded by putting some of our sidelined cash to work last week.
That said, we’re still holding about 20% of the portfolio on the sideline for a few reasons. First, the rally itself isn’t what we would term a decisive resumption of the uptrend, at least not yet. Volume has been extremely light on the way up (Nasdaq volume has been between 11% and 23% below average every day of the upmove), with many stocks showing similar action.
Second, some indexes are still toying with their June highs, which isn’t bad, but it’s not decisive strength. And third, most of the stocks we follow will report earnings during the next two weeks, and the reactions will have a lot to say about the health of the overall market.
Still, we’re not trying to rain on the recent rally or the big picture positives—at the end of the day, the evidence has improved since our last issue, so we’ve done some buying. From here, though, we’re looking for further strength (and some positive earnings gaps) before putting all our chips on the table.
[highlight_box]WHAT TO DO NOW: Do some buying and fine-tune your Watch List. Last week, in the Model Portfolio, we bought PayPal (PYPL), which looks like a liquid leader, and averaged up in Alibaba (BABA), which continues to act great. Our cash position now stands at 20%.[/highlight_box]
Model Portfolio Update
Last week’s rally in the market and most leading growth stocks pushed the most resilient stocks to new highs and resulted in a bunch of solid setups. There are still some flies in the ointment—many indexes are still below their June peaks, and the number of stocks hitting new highs is tame—but the evidence improved enough for us to put some of our sidelined cash back to work last Thursday, leaving us with around 20% on the sideline.
From here, our plan is to follow along with the market. If this low-volume rally fails and/or leaders crack on earnings, we’ll hold our remaining cash and sell any stocks that fall apart. But if more growth stocks lift off during earnings season, we’ll look to get fully invested by filling our portfolio’s two open slots.
Current Recommendations
BUY—Alibaba (BABA 153)—BABA continues to play out well, with the stock surging higher in early June, holding up during the market’s wobbles and then, last week, pushing to new highs (albeit on light volume). That prompted us to average up—we bought 20% more shares last week. (If you have a “full” position, it’s best to average up in relatively small chunks.) The company continues its spending spree, dishing out another $1 billion or so to boost its stake in Lazada, one of the leading e-commerce platforms in Southeast Asia; Alibaba now owns 83% and is collaborating with Lazada in many ways. Alibaba’s next quarterly report (likely out in early- to mid-August) will determine the stock’s next big move, but we’re more focused on the bigger picture. With BABA recently surging out of a 30-month post-IPO base and analysts continuing to push up their estimates (now seeing 33% growth both this year and next), we think the stock’s uptrend has room to run.
BUY—Facebook (FB 164)—FB spiked to new highs on good volume after a 10-week rest period, which is a good sign heading into earnings next week. While the company is in the news nearly every day, the biggest announcement came last week when Facebook said that, after a test period in a couple of countries, it would begin rolling out advertisements on its Messenger platform (which has 1.2 billion monthly users) globally. Short-term, we doubt Messenger will contribute much to the firm’s top line; Facebook was slow to ramp up ads on Instagram a few years back. Long-term, though, it opens up another gigantic opportunity for the company that should keep growth humming. We restored FB’s Buy rating last week when the stock popped higher, though with earnings out next Wednesday evening (July 26), any new positions should be kept on the small side.
BUY—PayPal (PYPL 58)—We added PayPal to the Model Portfolio last week, and we’re optimistic that the stock entered a sustained uptrend in April (following a 21-month, post-IPO consolidation) thanks to its dominant position in digital payments and money transfers, an industry with years of growth ahead. After many quarters of fretting over competition, it turns out PayPal has become more of a partner with other big payment firms. It has deals with Mastercard and Visa (in fact, PayPal just extended its partnership with Visa on Tuesday, expanding the acceptance of PayPal payments in locations that accept Visa), and last week announced that PayPal would be included as a payment option on Apple’s iTunes and App Stores. Long-term, there’s little standing in the way of 20%-plus earnings growth for many years (analysts see the bottom line up 19% this year and 20% next, with free cash flow larger than earnings), though short-term, there’s always the risk that next week’s quarterly report (July 26) could dent the stock. For that reason, there’s nothing wrong with buying a smaller position here, though we kept it simple and bought our normal-sized position given PayPal’s sponsorship and recent strength.
BUY—ProShares Ultra S&P 500 Fund (SSO 93)—SSO pushed to new highs last Friday after three tests of its 50-day line in late June and early July. The vast majority of the evidence points to this being a bull market that should stretch higher in the months ahead, so an index-based leveraged long fund remains a fine way to put some money to work. If you’ve been following along with us, just sit tight with your shares (we sold half a couple of months back) and give them plenty of rope. If you don’t own any, now’s a good time to take a position, though a stop in the 87 area makes sense.
HOLD—Shopify (SHOP 92)—So far, so good. Shopify’s consolidation, which effectively began in early June, is now in its seventh week and has seen a maximum retreat of 18%. Given the stock’s advance since the start of the year, such action is totally normal. In what could be a big move, the company inked a deal with eBay to allow Shopify’s merchant clients to list and sell their wares directly on eBay from their Shopify account, further boosting the attractiveness of its platform. Earnings are due out August 1, and the reaction will be key to SHOP’s intermediate-term outlook. That said, having already sold a bit more than half our position in two separate chunks, we’re willing to sit through a deeper correction if need be, with a stop near the 30-week line in the low 70s.
BUY—Universal Display (OLED 124)—OLED nearly forced us out two weeks ago when it dipped below its 50-day line and came close to our mental stop in the mid-100s. We’re glad it didn’t, because shares have ripped higher in recent days, toying with resistance in the low 120s. There’s been no news from the company in a while, though some of the big players (including Samsung) are ramping their production capacity for organic light emitting diodes due to strong demand. One way or another, that should play into the hands of Universal Display, though the big tell will come on August 3, when second-quarter earnings (and any forecast for the rest of the year) are released. As always, there’s risk here given OLED’s down-the-food-chain position, but the potential is enormous. We’ll go back to Buy, though you should keep new positions on the small side ahead of earnings.
HOLD—Veeva Systems (VEEV 64)—VEEV’s action in recent weeks has been neither great nor bad. The stock held its 50-day line during the entire correction, which is encouraging, but there’s been very little buying volume on its recent bounce, and it’s still a few points below its old highs. We’re not reading too much into the stock’s day-to-day action so will continue to stick with our plan—if VEEV holds above support in the upper 50s (call it 58, give or take), we’re happy to give it a chance given the company’s excellent growth prospects. But a clear rally failure from here would have us taking our modest profit and moving on.
BUY—XPO Logistics (XPO 61)—XPO was walloped on Monday after announcing a good-sized secondary offering (11 million shares), which will represent nearly a 9% dilution to the total share count. The company also announced preliminary second-quarter results, which looked good, with revenues a bit higher than estimates, though cash flow was so-so. Still, our focus is on what comes next—XPO hinted that the share offering could be used to fund a much-rumored acquisition which could be a bullish event, and beyond that, management’s outlook for the rest of the year (earnings are due out August 3) should be pivotal. The stock corrected to as low as 59 after the announcement, but has bounced back and stabilized. We’ll stay on Buy, but will watch closely.
Watch List
Carvana (CVNA 22): Carvana is on the speculative side of things (which means you need to handle it with care—see our write-up on IPOs later in this issue), but we love the mass market story, the triple-digit revenue growth and the stock’s unusual strength and recent setup.
Celgene (CELG 135): CELG isn’t in a true uptrend yet, but we think biotech stocks are beginning to turn up and see the stock as a liquid leader in the group. Earnings are out next Thursday (July 27).
Exelixis (EXEL 27): EXEL has begun to pull back after thrusting to new highs during the past couple of weeks. Earnings are due out August 2.
ServiceNow (NOW 110): We like NOW’s setup and its business, though we’ll likely wait to see how earnings (due out July 26) are received before considering jumping in.
Other Stocks of Interest
The stocks below may not be followed in Cabot Growth Investor on a regular basis. They’re intended to present you with ideas for additional investment beyond the Model Portfolio. For our current ratings on these stocks, see Updates on Other Stocks of Interest on the subscriber website or email mike@cabotwealth.com.
Trade Desk (TTD 55) — Trade Desk’s cloud-based technology platform lets clients buy and manage their own digital advertising campaigns, including display ads, video ads and ads on social media. Users can buy ads on TVs, laptops, mobile phones and any other connected devices, and use a robust data package to optimize results. The company’s customer retention rate is 95%, and more than 80% of revenue comes from existing customers. Interest in this young stock (public just since September 2016) peaked after a May 12 gap up from 40 to 54 that followed an enormous earnings beat. Since that big move, TTD has ranged as high as 58 in early June, but has mostly traded in a consolidation pattern with support at 48 and declining highs. A breakout above 56 would be an intriguing development. Quarterly earnings are likely out in early August.
Lending Tree (TREE 181) — Like Trade Desk, Lending Tree is riding the wave of business activities that are moving online and into the cloud. Lending Tree’s website is the largest online lending marketplace, a place where lenders and borrowers can connect. The company provides a huge database of mortgage, credit card, home equity, auto and small business loan rates and providers, and non-mortgage loans have grown to be more than half of revenue. Lenders see the site as a great place to find motivated loan seekers, and people who want loans can do all the comparison shopping they want. The network effect of more online users attracting more online users (both customers and lenders) should keep revenue growing; 2016 growth was 51% and Q1 was 40%, and management sees 40% growth for the year. Lending Tree will report its Q2 results on July 27, and analysts are looking for revenue of $135 million and earnings of 94 cents per share.
Workday (WDAY 103) — Just to complete the hat-trick, Workday offers cloud-based software that takes traditional Human Resources (HR) functions like finance, payroll, human capital management and business analytics online. The company is a global concern, with offices in the U.S., Canada, Europe, Australia and Asia. Revenue comes primarily from subscription services, which keeps revenue flowing. The company turned profitable in fiscal 2017 (which ended in January), and has booked three quarters in a row with triple-digit earnings growth and its roster of customers includes both small-caps and Fortune 50 corporations. Customers typically sign on for one or two services, then expand into more components of the Workday suite. The global potential for Workday is vast.
The Great Unloved Bull Market
One of the amazing features of this bull market is how few investors seem to be truly buying into it. We’re not talking about short-term sentiment measures, which remain mixed (options investors are relatively giddy, individual investors cautious, etc.), but rather longer-term money flows.
According to the Investment Company Institute, from the beginning of 2015 through October 2016, money poured out of domestic equity mutual and exchange traded funds to the tune of $217 billion. That reflected the mini-panic seen during the 2015/2016 market downturn, the fears surrounding Brexit and hesitation leading up to the U.S. election. It was a sign that there was plenty of pent-up demand for stocks, which was unleashed once the election was over.
Once the market took off in November, money did come into the market—but only for three months! Now, money is being yanked from the market again. Shown to the right is the three-month moving average of net inflows into domestic equity funds since early 2015; you can see that the figure was solidly negative through late last year, and then spiked positive into the end of January.
But since late January, it’s been all downhill, with nearly $30 billion withdrawn since the start of May. In fact, despite the bull market this year, money flows have been net negative since the beginning of 2017, a clear sign investors clearly aren’t anticipating further gains.
Another way we like to look at money flows is on a relative basis—specifically, money flows into domestic equity funds versus flows into bonds. Theoretically, if money is gushing into “safe” bonds and out of “risky” stocks, it’s probably a good indication that investors aren’t overly bullish and are valuing safety and steadiness over volatility and potential big rewards. And that’s exactly what we’re seeing now.
The chart to the right is a rolling three-month total of money flows into stocks minus those into bonds. When the figure is above zero, it means more money is flowing into stocks than bonds, and vice versa. Similar to the first chart, money flow was heavily negative for most of 2015 and 2016 heading into the U.S. election and then spiked higher for a bit.
But what’s shocking is that, as of the end of June, the difference in money flows between stocks and bonds hit a new multi-year low. That’s not a sign of greed! All in all, since the start of 2015, there have only been five months (out of 31) where flows into domestic equity funds outpaced flows into bond funds.
As we wrote at the outset, these money flow statistics don’t tell you much about the short-term direction of the stock market, but on a longer-term basis, they give you a strong indication of the sentiment of the average investor. Right now, with money flowing out of stocks and gushing into bonds, it’s clear that most people aren’t bullish on the stock market—a good sign from a contrary point of view.
How to Play IPOs (Hint: Carefully)
After many years of little IPO action (just $19 billion worth of IPOs priced last year, lower than 2008 or 2009!), the spigots have opened a bit in 2017. We’ve spotted a few that we’re enthusiastic about, including Carvana (CVNA), which we wrote about in our last issue and which we have placed on our Watch List.
However, IPOs are often very tricky to handle because their lack of sponsorship (it takes time for big investors to build positions) and low trading volume often result in wild volatility and sudden ups and downs.
Look at CVNA, for instance. After coming public in April, the stock dipped from 14 to 9 during its first month (-35%) before running up to nearly 24 (+160%!) in three-plus weeks. It then immediately dipped 22% before bouncing back. On average, the stock moves more than 5% from high to low every day and trades less than $20 million per day.
Of course, volatility isn’t a bad thing—upside volatility is where profits come from! But such huge swings (often without news and independent of the market) can make a stock challenging to own. Thus, if you play these names, it’s probably best to start small (say, one-third or one-half of your normal position size, dollar-wise) and slowly build your position over time if the stock shows you a profit. That will allow you to participate in a big move, but if the stock quickly peters out, your loss should be reasonable.
For our part, if we did buy a stock like Carvana, we’d likely start with a half-sized position, would give the stock plenty of rope (probably our maximum 20% on the downside) and attempt to average up in chunks if it headed higher. IPOs can be star performers if institutions take a liking to them, but it’s important to have a plan to handle their wild and crazy ways.
Cabot Market Timing Indicators
After a sloppy June and early July, the buyers have begun to return, pushing most indexes and growth stocks higher. We’ve put some money back to work, and if more leaders emerge (or re-emerge) on earnings, we’ll look to get fully invested.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines don’t give signals often (the last one was a Buy back in April 2016), but it’s our most reliable indicator—by consistently staying on the right side of the market’s major trend, you’ll ride the big bull moves and avoid the major downturns. Right now, the longer-term trend remains clearly up, with the S&P 500 (by 5.0%) and Nasdaq (by 8.2%) holding well above their respective 35-week moving averages.
Cabot Tides: Bullish
Our Cabot Tides are also bullish, with all five indexes we track (including the S&P 500, the daily chart of which is shown here) holding above their 50-day moving averages. Granted, it’s not the strongest intermediate-term uptrend, as many indexes are still within (or just above) their recent ranges. Still, by our measures, both the intermediate- and longer-term trends are up—reason enough to remain bullish.
Two-Second Indicator: Healthy
The Two-Second Indicator continues to be on-again, off-again, with eight readings of fewer than 40, then four readings of plus-40, and now another five readings of fewer than 40. All told, the readings have been mostly positive, so we believe the broad market is healthy, but what we’d really like to see is a couple of weeks in a row of tame readings to clear the air.
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All Cabot Growth Investor’s buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special bulletins via email and the recorded telephone hotline. To calculate the performance of the portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
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THE NEXT CABOT GROWTH INVESTOR WILL BE PUBLISHED AUGUST 2, 2017
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