We’re adding what we believe can be a leading glamour stock of the bull market. Elsewhere in tonight’s issue, we write about the recent long-term breakout by Chinese stocks.
Cabot Growth Investor 1375
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Buyers Mostly Absent
From our perspective as students of the market, the recent action of the market is relatively encouraging. Whether it’s the tragic, historic damage caused by Harvey, North Korea’s never-ending provocations, trade threats with China, the Federal Reserve’s upcoming balance sheet shrinkage or the various mishaps in Washington, D.C., the market has certainly had plenty of reasons to fall into a correction—especially since it hasn’t had a meaningful pullback in 10 months!
So the fact the S&P 500 and Nasdaq are both less than 2% off their all-time highs and many leading growth stocks are showing similar resilience is a good sign for the overall bull market. (It doesn’t hurt that sentiment is turning bearish; $15.9 billion has been yanked out of domestic equity funds during the past two weeks, a big figure.) As the saying goes, if the market doesn’t go down on bad news, it’s good news. So the longer-term odds continue to favor higher prices in the months ahead.
However, in the short- and intermediate-term, buyers are mostly absent. Although many stocks and indexes are holding up well, few are actually pushing higher, and those that do start to lift usually give up their gains soon after. And the broad market has slowly sagged in recent weeks. Our Cabot Tides and Two-Second Indicator are still negative, and the Nasdaq hasn’t enjoyed an up day in above-average volume in two full months!
No matter how resilient the market appears, until the buyers show up, stocks remain open to getting battered by any bad news that shows up down the road.
A couple of very good (or bad) days could change the picture, but right now, the market’s mixed evidence keeps us in a cautious (but not defensive) stance, holding some cash and selling any stocks that break down, while sticking with top performers and being choosy on the buy side, looking to add new potential leaders, as we’re doing tonight.
[highlight_box]WHAT TO DO NOW: Stay cautious, but don’t stick your head in the sand, either. In the Model Portfolio, we sold Veeva Systems (VEEV) on Monday after the stock cracked on earnings, but given our large cash position, we’re adding GrubHub (GRUB) tonight, which will leave us with around 30% in cash. Details inside.[/highlight_box]
Model Portfolio Update
After months without a major negative earnings reaction in the Model Portfolio, we finally took a hit last week when Veeva fell out of bed after its report, closing below our mental stop and forcing us to sell. Still, the damage for the week wasn’t all that bad—the portfolio finished effectively flat last week and remains up more than 20% on the year.
The sale of VEEV left us with around 40% in cash, which seems high given the market’s not-bad-but-not-great standing. Thus, tonight we’re replacing VEEV with GrubHub (GRUB), which we believe has a chance to be a leading glamour stock going forward. That leaves us with 30% in cash, giving us cushion if the market weakens but buying power if the bulls take control.
Current Recommendations
BUY—Alibaba (BABA 171)—Chinese stocks in general and Alibaba in particular have been super performers in recent weeks, so, given the sluggish market, it’s not surprising to see some profit-taking set in. Still, BABA is in fine shape, well above its 25-day line, and a few analysts have upgraded shares since the August 16 earnings release, thinking even the firm’s bullish guidance for the current fiscal year (ending next March) is likely conservative. As we write later in this issue, short-term, the path of BABA and Chinese stocks as a whole is unclear, but long-term, both have only recently lifted out of huge consolidations, which bodes well when looking down the road. Sit tight if you own some, and if you don’t, you could buy some BABA around here, though it’s probably best to keep new positions on the small side given the market’s indigestion.
BUY—Facebook (FB 170)—FB has pulled back during the past month along with many growth stocks, but it’s suffered no abnormal selling and, in fact, has been very orderly in its retreat. The company continues to ink deals to add streaming video to its platform in an effort to attract more eyeballs (and keep them on Facebook for longer); Facebook will stream 15 mid-level college football games this fall, beginning this coming Saturday (September 2). The question going forward is whether the law of large numbers begins to catch up with the company—revenue growth has been jaw-dropping (currency-neutral ad revenue rose 49% in Q2) given its size ($33.2 billion in annual revenue), but analysts are currently modeling just a 22% earnings gain in 2018. Given the history, we think those will prove conservative as Instagram ramps and as the rollout of ads on Messenger could open up an entirely new mass market. Bottom line, we think Facebook’s fundamental story still has a lot of upside, and the chart tells us big investors agree. You can start a position here if you don’t own any.
BUY—GrubHub (GRUB 56)—We’re adding GRUB to the Model Portfolio tonight (our official buy price will be the average of the stock’s high and low tomorrow, August 31). As we wrote in the last issue, we think the perception surrounding GrubHub’s future has improved, not just because of a string of positive quarterly results, but also because of its recent deals with Groupon and Yelp to take over those firms’ online takeout ordering operations, which has re-set the competitive landscape in GrubHub’s favor. The stock has impressively traded tightly since its big earnings surge more than two weeks ago, despite the wobbly market. There’s certainly risk if the market has a leg down in the near future; a pullback to 49 (where the 50-day line stands) or below (the prior base was in the mid- to upper-40s) isn’t out of the question if the market slides. But if things go right, we think the upside is tremendous as the company integrates its recent acquisitions and expands into more markets. You can take a position here, assuming you have a good amount of cash on the sideline.
BUY—PayPal (PYPL 62)—PYPL has been solid as a rock during August, moving sideways between 58 and 61 despite the volatility in the market and growth stocks, and poking out to new highs today. While many analysts have feared competition in the digital wallet and payment space for many quarters, PayPal’s recent deals with a bunch of major banks and payment firms (Bank of America, JPMorgan Chase, Mastercard, Visa, etc.) have made the company’s service far easier to use, which has boosted membership (6.5 million new accounts in Q2, the most additions since 2014) and, interestingly, cut back on customer service needs, which has bolstered margins and cash flow. Longer-term, there’s building excitement surrounding the firm’s Venmo money transfer platform—it’s popular with millennials, volume was up 103% in the second quarter (to $8 billion), and PayPal is going to start to monetize it by rolling out an option that allows customers to use their Venmo balances for e-commerce purchases. If management continues to pull the right levers, there’s no reason PayPal won’t grow at healthy rates for years to come. You can buy some shares around here.
HOLD—ProShares Ultra S&P 500 Fund (SSO 92)—Our position in SSO is subject to the on-the-one-hand, on-the-other-hand mentality of the market—the S&P 500 (and hence SSO) hasn’t made any progress since mid-June and continues to hover right around its 50-day line, and yet, it’s less than three points from all-time highs. We’re not dead set against grabbing a few shares if you have a lot of cash, as long-term, we believe the market will move higher. But until we see some improvement from our market timing indicators, we’ll officially stay on Hold and wait for some decisive buying to appear.
BUY—Shopify (SHOP 108)—It’s looking more and more like SHOP is ready to get going if the market can snap out of its funk—the stock made two forays into new high ground (once after earnings at the start of August, and once last week) after its peak in early June, and the stock raced out to another new high today. As we’ve written before, it’s unusual for a leading growth stock (which SHOP clearly is) to top out after just a few months of rallying as it takes longer for institutional investors to build positions—at the end of June, 415 mutual funds owned shares, up from 313 at year-end, and we would expect a couple hundred more to get on board in the months ahead. On a fundamental note, we think investors are still underestimating both the potential size of the market (the firm serves more than 500,000 clients, up around 125,000 over the past six months) and the attractiveness to large merchants (its higher priced Shopify Plus offering now accounts for 18% of its recurring revenues, up from 13% a year ago), which should drive the firm’s average take-rate higher. The market hasn’t given the all-clear, but we’re going to place SHOP back on Buy tonight. We advise keeping new positions smaller than normal for now.
HOLD—Universal Display (OLED 125)—In the last issue, we wrote about the importance of letting a stock make the decision for you, often by setting mental stop and then following the plan. As we discuss below, VEEV tripped its stop, so we were forced to sell out. But OLED has been dancing just above its stop (which is in the 107 area, give or take a few dimes), so we held on, and now it looks as if our patience is starting to pay off—the stock leapt back above its 50-day line on outstanding volume today after an analyst released some bullish commentary, saying Wall Street is underestimating the growth potential. The action is certainly a plus, of course, and ideally it marks the end of the stock’s three-month up-and-down phase. That said, it’s too soon to conclude that, partly because of the market, and partly because we’ve seen lots of “one day wonders” recently (stocks that look great for a day or two and then fall right back to where they were before). All told, then, we’ll stay on Hold for now, but will be watching closely; if OLED holds (or builds) on today’s rally for a couple of days, it could be a sign that the tide has turned.
SOLD—Veeva Systems (VEEV 58)—As a company, Veeva’s second-quarter report confirmed that it has a long runway of growth ahead—sales (up 27%) and earnings (up 53%) topped expectations, and management even nudged up its outlook for the next couple of quarters, too. But the stock had different ideas, as VEEV fell sharply from the get-go and closed well below support last Friday; we sold our shares via a Special Bulletin on Monday morning. (Our profit ended up at 11%.) Long-term, it’s possible the stock could repair the recent damage, and maybe we’ll jump onboard for a third trip (we also owned VEEV last year and made a small profit on it then, too). But right now, the stock’s two and a half months of sideways action, followed by the big-volume gap lower, is a bearish sign.
Watch List
Exact Sciences (EXAS 41): There aren’t many companies with triple-digit revenue growth and a potentially revolutionary new product (in the colon cancer screening field), but Exact Sciences is one of them. While some short sellers have attacked it, many big investors are believers—446 funds owned shares in June, up from 321 at year-end.
Exelixis (EXEL 28): EXEL does have some “results risk” as it has some important clinical trial data set to be released in the months ahead. But the stock is set up well and the firm has surging sales and earnings growth already.
ServiceNow (NOW 114) and Workday (WDAY 108): Both NOW and WDAY look poised to get going if all goes well. WDAY reports earnings tonight (August 30), which could be a catalyst for both stocks if the report is well received.
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.
Alcoa (AA 43) — The recent spike in the price of aluminum is doing great things for this giant in (almost) all things aluminum. In September 2015, Alcoa, the vertically integrated aluminum company that produced everything from bauxite to alumina to aluminum to cast and rolled products to highly engineered products, announced that it would split into two companies, Alcoa and Arconic. Alcoa is now the mining/refining/casting/rolling company and Arconic is the high-performance products entity. Higher global demand (and production cuts in China) have aluminum prices at six-year highs, which investors think will boost the firm’s bottom line in a big way. The stock has staged an impressive breakout over the past week.
Five Below (FIVE 49) — Five Below, which operates a string of stores that sell discounted merchandise aimed at teens, with nothing selling for more than $5, is beating the downtrend in brick-and-mortar retail. The company has more than 575 stores in 32 states and has an aggressive program of opening new locations (100 in 2017 alone) and breaking into the California market. Management believes there’s room for at least 2,000 locations, which should keep growth humming for years to come. Revenue has grown 20% or more annually since 2009, and analysts see this trend continuing at least through 2020. FIVE formed a double top at 53 in May and June, and has been setting up a base under resistance at 51 for a few months. Q2 results will be announced today (August 30) after the close, so keep an eye on the reaction.
Proofpoint (PFPT 92) — As hackers have grown more aggressive and devious in their attacks on email, databases and websites (including new wrinkles like malware and ransomware) old-line cybersecurity firms have been losing ground to innovators like Proofpoint. The company’s suite of software services provide Email Fraud Defense, Social Media Protection and Threat Response on a cloud-based subscription model, which keeps churn low and free cash flow (more than $2 per share this year) high. Revenue grew by 41% in 2016 and by 43% and 36% in Q1 and Q2, respectively, with 97% coming from subscriptions. PFPT has been basing sideways since it nicked 94 in June in a base-on-base pattern. Analysts are hoping that the quarterly report from rival Palo Alto Networks (due out Thursday, after the close) may renew investors’ interest.
Vantiv (VNTV 71) — Vantiv is a major player in payment processing software, with a platform that lets merchants accept credit, debit and prepaid payments at brick-and-mortar locations, via mobile devices or online. The company made headlines with its $10 billion takeover of U.K. rival Worldpay, which will boost Vantiv’s footprint in the low-margin, high-scale world of e-commerce. VNTV has been a steady mover, but its latest move came after a five-month pause that started in March 2017. The stock caught fire in early August when the takeover of Worldpay was finalized, roaring from 64 on August 1 to 73 on August 16 in a high-volume rally. A buy of VNTV on the current pullback should work well over time.
Long-Term Breakout in Chinese Stocks
We’ve always had an investing attraction to China; it’s hard not to when you have a giant economy that’s growing at 6% to 8% rates annually. Many Chinese stocks have worked out well for us, including NetEase (NTES) back in 2003 when its business revolved mostly around its search engine, and Baidu (BIDU) in 2009-2011 when the stock ran significantly higher as the Google of China.
So far this year, Chinese stocks had been racing up the tracks, and like many areas of the market, what interests us is that the group appears to have only recently gotten going from a huge, multi-year consolidation.
Shown here is a monthly chart of the PowerShares Golden Dragon Fund (PGJ), which tracks just about every Chinese stock that’s traded in the U.S. (different from the Shanghai Composite or a related overseas index). You can see that PGJ had a big dip in 2008-2009, another dip in 2011-2012, and then a long three-year sideways phase from 2014-2016. This year, PGJ has gotten going, breaking out not just from the three-year lull but hitting new all-time highs in the process!
Like many stocks and sectors, such a decisive long-term breakout bodes well when looking out many months or even during the next couple of years. Shorter-term, though, PGJ’s lack of any meaningful dip since the start of the year does leave it open to a correction as pent-up selling pressures (profit taking) could be released.
And that leads us to Alibaba (BABA), which has been in a smooth uptrend since we added the stock in mid-April, and after earnings two weeks ago, accelerated to the upside. Like the sector, BABA has certainly earned the right to pull back—it’s only penetrated its 25-day line once all year (!) and the post-earnings move was a bit exuberant.
However, like Chinese stocks as a whole, BABA catapulted out of a multi-year consolidation in April. Given that it’s a liquid leader of the advance, the odds strongly favor the stock’s next consolidation leading to higher prices, unless the overall bull market falls apart (which we’re not expecting).
Similar to how we’ve handled Shopify (SHOP), it’s possible we could take partial profits in BABA if we detect an intermediate correction unfolding. But we are also determined to hold a good-sized position through any reasonable correction, thinking the stock could be in the early innings of a longer-term advance.
On the Other Hand …
While investing in early-stage situations like BABA (and Shopify (SHOP) and PayPal (PYPL), also in the Model Portfolio) raises your odds of success, you also have to force yourself to avoid “bargains” in highly regarded growth stocks that have hit the skids. Ulta Beauty (ULTA), which was a solid winner for us from 2014 through 2016, is a good example.
By our measures, ULTA originally got going back in late 2014 when it staged a huge gap up on earnings. (Volume that day was more than 10 times average, a big clue that the trend had turned up.) As the stock’s cookie cutter story attracted more followers, ULTA motored from roughly 120 to nearly 315, remaining above its long-term 40-week moving average for all but a few weeks during that time.
But that was then. Now, the tide has completely turned. ULTA cracked its 40-week line in early July, slipped further over the next few weeks, and then collapsed on earnings last week.
This goes along with what we wrote recently about the difference between a company and the stock. Is Ulta Beauty still a solid growth company? Absolutely, as sales and earnings rose 21% and 29%, respectively, in the latest quarter, and analysts see 20%-ish earnings growth going forward. But after a nearly three-year advance, perception of that growth has peaked, along with the stock.
Lesson to learn: you always want to be alert for the combination of a long price advance (at least a year, usually 18 months or longer) and an abnormal price break below long-term support. Such action might tempt you into grabbing a bargain, but in reality, it’s a sign that institutional investors are unloading big positions, a process that usually takes months to finish.
Cabot Market Timing Indicators
On the one hand, the intermediate-term trend looks iffy and large swaths of the broad market are in rough shape, including small- and mid-caps. On the other hand, the long-term trend is up and many growth stocks are holding up well. Overall, it’s still a bull market, and a little buying is OK, but we’re mostly biding our time for a stronger tape.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines remain bullish, and we’ve seen the big-cap indexes work off their “overbought” condition by moving mostly sideways since early June. Back then, the S&P 500 and Nasdaq closed 6.5% and 11.4% (respectively) above their 35-week lines; last week, the figures were 2.6% and 4.6%. (Both indexes are flat to slightly lower since June 2.) From a big-picture perspective, such action is normal, and with the indicator still positive, we expect the next big move to be up.
Cabot Tides: Bearish
Our Cabot Tides are negative, telling us the intermediate-term trend is down, though if you want to call it sideways-to-down we wouldn’t argue—many indexes are hanging around their 50-day lines, though small- and mid-cap indexes (like the S&P 600, shown here) are in clear downtrends. A couple of good days could produce a new Buy signal, but we need to see it happen before getting aggressive on the buy side.
Two-Second Indicator: Unhealthy
Our Two-Second Indicator is also negative, as the number of stocks hitting new lows each day remains too high for comfort, including a string of triple-digit readings earlier this month. At this point, we want to see at least five or six days in a row of sub-40 readings (and preferably more) before concluding the selling pressures on the broad market have receded.
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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 SEPTEMBER 12, 2017
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