In tonight’s issue, we details our recent moves and our thinking, as well as update the track record of our most reliable market timing indicator. We also talk about one of our favorite growth stocks we don’t own which, after a four-year (!) consolidation, looks like it could be ready to turn.
Cabot Growth Investor 1377
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Broad Market vs. Growth Stocks
In normal market years, the major indexes and most sectors act in relative unison. That doesn’t mean that certain areas don’t perform better or worse, or that mini-divergences can’t take place between, say, small- and large-cap stocks. But for the most part, the tide lifts (or sinks) most boats.
So far, though, 2017 hasn’t been a normal year. The Nasdaq in general (and growth stocks in particular) dazzled for the first five months of the year, and even through the summer, found a way to grind higher. Meanwhile, other indexes stagnated—the S&P 500 made basically no progress from March through mid-August, while small-caps’ dry spell lasted even longer, dating back to early December of last year.
Recent weeks, though, have seen a reversal of that trend—the stodgy Dow has been outperforming the Nasdaq for much of September, beaten-down groups like financials, industrials and retail have found buyers and our favorite broad market measure (our Two-Second Indicator) has flashed a green light. But, while that’s going on, most growth stock leaders (many of which we own) have been whacked!
These divergent situations are challenging, but as always, it’s important to go with the evidence. First off, you should pay most attention to what you own—whether it’s honoring loss limits or mental stops, or reacting to abnormal selling, you shouldn’t ignore the weakness in your stocks just because the Dow or S&P 500 are hanging tough. Indeed, we did some partial profit taking this week and placed some stocks on Hold.
On the flip side, all three of our general market timing indicators are still bullish, which tells us the odds are good that higher prices are coming down the road. And that tells us that there should continue to be buying opportunities ahead, either in growth stocks or, if the rotation continues, new leadership from some other areas.
In other words, you want to follow the plan when it comes to your stocks, but you want to make sure you stay flexible going forward—if the growth stock selloff spreads to the rest of the market, we could raise more cash, but continued signs of support (like we saw today) would likely lead to some great buying opportunities.
[highlight_box]WHAT TO DO NOW: For now, we’ve pared back and are content to follow the market’s lead. In the Model Portfolio, we’ve taken partial profits in Alibaba (BABA) and Universal Display (OLED), selling half our stake in each, giving us a cash position of around 27%.[/highlight_box]
Model Portfolio Update
Growth stocks have gone haywire in recent days, even as the general market has hung in there. This type of situation is tricky to handle. When it comes to stocks you own, your decisions should be based on (a) the action of the stock itself, (b) your profit cushion and (c) your position size, in that order. Obviously, if a stock is truly breaking support and/or has tripped your loss limit, you should sell out.
Beyond that, though, you should use judgment incorporating the above three factors. A stock that’s been hit very hard, where you have no profit and a good-sized position, should be first on the chopping block. On the other end of the spectrum, a stock that’s holding above support, where you have a good profit and have already taken some chips off the table, can be given more rope.
That guided our thinking early this week, as we booked partial profits in both Alibaba (big position) and Universal Display (abnormal action), but are holding our remaining stocks. Our cash position is now around 27%, and as usual, our next move—buy or sell—will be based on the action of the market and leading growth stocks.
Current Recommendations
HOLD—Alibaba (BABA 171)—On the chart, BABA doesn’t look bad, as the stock is still holding north of its 50-day line. However, we decided to take half our shares off the table in Monday evening’s Special Bulletin partially because our position had grown to a large size (more than 15% of the portfolio coming into this week) and partially because the stock hasn’t had a correction all year, which, combined with the recent stalling out, raises the chances of a “real” pullback. Also, a big reason we took some off the table is to give our remaining shares more room to maneuver—we still think BABA is one of the liquid leading growth stocks (possibly the top dog), and see it as closer to the beginning of its overall run than the end, especially given its buoyant earnings estimates (up 46% this year, up 32% next), dominant position in the industry and the fact that the stock just hit all-time highs in May. For now, then, we’re ringing the cash register, while aiming to hold the rest of our shares through any correction that develops.
BUY—Exact Sciences (EXAS 47)—We took a half position in Exact Sciences last week, and so far the stock is acting well. We have high hopes for the company’s Cologuard product, which looks like the next big thing in colon cancer screening and is being adopted en masse by physicians across the U.S., leading to rapid revenue growth (up 123%, 144%, 226% and 172% during the past four quarters). With just 2% of the potential market, management has some very aggressive expansion plans in place for the years ahead. We went with just a half position because EXAS wasn’t at a great entry point and because, frankly, there are some risks here—it’s a one-product company and short-selling outfits have already taken swings at the stock this year. Still, we obviously love the potential, and the fact that shares have held up so well in recent months despite various worries bodes well. You can buy a half position around here or on dips of a couple of points, with the idea of buying more if EXAS advances and, of course, growth stocks as a whole stabilize.
HOLD—Facebook (FB 168)—We placed FB on Hold earlier this week after the stock cracked its 50-day line on very heavy volume. There’s no clear reason for the selling, even though many want to find one; some are blaming the decision by CEO Mark Zuckerberg to sell 35 million to 75 million shares during the next year and a half, but that’s superficial news given that the stock trades an average of 17 million shares every day. More important to the stock’s long-term future is the continued growth in the business. Instagram just announced they’ve surpassed 800 million monthly users (up from 700 million in May), 500 million of whom log in daily, and the number of advertisers on the photo- and video-sharing platform has doubled since March. All told, FB isn’t that weak (it’s just 5% off its all-time high!), so we’re not panicking. On the downside, we’re using a rough stop near the 200-day line (at 148 and rising slowly), which the stock has held above on most pullbacks of the past few years.
HOLD—GrubHub (GRUB 52)—GRUB is off to a soft start, mostly because of the market, but also due to news last week that Amazon is expanding its reach into the food delivery business. Fundamentally, these forays by others into the online food ordering/delivery sector haven’t hurt GrubHub’s results one bit, and we doubt anything with Amazon (which is still a small fry in the business) will be different. But a big reason for our purchase was that the company’s slew of acquisitions lately changed investor perception concerning the question of competition—so if fears of competition are still bringing out lots of sellers, that theory could be wrong. That said, GRUB isn’t a disaster here (it’s still above its breakout level from August), so we’re comfortable hanging on. But given our loss we’re keeping shares on a relatively tight leash, with a mental stop in the 47 to 48 area.
BUY—PayPal (PYPL 63)—PYPL has pulled back this week but the damage is limited; so far, the stock hasn’t even touched its 25-day line, as this dip comes after a few days of strong upside volume that resulted in new highs. The firm has been relatively quiet on the news front, though it continues to make some small investments in payment and online marketplace companies; it recent joined a small fundraising round for Raise, a private company that operates a marketplace for gift cards. If the Nasdaq really caves in, PYPL will probably go along for the ride, but so far, the stock’s uptrend looks good and we continue to think the stock has lots of upside as the digital payment revolution goes on. Hold on if you own some, and if you don’t, you can grab a position here or on dips.
BUY—ProShares Ultra S&P 500 Fund (SSO 96)—While growth stocks have hit a pothole, the general market remains in good shape. In fact, all three of our market timing indicators are bullish, and the S&P 500 is less than 1% from all-time highs as money rotates into financials, industrials, retailers and other sectors. Sure, there’s always a chance that weakness in the Nasdaq continues, and that drags down other indexes, but you know us—we go with the evidence, and right now the chart of SSO shows a steady string of higher highs and higher lows. Throw in the many positive longer-term studies from earlier this year that point to higher prices down the road, and we’re sticking with our Buy rating.
HOLD—ServiceNow (NOW 115)—Our timing with ServiceNow was off, as the stock, which had been tightening up nicely just south of new-high ground, fell with the market. Like most growth stocks, the slide was notable but not extreme; shares dipped below their 50-day line but found support near the top of their July-August range and snapped back today. Moreover, NOW has a history of two-steps-forward, one-step-back types of advances, so we want to give the stock some rope. Bottom line: If you bought with us, hold on here, but we’re using a mental stop in the mid 100s area in case things go awry.
BUY—Shopify (SHOP 117)—SHOP has had a big run this year, and recently motored from an early-August low at 88 to a high near 124 in just five weeks. Thus, market wobbles or no, the stock was due for some selling, which is what we’ve seen. How you handle the stock has a lot to do with the factors we mentioned earlier—we’ve already sold half of our initial position and it’s unlikely the stock’s overall advance is complete after just nine months, so we’re giving SHOP plenty of leeway (possibly down to support in the low 80s if need be). If you have a small profit (or a loss), you should use a much tighter stop, maybe in the upper 90s. But right now, we’re not thinking too defensively—we’re leaving SHOP on Buy, so if you’ve yet to buy any, we’re OK picking up a few shares on this weakness.
HOLD—Universal Display (OLED 128)—OLED hasn’t broken down, but the wild action of late—from 110 in late August to 145 in mid-September, all the way back down to the mid 120s this week—looks a bit abnormal to us. Granted, much of the movement was centered on Apple’s new iPhone X (which uses organic light emitting diodes from Samsung, which is a big customer of Universal Display), with recent reports of delays and so-so demand hitting the stock. We still think the underlying story is intact, but given the wobbly action (and the fact that we’ve already sat through a two-month correction this summer), we decided to take half our stake off the table on Monday’s Special Bulletin. As usual, with some profit in our back pocket, we’re aiming to give the rest of our shares some leeway—if the OLED revolution remains on track, Universal Display should do very well.
Watch List
Celgene (CELG 143): CELG remains in good shape. We think the long bottoming out period is over, and many years of 20%-plus earnings growth should keep big investors on the buy side.
E*Trade (ETFC 43): ETFC isn’t our typical growth stock, but it’s our favorite Bull Market stock and we think it can thrive if financial stocks kick into a higher gear. We like the setup, and recent monthly trading reports show that business remains on solid footing.
Five Below (FIVE 54): After years of base-building, FIVE may finally be ready to get going, with an excellent growth story and numbers that could take it far. See our writeup later in this issue.
Wynn Resorts (WYNN 145): Similar to Celgene, WYNN is a good-looking (and good-sized) turnaround situation, with business improving not just because of a general improvement in Macau, but also because of the firm’s latest resort (Wynn Palace) in that area, which has huge potential.
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.
AbbVie (ABBV 85) — AbbVie is a pharmaceutical company whose headline rheumatoid arthritis drug, Humira, brought in almost two-thirds of its 2016 revenue. That explains why the company’s big win in a Humira patent infringement suit caused its stock to soar on September 7. The “patent cliff” issue had been weighing on ABBV for a while, scaring off some investors who were attracted by the stock’s reputation as a Dividend Aristocrat, stocks that have increased dividends every year for 25 years. ABBV’s dividend yields 3.0%, which is great for a stock with a relatively low 13 forward P/E. Management has said that Humira has great prospects for increased sales, and the company’s positive news from a mid-stage study of an eczema treatment added fuel to the fire on September 8 (and took some wind out of Regeneron’s sails). ABBV’s bullish longer-term forecasts are reminiscent of Celgene’s similar optimism that kicked off a multi-year run. AbbVie may be setting up the same kind of performance.
Ligand Pharmaceuticals (LGND 134) — Ligand Pharmaceuticals is a mid-cap biotech company with a unique approach to drug development. The company does early stage discovery and development of drugs, then partners with major pharmas who decide whether to proceed to clinical trials. The company’s strategy is to have a ton of projects (which it calls “shots on goal”) and the count is currently 155 fully-funded projects with 92 different partners. 17 products have been approved so far, and management is projecting 28 to be marketable by 2020. Two-thirds of revenue comes from royalties, with the rest supplied by less-predictable contract payments. Revenue was up 52% in 2016 and analysts are expecting earnings to grow by 21% this year and 31% in 2018. LGND, which is probably too thinly traded to qualify for the Model Portfolio, has been through a long, well-formed cup formation since its high at 140 in August 2016 and has been trading in a tight range between 134 and 137 for a couple of weeks. It’s a good story and a nice setup.
RPC Inc. (RES 24) — RPC Inc. is a nuts-and-bolts oilfield services company that supplies pressure pumping, tubing solutions and rental tools to the industry. Oil prices have put all stocks in the oil patch through the wringer in the past couple of years; revenue fell 46% in 2015 and 42% in 2016. But revenue grew by 58% in Q1 and 179% in Q2, with earnings up by triple digits, and analysts are forecasting sales and earnings to surge higher in the quarters to come. In short, RPC has everything in place—no debt (the result of a good tactical decision by management in 2016), huge earnings estimates and progressive gains in revenue—to be profitable in any circumstances and to benefit manyfold if oil prices keep increasing. If oil gets moving, RPC could be a leader.
It’s Hard to Keep Things Simple
We got the above title from The Perfect Speculator, a book about a fictional (as far as we can tell) speculator who was teaching a friend how to invest. We seem to come back to this theme every month or two—despite all the variables, volatility and uncertainty in the market and economy, your best indicators and methods are often the simplest ones.
Our Cabot Trend Lines are a perfect example. While pundit after pundit examines the market from a perspective of valuation, earnings growth, interest rates, economic reports and the like (and even then, they tell the average Joe that there’s no use timing the market!), it turns out that a simple long-term, trend-following strategy does great.
The Cabot Trend Lines use just two indexes (S&P 500 and the Nasdaq, the two most-followed market measures out there). Only end-of-week closing prices are used, so you can ignore what happens from Monday through Thursday. And each index is compared to one moving average (its 35-week moving average).
If you’re on a Buy signal, as we are now, a Sell signal is produced when both indexes close below their respective 35-week lines two consecutive Fridays. It’s the opposite for a new Buy signal, with two straight weeks by both indexes above their 35-week lines giving the green light. Pretty simple.
And how have the Trend Lines worked? First, there aren’t many signals, just 26 during the past 17 years, including a few years with none at all! Our last signal, in fact, was back in April 2016 as the market came out of its mini-bear market.
As for results, it turns out that if you theoretically bought the Nasdaq at every Buy signal during the past 17 years, and went to cash during Sell signals, you’d have doubled the market’s return during that time, up 185% vs. 90% for the Nasdaq. That equates to beating the Nasdaq by 2.5% annually, on average, for 17 full years.
That said, we don’t really advise trading the Trend Lines or any of our other indicators; they’re meant more as guideposts for our Model Portfolio’s stance. In general, the Trend Lines will be positive for 75% to 90% of major bull markets, and negative for similar percentages in bear markets. In other words, it keeps you on the right side of the market’s major trend.
Of course, like any indicator, the Trend Lines aren’t perfect. There will be whipsaws in choppy years; there were five combined signals in 2005-2006, and again in 2011-2012, for instance. But following the Trend Lines means you’ll be mostly bullish during major uptrends and mostly defensive during big downtrends—that alone puts you ahead of 80% of investors.
Beyond the Trend Lines, though, the larger point is that, in the market, you don’t have to dive into the arcane and complex to make good money. You’re usually better off ignoring all the noise and keeping things simple.
Is it Finally Time for Five Below (FIVE)?
The recent action among growth stocks as a whole hasn’t been encouraging, but what’s interesting is that, while some extended and “late stage” stocks have been hit, other growth areas that have sat out the dance have begun to find buyers. Biotech, which bottomed out for about two years, is one example that we’ve written about recently. And another is retail, which has been weighed down by terrible traffic trends at malls and fears (probably well founded) that Amazon will take big share in the years ahead.
We, of course, have never had any interest in the old, stodgy mall-based retailers. But Five Below (FIVE) is a name we’ve watched for a very long time (and even owned for a brief period last year), and we think it has big potential. As a glorified dollar store, the firm’s teen and pre-teen merchandise has always sold well—comparable store sales have grown 11 years in a row, and the second quarter saw the fastest growth in that metric since 2012!
Granted, there has been some hubbub about whether Five Below’s results have been boosted by the fidget spinner craze, and they probably have. But the story is much bigger than that. The firm has 584 stores, and because new openings pay back their investment in about a year, management is opening stores like mad, with 100 new stores this year, on its way to more than 2,000 in the long-term. Sales and earnings should grow 15% to 25% for many years.
And the stock is a big part of the story, too—FIVE has now been in a huge post-IPO base since November 2013 (!), and we like the recent, tighter consolidation, which came after a string of 11 weeks up in a row, a sign of institutional accumulation. The stock touched new highs today.
The bottom line is that Five Below’s story and numbers have always been attractive, and now, after years of base building, the stock could be ready for a major run. It’s near the top of our Watch List. WATCH.
Cabot Market Timing Indicators
The selling pressure on growth stocks demands action, which is why we trimmed our sails earlier this week. But now’s not a time to get overly cautious—from a top-down perspective, the market is in fine shape, so we’re holding our resilient stocks and looking for new buying opportunities.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines are our most reliable indicator and, as we highlighted earlier in this issue, have a great long-term track record of keeping us on the right side of the market’s major trends. Today, it remains firmly bullish, with the S&P 500 and Nasdaq closing last week 4.0% and 5.4% (respectively) above their 35-week moving averages. Thus, the odds still favor higher prices in the months to come.
Cabot Tides: Bullish
Growth stocks and the Nasdaq have been under some pressure, but our Cabot Tides remain clearly positive, as most indexes (including the S&P 400 MidCap, shown here) are well above their lower (25-day) moving averages. With both the intermediate- and longer-term trends pointed up, it’s a good reason to (a) not get overly negative and (b) continue to keep your eyes open for new buying opportunities.
Two-Second Indicator: Healthy
Our Two-Second Indicator has been on-again, off-again this year, but its action in recent weeks is very impressive. We’ve now seen 13 straight days of fewer than 40 new lows (with the past 11 all coming in below 20), a sure sign the broad market has returned to health. Long-term, that’s a good sign that the bull market has further to run.
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Send questions or comments to mike@cabotwealth.com.
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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 OCTOBER 11, 2017
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