In tonight’s issue, we go over all our recent moves, dive into the recent action in one of our stocks and review one of our proprietary indicators that, along with some precedent analysis, adds further evidence to the market’s bullish outlook.
Cabot Growth Investor 1378
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“Markets are Never Wrong; Opinions Are”
We’ve read hundreds of investment books and articles through the years, but of all the witty comments and market truisms, the above quote from Jesse Livermore remains our favorite—so much so that we had it engraved above the mantel in our office’s fireplace! The message, of course, is simple: Focus on what the market is actually doing, not on your opinion of where the market should go.
This year, you’ve heard many reasons why the market should go down, such as the notion that the bull market has been running for eight years (we’d disagree with that assessment, but that’s another subject), valuations are high, Washington, D.C. is in disarray, war on the Korean peninsula could break out, the Fed is raising rates and decreasing its balance sheet, Hurricanes Harvey and Irma and more.
But what has the market done? Go up! Obviously, there have been some rough spots along the way, but our two major trend-following indicators (Trend Lines and Tides) have been bullish for nearly the entire year. And today, in fact, the picture is as bright as it’s been—all the major indexes are in sync on the upside, the broad market has kicked into gear and many stocks and sectors are acting well.
About the only thing to worry about right now is that there’s not much to worry about! Many of the fears from earlier this year have disappeared, at least for now. Not that we’ve seen much in the way of exuberant sentiment (money was actually yanked from equity funds overall during September and early October!), but there’s no question that the action has been a bit hot and heavy lately—and with earnings season getting underway, that combination could lead to some potholes in the market and some individual stocks.
Thus, you still need to be ready to take action should any of your current holdings hit the skids, and on the buy side, it’s probably best to be a bit choosy given the recent run and earnings season. But, overall, the market’s message is clear: It’s a bull market, and the odds continue to favor higher prices down the road.
[highlight_box]WHAT TO DO NOW: Remain mostly bullish, but be sure to follow your plan for each of your stocks. In the Model Portfolio, we sold half of our remaining Shopify (SHOP) position last week, averaged up in Exact Sciences (EXAS) and ProShares Ultra S&P 500 Fund (SSO) and added a new position in Five Below (FIVE). Our cash position is near 14%.[/highlight_box]
Model Portfolio Update
The past two weeks have been eventful for the Model Portfolio, with a handful of moves and a sudden decline in one of our biggest winners. All told, our stocks are a bit mixed at the moment—most are acting fine, though we have three (GrubHub, Universal Display and our remaining small position in Shopify) on relatively tight leashes.
We still have about 14% in cash, and we’re looking to put that cash to work, though given that earnings season is about to rev up and most stocks have enjoyed good moves higher of late, we’ll be picky.
As for the portfolio’s structure, we already have 10 stocks, which is normally our maximum, but we’re willing to go over, given our “extra” cash due to the partial profit taking. We’ll see how everything plays out, but we will definitely keep the portfolio relatively concentrated.
Current Recommendations
BUY—Alibaba (BABA 185)—BABA punched out to new highs this week, a bullish sign. The company continues to make news, mostly through stakes in other companies. One online lender it has a stake in (Qudian) is set to go public soon. Alibaba is moving into the online game business, buying Ejoy (which was founded by the former COO at NetEase and has several mobile games) and setting up a business unit to focus on the sector. And Alibaba took a majority stake in Chinese logistics operation Cainiao Network. As for the core e-commerce business, expectations are high, and the next quarterly report will likely be released in early- to mid- November. At some point, the stock will have a “real” correction and base-building period, but so far, selling pressures have been limited to just a week or two before the buyers step back in. We’ll stay on Buy.
BUY—Exact Sciences (EXAS 49)—We filled out our position in EXAS last week, as our initial stake got off to a good start. More and more analysts seem to be coming around to the thought that Cologuard is going to grab a big chunk of the colon cancer screening market. It has just 2% of that market today, but it’s already shown to be reaching new populations (half of users have never been screened before) and management thinks it can expand manyfold from here. Of course, as a one-product company, there is downside, and it’s worth nothing that EXAS was attacked back in May by the same short-selling outfit that hit SHOP last week. (EXAS fell sharply for a few days but stabilized after.) That said, if business continues to grow wildly (sales up 172% last quarter!), we think higher prices are coming. You can buy some here or on dips of a point or two. Earnings are due out on October 31.
HOLD—Facebook (FB 173)—FB has a nice-looking setup, having etched a tight consolidation during the past 11 weeks, which included a sharp shakeout late last month. Still, the stock’s failure to get going even as the market has lifted is a worry. We’re still believers in the long-term story, and for our position, FB would probably have to decisively crack its 40-week moving average (currently down around 152) and its summertime lows (145 or so) before we say adios. If you have a good profit, then, we advise just sitting tight and giving the stock room to bounce around. If you have a small profit or a loss, a stop in the low 160s makes sense. Earnings are due on November 1.
BUY—Five Below (FIVE 56)—We grabbed a new position in Five Below last week, and we remain optimistic that shares are early in a new, sustained advance. Short-term, that doesn’t mean FIVE can’t wiggle around, especially if the market pulls back, but our thought is that the longer-term trend has turned up. Fundamentally, we like both the company’s growth (and growth potential) and the consistency of that growth—it’s the combination that attracts big investors. Indeed, nearly 500 funds now own shares, and we see that number increasing as the firm continues to execute. If you don’t own any, you can buy some here or on dips of a point or two.
HOLD—Grubhub (GRUB 52)—GRUB has stabilized but hasn’t followed through on its early-August surge as we’d hoped. That said, the action hasn’t been abnormal, the major trend is up and the story remains intact. Yesterday, the company completed its purchase of Yelp’s Eat24 subsidiary, which should immediately boost business and lead to excellent synergies over time. We’ll continue to play the stock by the book—a drop below 48 or so would likely have us cutting our loss and moving on, but otherwise, we’re happy to hold on and give the stock’s longer-term uptrend a chance to resume.
BUY—PayPal (PYPL 68)—PYPL remains in a smooth, steady uptrend, having perked up to new highs today after an analyst upgrade. Fundamentally, the company expanded another key deal in recent days—PayPal and MasterCard recently extended their partnership into Canada, Europe, Latin American and the Caribbean, giving PayPal a presence in millions more point-of-sale locations, and letting people easily switch cash from their PayPal accounts to MasterCard debit cards. After the stock’s run in recent months, the valuation looks a bit stretched (36 times this year’s earnings estimates, compared to 20% expected growth next year), but remember that (a) estimates could be conservative, and (b) PayPal’s free cash flow is meaningfully larger than reported earnings. That’s not to say that the stock can’t have a correction—earnings are due on October 19—but we’re more focused on the longer-term bullish story playing out over time. We’ll stay on Buy, but keep new positions small this close to earnings.
BUY—ProShares Ultra S&P 500 Fund (SSO 100)—From March 1 (when the S&P 500 tagged 2,400) to late-August (2,417), the S&P 500 didn’t make much progress for about five and a half months. But since then, the index (and SSO, which tracks the index on a 2-to-1 basis every day, up or down) has finally kicked into gear, and its recent action suggests it may have taken the leadership baton from the Nasdaq. Given our bullish market timing indicators and some other longer-term studies (including our 7.5% Rule, which is still in effect; see our comments later in this issue), we expect SSO to continue to trend higher over time. We averaged up last week, adding 20% more shares to our position (i.e., if you own 100 shares, buy another 20).
BUY—ServiceNow (NOW 121)—Similar to SSO, NOW’s most recent shakeout—occuring in late September and taking shares back to where they were in early June—likely cleared the decks for higher prices. The stock shot ahead to new all-time highs quickly after its dip and remains in good shape. Fundamentally, the next update will come when earnings are released on October 25; beyond the headline sales and earnings data will be new bookings, renewal rates, and, of course, free cash flow, which is becoming a larger part of the story. We’ll stay on Buy, but as usual, it’s probably best to keep new positions smaller than normal ahead of the quarterly report.
HOLD—Shopify (SHOP 95)—Shopify went over the falls last week after a well-known short-selling outfit claimed that the company would get in trouble with the government for overly aggressive advertising, questionable accounting and some other stuff. As usual, we find the likelihood of these claims questionable, as 453 mutual funds owned shares in June, likely after doing their own research. However, what counts isn’t the news, but the reaction to that news, and the fact that SHOP has fallen on giant volume is clearly negative. We had already sold about half of our original position back in the spring and summer, and we took half of the remaining position off last week, leaving us with a small (less than 4% of the Model Portfolio) position. Despite the recent drop, SHOP’s longer-term trend is not broken, so we’re holding our remaining position with a mental stop in the low- to mid-80s. That said, the intermediate-term outlook has dimmed, so if you have a small profit or a loss, we’d exit and look for greener pastures.
HOLD—Universal Display (OLED 130)—OLED hasn’t done much since its big rally-and-drop sequence in September, which can be viewed either as a good thing (it’s holding above logical support—the meat of its prior base and its 50-day line) or a bad thing (unable to bounce with the market in recent days despite the sharp drop). Ideally, we’d like to hold our remaining half-sized position (we sold half late last month) through earnings (likely out in early November), as another blowout quarter would refocus investors on the major demand for organic light emitting diodes that’s likely to play out. But we’ll simply let the stock make the decision for us—a close down into the 117 to 118 area would probably have us taking the rest of our profit and moving on, but right here, we’re holding.
Watch List
Autodesk (ADSK 119): After three shakeouts since late May, ADSK looks like it’s prepping for a new run. See below.
HubSpot (HUBS 84): It’s on the thin side, but HubSpot looks like a potential new leader. The company’s inbound marketing platform is gaining traction and driving solid revenue growth, while the stock has recently broken out on the upside.
E*Trade (ETFC 44): Greater money flows, rising short-term interesting rates and more trading activity should all help ETFC’s bottom line rise faster than expected in the quarters ahead.
Vertex Pharmaceuticals (VRTX 154): VRTX has consolidated in a tight range for the past three months. The firm’s various cystic fibrosis drugs are a hit, with more in the pipeline. Earnings should grow more than 90% this year and in 2018.
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.
Autodesk (ADSK 119) — Autodesk is the dominant provider of software that architects, engineers and manufacturers use to draft and model designs, enable collaboration and manage data. The company has been in transition from a software buying model to a software-as-a-service model, going from big intermittent sales to predictable monthly subscriptions, which has had a negative effect on revenue and earnings for a while. But the subscription model is starting to build cash flow—the company is aiming for $6 in free cash flow per share in 2020 and $11 in 2023—and that could be the next impetus for the stock. ADSK has been trading in a tightening range since May, with resistance at 115 to 117, but the stock has crept higher recently and we think it’s just a matter of time before the breakout comes. Autodesk is following in the footsteps of Adobe, which underwent a similar business model transition with great success. We’re keeping a very interested eye on this one.
Blue Buffalo Pet Products (BUFF 29) — Blue Buffalo makes high-end pet food, with a little kitty litter thrown in. It’s a pretty remarkable story for a company incorporated just in 2012, as the company has achieved U.S. and Canadian distribution in every channel from national pet superstore chains, regional chains, local pet shops, farm and feed stores, vet clinics and online, and is actively courting major grocery chains and mass retailers. And yet it has just 3% market share! The company has a full line of wet and dry foods for all breeds, all diets and all life stages. High quality and excellent distribution has led to steady revenue and earnings growth. From its IPO peak at 29 in August 2015, BUFF corrected to 15 in February 2016, then rebounded in March 2016. After a 16-month consolidation, BUFF got moving again in August and is knocking on the door of new all-time highs. It could be a steady advancer if management pulls the right levers.
KB Home (KBH 27) — KB Home has built nearly 600,000 homes since it started in 1957 and it’s enjoying the renewed strength of the homebuilder industry. KB booked a 19% jump in revenue in 2016, and has shown improving growth in the first three quarters of 2017, with 21% growth in Q1, 24% in Q2 and 25% in Q3. In the latest quarter, the number of homes delivered jumped 11.2%, while the backlog hit 5,455 homes, up 4.4% year-over-year. KBH, which had corrected from 24 in July to 21 ahead of the earnings report, gapped up to 24 after the earnings beat and has motored higher since then. KBH still trades at a reasonable 19 P/E and analysts are calling for 55% earnings growth this year and 21% in 2018. KBH, which was a leader earlier in the year, is back on track.
Match Group (MTCH 26) — Match Group specializes in online dating, and operates more than 45 brands—Match, Tinder, okcupid and PlentyofFish, for example—in 38 languages and more than 190 countries and has about 5.5 million paid members. But what investors are interested in is the Tinder brand, a mobile-only, global platform that’s highly successful with millennials. The Tinder dating app has over 40 million downloads, and can support paid add-on and premium services. By one estimate, the online dating population is expected to grow from 511 million today to 672 million in 2019, and Match casts a wide net in that ocean. MTCH built a long base from October 2016 through August 2017, but the late-August breakout consolidated for a few weeks under 24 and is headed higher.
A Quick Update on the 7.5% Rule
Our 7.5% Rule flashed near the start of March this year, which occurred because the S&P 500 closed at least 7.5% above its 35-week moving average for the first time in at least nine months. While that might not sound overly significant, such a scenario has only occurred 10 other times since 1980 (about once every three years on average), and when it flashes, it signals two main things for the market.
First, it indicates that higher prices are likely during the next few months, if not a year or more. Since 1980, past 7.5% signals resulted in 5% gains after three months, 9% after six months and about 15% after a year. So far, this year’s signal is a bit below average (up 7.2% after seven months), though the Nasdaq is up 12.4%. Not bad.
The second indication, which was nearly as interesting as the overall returns, was that prior 7.5% green lights resulted in very little pullbacks from the signal—on average, the S&P dipped a maximum of just 2.5% from the signal during the next year. For 2017, that would translate to around 2,320 on the S&P, and sure enough, that was right around the index’s post-signal low.
Of course, we’re not going to rely solely on something from seven months ago to tell the market what it can or can’t do. But the fact that we’re “only” seven months into the latest 7.5% signal backs up the overall bullish outlook.
Digging a bit deeper, it’s interesting that, of the 10 prior signals, the early-1985 signal is tracking closest to this year’s. That’s not surprising, as we’ve written many times before about the various similarities between now and then—a very long-term breakout in the market (1982 vs 2013, respectively), a year or two of gains and then a shallow, 18-month mini-bear market (mid 1983-1984 vs 2015-2016). Both markets then resumed their uptrends, with the 1985 scenario seeing the S&P 500 double within three years!
We’re not going to draw any one-for-one comparisons, but the 7.5% Rule earlier this year continues to be a bullish tailwind for the market, and the still-strong comparison between today and the mid-1980s is another plus.
If You Have a Newborn, You’re Going to Have Some Sleepless Nights
We thought of the above truth last week when, out of nowhere, Shopify was nailed when a short-selling outfit released a detailed report ripping the stock. We sold half our remaining shares in response, but also fielded many questions about how the steep drop could have been prevented.
We always go back and review our trades at a later date (when cooler heads prevail), which is important to help constantly improve. But oftentimes, a large part of trading simply comes down to accepting the nature of the stocks you’re trading. In the same way that you can’t expect to sleep through the night with a newborn, you can’t expect growth stocks to adhere to a set of low risk, high reward rules.
Growth stocks are generally going to be volatile. They’re going to gap up and down on earnings, sometimes 10% or more. They’re going to be targeted by short sellers. They’re going to be run up and down on a short-term basis by traders looking to make a quick buck. If they become popular enough, they’re going to be debated back and forth online and on TV. And, fundamentally, they’re also likely to enjoy big valuations, see lots of insider selling on the way up, attract some competition and, eventually, have a bad quarter or two.
Of course, growth stocks are also capable of making huge upside advances, especially over time in a bull market. And if you catch just a couple of those, it can make all the difference to your portfolio!
But the point is that the above characteristics (among others) are a given—instead of trying to avoid them (which usually ends up costing you money over time), accepting them as facts and dealing with them prudently (via position sizing when you initially buy and, possibly taking partial profits on the way up) is the way to go.
Cabot Market Timing Indicators
Sometimes our indicators need some extra interpretation, but right now, the message is clear: With all our measures pointed up, the bull market remains healthy as a horse. That doesn’t preclude short-term pullbacks or earnings shenanigans, of course, but the path of least resistance is up.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines remain in fine shape, with the indicator’s positive stance more entrenched now that the S&P 500 has ratcheted higher in recent weeks. At last Friday’s close, the S&P and Nasdaq were 5.4% and 7.2% above their respective 35-week moving averages, keeping the market’s larger, longer-term trend firmly bullish.
Cabot Tides: Bullish
After months of somewhat divergent action, all of the major indexes are in gear on the upside, which keeps our Cabot Tides bullish. While there’s been some rotation into the broad market in recent weeks, the Nasdaq (daily chart shown here) isn’t sitting out the party—it’s pushed to new highs recently along with everything else and remains nicely above its lower (50-day) moving average. Thus, the intermediate- and longer-term trends continue to point north.
Two-Second Indicator: Healthy
Our Two-Second Indicator is also in bullish territory, as the number of stocks hitting new lows has been fewer than 40 (and usually fewer than 20) every day since the beginning of September. That’s a great sign that the selling pressures on the broad market remain light, which tells us the overall bull market is in good health.
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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.
Charts show both the stock’s recent trading history and its relative performance (RP) line, which shows you how the stock is performing relative to the S&P 500, a broad-based index. In the ideal case, the stock and its RP line advance in unison. Both tools are key in determining whether to hold or sell.
THE NEXT CABOT GROWTH INVESTOR WILL BE PUBLISHED OCTOBER 25, 2017
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