We’ve pared back during the past few days in the Model Portfolio, but we\'re not sticking our heads in the sand and are giving our profitable stocks room to consolidate. In tonight’s issue, we dive into our game plan for our remaining stocks, and we also do some sector analysis, including two areas that are launching new leaders.
Cabot Growth Investor 1382
[premium_html_toc post_id="142131"]
Some Abnormal Selling Appears
This year has been fantastic for growth stocks, but even during the persistent uptrend, we’ve seen a few sharp selloffs and periods of rotation out of the growth leaders and into other areas like transports, financials and cyclicals in general. June and September saw growth stocks lag as money flowed into these other areas, and after a huge run during the past few weeks, another round of rotation wasn’t totally unexpected.
However, this selloff in growth stocks has a distinctly different feel to it for a few reasons. First, leading stocks are further extended in their runs than before the earlier bouts of selling; many have been running without much of a correction since the spring. Some haven’t pulled back all year!
Then we saw some leaders we own (like PayPal) and others we don’t (like Square) show signs of exuberance and move out of trend on the upside. Of course, these types of climax signals are very inexact, but they can often occur near intermediate-term peaks. And now, of course, we see a barrage of high-volume selling, with some leading stocks and sectors decisively breaking down and even resilient names getting knocked around.
What does it all mean? Well, first and foremost, it’s vital to remember that it’s still an overall bull market—our trend-following timing indicators are both clearly bullish. However, as growth investors, we don’t advise ignoring the recent weakness; given the above evidence, the odds have increased that some stocks and sectors have hit significant peaks.
So what should you do? Sell any stocks that crack, and don’t hesitate to take partial profits in bigger winners that are acting iffy. We’ve done that in the Model Portfolio, selling two stocks outright and taking partial profits in two others, and we could raise more cash if the selling pressures remain intense.
However, you shouldn’t stick your head in the sand, either—with the overall uptrend intact, some growth stocks holding up well and other sectors (like retail and financials; see more on this later in this issue) showing some spunk, there could be some new buying opportunities in the weeks to come.
[highlight_box]WHAT TO DO NOW: For now, though, we’re content to hold some cash and wait for the market to settle down. We’ve sold all of Autodesk (ADSK) and ServiceNow (NOW), and sold one-third of our stakes in Exact Sciences (EXAS) and PayPal (PYPL), leaving us with around 28% in cash. We’ve also added to our Watch List as we follow where the big money is flowing.[/highlight_box]
Model Portfolio Update
With growth stocks going haywire, the key is to pay attention to portfolio management as much as chart analysis, because if you’re only going by charts, you’ll probably end up selling just about everything you own during a big selloff. Instead, you also want to factor in (a) your profit cushion and position sizes, as well as (b) whether you’re willing to sit through a possible correction. In our case, we’re trying to play out some longer-term trends in liquid leaders like BABA and PYPL (and FB, of course), while faster-moving names will likely have tighter stops, given their downside potential if the sellers truly take control.
Overall, the recent selloff among growth stocks demands action and raises the chances of a deeper retreat. But it’s also still a bull market, so after raising some cash, we’re willing to give most of our remaining stocks room to breathe, while keeping our eyes open for new leadership.
Current Recommendations
HOLD—Alibaba (BABA 173)—BABA’s laggy action for the past three months finally caught up with it, as shares suffered a big-volume drop below their 50-day line before finding support yesterday. Short-term, there could easily be more downside (or at least choppy trading) given that shares haven’t had a meaningful pullback all year. Longer-term, though, nothing in the chart, the company’s fundamentals or the market as a whole tell us that Alibaba has hit a major top, so we continue to expect higher prices. We sold half our original shares in late September, and we could always trim a bit more if the market remains dicey. But we’re aiming to hold most of our remaining shares though this consolidation—right now, we’re using a loose stop near the 40-week moving average, which is currently near 150 and rising.
SOLD—Autodesk (ADSK 107)—We hadn’t suffered through a bad earnings reaction in a while, but ADSK unfortunately gave us one, as shares plunged after a so-so quarterly report. The major story is intact, but the company has created some confusion (including some refocusing on certain products) that will add a few one-time charges. The stock hasn’t been able to bounce since its gap lower and is no higher now than it was back in May. We took our 12% loss last week and are holding the cash; there will be better stocks to own going forward.
HOLD—Exact Sciences (EXAS 54)—We decided to take partial profits in EXAS earlier this week (selling one-third of our shares) as the stock came under selling pressure after repeatedly being unable to get over the 60 level. However, that move will allow us to give our remaining shares more room to breathe—with some profit in the bank, we’ll allow shares to retreat back toward our cost basis (near 48) if need be. Fundamentally, Exact still has tremendous potential as Cologuard use ramps up, which seems likely as worries surrounding insurance coverage and reordering have been answered. If you haven’t yet, you can take some off the table and hold the rest.
HOLD—Facebook (FB 176)—FB has pulled back with other growth stocks but the damage isn’t that bad, as the stock sits just 5% off all-time highs. Of course, shares haven’t made much upward progress, either, hence our Hold rating in recent weeks, but the long-term trend here remains firmly up. As for the company, we’re intrigued by Facebook’s move into content—its new Watch platform, which looks like it will compete with YouTube, is sure to be a big investment (including original content) but the payoff could be huge as more and more content viewing moves online. The real key, in our view, is how conservative next year’s earnings estimates are (now at just +13%)—big upward revisions would probably kick the stock back in gear. For now, though, we’ll just stick with a Hold rating until we see buyers arrive en masse.
BUY—Five Below (FIVE 66)—Five Below’s growth story continues to play out, with the company reporting a terrific quarterly report late last week. Revenues grew 29%, driven by a very healthy 8.5% hike in same-store sales, while earnings lifted 80% to 18 cents per share, five cents ahead of estimates. The firm also opened a mammoth 41 new stores in the quarter, ending October with 625 stores; encouragingly, management said unit volumes at new stores opened this year are on track to be the largest in the company’s history. Guidance for the busy fourth quarter was hiked, and the stock has been acting well, rallying to new highs before and after the news and moving further above the breakout level of its four-year consolidation (near 55). Retail stocks have actually gathered strength as traditional growth stocks have gotten hit (see more later in this issue on that topic), and FIVE is clearly one of the leaders. We’ll stay on Buy, though try to get in on dips of a couple of points.
BUY—Grubhub (GRUB 68)—It’s only been a week, but so far, the most resilient growth stocks during the selloff have been ones that are “fresher” (just broke out of long-term launching pads within the past three months) but also are in well defined uptrends. GRUB fits that description to a T, and we’re pleased to see the stock holding up very well in recent days, not even dipping to its 25-day line. We continue to think the big story here is that the competitive landscape, while still intense, is easing; some smaller operators have folded up this year, and Grubhub’s scale is proving to be a major differentiator. As the industry consolidates and grows, we think the company can post excellent growth for many years as more takeout orders go online. We’re OK buying a small position here or on dips of a point or two.
HOLD—PayPal (PYPL 73)—PYPL was the second of two stocks we’ve taken partial profits in over the past week, selling one-third of our position. The main reason wasn’t just the recent down move, but also the stock’s uninterrupted uptrend since April and move out of trend on the upside, which typically precedes a rough stretch. However, as with some other liquid leaders we own, the goal now is to ride out near-term headaches, thinking PYPL will head higher down the road because the firm’s underlying business trends are strong and have a long way to run. If you have a loss, you should tread carefully, possibly using a stop near the recent lows (68-ish). But if you have some cushion like us, we advise keeping things loose with a stop in the 60 to 62 area, allowing the stock room to build a new base.
BUY—ProShares Ultra S&P 500 Fund (SSO 106)—SSO has benefited from the market’s recent rotation, lifting to new highs earlier this week before pulling back a bit. We’re not big on “overbought” statistics, which have a poor track record of predicting market moves, but it doesn’t take a computer to tell you the S&P 500 (and the Dow Industrials) are stretched to the upside here. With our trend-following market timing indicators solidly bullish, we’re staying on Buy, but if you’re looking to enter, aim for dips toward the 25-day line (now at 103 and rising quickly).
SOLD—ServiceNow (NOW 118)—We cut bait with NOW on Monday evening’s Special Bulletin as the stock knifed through its 50-day line on huge volume, closing the day below our buy point. (We sold the following day as usual, with our exit price right around our cost basis.) Sure, the company is doing fine, but as we often write, the company is not the stock—and the fact that the stock stalled out for the past month and collapsed below support means big investors are paring back. We’re holding the cash and will redeploy it in a stronger situation when we see the right setup.
HOLD—Shopify (SHOP 96)—SHOP’s action had been very encouraging since its early October plunge, but the stock is back in the soup, returning to its lows of the past three months in the low- to mid-90s. The story is great, but even the longer-term chart is turning iffy now, with repeated bouts of huge selling. That said, we’ll continue to play it by the book—if SHOP can hold above long-term support in the upper 80s, we’re happy to give it a chance, but if not, we’ll take the rest of our profit and look for greener pastures.
HOLD—Universal Display (OLED 164)—OLED has pulled back sharply, which is why we’ve placed it on Hold. That said, we really don’t view the action as abnormal because downside volume hasn’t been outrageous and the stock remains well above its prior highs (near 145) and found support at its 10-week moving average on Tuesday. Of course, after such a big run this year, we can’t rule out that OLED has already hit its point of peak perception, but we think it’s more likely that big investors are still starting and building positions—“only” 411 mutual funds owned shares at the end of September, though that was up from 387 three months earlier—in anticipation of what should be a few years of strong growth. We sold half our shares in September and advise giving your remaining shares some leeway.
Watch List
Diamondback Energy (FANG 106), ProPetro (PUMP 18) or other energy stocks: While growth stocks have sold off and many others have rallied, energy stocks have mostly bided their time, which we view as a positive following their recent run. Some of the firms have explosive growth prospects as drilling activity ramps up.
E*Trade (ETFC 49): It’s not revolutionary, but ETFC has been a leading Bull Market stock all year and now has surged to new highs on excellent volume. See more in A Tale of Three Sectors.
Nutanix (NTNX 35): The story is a bit of an ice cream headache, but NTNX is very liquid, has a strong chart and rapid growth thanks to its enterprise cloud solutions.
Planet Fitness (PLNT 32): PLNT remains one of our favorite cookie-cutter stories and the stock continues to act very well. A pullback or shakeout could provide a nice entry point.
RH Inc. (RH 150): Formerly known as Restoration Hardware, the company is doing well with a business model shift toward large stores, and the stock is being helped by management’s deft move of buying back half of all shares earlier this year! Earnings and cash flow are expected to be huge going forward.
Splunk (SPLK 80): SPLK is still holding up well despite the carnage in software stocks. The longer it can remain resilient, the greater the odds that its earnings-induced breakout kicked off a new advance. Growth here is very brisk.
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.
Continental Resources (CLR 47) — The rebound in oil prices (plus the rotation out of the growth stocks) has put new life into many energy stocks. With two million net acres in the Bakken region and rich holdings in Oklahoma, Continental Resources is an efficient explorer/driller/producer that used the lull in activity to increase its efficiency. Continental’s skills are so sharp that the company can make money even if oil prices drop below $30 per barrel. (Crude is around $60 per barrel right now.) Revenue has grown big in the last three quarters (51% in Q1, 47% in Q2 and 38% in Q3) and analysts are expecting Continental to return to profitability this year and grow earnings by 169% in 2018 thanks to a large production increase. This is a big story.
Insulet (PODD 69) — As chip stocks and software companies are getting killed by investors, Insulet is off to the races. The company’s fortunes rest on its Omnipod infusion system for insulin-dependent diabetes, a product that has pushed Insulet to seven quarters of at least 25% revenue growth. Omnipod is a small, lightweight, disposable device that can be worn under clothing and is operated by a handheld controller. The device’s advantages have allowed it to steal market share in the highly competitive (and large) diabetes monitoring market. PODD gapped on earnings in November and has been holding near 70 in recent trading and it looks like a successful long-term story.
Roku (ROKU 44) — When media analysts talk about the move toward dumping expensive cable subscriptions, Roku’s streaming television platform (along with Netflix) is exhibit one. Roku lets customers build their own lineup of content from choices like Hulu, Netflix, DirecTV, Amazon Video and Vudu. The company isn’t yet profitable, but revenue growth is steady and the stock (which came public in late September) already has over 90 institutional investors on board. There is a ton of volatility here—ROKU was trading at 18 on November 8, 52 on November 28 and is back down to 41 now—but as a pure play on the cord-cutting movement, it’s a great way to get in on the action. If you buy, keep it small and use a very loose leash.
Teladoc (TDOC 32) — Teladoc is the global leader in virtual doctoring, which gives patients access to over 3,100 board-certified physicians via a 24/7/365 service that charges $40 per visit and promises median wait times of 10 minutes. In the third quarter, the company reported U.S. paid membership of 22.6 million (up 33% from a year ago), 306,000 total visits (up 51%) and a 100% increase in business clients. Teladoc completed its $440 million acquisition of medical specialists network Best Doctors in July, adding a whole new layer of expertise and medical resources to its offerings. Businesses subscribe to Teladoc’s services to give their employees access to diagnosis, prescriptions and advice without the downtime of a visit to an off-site doctors’ office. TDOC has recently surged back to its highs. This looks like a big story for the future.
A Tale of Three Sectors
Last week’s violent moves were the sharpest all year, yet while all the attention is on the day-to-day action, we’re more interested in the intermediate- and longer-term charts. And on that front, it’s looking more like last week could have been a turning point for three sectors.
On the bearish side, chip stocks look suspect to us. Take a look at the weekly chart of the Semiconductor Index—it broke out of a big base in July of last year (during the post-Brexit rebound in the market) and rallied as much as 87% since. We’re never, ever one to call tops, but it doesn’t take a chart expert to see that the group has had a largely uninterrupted run for more than a year, following by abnormal-looking selling pressure. We’d be careful with any chip stocks you own, especially if you have big positions and/or losses.
On the flip side, there are some potential early-stage opportunities in two sectors. The first is retail, which has mostly sat out the dance this year due to horrid performance from some huge, old, mall-based retailers. But a few leaders started to push higher a couple of months ago, and the sector as a whole (symbol XRT) spent most of June through November bottoming out before soaring to multi-month highs in recent days.
Five Below (FIVE) remains our favorite in the sector; the firm’s quarterly report last week was terrific and the stock is perched at all-time highs. That said, this sector has a history of launching new leaders, and we have a couple of other retail stocks on our Watch List—we could add one of them if the market settles down a bit.
Another area we’ve been watching is the financials. The sector has had a couple of false starts this year, but the price and volume action during the past couple of weeks raises the odds that a sustained advance is getting underway.
We don’t have much love for slow-growing banks, but we do like Bull Market stocks (whose businesses are tied directly to the health of the financial markets), which have begun to power ahead.
Our favorite remains E*Trade Financial (ETFC), which will benefit from the trifecta of higher interest rates (much of its revenue comes from interest income), tax cuts and, of course, more commissions. The stock looked like it was getting going a couple of times during the past few months, only to move sideways. But this big-volume rally looks like the real McCoy.
In total, the recent wave of violent rotation could provide some longer-lasting clues about where the market’s leadership is heading, and we’re already starting to see some interesting opportunities emerge.
Losing Principle vs. Losing Profits
The past week was one of the most vicious selloffs we can remember. Of course, it’s painful watching a handful of stocks get taken out and shot, but that’s part of the game—volatility on the upside is where our profits come from, after all, so it only makes sense that you’ll see sharp selloffs when the sellers arrive.
As trend followers, we treat weakness in stocks we have big profits in much differently than stocks in which we have losses—losing some open profits, in other words, is something that comes with the territory if you’re aiming to land a big winner. But letting a loser run is no way to make money over time. That’s why, for instance, we’re still holding a chunk of Alibaba (BABA), which we have a big profit in, while we exited our position in ServiceNow (NOW), which broke down this week and was near breakeven.
We’re not trying to say that profits shouldn’t be guarded or that partial profits aren’t a good idea. But assuming the overall bull market is intact, you want to try to sit through some corrections with most of your winners, while quickly ridding yourself of losses. At some point, giving your winners some rope will prove wrong (the stocks will decisively break down), but over time, letting them run will land you some homeruns, and those make all the difference.
Cabot Market Timing Indicators
Our timing indicators tell us the overall market remains in good shape, with the major trends pointed up and even the broad market showing some improvement. That’s no reason to ignore the selloff in growth stocks, but it is telling you not to get overly defensive and keep your eyes open for new leadership.
Cabot Trend Lines: Bullish
The Cabot Trend Lines remain clearly bullish, with the S&P 500 (by 6.9%) and Nasdaq (by 7.8%) closing last week well above their respective 35-week moving averages. With the indexes stretched above their longer-term moving average and wobbles among growth stocks, a retreat isn’t out of the question. But there’s no doubt the market’s bigger picture remains bullish.
Cabot Tides: Bullish
Our Cabot Tides are also still bullish, as all five of the indexes we track (including the S&P 600 Smallcap, shown here) are trading well above their lower (50-day) moving averages. The recent pick-up in volatility is a bit of a worry (could be a sign of distribution), but as trend followers, it’s best to keep it simple—right now, the intermediate- and longer-term trends are pointed up, so the odds favor higher prices ahead.
Two-Second Indicator: Unhealthy
With the rotation out of growth stocks and into sectors like industrials, transports, commodities and financials, our Two-Second Indicator has improved somewhat, with the number of new lows easing in recent days, including a handful of sub-40 readings. It’s not enough to conclude the broad market has returned to health, but it’s a good start.
[premium_html_footer]
Send questions or comments to mike@cabotwealth.com.
Cabot Growth Investor • 176 North Street, Post Office Box 2049, Salem, MA 01970 • www.cabotwealth.com
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 DECEMBER 20, 2017
We appreciate your feedback on this issue. Follow the link below to complete our subscriber satisfaction survey: Go to: www.surveymonkey.com/marketlettersurvey
Neither Cabot Wealth Network nor our employees are compensated by the companies we recommend. Sources of information are believed to be reliable, but are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on the information assume all risks. © Cabot Wealth Network. Copying and/or electronic transmission of this report is a violation of U.S. copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, call 978-745-5532, visit www.cabotwealth.com or write to support@cabotwealth.com.
[/premium_html_footer]