After a modest bounce in May and early June, another thunderstorm has hit the market, driving the indexes and most stocks to fresh lows. Of course, the Federal Reserve is on everyone’s mind these days, but really, you don’t need to guess about what they’ll do and what effect it will have--just following the market’s trends has kept us mostly on the sideline in recent weeks and months, and they’ll be your best guides going forward. In the meantime, we’re actually trimming one of our two positions tonight, but we’re keeping our eyes open for signs the buyers are putting up a fight.

In tonight’s issue, we write about the energy sector, our current holdings and a few new ideas, too. We offer no predictions and remain mostly safe on the sideline, but the environment is certainly ripe for a turn given how everyone’s predicting doom, so it’s important to keep your head up and be ready should the evidence improve.

Cabot Growth Investor Issue: June 16, 2022

Another Thunderstorm
As we wrote in the last issue, the market gave off some positive vibes for much of May and early June, but the big question was whether the selling storm had completely passed or if another downpour was over the horizon. The past week has clearly answered that question, with the major indexes suffering a mini-crash of sorts, with some (like the Nasdaq) falling more than 10% in just a handful of days.

Of course, the headline-grabbing news of the week (and reason for the latest selling wave) concerns the Federal Reserve, which is on the rampage of sorts, raising rates by the largest amount since 1994, promising more to come and at the same time running off their balance sheet (draining liquidity) to combat inflation. Hence, the market is growing ever more worried about a big economic pothole.

Really, though, while talking about that sort of thing is fine at the dinner table, one of our main messages now is to ignore all that noise and the predictions that go with it. You don’t need to forecast what the Fed will do or how it will impact housing or lending or earnings; heck, the Fed itself seems to change its mind every couple of weeks about how far this tightening cycle will go or how fast it will be. Most times, we’ve found immersing yourself in market-wide news does more harm than good. (Individual company news and outlooks are often a different story.)

In fact, we’d argue that keeping things simple—by using some basic trend-following models like the Tides and Trend Lines, for instance—has worked far better during this bear phase than all the economic forecasts and fundamental guesswork put together. And that will be true on the other side of this decline, too: The market is currently not examining June or July, but is looking ahead to see what the world will look like in November or December, so it’s nearly a sure bet that when the trends really do turn up—when the next bull market gets underway—horrible news and predictions will still dominate the headlines.

Back to the here and now, nothing has really changed, with the intermediate-term and longer-term trends down for the indexes and most stocks—though, when looking at some secondary evidence, there are still a few morsels of encouragement, including a positive divergence from the number of new lows this week and, of course, widespread pessimism among nearly all investors.

What to Do Now
Overall, we’re keeping our eyes open for any upturn, but we need to see more than just a couple rays of light before putting money to work. In the Model Portfolio, we remain highly defensive, and tonight, we’re going to sell half of our remaining position in our ProShares Ultra S&P 500 position to respect the latest weakness, leaving us with around 88% in cash. Looking ahed, we would like to put a bit of that gigantic cash hoard to work if the market stabilizes, but with so many air pockets around, we’ll continue to practice patience.

Model Portfolio Update
We were ready, willing and able to do some buying last week, and our indicators came fairly close to flashing green, but of course the sellers arrived beginning last Thursday, driving most indexes to new lows. Thus, with the trends still down and few stocks making any headway, we continue to advise a highly defensive stance until this bear phase finishes up.

Of course, doing nothing on the buy side isn’t what anyone’s goal is; none of us follow the market every day to just sit in money market funds. And that has brought up some related questions regarding the Model Portfolio, with some wondering why we own anything, others wondering if some nibbles in beaten-down stuff is worthwhile, with another group thinking a probe on the short side could be worthwhile.

Really, the answer to all of them is: There’s nothing wrong with it, but it’s really more of a personal decision on how you want to run your ship. What counts is the portfolio’s main stance, which should be defensive.

In terms of determining exactly “how” you want to be defensive, there are no perfect answers. We have professional friends that hold 40% cash and consider that hugely cautious (and compared to their peers, they’re right), while others will have 100% in cash for months. If we had to pick a perfect figure for us, it would be 75% in cash, but we also try not to leave our brains at the door, either—if the market is simply a meat grinder, we’re not afraid to hold more cash than that, as we did for a few months in 2008/2009. The exact cash level isn’t as important as the idea to limit the chances of a big downside move in your portfolio.

As for nibbling, it’s a similar story—there’s nothing wrong with doing a little buying (or trading) here or there, and we provide plenty of ideas (via Other Stocks of Interest, our Watch List or elsewhere in the issue) if you want to roll the dice. Heck, we’re not against that ourselves, and if the market can stabilize, we might put a bit of our cash hoard to work, though we’ve held off because of the still-huge numbers of air pockets we see out there. That said, what we would urge you to do if you buy is to focus on potential leaders—trying to flip a beaten-down name for a quick 5% or 10% move may sound tempting, but it’s a tough game; you’re usually better off trying to start a position in a potential big winner.

Lastly, there’s the question about short-selling, where we have two main thoughts. First, shorting here could work, but realize you’re doing it after a 20% to 30% decline in the major indexes and 50% to 75% drops in many former leaders; we offer no predictions, of course, but at the very least you’re probably better off shorting after a two- to four-week rally into resistance. More important is something we’ve written about before: Remember that the big money is in the big swing, owning some fresh leaders during the next uptrend. That’s really where most of your focus should be and, when looking back in a few years, will be the biggest factor in your results.

Back to the here and now, we remain highly defensive, but given the horrid news environment and baked-in expectations of so many negative things (recession, inflation, more aggressive Fed hikes, etc.), we remain on the lookout for a turn higher and some improvement from our indicators. When it happens, it will be worth the wait, but once again tonight we’ll sit tight and see how things develop.

Current Recommendations

Devon Energy (DVN)—Oil stocks in general and Devon in particular haven’t been immune to the recent market-wide selling; DVN suffered three straight days of heavy-volume selling after piercing an upper channel line on its chart (a sign of the stock being intermediate-term overbought) and was whacked again with the group today, so it’s certainly possible the long-awaited correction/consolidation is at hand. That said, we’re not panicking quite yet for a few reasons. First, the stock is back down to its levels of early May, so at this point this looks a lot more like an overdue retreat rather than a major top. Second, DVN recently went ex-dividend (it’ll pay $1.27 per share on June 30 if you owned it at the close June 10), and we’ve noticed that many big dividend payers in the commodity space have tended to act sloppy for a couple of weeks after going ex-dividend (as payout chasers leave for greener short-term pastures). Third, we’re now 85% of the way through the second quarter, and it’s hard to ignore the fact that Devon’s cash flow should set another new high—oil (around $108) has averaged 10% more than in Q1, while the average natural gas price this quarter (around $7.60 even after this week’s dip) is more than 50% (!) above than its Q1 average, both of which should lead to a higher payout in September (and a bigger free cash flow figure for Q2). And then there’s the firm’s latest acquisition, where Devon picked up 38,000 oily acres in the Williston Basin, nearly doubling the number of wells it has in operation in that area; the acquisition is expected boost per-share free cash flow figures by 3% to 5% given current strip prices. (The board is also expected to boost the fixed portion of the dividend by a couple of cents per quarter once the deal goes through.) Now, obviously, investors are looking ahead and stocks trade based on perception, so all the current fundamentals in a world don’t guarantee anything—but the fact is, to this point, it’s hard not to be extremely impressed with the resilience in energy prices (even at “only” $90 oil, Devon stands to crank out more than $2 of free cash flow per quarter), with recession fears, a clearly aggressive Federal Reserve and consistent dumps from the strategic petroleum reserve failing to make a dent; current oil prices remain north of $110, and even the out months (December 2023) are still around $90. We’re not complacent, and if DVN really gives up the ghost, we could prune our position further, but we think hanging on is the best course of action here. If you’re looking to do some buying in the oil patch, check out our writeup on the group and some fresher names later in this issue. HOLD

ProShares Ultra S&P 500 Fund (SSO)—The halfway decent rally that started in late May has gone up in smoke, and SSO has suffered because of it, slipping to new bear lows earlier this week. Obviously, the only reason we’ve owned a leveraged long index fund in this environment is due to of portfolio management; we thought it better to at least have a toe in the market’s door given some of the positive secondary evidence (horrid sentiment and other factors usually lead to at least a countertrend rally) looked somewhat encouraging, and frankly, we still lean toward that view given our huge cash hoard and the fact that we only own one “real” stock—and that’s not even a traditional growth name. That said, while we’re not craving more cash, we also have to respect what’s going on; we were OK holding SSO through the decline into May and during the bounce phase, but seeing another leg down prompts us to at least take a little action. Thus, we’re going to sell half of our remaining SSO position and hold the cash for now--though, if the market can stabilize for a bit and some evidence (like new lows, etc.) improve, we may put a bit of cash back to work in a half-sized position or two. But as for the here and now, we’re trimming and holding the cash. SELL HALF, HOLD THE REST

Watch List

• Celsius (CELH 53): CELH was one of many stocks that showed a nice rally off the May lows, and while it’s taken a hit, volume has been much tamer than during the May liftoff, and the stock is still miles above its bear lows near 40. We’ll see how it goes, but we don’t view the recent dip as abnormal—more likely CELH is still in a bottoming pattern as it waits for the market to get moving.
• Enphase Energy (ENPH 168): ENPH actually still looks decent on the weekly chart—it’s still in the vicinity of its 10- and 40-week lines and is well north of its May low (near 129). Fundamentally, the move to waive solar import tariffs for the next couple of years should be a boon for growth, which was already in high gear. An eventual move above 225 (with a healthier market, of course) would be very intriguing.
• Halozyme (HALO 43): HALO has a similar higher-low pattern as ENPH, as the stock was 31 in January, 32 in February, 37 in May and, this week, dipped near 42—all while the major indexes are bumping downhill. That doesn’t mean the stock can’t eventually keel over, but the longer it shows relative strength, the greater the chance the stock will help lead the next bull run. HALO remains near the very top of our watch list. See more below.
• Intra-Cellular Therapies (ITCI 53): The longer ITCI continues to hold up relatively well—it’s “only” 19% off all-time highs—the more we’re intrigued, thinking that many sharp institutional investors are betting the firm’s bi-polar treatment is a game changer (and could attract potential buyers, too). Interestingly, despite the horrid environment, the number of mutual funds owners grew from 384 to 509 between October 1 and March 31.
• Pure Storage (PSTG 24): Our go-round with PSTG in March obviously didn’t work; the stock is still a few points below our sell price in early May, in fact. But the firm’s latest quarterly report (sales up 50%, earnings well above estimates and up from a loss last year) caused yet another big earnings gap, and the stock has held about half of that move despite the market’s implosion. See more below.
• Shockwave (SWAV 156): SWAV has been all over the map of late, first getting a big boost when it was announced the stock would be added to the S&P 400 MidCap Index (addition is Friday), but it got caught in the market’s crosshairs on Tuesday with sellers taking advantage of the run-up. We’re more focused on the bigger picture chart action (massive-volume support on earnings in May) and sterling fundamentals (including triple-digit sales and earnings growth). Keep SWAV on your watch list.

Other Stocks of Interest
Bumble (BMBL 30)—There will surely be plenty of new leadership during the next bull run, and one thing we like to look for are so-called follow-on opportunities—companies that can be fresh winners in an established sector. As Covid restrictions and fears fade, one area to look at is the online dating sector as people of all ages change out of their sweatpants and head back out on the dating scene. Match.com has long been the leader here, and by size, it’s still the big player—but we think Bumble could be “the next” Match.com or Tinder in a sense, with a couple of big differences that has people signing on. The first and most noteworthy thing is that women have to make the first move when it comes to initiating a chat, giving them the power to command the conversation. (It’s a boon to many guys as well, who are fine not having the pressure to reach out first.) Second, Bumble has a policy that cuts back on “ghosting,” where one party abruptly cuts off a conversation; on Bumble, any chat that isn’t responded to within 24 hours goes away, creating a sense of urgency to get things moving. Most believe there are fewer spam bots as well, which is another plus. Most of these improvements are credited to founder and stemwinder Whitney Herd, who’s just 32 years old but cut her teeth at Tinder (which is owned by Match) as the VP of marketing and seems to have come up with a better mousetrap. Bumble also has an older app named Badoo that operates mostly overseas (business has suffered of late in part due to the Russian invasion, with lots of Belarus, Russian and Ukraine subscribers cancelling for obvious reasons), but the namesake app is the big driver (three-quarters of revenue and growing) and is what investors are focused on. In Q1, total revenues lifted 24%, but the Bumble app itself saw sales up 38%, led by a 31% gain in subscribers from a year ago (and up 8% sequentially), while revenue per user lifted 5%, all of which resulted in the firm’s first profitable quarter. As for the stock, it came public near the growth stock summit in early 2021 and imploded from a post-IPO peak near 80 to a low around 16 in March—but the stock found massive-volume support there, and did so again after Q1 results in May. BMBL is still south of its 40-week line, but it looks to be building a bottom over the past few months, and if business stays strong, we think it could start a new uptrend once the market gets out of its own way.

Pure Storage (PSTG 24)—At one time or another, many stocks will look fairly resilient during a bear phase, only to eventually disintegrate and never be heard from again. But some really do have something special, and while that won’t mean too much as long as the sellers control Wall Street, it will keep big investors interested and attract more big fish when the trend turns up. We took a shot at Pure Storage during the market’s ill-fated March rally, eventually selling in early May (near 29) just before the stock tanked to 22. But then came earnings, and it turns out Pure’s story is as strong as ever: To review, the company not only has what appear to be the best storage products out there for enterprises, but it’s also shifting to a storage-as-a-service model, with big clients signing up for subscriptions that let them upgrade and buy storage for a set fee, rather than one-time rebuys—the result being higher margins and steadier results. And because Pure’s offerings have a simple architecture, supply chain issues have been basically nil. In Q1, revenues boomed 50%, while its subscription-related products grew 35%, with remaining performance obligations lifting 29%. (Fifty-four percent of the Fortune 500 are customers.) Granted, some of the growth came from big orders that Pure thought would close later this year, but the bottom line is that sales growth is accelerating (up 37%, 41% and 50% the past three quarters) while earnings surge and the firm has been trashing estimates for many quarters; Wall Street sees the bottom line up 20%-ish both this year and next, which should prove very conservative. Chart-wise, PSTG is still below where we sold it, so we can’t say it’s ready to soar, but what stands out in recent months are the bevy of massive-volume buying clues—look at the weekly volume and notice, starting in the middle of last year, the repeated slew of volume buying spikes, which is a clear sign of accumulation. (Indeed, 547 funds owned shares at the end of March, up from 417 six months prior, despite the bear phase.) That doesn’t mean much now, but if PSTG can hold up here and get moving when the pressure comes off the market, we still think it has a chance to be a leader.

Halozyme (HALO 43)—Halozyme has been the top stock on our watch list for a few weeks now, and while it’s not immune to the market’s wiggles, the stock has actually been going up and rounding out a big launching pad as the indexes implode. And, really, why shouldn’t it? While economic fears abound and interest rates spike, none of that should affect the firm’s enticing growth story: Halozyme’s Enhanze drug delivery technology uses a proprietary method to break down cellular barriers to bulk fluid flow in the skin, which means many leading treatments can be given via IV in just a few minutes instead of a few hours. Halozyme gets milestone payments as licensees move Enhanze versions of existing drugs through the approval process, but the real money is in ongoing royalties—right now, two drugs (one by J&J and one by Genentech) are driving royalties higher (the firm sees royalties rising 50% this year and making up 55% of revenues), and those two have further upside down the road. But just as exciting are a handful of new Enhanze-related launches that are likely to be approved starting next year, the first of which is an autoimmune treatment by Argenx that many analysts think could have north of $2 billion of revenue by 2026. All in all, Halozyme has a longer-term goal for royalty revenue to reach $1 billion by 2027 as these new treatments hit the market. And then there’s the company’s purchase of Antares Pharma, which brings Halozyme a royalty-based auto-injector platform that will be immediately accretive to results. For 2022, earnings as a whole for HALO are expected to rise just 5%, but that’s solely because it’s starting to pay taxes; revenues should rise 33%, and next year, both sales and earnings are likely to grow at 30%-plus rates, with plenty of expansion beyond that. (We’re not huge on valuations, but the trailing P/E of 21 certainly seems reasonable.) If you’re looking for something to worry about, some Enhanze patents could expire within two (in Europe) to five (in the U.S.) years, though management is downplaying that, saying so-called co-formulation patents and its other intellectual property, not to mention its clients’ comfort in getting the proven product from Halozyme rather than a fly-by-night operation, make it very confident in future royalty streams. Clearly, big investors agree, as HALO continues to act well, with even the recent dip finding support near the 50-day line. We could consider a half-sized stake if the market can firm up a bit, but whether you nibble or not, the stock is in pole position to do well if/when the bulls return.

What’s Next for Energy Stocks?
In what’s been a historically bad first five-plus months for the market, about the only port in the storm has been energy, with oil and gas names being bid up thanks to elevated prices but also massive shareholder return plans. But the question, as always, surrounds the future—the advance in the sector is clearly not in the first or second inning (see chart) and many stocks in the group have finally succumbed to selling in recent days. That said, we’re extremely “impressed” that oil prices have remained so resilient despite recession fears and a super-hawkish Federal Reserve.

Overall, most energy stocks are probably better Holds than Buys at this point, but we are seeing more secondary titles get moving of late—while that can also be a sign the sector’s advance is long in the tooth, a couple stocks are very intriguing as recent M&A activity has changed their outlook, and the stocks are responding.

The first (and our favorite of the two) is PDC Energy (PDCE), a mid-sized explorer (market cap just under $8 billion) that recently completed a $1.3 billion takeover of a private operator, giving the company the leading position in the Wattenberg Field in Colorado. When combined with some efficiencies and elevated prices, the cash flow outlook here reminds us of what we saw from Devon and others a year ago—assuming $90 oil and $5.50-ish gas, PDC should produce about $17 per share of free cash flow annually (north of 20% of the market cap!) through 2023, and 60% of that should be returned, mostly via share buybacks (15% of shares outstanding could be bought back by year-end 2023) but also dividends (base dividend 1.7% yield, with special payouts likely, too). PDCE didn’t do much from November through mid-May, but after the buyout finished up, it’s moved out to new highs has pulled back into an area of support.

Another similar story is Oasis Petroleum (OAS), which is even smaller ($3.3 billion market cap), but it’s about to double in size—a merger-of-equals between it and Whiting Petroleum (WLL) making it a huge player in the Williston Basin. The hitch here is the deal hasn’t officially gone through yet, but management sounded confident the knot would be tied in the third quarter, and when it does, Oasis should be a powerhouse: The firm should pay a $15 per share special dividend when the deal goes through, and at $85 oil and $3.50 natural gas, free cash flow should total about 17% of the new market cap annually, 60% of which should be returned. Similar to PDCE, this stock didn’t do much for about six months, but OAS has come alive since mid-May and this week’s dip is sharp but normal looking so far.

Obviously, if the group turns south—either due to continued market weakness or a retreat in oil prices—then PDCE and OAS will likely follow the crowd. But far from down-the-food-chain names, both appear to have a new lease on life due to their recent bold acquisitions. We’re not opposed to a nibble on this dip, albeit with stops if you do enter.

Where to Follow our Two-Second Indicator
We’ve received a few questions about our Two-Second Indicator, which, as the name suggests, takes just two seconds to check each day … if you know where to find it. On that note, the first answer to the title of this section is: Right here in Cabot Growth Investor as, for the time being, we’ve replaced our Real Money Index with the Two-Second Indicator on the market timing section of each issue.

Yes, we still like our Real Money Index, which we’re following in-house, but as we wrote in the last issue, the new low figures are likely to provide great insight as to when the bears have finally run out of ammunition. Thus, we’d rather shine a light on those readings in the days and weeks ahead as we prep for the next sustained advance.

If you want to follow the readings on a daily basis, there are two options. One is to get it right from the horse’s mouth—go the Wall Street Journal (wsj.com/market-data/stocks/us). But the better option is probably to use Stockcharts.com, and enter the symbol !Newlonya; this one uses the same data as the Wall Street Journal, but is updated after the close. (That’s the chart you see in this issue’s market timing section.)

As for the here and now, the one ray of light from the new low figures is that this week’s market debacle showed yet another positive divergence—about 985 stocks hit new lows on the NYSE today (though we’ll see what the final figure is) vs. a peak of 1,063 in early May. That’s a small plus, but like so many things in recent months, is just one baby step. We want to see a strong market rally that decisively drops the number of new lows to below 40 (and preferably much lower); until then, the broad market is considered unhealthy.

Cabot Market Timing Indicators
The rally attempt of the past three weeks has gone up in smoke, with the indexes diving below their May bottoms. We’re not making any predictions and we urge you to ignore the noise; there are some rays of light and the environment is ripe for a turn. But as has been the case for weeks, we advise remaining defensive until the buyers truly step up.

Cabot Trend Lines: Bearish
The S&P 500 just this week closed down 20% from its highs, causing many to declare a bear market, but our long-term Cabot Trend Lines spoke up months ago—the indicator turned negative and late January—and remains clearly bearish today, with the S&P 500 (by 15%) and Nasdaq (by 21%) both miles below their respective 35-week moving averages.

Cabot Tides: Bearish
Our Cabot Tides came close to turning positive last week—but close doesn’t cut it, and of course since then all of the major indexes (including the S&P 500; daily chart shown here) have cascaded lower. We’ll let everyone else debate what comes next, but instead of predicting, it’s best to go with what’s in front of you—and with the intermediate-term (Tides) and long-term (Trend Lines) trends of the market pointed down, you should remain in your storm cellar.

Cabot Two-Second Indicator: Negative
For the next few issues at least, we’re replacing our Real Money Index with our Two-Second Indicator, simply because we feel the latter will provide more of a heads-up as to when the sellers have left the building. We’d like to see a few sessions in a row of sub-40 readings (the thin blue line near the bottom of the chart) as an all-clear sign--there were a few of those readings during the recent rally, but now the readings are exploding again. We did see a smaller number of new lows so far this week vs. early May, which is minor positive, but we have to see readings dry up before thinking the bears have finished their work.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on June 30, 2022.

About the Analyst

Mike Cintolo

A growth stock and market timing expert, Michael Cintolo is Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader. Since joining Cabot in 1999, Mike has uncovered exceptional growth stocks and helped to create new tools and rules for buying and selling stocks. Perhaps most notable is his development of the proprietary trend-following market timing system, Cabot Tides, which has helped Cabot place among the top handful of market-timing newsletters numerous times.