The market’s evidence has clearly improved during the past couple of weeks, so much so that our Cabot (and Growth) Tides are now on the fence, while our old Two-Second Indicator is starting to pick up on a bullish change in character for the broad market. That said, it’s close, but we haven’t seen anything definitive yet--tonight, we have no changes, but if we see some green lights, we’ll be on the horn with two or three new additions most likely.

In the meantime, we continue to hone our watch list and put together our game plan should the evidence continue to improve; we’re not going to go whole hog right away, but after six months of punishing action, we’re remaining flexible and write about a few potential fresh leaders in tonight’s issue.

Cabot Growth Investor Issue: June 2, 2022

The Rain Has Stopped—but Can the Sun Break Through?
Over the past couple of weeks, we’ve seen one famous investor say that inflation could lead to a worldwide depression; a much-followed banker tell us there’s a hurricane heading toward the economy, possibly a giant one; we’ve seen oil prices rise to multi-month highs and Microsoft cut guidance; and we’ve had Fed officials raise the possibility of continued Fed rate hikes later this year, reversing some talk that popped up a few days before.

And yet the market has been doing pretty well of late, with a quick retest of its nadir two weeks ago, a nice push higher last week and, after a soft patch, a big surge today. But that’s not all that caught our eye: For the first time in a couple of months, our Cabot Tides are on the fence, with most indexes close to five-week highs (which is effectively what it takes to get a green light). Not surprisingly, our Growth Tides (made up of a collection of growth funds) are a bit behind that but are also closing in.

Moreover, for the first time all year, we’re seeing signs of life from the broad market. As we write about later in this issue, our favorite measure of that area (the number of new lows) has been drying up nicely in recent days, partially because of some relatively rare breadth late last week—the NYSE saw three straight days of more than 80% of volume and more than 70% of issues up, things that usually portend positive action down the road.

Thus, it’s pretty clear the evidence has perked up; at this point, the downpour of selling orders has stopped, with the bulls fighting back to some extent. That’s all to the good—but it’s also far from a perfect beach day, of course, as “improving” doesn’t mean “positive” when it comes to our indicators, and that says nothing of individual stocks, very few of which are currently set up to run.

Overall, the way we look at it is this: The market needed to take a few baby steps before it could walk (never mind run), and for the most part, it’s done that. But for us to put our hard-earned money to work, we need to see the market build on these recent good vibes.

What to Do Now
If that happens, we’ll definitely take some action, likely adding two or three new names to our highly defensive Model Portfolio—and if things continue in the right direction, we’ll continue to extend our line. But that’s getting ahead of ourselves; right now, we’re fine-tuning our watch list but practicing a bit more patience to see if the storm has truly passed. We have no changes tonight.

Model Portfolio Update
The Model Portfolio has been generally defensive for six months now as the sellers have been winning the battle. The evidence has improved of late, with last week’s rally not just pushing the indexes higher but also seeing a few potential leaders perk up and some broader measures (like the number of stocks hitting new lows; see more on that later in this issue) acting well.

Really, though, right now is less about predicting what’s to come than making sure you have your game plan in place should the trends turn up. For our part, we usually like to step back into the market in stages, and that will be especially true this time, as our Cabot Trend Lines (long-term trend) are still firmly negative and, of course, most growth stocks are in the same boat.

For the here and now, if we see some further positive evidence—a consistent dry-up in the number of new lows or a Tides buy signal, or likely both—we’ll likely put 10% to 20% of the portfolio back to work to get a foot back in the door. At that point we’d still have 65% to 75% cash (ballpark), so the overall portfolio stance would still be cautious.

From there, we’ll be looking for strong stocks to continue to make progress; at this early stage, things that have approached key resistance (like the lithium stocks last week) have been quickly rejected. To be clear, that can always change, but it will have to if the market is going to have a sustained run. Another thing we’ll be watching is our own Aggression Index (shown here)—it’s perked up with the market of late, but any major strength would be a great sign that buyers are moving back into growth stocks.

In the meantime, we’ll again sit tight in a highly defensive stance, but we’re not far off from a Tides green light; if we get one, we’ll be on the horn with some changes.

Current Recommendations

Devon Energy (DVN)—About the only sector, even among the broad commodity space, that still is trending higher are oil and gas related names, and DVN remains one of (if not the) leading stocks in the group. (You could say Devon has been the top leading stock in the entire market during the past half-year, in fact.) And there’s good reason for it, as oil prices have continued to march higher, this time on news that Europe is starting to get real when it comes to halting purchase of (some) Russian oil; current prices have reached $116 per barrel, and even looking a year out, the futures market has oil prices north of $90, and if that stuck it would mean huge cash flow and dividends for many quarters to come. As we wrote in last week’s update, we think investors are starting to discount the possibility of “higher for longer” prices—for months, back of the envelope math suggested most leading oil names were pricing in $80 oil or so, but now that might be changing. However, such a process has a dark side, too, as higher expectations can leave the sector (and DVN) open to downside; this week, DVN and some peers pierced an upper trend line on their weekly charts, which can often be a yellow flag, telling you the stock is a bit giddy on an intermediate-term basis, so if we do see a reasonable retrenchment in oil (down 10 or 15 bucks from here), shares could get hit. We bring that up not to be a downer, but just as a heads up that the group is extended here and, if you own a big position in DVN (whatever that means to you), it’s probably not a bad time to lighten up. With us, though, we’ve already trimmed twice and remain mostly in long-term trend following mode, so we’ll hang on to what we have and see what comes as the trend remains clearly up. HOLD

ProShares Ultra S&P 500 Fund (SSO)—The S&P 500 has finally gotten off its knees of late, with a quick double bottom in mid-May followed by last week’s solid rally. And the bounce actually had a little oomph to it: As we mentioned on page 1, last week closed with three straight 80% up volume days on the NYSE, with each day also having 70%-plus of issues advancing; neither are true blastoff signals, but both are relatively rare and generally lead to good things over the next couple of months (especially when they appear after a good-sized decline). What we’re really waiting for is for some primary evidence to turn up (Cabot and Growth Tides) and some confirming evidence as well (our Two-Second Indicator may be changing character, but it’s too soon to tell). As for our position in SSO, we could have some adjustments soon, potentially trimming the position further but replacing it with a small buy in a new potential leader. Still, for now, less remains more in this market—less money at work, but also less trading, as those trying to jump in and out and reposition often end up in the meat grinder. As always, we’ll be on the horn with any changes, but if you’ve followed our advice so far, we advise continuing to hold your shares of SSO. HOLD

Watch List

• Albermarle (ALB 251): Both ALB and Livent Corp. (LTHM) broke out powerfully last week—but, as has been the case in this environment, those breakouts were soundly rejected early this week. Admittedly, some of that was due to a very bearish note from a big brokerage house, and neither is necessarily broken, but both now likely need more time to round out launching pads.
• Blackstone (BX 122): It’s not a true growth stock, but we’re increasingly high on Blackstone, which is currently back up to its December levels despite the devaluation in stocks and bonds (and worries about real estate) in recent months—big picture, it’s given up very little of its big 2020/2021 advance.
• Celsius (CELH 69): CELH is still 38% off its all-time high and is volatile as can be, so we don’t see it as something that’s ready to simply kite higher from here. But it does appear to have bottomed out (in fact, it appears to have stopped going down in January) and the numbers and growth potential (looks like another Monster Beverage of sorts) are huge. We’re keeping an eye on it.
• Enphase Energy (ENPH 199): ENPH was a massive winner in 2019 and 2020, but since then it’s spent 17 months shaking out the weak hands even as sales and earnings kite higher thanks to its best-in-class microinverters and battery storage systems. We think a couple of good weeks (and a healthy market) could kick off a bull move. See more below.
• Halozyme (HALO 46): HALO remains one of the top names on our watch list, rebounding from its May low in true tennis ball fashion to notch multi-month highs last week. Of course, like everything that’s perked up, the stock has hit a pothole this week, but overall it remains in good shape.
• Onsemi (ON 64): ON has been consolidating normally for months and is pumping out great growth numbers as its chips find their way into many long-term growth sectors. See more below.
• Shockwave (SWAV 167): SWAV is a lot like CELH—not ready to launch into outer space just yet, but the massive-volume support three weeks ago isn’t to be ignored, and the pristine sales/earnings/growth story here makes the stock relatively rare merchandise.

Other Stocks of Interest
Enphase Energy (ENPH 199)—When it comes to alternative energy, Enphase Energy doesn’t get a ton of press compared to EV stocks and the like, but it probably should—the firm is part of a near-duopoly on the solar microinverter market (it has nearly 50% market share, with SolarEdge (SEDG) around 40%), which are gaining popularity versus traditional string inverters. Both are needed to transform the DC current produced by solar cells to AC current used by a home or building, but microinverters (while more expensive) are far more efficient; avoid problems if one panel goes down (with string inverters, the whole system goes down, but microinverters let each module operate independently); and produce more energy per cell even at sunrise and sunset and even when the cells are partially covered. In fact, Enphase’s latest product (the iQ8, being rolled out now) is even more efficient and is the first “grid-forming” microinverter, so the solar system continues to work even if the power grid goes down (the first of its kind). Enphase also offers an advanced energy storage (battery) system (it shipped 120 megawatt hours of storage in Q1, up 20% sequentially, with another 12% sequential gain expected in Q2) and, through some recent acquisitions, is offering a smart EV charger early next year, but the microinverters and battery storage are the main drivers here. Moreover, the supply chain looks healthy (plenty of inventory and management said it’s in good shape) and inflation isn’t affecting results (with some modest price hikes here and there being absorbed). Long story short, business is strong in the U.S. and overseas (it expects huge European growth as so many individuals and businesses look to produce their own energy) and the market is expected to grow many-fold (20%-ish compounded through 2030!), which means Enphase should grow rapidly for years to come. Analysts see sales rising 50% this year and north of 30% next, while earnings lift 45% this year and 24% in 2023, all of which we see as conservative given the iQ8 rollout. As for the stock, ENPH had a massive, massive run from 2019 and 2020, and it’s now been consolidating in a huge range (120 to 250-ish) for 17 months—but, big picture, it hasn’t given back any of those prior gains, which we find encouraging. Nearer-term, we like that the stock etched higher lows in recent months (113 January, 119 February, 129 May), resisting the market’s decline, and now shares are perking up. Like everything growth, ENPH has some work to do, but a couple of good weeks would put it in pole position to be a leader once again.

Onsemi (ON 64)—The chip sector has fallen as much as 33% from top to bottom, with many popular names declining much more (NVDA down 55% at its recent low, AMD down 50%; WOLF, which we like fundamentally, down 55%, etc.), but Onsemi fell just under 30% and has already made half of that back. The big reason why: The company’s intelligent power and sensing chips and systems are perfectly suited for the boom in assisted driver systems and electric vehicles (including fast EV charging stations), as well as in industrial applications (power efficiency) and for broader energy infrastructure (it has long-term supply agreements in place with three of the top five players of solar inverters). Indeed, automotive and industrial revenue is the big driver, making up nearly two-thirds of revenue (a figure that should rise to at least 75% within a few years, partially thanks to getting out of lower-margin areas), with sales from those areas up 42% from the prior year in Q1. Interestingly, there’s also a silicon carbide play here (similar to Wolfspeed, which we wrote up in early April), thanks in part to a recent acquisition that should see revenue from these next-generation chips skyrocket by the end of next year. Throw in no issues with supply chains and everything here is firing on all cylinders—sales rose 31% and earnings more than tripled in Q1, both easily surpassing estimates, and Wall Street sees the bottom line surging 66% to $4.90 per share this year (the forward P/E ratio of 12 doesn’t hurt the cause). We would say that analysts see next to no growth in 2023, which is a bugaboo, but it’s likely that proves conservative—big investors certainly think that’s the case, given the aforementioned stubbornness of the stock and its rally since the pressure came off the market (ON is working on its sixth straight up week!). All in all, it’s a solid story and launching pad with some longer-term growth drivers, too.

Intra-Cellular Therapies (ITCI 56)—We wrote up ITCI back in March, thinking that if a money-losing biotech with a $5-plus billion market cap could hold up in a weak environment, something was up; as it turned out, the stock finally got hit hard (66 to 42 in a month!), which had us take our eyes off of it—but then shares snapped right back after earnings last month, adding to the intrigue. As it turns out, there’s good reason for the resilience: The story revolves around a drug (taken once daily via pill) called Caplyta, which the firm launched in early 2020 for the treatment of adult schizophrenia, and that is a solid business; there are 2.4 million patients with the disease, and Intra-Cellular is steadily penetrating that, with prescriptions ramping from zero to about 1,750 by year-end 2021, producing $25 million of revenue in Q4 of last year. But then the FDA approved Caplyta for bipolar depression, which is a game changer—in fact, the approval was the broadest of any bipolar drug, with Caplyta able to treat both Bipolar I and II, each either by itself or in conjunction with certain other therapies. The market is gigantic (11 million adults in the U.S. have bipolar of some sort), and the uptake has been rapid, with new prescriptions for the drug increasing 63% in Q1 from the prior quarter! And bipolar might not be the end of the story for the drug, either, as Intra-Cellular is in Phase III trials to use Caplyta to treat major depressive disorder (along with antidepressants), which affects north of 20 million people. As it stands now, there’s little doubt the drug is going to become a big one—sales in Q1 came in at $35 million, and analysts see revenue totaling $227 million this year (up from an estimate of $210 million two months ago) and $438 million next year, both of which will likely prove too low. Looking at the stock, it’s choppy, but shares kissed their 40-week line in early May and then surged on earnings—and, impressively, the stock is holding the vast majority of those gains, which is usually a sign the weak hands are out. We also like the ramping sponsorship (499 funds owned shares at the end of March, up from 413 and 384 the prior two quarters). It’s not for the faint of heart, but ITCI certainly acts like it wants to go higher if the market continues to straighten itself out.

Checking in on the Two-Second Indicator
One of the first signs you’ll usually see of a market bottom—or at least a change in character—is from our Two-Second Indicator, which measures the number of stocks on the NYSE that hit new lows each day. (We also monitor the Nasdaq figure, though that one has somewhat less value given all the junk on that exchange.) It’s one of the best measures we’ve come across in measuring the health of the broad market.

The reason we’ve always looked at new lows, and less so new highs, is because the former is more telling—the number of new highs may lag somewhat after a low depending on how deep a downturn was, but the number of new lows almost always dries up quickly after a meaningful low—and by “dries up,” we mean drastically, with new lows coming in below 40 and often below 20 or even 10 every day for many days or weeks, which is a stark contrast to the hundreds of new lows each day that are often common during big declines.

Take a look at the pandemic crash from March 2020. New lows obviously mushroomed during the meltdown, but notice that as soon as the S&P 500 up-ticked (bottom panel), new lows dried up rapidly; there were three bad days in early April, but it was clear sailing in the weeks ahead—and that was even during a time when the NYSE-type names (cyclicals, financials, etc.) were languishing.

The prior deep correction came in the fourth quarter of 2018. See how new lows expanded as soon as the S&P 500 began falling in early October, and they stayed elevated for three months, even when we saw a rally attempt in November. Then there was a selling crescendo in December that saw new lows top 1,200 two days, but that was it—after the low, the broad market showed a complete change in character.

And, yes, it even happens after deep bear markets—in 2009, we saw the number of new lows explode higher in February and March as the final low formed, but four days after the bottom, new lows totaled 14 and remained south of 20 for many weeks to come.

To be clear, there are times when new lows will dry up … and then expand again; like everything else, there are no perfect indicators and you have to stay flexible. But after a multi-week (or multi-month) stretch where most days see hundreds of new lows, a quick dry-up that lasts a couple of weeks is very often a bullish sign.

Which brings us to the current environment. Shown here is a chart of the Two-Second Indicator since the start of the year; obviously, new lows grew rapidly as the market cascaded in January and again in February. And, interestingly, even as the market rallied in March, the number of stocks hitting new lows never really caved in; there was just one day during the entire rally phase that new lows came in south of 40, and of course the implosion after that saw new lows mushroom.

But now, maybe, we’re starting to see something: New lows came in at 40 last Thursday, and the readings since then have been 36, 33, 52 and around 38 (today). It’s not an all-clear, but it’s definitely something to watch: If the readings improve from here, it would be a big sign that the sellers have left the building. Stay tuned.

Bottom Fishing in IPOs
IPOs are a bit of a Catch-22 here—on one hand, given the decimation to so many former leaders, it’s very likely most of the leadership for the market’s next sustained advance will come from new names … many of which can be found in the IPO lineup of the past year or so. On the other hand, just about anything that came public in recent months (even before the top in November) has also been dismantled as investors have hunted for safety.

That doesn’t mean we’re going to suddenly start buying falling knives in IPOs, but we are widening our net to look for names that may have been gutted by the market but have the story and numbers to bounce back down the road. One idea: Olaplex (OLPX), which makes haircare products. That doesn’t sound exciting, but it actually looks like the firm has something special on its hands, with a patent-protected “technology” that protects, strengthens and repairs the bonds in hair that break when damaged. It’s the #1 bond-building haircare brand among professionals (which make up 43% of revenue) as well as the #1 brand on Amazon and Sephora (specialty retail and direct sales to consumers each are 28% of sales)—and, for what it’s worth, it’s by far the most popular among its peers on social media (Instagram), too.

It sounds simple, and in some sense it is, but Olaplex has a variety of products that are popular (more than four of them bought by the average customer) and, impressively, despite this being “just” haircare, the business model looks powerful, with after-tax profit margins north of 45%! Just as impressive is the sheer growth: In Q1, sales lifted 58%, earnings were up 44%, and the firm launched into Ulta’s retail and online channels during the quarter; management sees the top line lifting 36% this year, while analysts see earnings up 34%, with 20%-plus growth in the years that follow.

As mentioned above, the stock needs work and some seasoning, but it’s been trying to bottom out since March and found some good-volume support of late. We think it’s worth keeping a distant eye on to see if it can turn the corner. WATCH

Cabot Market Timing Indicators
The past two or three weeks have brought some positive baby steps, with the indexes holding support and bouncing despite a rash of bad news and forecasts, with new lows starting to dry up and with growth funds outperforming defensive stocks. Our Cabot Tides are close to a green light, and if that happens, we’ll put some money to work—but we don’t anticipate signals, so tonight we remain defensive.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines have certainly improved in recent days, though they came into this rally incredibly stretched to the downside, so the sell signal is firmly intact—the S&P 500 (by about 7%) and Nasdaq (by 14%) are well below their respective 35-week lines. Obviously, this is a slower-moving indicator, but it’s also our most reliable—the rally so far is encouraging, but there are clearly still headwinds out there.

Cabot Tides: On the Fence
By holding support for a couple of weeks and perking up in recent days, our Cabot Tides are now on the fence, with all five indexes (including the S&P 600 SmallCap, shown here) above their lower (25-day) moving average, and that average is flattening out. Of course, to us, close is not enough—we like the improvement, but the indexes (and growth funds) needs to show a bit more strength to flip the intermediate-term trend back to positive.

Cabot Real Money Index: Positive
Our Real Money Index has come off its nearly two-year lows; last week, in fact, was the first in eight that money actually flowed into equity funds and ETFs. Even so, the panic selling from April/early May should have positive intermediate-term ramifications, and the five-week sum is still well into negative territory—from a contrary perspective, that’s a good thing.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on June 16, 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.