The first half of the year is in the books, and it was a doozy, but we’re glad we’ve been able to sidestep a good chunk of the historic damage. Now the focus is on what’s next, and it’s important to respect the evidence today (we’re remaining highly defensive) but also stay flexible; we have seen some relative strength in some growth areas and we’re open to whatever comes. In the near-term, we’d like to put a little of our giant cash hoard (89%!) to work, but want to see the market stabilize a bit more first.

Cabot Growth Investor Issue: June 30, 2022

Stay Defensive—and Flexible
We’ve said many times that the market serves to fool the majority, and that’s certainly been the case this year. Coming into 2022, the economy looked strong as fears of the omicron virus variant faded and the major indexes were near new high ground. Of course, there were cracks under the surface (many growth stocks broke down around Thanksgiving), which is a big reason why we came into the year 45% in cash, but that hadn’t been noticed by most.

Today, of course, the outlook has done a 180—the major indexes are down in the neighborhood of 20% (S&P 500) to 30% (Nasdaq), with individual growth stocks a graveyard of scary sights, with dozens down 50% (like Meta/Facebook) to 75% (Shopify) just since the calendar flipped, all while inflation roars, the Fed slams on the breaks and most now believe a recession of some sort is inevitable (it it’s not here already).

We have a few thoughts as we move into the second half. First, if you’ve taken some lumps (and let’s face it, we all have to some extent), learn from them—and, importantly, don’t let them affect your psyche: Whether you’re up or down small, down some, or down a lot so far this year, the goals are to (a) make sure your portfolio doesn’t give up much more ground until the bear is over, and also (b) that you’re there to take advantage of the next bull market when it arrives. That’s where great profits will be made, but you have to be there with the money and confidence to take advantage of it.

Second, it’s important to respect the evidence—but it’s just as important to keep an open mind. Six months ago, few if any anticipated the worst first half for the market in decades, and few are likely to see a huge turnaround coming when it gets underway. A better way is to just go with the flow: Today, our three key market timing indicators—Cabot Trend Lines, Cabot (and Growth) Tides and Two-Second Indicator—remain in unison saying the sellers are in control. Tonight, we’re again sitting on our hands and holding a giant cash position.

However, we’re also open to whatever comes. Remember that the market isn’t trading on today’s news but is looking at this coming December and January, so if it begins to see a better (or not worse) future, the bulls could return. Right now, we’re watching the market’s latest downdraft closely to see if some of the nascent relative strength among growth funds and stocks (many stopped going down in May) can continue.

What to Do Now
But whatever happens, the point is you want to listen to the evidence—both on the way down (now) and the way up (down the road). As mentioned above, we’re standing pat in the Model Portfolio once again, though we remain interested in re-jiggering things a bit if the market can stabilize, possibly adding a small position or two in resilient titles. For now, though, we’ll keep our powder dry and hang onto our huge 89% cash position.

Model Portfolio Update
The first half of the year is in the books, and I think most everyone is happy about that. We haven’t been immune to the damage, taking a few lumps to start the year and then taking a few body blows during the market’s false March/April rally, but overall we’re down far less than the indexes and nowhere near the worst of the glamours.

While the bear phase has surely doled out some lessons that can be incorporated into everyone’s trading, your focus should always be on what’s to come; assuming you’re defensive, now’s not the time to let any wounds from earlier this year cloud your judgment. Frankly, we’ve found that’s one of the bigger impediments to people doing well over time in the stock market—having lived through a few ups and downs in recent decades, it’s uncanny how many throw in the towel, lose patience and become convinced the market “can’t” go up, and then miss out on the next up-move. Just a reminder to keep your chin up despite the bad news and tough environment.

As for the here and now, we’re still aiming to nibble on one or two potential leaders; if we had to draw up a defensive stance on paper, it would probably be 70% to 80% in cash and maybe three or four small positions, that sort of thing. But there’s one big thing standing in our way of doing that right here.

We’re talking about the meat grinder environment, which we’ve written about before: Every couple of days it’s not unusual to see a stock we’re watching and that’s acting resiliently take an outsized hit—for instance, Enphase (ENPH) approached resistance on Monday and then fell 15% over the next two days. Meanwhile, other names are simply super wild; Celsius (CELH), for example, has gone from 72 to 53 (down 24%), back to 69 followed by another slip to 62—all within the past three weeks.

We don’t see this as abnormal action—both ENPH and CELH are still on our watch list—but the point is that even a small position here or there is tough to hang onto.

If the market and potential leaders can quiet down a bit, or if we see some green lights from secondary indicators (check out our write-up on the Aggression Index later in this issue), we would still like to put a little money to work, preferably in a couple of names that aren’t swinging around 7% every day. But tonight we think the better part of valor is to again sit tight and hold our huge cash position as we wait for more signs of a bullish change in character.

Current Recommendations

Devon Energy (DVN)—DVN and energy stocks have joined the bear phase “party” of late, with the group breaking hard two weeks ago, though some have started to find support in recent days (albeit with lots of volatility). We’re students of the market first and foremost, and as we wrote about in last week’s update, we think the odds favor an intermediate-term top is now in for the group—following huge runs that were very obvious (everyone knows oil and gas prices are sky high), the decisive selling and overall market environment mean the odds favor the recent highs should hold for a while as investors look to cut back on profitable names and larger positions. (This is what we call “meat left on the bone” selling, where investors tend to pare back on things that haven’t yet gone through the wringer.) Because of that, if you have a big position (whatever that means to you), we think taking some partial profits makes sense, preferably on rallies—and in fact, despite us having already sold 2/3rds of our original stake earlier this year, we could trim a bit more if DVN bounces some from here. That said, we’re not ready to say the overall bull move is done for DVN or the group at this point—in fact, while we never argue with the market, it’s not hard to see that a lot of the selling at this point is more about general worry and likely portfolio positioning than any fear about business: Both oil and natural gas prices have come down, but both remain elevated ($107 or so for oil, with even December 2023 contracts fetching $85; gas is hovering near $6.50), so much so that even if oil prices fell another 25% from here, Devon would still be yielding about 7% annually at these prices, with plenty more in the till for share buybacks and debt reduction. Moreover, given how strong pricing was in Q2, it’s a very good bet that Devon and its peers will be reporting and paying out even larger dividends in a couple of months (larger than the $1.27 per share DVN officially paid out today), which could start to attract some short-term dividend hunters. (Devon’s Q2 quarterly report and dividend announcement are due August 1.) Again, we’re not complacent or arguing with the stock—if DVN and its peers really keel over from here (especially on a dip below the 200-day line near 50), we’ll be forced to at least trim further if not sell outright. But having already cut back most of our position and having sat through the break, we think it’s best to hold here and give the stock room to maneuver. HOLD

ProShares Ultra S&P 500 Fund (SSO)—The S&P 500 bounced off its mid-June low and into its 25-day line earlier this week before giving back about half that move in the latest bout of weakness. Nothing has really changed here: We trimmed our already-modest position a couple of weeks ago, and given our gigantic cash hoard, the horrid investor sentiment and many secondary studies (the S&P has seen four of the past five weeks result in 5% or greater gains or losses, something that has often occurred near bear lows), we’re fine holding on here. But we’re also flexible—if the market does actually get up and going, we could sit tight with our remaining shares or even add to them, though we might also consider dumping them and moving the money into a potential leading stock. We’ll see how things play out and will obviously be on the horn with any changes, but tonight we advise sitting with what you have. HOLD

Watch List

• Argenx (ARGX 381): Money-losing biotechs are always tricky, but as we write later in this issue, the sector could be in pole position to help lead the next bull run and ARGX is definitely one of the top actors thanks to a potential blockbuster on its hands. See more later in this issue.
• Celsius (CELH 65): As mentioned earlier, CELH has been all over the place of late, but we still like the general action—the last three weeks of volatile action is (mostly) holding above the multi-month bottoming area. The firm’s energy drink business shouldn’t be much impacted by inflation or the economy, either; earnings are likely out in mid-August.
• Enphase Energy (ENPH 196): ENPH has been rejected from resistance in the 210 to 220 area again, which is a hallmark of a tough environment. Still, bigger picture, the stock is holding in its range and acting resiliently, and demand for its solar microinverters and storage systems should remain in 5^th gear for a long time to come.
• Halozyme (HALO 44): HALO has been hacking between 42 and 48 during the past five weeks—it could be putting the finishing touches on a 16-month long consolidation. The story remains as solid as ever, and there’s no reason earnings (likely out in early August) won’t be pleasing.
• Li Auto (LI 39): Chinese stocks have actually been outperforming for a couple of months and LI is a well-sponsored name that could be the next big thing in that country’s electric vehicle market. See more below.
• Intra-Cellular Therapies (ITCI 57): ITCI is another one of our favorite biotech names, and it’s similar to ARGX in the sense that it’s being driven by a relatively new, potential blockbuster treatment. The stock is trading relatively tightly, just shy of resistance.
• Shockwave (SWAV 190): SWAV was up, down and up again recently, both due to the market and a recent index addition (it was added to the S&P 400 MidCap). Yes, it’s expensive and the stock had a monstrous run the past two years, but the growth numbers here are hard to top as its lithotripsy offerings for calcified arteries are seeing huge uptake both in the U.S. and overseas (it received approval to sell in China in late May).

Other Stocks of Interest
Li Auto (LI 39)—It’s hard to have much confidence in just about anything on the long side these days, as even “good” companies have seen their stocks hit air pockets—and that means when it comes to Chinese stocks, it’s tough to even consider them given the risk the government will put some on the naughty list. And yet … Chinese stocks, having gone through the wringer, have actually been bottoming out for the past few months, with many perking up partly due to expectations that China is starting to take business-friendly steps following some major Covid shutdowns. You could look at an ETF as a way to play it (the KraneShares China Internet Fund (KWEB) is one), but when focusing on individual stocks, Li Auto is a newer name (public in mid-2020) that has good sponsorship (620 mutual funds own shares) and is a big player in China’s electric vehicle market—actually, the firm’s vehicles sound like juiced-up hybrids, with big electric batteries and efficient motors that result in longer driving ranges. The firm’s Li One first hit the market in late 2019 (the 2021 model just came out in May), and is a six-seat, large, premium SUV, and sales there have been gigantic; in Q1, deliveries of that vehicle came to 31,716, up 152% from a year ago, and May’s deliveries were up 166%! Granted, the shutdowns and resulting supply chain issues could crimp June and maybe July deliveries, but there’s little doubt demand is big. That was also seen in the firm’s second product, the just-released Li 9, a full-size, six-seat SUV for families (more space and comfort; top-notch safety features), which garnered more than 30,000 orders (each required a $750 deposit) just a few days after being released! (Deliveries should begin in August.) Growth here has been out of this world, with revenues up 176%, 163% and 226% the past three quarters while earnings have been in the black during that time; again, Q2 could certainly see some hiccups, but the market is looking past the worst of any lingering supply issues: LI has been super strong since mid-May, soaring seven weeks in a row and reaching 18-month highs in the process. This week brought news of a good-sized rolling share offering, which has pulled LI in somewhat, but there’s little doubt the trend has turned up. Volatility is extreme, but it’s an intriguing situation; we’ve put the stock on our watch list.

Duolingo (DUOL 89)—So here’s a neat story of a company that flies under the radar but dominates a growing niche: Duolingo is the highest grossing education app and has become the most popular way for people to learn languages (the firm says seven times more people Google “Duolingo” than “learn Spanish”). The firm offers courses in more than 40 languages with fun, on-demand and even game-like learning, which keeps people motivated and builds loyalty—and, most interestingly, it doesn’t put the content behind a paywall, allowing people to learn for free (albeit while seeing ads). It also has a premium version (now called Super Duolingo) with no ads and many additional features. All in all, many of the numbers are extremely impressive, such as the fact that the number of people learning Irish on Duolingo is larger than those who natively speak it (!), and there are more people learning a language on the app than the number of foreign language learners in all U.S. high schools. In total, at the end of Q1, there were 49.2 million monthly active users (up 23%), 12.5 million daily active users (up 31%) and 2.9 million paying subscribers (up 60%). Subscription revenue (up 45% in Q1 and making up nearly three-quarters of revenue) is the main driver, but advertising (up 27%) is healthy as is the Duolingo English Test, which is used for international admissions by more than 3,600 higher education programs around the globe (just 10% of revenues but up 60% in the past year) and has big potential as standardized assessments go online. Analysts see total revenue up 41% this year and 28% next, and while earnings are in the red, free cash flow is solidly in the black. And the stock certainly seems ready to get moving if the market can get out of its own way: DUOL came public last July and mostly imploded with the market in the months that followed, but the action has firmed up nicely since March—the stock found good-volume support that month, the retest in May saw another round of buying after Q1 earnings impressed, and last week the stock nearly touched six-month highs! Don’t get us wrong, there’s still work to be done (the downtrending 40-week line has led to a pullback this week), but it certainly looks like the stock has a solid low to work from.

Procore Technologies (PCOR 45)—Anyone’s that done a full or partial home renovation knows the challenge (nightmare?) of getting every interested party—general contractor to equipment and material suppliers to insurers to financiers to the actual workers, etc., etc.—on the same page; multiply that complexity by 100 for huge projects, with dozens of quotes, budget changes and more, and it’s no wonder that the typical non-residential construction project runs 80% over budget and months behind schedule. That’s where Procore comes in, with the leading software platform that’s dedicated to the construction sector and all the complexities that go along with it—it’s able to get everyone on the platform (it charges based on size of the project and number of products signed up for; no per-user fees) usually with annual or even multi-year terms, offering everything from bid management to coordination to financial projections and more, and north of 250-plus other apps integrate into it. All in all, customers reported that they were able to drive a 48% boost in construction volume per worker using the platform! As for competition, the biggest one is basically do-it-yourself spreadsheets, work documents and emails (not to mention a lot of papers and faxes), and besides, the market is so giant that there’s plenty of room for everyone—and Procore is taking advantage of that. Yes, economic fears and higher rates would seem to hurt business, but that’s not the case—in the Q1 call, management said “the reality is that despite the challenging environment, construction activity is robust, and customers tell us that they’ve never seen stronger and healthier project backlogs.” And the numbers agree: Procore’s revenue growth is actually accelerating (27%, 30%, 33% and 40% during the past four quarters), and in Q1, the company added 616 new clients (5% gain in the customer base sequentially); earnings are in the red, but like many software firms, free cash flow is positive (by a hair). As for the stock … well, that’s where the good tidings end: PCOR came public last May, meandered for a while and then went down the chute until hitting 40 in May. However, shares have found repeated support since then and actually popped above the 50-day line for a couple of days before falling back this week. It’s going to take some time, but when investors look ahead to re-accelerating economic activity and growth stocks come back in favor, our bet is that PCOR can be a winner.

Keep an Eye on Cabot’s Aggression Index
In recent weeks we’ve been telling you to keep an eye on our Two-Second Indicator—so much so that we decided to put it in our market timing section for the foreseeable future. We still think that will be one of your best (likely confirming) clues that the sellers have left the building.

But just as important to us as the overall market is the action of growth stocks, which is what we actually are aiming to buy. Some of that will come from our (newer) Growth Tides, which focus on growth funds like the Next-Generation Nasdaq 100 (QQQJ—shown here).

But a lot will also come from our Aggression Index, which is a longer-term indicator that’s done an underrated job of highlighting periods when institutional investors are favoring growth names, and when those investors are instead hiding in defensive areas. The Index simply looks at the ratio of the Nasdaq Composite to the Consumer Staples Fund (XLP) on a weekly chart with the 10-week and 40-week moving averages—if the ratio is above a rising, lower moving average, it’s positive (Nasdaq/growth is in favor), if not, it’s negative (defensive stocks in favor).

Like every indicator, it’s not perfect, but the past few years it’s been mostly spot-on, with some great signals—it was positive from August 2016 through mid-October 2018, catching that growth stock run, and the April 2020 buy was terrific as well. And more recently, you can see in the above chart the sell that occurred at the tail end of December 2021, which was obviously a harbinger of this year’s mess.

But we’re writing about the Aggression Index now because it’s at a key level: The Index has taken on water this week, but overall has steadied itself since mid May as the 10-week line has caught up on the downside. And now (like so many things in the market), we’re looking to see if the Index can actually go up; a good couple of weeks could produce a green light. If it happens, it could be the first sign since the bear phase began that growth stocks are starting to come back in favor; it’s worth keeping an eye on.

Will Biotech Lead the Next Growth Advance?
If the Aggression Index (along with our more primary market timing indicators) does turn up, we’re seeing more and more evidence that biotech stocks—and medical names more generally—could be the horses that many big investors choose to ride. And one big reason might be the long-term stance of the sector: Below is an eye-opening chart of the S&P Biotech Fund (XBI), which we prefer because it isn’t heavily weighted toward a few mega-cap names. Anyway, check out the monthly chart, which shows a massive leadership run to 91 back in the summer of 2015 … and in the seven years since, it’s fallen a net of 15% thanks to the washout so far this year.

Of course, bad performance doesn’t mean biotech is destined to rally, but (a) the sector (again, including medical and drug names) has long had a history of coming in and out of favor over many years; (b) XBI has actually shown relative strength over the past two months, popping back above its 50-day line in recent days, and (c) we’re seeing many more individual medical names that are perking up in the group—in fact, the medical space has some of the few growth stocks that have etched legitimate launching pads in recent months (they could be ready to get going if/when the market firms up).

We’ll take it as it comes, of course, but the longer this goes on the better the chance a bunch will have good runs in the next bull phase.

Our two favorites right now are Halozyme (HALO), which remains near the very top of our watch list, and Intra-Cellular Therapies (ITCI), which is more speculative but has a blockbuster drug on its hands for the treatment of Bipolar disorders. But there’s another well-traded stock we’re keeping an eye on.

Argenx (ARGX) is a Dutch outfit that’s losing money but is strong due to a new drug (Vyvgart) that treats myasthenia gravis, a rare autoimmune disorder that causes skeletal muscles to weaken and can be life threatening if it affects the throat. (Ironically, the drug is also licensed to Halozyme as they’re working on an Enhanze-related version of it.) The drug just launched late last year, brought in $21 million of sales in Q1, was released in Japan in Q2 and should hit Europe later this year, and label expansions are likely for other indications. Sales should ramp from here, and while the bottom line is in the red, many analysts see Vyvgart bringing in $2 billion annually with three or four years.

Most interestingly, ARGX topped with the biotech group way back in February 2021 and has basically chopped sideways in a wide 35% range—but like most of the best names we’re following, shares have etched higher lows since January and they’re actually back to its highs from last year. Like ITCI, Argenx is being driven mainly by one drug, which isn’t our ideal scenario, but the fact both stocks are perched near all-time highs in this market environment is certainly telling. WATCH

Cabot Market Timing Indicators
It’s been one of the worst first six months of a year in the past century, and while we’d never wish for that, we’re proud of the performance of our market timing indicators—the Trend Lines have been negative since late January, the Tides have been negative for all but three to four weeks and our Two-Second Indicator has seen just six sub-40 readings all year! We have every confidence these (and other) measures will tell us when the next bull move has started, but today they continue to tell us to stay safe.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines don’t speak often, but that’s a big reason why they’re our most reliable indicator. Today, this long-term trend measure remains bearish, as both the S&P 500 (by around 13%) and Nasdaq (by a huge 18%) are miles below their respective 35-week lines. That doesn’t preclude a rally, of course, but until we see a fresh green light from the Trend Lines, the onus is on the bulls.

Cabot Tides: Bearish
Our Cabot Tides are also bearish, with all five indexes we track (including the S&P 400 MidCap, shown here) stuck below their moving averages. We would note that, for the first time all year, the growth-oriented indexes (like the Nasdaq) and some growth funds are actually showing a little relative strength, which is a plus—but the market still needs to gain a few percent from here to turn the intermediate-term trend up.

Cabot Two-Second Indicator: Negative
Our Two-Second Indicator rounds out our negative batch of indicators, as the number of new lows has remained north of 40 during the current rally attempt; the lowest reading seen was 65 before they began expanding again. Remember, this is descriptive and not necessarily predictive—a few strong, broad up days could see readings dry up—but as always it’s best to wait for that to happen. Right now, the broad market remains unhealthy.

The next Cabot Growth Investor issue will be published on July 14, 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.