The market’s downtrend remains in place, with the trends of the major indexes and growth stocks still solidly down, and just as important, we’re still seeing many blowups among individual names, with retail stocks like Target and Walmart going over the falls this week. Thus, we remain defensive, with north of 80% in cash.
That said, we’re not joining the growing chorus of super-bears out there--there are tons of extremes when it comes to the selling and sentiment that a low could come at any time. We’re not predicting that, but we are spending most of our time hunting for new leaders--and interestingly, we’re seeing a few candidates even after the recent down move, writing about most of them in this issue.

Cabot Growth Investor Issue: May 19, 2022

The Market Is a Game of Outliers
In his book How to Trade in Stocks, Jesse Livermore had a passage about the pitfalls of averaging down (buying more of a stock as it goes lower and lower), with an example given of an investor who buys multiple times as the stock cascades lower from 50 to 29. But the most telling part of the quote came at the end: “Of course, abnormal moves such as the one indicated don’t happen often. But it is just such abnormal moves that the speculator must guard against to avoid disaster.”

What he was saying, in effect, was that it’s the downside outlier trade that can really set you back. And over the years, we’ve learned it’s the inverse that’s true as well—if you cut your losses short, you’ll find out that most of your trades basically offset each other, with a relatively few bigger winners accounting for most of your profit. To us, the market is really a game of outliers: It’s not about being right all the time, it’s about being wrong small and being right big (or bigger). That’s really what our system (market timing and stock selection) is all about, avoiding big mistakes and grabbing a few shooting stars when they appear.

Today, of course, we’re still in the midst of a downside outlier move in the market (Nasdaq as much as down 30% from its high) and many individual stocks (tons down 60% or more), which is why our system’s had us mostly on the sideline during this time. And today nothing much has really changed—the trends are still down, and few stocks look good, so we remain highly defensive.

But we really brought up the outlier theme for what comes next, and something we want to emphasize here: When it comes to big moves, our focus is on the bull phase that will be spawned after this mess finishes up. Having already seen so much damage over a good amount of time (six months from the Nasdaq’s peak) creating so many oversold and sentiment extremes (Investors Intelligence saw an 11-year high in bearish advisories this week; big-name earnings blowups this week only add to the worry), the pieces are certainly in place for a meaningful low—and when that comes, there should be opportunities aplenty to grab some upside outliers that can make all the difference in your portfolio.

What to Do Now
Right now, then, we continue to hold a ton of cash, but we’re not burying our head in the sand or gabbing with everyone about all the bad news—instead, we’re focused on growth stocks finding support and reacting well to earnings (yes, there are a few), some of which we could nibble at if the market finds some real buying. Tonight, we have no changes, with the Model Portfolio holding north of 80% in cash.

Model Portfolio Update
We run a relatively concentrated portfolio, ideally with 10 positions if fully invested, which allows us to quickly add or pare back exposure. Because of that, holding a good amount of cash isn’t that unusual—we’ll occasionally have 50% in cash if growth stocks enter a tough correction, though it’s still rare for us to get up to, say, two-thirds in cash, with north of 75% or 80% when there’s basically nothing working on the growth side of things.

That’s where we find ourselves now, with the market’s latest wipeout forcing us out of a couple more names, leaving us with around 85% on the sideline; frankly, we try to avoid such a scenario, but we’re also not simply going to throw our money into a furnace. We’re not opposed to adding a half-sized position or two if the market and (more important) some growth stocks shape up—but at this point, with every bounce being sold into, we’d prefer to be safe on the sideline than trying to pick up nickels in front of bulldozers.

Right now, our main focus is on what comes after this decline finishes up: A sustained, early-stage bull run, almost certainly with fresh leadership that can trend higher for months. We’ve been through these sorts of meltdowns before, and while we take some lumps, we don’t lose any limbs and make it all back and more when the bulls reappear.

That is really the prize that most should keep their eyes on—but to benefit from it, you should remain defensive and patient as the bear phase plays out.

Current Recommendations

Arista Networks (ANET)—ANET was doing its best to hold support near its 200-day line a couple of weeks ago, but the market’s collapse was too much to overcome, forcing us out of our position. Frankly, while the current growth stock graveyard is littered with names that are almost certainly past their point of peak perception, we wouldn’t go that far with Arista quite yet; shares are “only” 31% off their high even after Cisco’s dud of a quarterly report last night, and despite supply chain issues growth this year and next looks quite strong thanks to ever-growing demand for its networking gear, especially by the cloud titans. Still, while we wouldn’t bury ANET in the graveyard of so many growth names, there’s no question that the stock is trending down, and there’s no certainty that the supply chain issues that popped up in Q1 won’t worsen and crimp growth. We sold last week and are comfortable holding the cash. SOLD

Devon Energy (DVN)—DVN has been all over the place of late, but there’s little doubt it continues to act well—shares burst higher following the Q1 report, and while the worst of the recent market waterfall did yank the stock lower for a couple of days, it returned to new high ground earlier this week. All in all, having already taken partial profits a couple of times, we’re mostly in trend-following mode, allowing the stock plenty of wiggle room as it works its way higher. On a positive note, it does seem like, at least in the near-term, investors are beginning to discount “higher for longer” energy prices—just to be conservative, we often quote Devon’s cash flow prospects at lower prices ($80 oil = ~$7 of free cash flow per share), but if you’re of the mind that $100 oil is here to stay (and more investors seem willing to bet on that recently), that figure rises to around $9.30 per share annually, which of course would lead to even bulkier dividends and share buybacks, along with quicker debt reduction. All that is a way to say it’s definitely possible we could see this bull run continue (possibly even accelerate), especially if oil and gas prices actually push higher from here. Now, with that said, to play the other side of the fence, we’re not ignoring what Fed Chairman Jerome Powell said this week—effectively, that the Fed is going to keep tightening until inflation comes down … and it’s hard to see inflation coming down much until energy prices do (at least 15 or 20 bucks worth), which, when combined with the fact that energy stocks are very obvious and the market remains iffy with tons of stocks hitting air pockets, does raise risk. If you own DVN and have a “big” position (whatever that means to you), we do think shaving off a few shares makes sense. However, as mentioned above, we’ve already sold about two-thirds of our initial stake, and the underlying cash flow story remains rare even if we do get a retreat in oil prices; while our antennae are up, we think you should continue to sit tight if you’ve been following our advice. HOLD

ProShares Ultra S&P 500 Fund (SSO)—With 85% on the sideline, we’re obviously not in the mood to raise more cash; even if the market keels over from here, our losses will be relatively limited, and of course having at least one foot in the market’s door will allow us to crawl higher should we finally rally for more than just two or three days. Moreover, while we never predict things, there’s no question that many longer-looking measures actually bode well. One data point: Through last week, the S&P 500 had fallen six weeks in a row and dropped more than 10% during that time; that’s only happened five other times since 1950, four of which were higher a year later, with a total average return of +18%. Throw in some of the massive oversold (nearly 30% of Nasdaq stocks hit new lows every day for five days during the worst of the recent selling, nearly on par with other major lows) and negative sentiment measures (the Investors Intelligence survey has 15% more bears than bulls, the lowest since 2011) and it’s certainly possible we’ll hit a low somewhere around here. We’re obviously not whistling past the graveyard given the portfolio’s overall stance, but right now, we think it’s best to grit our teeth and hold SSO—if we do get a solid bounce in the market that shows promise, we could always lighten up here (while possibly adding a couple of half-sized positions in other names), but at this point, sitting tight is the best course. HOLD

Watch List

• Albermarle (ALB): The lithium story isn’t hard to understand, and Albermarle is one of the more straightforward ways to play it—sales and earnings are soaring now and should kite higher for years to come. Shares look to be rounding out a six-month launching pad. See more below. Livent Corp. (LTHM) is another, smaller player in the lithium space we’re also watching.
• Blackstone (BX): We’re keeping an eye on BX, which, despite being a dyed-in-the-wool Bull Market stock, is still holding its own (same level now as in late January) and found big-volume support near resistance last week. A good week or two would go a long way toward rounding out a launching pad, and bigger picture, there’s every reason to expect the stock will do well during the next market advance.
• Celsius (CELH): CELH still needs work on the chart for sure, but the firm’s energy drinks continue to take share in a gigantic market, growth is fantastic and the stock has held support since January. See more later in this issue.
• Halliburton (HAL): HAL etched a nine-month rest last year, broke out powerfully in January, ran nicely into April and is now five weeks into a normal (22% deep) consolidation. In this market, there are never any sure things, but the odds favor this action being a pause that refreshes, especially with oil prices remaining stubbornly high despite a hawkish Fed and economic fears.
• Halozyme (HALO): HALO is the top name on our watch list right now, as the stock has just about all of the characteristics we’re looking for—early-stage, a big story, excellent recent numbers and even a reasonable valuation (~20 times earnings). Earnings estimates are mundane this year (up just 4%), but that’s solely due to a higher tax rate; management sees royalty revenue up 50% this year and earnings should accelerate in 2023 (current estimate: up 37%). The stock has surged back toward multi-month highs after earnings.
• Shockwave (SWAV): As we write later on, neither CELH nor SWAV are ready to zoom higher right now, but both tested major support last week and found outsized volume support after earnings. Shockwave’s story and numbers are as good as it gets. It’s worth keeping an eye on it.

Other Stocks of Interest
Albermarle (ALB)—Some ideas are so straightforward they don’t require a lot of explaining, and that’s the case when it comes to lithium, which is the least dense element that is a solid at room temperature, making it perfect for batteries. Because of that, lithium is in hot demand as the world is set to move increasingly to electric vehicles—if you believe the long-term projections, EV sales should rise from 6.3 million last year to 21.7 million in 2025 and 40.6 million in 2030, all of which should lead to a corresponding demand hike for lithium (demand to triple from 2021 to 2025, then double again by 2030). Albermarle looks like the institutional way to play this trend, with many different mines, projects and joint ventures around the globe that produce lithium hydroxide (fast becoming the preferred option for EV batteries and other high-end energy storage) and lithium carbonate (also in big demand). All told, the firm had total capacity of around 88 kilotons last year, but it’s set to boost that 25%-ish this year and to 200 kilotons by 2025—and when combined with much higher pricing for lithium (in Q1, prices rose 66% from a year ago!), there’s little doubt that Albermarle is going to get much more profitable over time. Indeed, the Q1 report was outstanding—total sales rose 36%, led by lithium revenue up a whopping 97%, and while some of that was due to a one-time sale, the top brass sees pricing about double what it was last year with its contract renegotiations, which should help lithium-related EBITDA to more than triple in 2022. The firm also does a good business in bromine (used in a variety of flame retardants and a variety of applications in autos, electronics and more), with sales up 28% in Q1, and it has a small catalysts business, but the story is really all about lithium. Obviously, if there was a hiccup in EV sales, that would be bad, and we would note that the company is spending big on expanding its capacity, which is a risk. But there’s little doubt the wind should remain at the firm’s back for years to come. ALB about tripled from the post-vaccine breakout in November 2020 to its peak last November, then corrected 40%-ish into March. It steadied itself thereafter and the quarterly report two weeks ago may have kicked off the stock’s repair process. It needs some work, but ALB is on our watch list.

Shift4 (FOUR)—Payment stocks remain on the outs, with Block (SQ) and PayPal (PYPL) both more than 70% off their highs and the buy now, pay later crowd (led by Affirm (AFRM), down 87%) look even worse. Still, the broad payment theme is a long-term growth area, with new winners emerging every few years—and we think Shift4 has a chance to grab the leadership baton during the next bull market. While there’s competition, Shift4 seems to have one of, if not the, best end-to-end commerce platforms out there; instead of having a few different payment-related vendors (for hardware, analytics, software, processing, security, you name it), this company can do it all for clients, whether they’re small restaurants or massive resort campuses, selling online or offline or both—and it integrates into hundreds of popular software suites, making it easy to set up. While not a household name, Shift4 has been around a couple of decades and is no small fry, processing billions of payments a year from more than 200,000 customers. It’s very popular among restaurants and hospitality clients (it recently inked deals to process payments at a few big ballparks in the U.S.), but it’s branching out rapidly, with BetMGM, Starlink and many charities signing up, too. With more clients taking all-in-one solutions, Shift4 has been growing rapidly and profitably for many quarters—in Q1, despite the impact of omicron in January, payment volume rose 68% from a year ago, revenues less network fees were up 53% and earnings of 15 cents per share were up from a loss and topped expectations by seven cents. Management sees full-year revenues less network fees up around 31% while EBITDA should rise nearly 50%; analysts see earnings north of $1 this year, with strong growth for years to come. As for the stock, it’s … not strong, having fallen for months after topping near 100 last summer. But FOUR is still hanging around its late-January low (far better than most growth stocks) and found good-volume support last week. It’ll take a bit to set up, but FOUR is on our “back burner” watch list—it has the story and numbers to be a fresh leader, and a couple of good weeks could make the past few months look like a solid bottom.

Starbulk Carriers (SBLK)—We’ve written about Starbulk a couple of times this year, a small-cap dry bulk shipper (128 owned vessels) that’s relatively well managed. The trick with any shipping stock is the cyclicality of the industry—charters here usually last just a couple of months at a time, so when rates plummet, so do sales, earnings and the stock price, usually in a hurry. However, like so many commodity-related areas, the underpinnings here should be solid for a long time to come: After years of slow times and with uncertainty surrounding emission regulations, investment has dried up, with the global orderbook for new ships at 25-plus-year lows (fleet growth in 2023 should be the lowest since 2000), even as routes are getting longer and port congestion issues remain. Thus, while there will be peaks and valleys, charter rates should remain elevated for a while, and when combined with Starbulk’s solid dividend policy and financial position, we think this small-cap name has further upside—the company keeps $2.1 million in cash for each of its ships as cushion, but pays out whatever cash it has on the books above that, which has led to gigantic payouts ($1.25 per share for Q3, and $2 per share for Q4!). Those figures are likely to come down some as the second half of last year saw charter rates go bananas, but even as rates have eased the firm’s annual free cash flow should be 15% to 20% of the current market cap, so buoyant dividends are likely going forward—the next quarterly report (and dividend announcement) are coming May 24. As for the stock, SBLK is one of the few in the market (commodity or otherwise) that sports a legitimate setup: After breaking out of a multi-month zone in February, shares quickly rallied into the 30 area, but that led to another two-plus-month consolidation. But it looks like SBLK wants to head higher, assuming the quarterly report doesn’t offer up any real disappointments.

Follow the Volume
With the market having gone over the falls, now is the time to be looking for growth stocks that are showing some relative strength; it’s these types of names (as opposed to the popular former winners that have collapsed) that are likely to be your leaders down the road. However, with 75% to 90% of stocks (depending on the exchange) below their 200-day lines, it makes it hard to find real tennis balls (those bouncing after dips) since so many names act like eggs (sitting there splattered on the floor).

In these environments, we think volume is one of your best heads-up that institutional investors are grabbing shares—giant-volume buying at or near key support (often after an undercut of obvious levels) is usually at least a line in the sand, and sometimes it can mark a climactic turning point. Interestingly, we saw a few instances of this in the past week or two even as the market was falling.

One came in a name we wrote about a month ago—Shockwave Medical (SWAV) is using a proven technology to more effectively break apart calcium in clogged arteries, and with a better safety profile, too, with coronary applications the big draw today. The stock had a nice rebound in March and early April but imploded with the market after that, diving below its prior low last Monday. But then Q1 results were released (sales up 194%, earnings of 39 cents beating by 21 cents), leading to big upward revisions in estimates (analysts see earnings of $1.93 per share this year, up from $1.39 pre-report) and a surging stock: SWAV ended up rallying 18% last week on its heaviest weekly volume since December 2019! Let’s see if the stock can begin to round out a launching pad from here.

Another idea we’re keeping a distant eye on is Celsius Holdings (CELH), the maker of energy drinks that are actually designed for active people—they have no preservatives, aspartame or added sodium, and most important, have been proven (according to a few neutral studies) to actually boost metabolism and fat burning. The firm currently has 4% market share but is gaining more as distribution picks up (nationwide launches in Sam’s Club. Lifetime Fitness and Circle K locations recently, along with a big expansion within Walmart’s, too). To be fair, the SEC has been in touch here, and that (along with the market) was one reason the stock got hit so hard after its November peak. But since January, CELH has held support near 40 multiple times, and last week’s quarterly report (sales up 167%, earnings up 800%; analysts see both booming this year and next) brought another huge wave of support, with the stock rallying 11% for the week on the heaviest volume since last June.

Again, CELH, like SWAV, still has plenty of work to do—maybe last week’s buying waves will fade if the market has another leg down. But barring actual setups (few are out there), outsized volume at key levels can be an early clue for a stock that wants to get going. Both SWAV and CELH are on our watch list.

The Fed: Important? Yes. All Powerful? No.
It was the late, great Marty Zweig that coined the phrase “Don’t Fight the Fed,” and there’s no doubt they have an influence over the economy and stock market. In fact, (very) long-time subscribers might remember the Power Index, which for years in the 1970s and 1980s was our most reliable market timing measure—it was based on the movement of short-term Treasuries, effectively telling us when the market was anticipating a tighter or looser Fed.

Today, of course, we have 40-year highs in inflation and the Fed is taking action, hiking rates and (soon) running off their balance sheet, and there’s little argument that is a reason stocks have been hit in recent months. But just realize that, while the Fed is a key input, the market can often look over the horizon to better times even if the Fed is still in a hawkish mood.

The examples are everywhere, but here are a few: Starting in December 2016, the Fed hiked rates four times during the following year, but 2017 was one of the best growth stock environments since the Internet bubble. Then there was the fact that the Fed hiked rates 17 straight times from 2004 to 2006, which, while not amazing, was a generally positive time. There were also three rate hikes in 1999, one of the best market years of all time.

On the flip side, consider that the Fed began cutting rates in September 2017 (by 50 basis points no less) and cut rates by a total of 3% by March 2008—and of course the market still collapsed during the following year. The same thing happened during the 2000-2003 bear, with the first rate cut in January 2001 and 2.5% of cuts by May, but the market didn’t bottom for another year and a half afterwards.

To be clear, with lots more rate hikes on the way, the Fed will likely be a headwind for the market. But history tells us that it’s not a one-for-one relationship; oftentimes the market will see better times ahead even when the Fed is in the midst of a tightening phase. Thus, you’re better off staying laser-focused the market itself—especially the trends of the indexes and leading stocks—which will do a better job of telling you when it’s time to put money to work.

Cabot Market Timing Indicators
There’s certainly enough bad news and selling extremes to create a meaningful bottom—if we see signs of that, we could put a small amount of money to work given our giant cash hoard. But at this point, buyers have been unable to rally the market for more than just a couple of days; with the trends firmly down, we remain defensive.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines remain buried, with the S&P 500 and Nasdaq a whopping 12% and 19% (respectively) below their 35-week moving averages. If we close the week here, those would be the largest spreads in years—that certainly could be worthy of a bounce, but it’s likely going to take a while before the longer-term trend is supportive of stocks.

Cabot Tides: Bearish
Our Cabot Tides are also clearly in the bear camp, with all five indexes we track (including the S&P 400 Midcap, shown here) well below their lower (now 25-day) moving averages. (It’s the same story for our Growth Tides, too, though we’ve seen a smidgen of relative strength there in recent days.) Given the extreme oversold and sentiment readings, a workable low is possible soon (maybe last week was it). But the indexes will effectively need to hit a five-week high to turn the intermediate-term trend up, which will take some work.

Cabot Real Money Index: Positive
It took a few months, but our Real Money Index is delivering a clear message: Investors are hitting the eject button in droves, with a total of $44 billion being yanked out of equity funds and ETFs during the past five weeks, the largest total since July 2020, during the height of the post-pandemic weakness. Like every sentiment/contrary measure, it can get more extreme, but such worry is usually a positive short- to intermediate-term sign.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on June 2, 2022.

Analyst Bio

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.