The market has been up and (mostly) down, but not much has changed with our thoughts: The primary evidence remains terrible, though we continue to see more than a few rays of light from some secondary indicators. For now, we’re remaining defensive (we sold two more half positions this week) and are patiently awaiting the bulls to return.

In tonight’s issue, we write about a couple of commodity-names that we’re watching closely, as well as go over some thoughts on handling big losers (it happens to the best of us) and some of those secondary indicators we’ve mentioned--you can cut the bearishness with a knife, so it’s best to at least stay alert to a positive change in the market’s character.

Cabot Growth Investor Issue: May 5, 2022

Patience Is a Virtue
We’ve written many times about how the market is a contrary animal, which is the biggest reason many investors slip on a variety of banana peels. Nowhere is that more true than when it comes to activity—all our lives we’re taught to fight through adversity, to never quit, to always give it our best effort, starting at a young age. All of us have given our kids a hard time if they lallygag around the base-paths or cut corners with their homework, and the general media is filled with never-say-die stories of success.

Even in the financial press, activity is what people gravitate toward—there’s not much airtime dedicated to the guy or gal that did next to nothing during the past few months. But sometimes, that’s exactly the right thing to do, as we’ve seen during the past six-ish months in the market. Patience remains a virtue in the market.

While the major indexes have continued to sag and growth stocks have continued to disintegrate, nothing has really changed with our general thoughts. Clearly, the market’s primary evidence remains in the muck, with not only the trends of the indexes and growth funds pointed down, but with every up day bringing a fresh wave of selling pressure, such as today’s post-Fed meltdown. We came into the week with nearly two-thirds in cash and leapt out of two more positions earlier this week, leaving us with three times as much cash as stock.

That said, there’s no question that the reasons for the decline—the Fed hiking rates and running off their balance sheet, elevated inflation and commodity prices, surging mortgage rates and plunging junk bond prices, all with a fear of recession from an inverted yield curve thrown in—are very obvious at this point. Indeed, you can cut the bearishness with a knife, which often means many have already sold out, all while we’re still seeing some positive broad market divergences (fewer new lows, etc.).

The combination of the growth stock wipeout since mid-November and huge and growing pessimism means the next sustained upmove should be a doozy—effectively a fresh new bull market with lots of growth stocks that can rally for months if not a year or more. That’s why we’re keeping our head up and eyes open for any sign of a meaningful low.

What to Do Now
But until those signs emerge, the story remains the same: Practice patience, be defensive and keep most of your money on the sideline. In the Model Portfolio, we sold our half-sized stakes in Palo Alto Networks (PANW) and Pure Storage (PSTG) earlier this week, leaving us with 74% on the sideline. Details below.

Model Portfolio Update
Growth stocks began to break down nearly six months ago, and since early December the Model Portfolio has had a minimum of 45% in cash and has averaged around 60% cash, which is normally a highly defensive stance, especially when occurring over a multi-month period. But for growth stocks, this has been a nowhere-to-hide environment, with rolling selling waves hitting every nook and cranny out there.

As that’s continued, we’ve continued to pare back, including this week’s jettisoning of Palo Alto Networks and Pure Storage, leaving us with a giant 75% in cash.

Ideally, we won’t be holding that much cash for long. We continue to see positive signs from more and more secondary measures, and while that’s no reason to buy, at some point all of the built-up pessimism and the fact that fewer stocks are participating on the downside (fewer new lows) will lead to good things.

Put it all together, and we’re doing everything possible not to sell wholesale, but obviously our main goal remains to hold much more cash than stocks and avoid as much damage as we can until the bulls show up. In the meantime, we continue to build our watch list, but for tonight we have no further changes.

Current Recommendations

Arista Networks (ANET)—ANET reported Q1 results earlier this week and there were two takeaways: First and foremost, demand for its wares is excellent and should remain that way for many quarters—but, second, the supply chain issues aren’t getting better, which could crimp near-term margins. As for the specifics, the headline numbers (sales up 31%, earnings up 35%) and Q2 outlook were both fine, coming in nicely above expectations thanks in part to continued share gains from Cisco and others. However, the conference call revealed that some suppliers are “de-committing” on orders, often the week that they’re supposed to be delivered—resulting in Arista having to pay up for supplies elsewhere. That’s not ideal, but (a) the firm is hiking some prices to offset higher costs, and (b) clients are still ordering like mad, with purchase commitments totaling $4.3 billion at the end of Q1, up from $2.8 billion at year end, with some of those orders for 2023 and even 2024! Big picture, there’s not much doubt that Arista is going to grow nicely for a long time to come, though the near-term could be more challenging. Not surprisingly in this market environment, ANET has taken a hit after the report, moving below its 200-day line—though still barely holding near its lows from this year. With so much cash and a good fundamental outlook, we’ll give ANET a smidge more rope, but shares need to show support right quick. HOLD

Devon Energy (DVN)—DVN has snapped back beautifully after its own Q1 report this week. The numbers themselves were predictably fantastic: Free cash flow came in around $2.15 per share, which led to a $1.27 per share dividend (payable June 30; ex-dividend date June 10), buybacks totaling around 1% of outstanding shares, plus another $350 million cash was added to the books. Not much changed with its outlook ($80 oil and current natural gas prices should lead to around $7 per share of free cash flow this year; $90 oil should result in north of $8 per share, etc.), but what did change was management’s confidence in the stock: The buyback authorization was boosted again, and while they won’t be robotic about it, the hints were there that repurchases could total north of $1 billion by year end (another 2% to 2.5% of shares outstanding). Moreover, there will still be enough cash left over so that year-end debt will be tiny (aiming for just 0.2x EBITDA), which in turn could lead to higher shareholder returns in 2023 (i.e., more of the free cash flow could be paid out) even if oil prices do come back down to Earth. (Right now, the company pays out up to half of its free cash flow after the base dividend, but there’s no reason that can’t move up if there’s no need to build up cash.) The reaction to the report was excellent, with the stock racing higher on big volume and powering ahead to highs yesterday before pulling in with the horrid market today. We do think the big-volume move after the recent shakeout may have cleared the air—but officially, we’ll stay on Hold, preferring to see the stock settle down a bit before restoring our Buy rating. HOLD

Palo Alto Networks (PANW)—Palo Alto Networks has a great business that should continue to grow nicely for a long time to come, both from legacy products and (most important) its next-generation offerings, which more and more clients are adopting. That said, the company is not the stock, and after acting in a near-picture-perfect manner during the entire correction, the sellers finally came around for stuff that had “meat left on the bone” (names that were holding up well). We were more than willing to sit through a few days of poor action, but PANW couldn’t find any support (nor could its cybersecurity peers), going from new highs to the 40-week line in just a couple of weeks, which isn’t what you usually see from a stock that’s getting ready to move; thus, we sold our half-sized stake on a special bulletin yesterday. To be fair, PANW isn’t the worst-looking chart out there, and if it really kicks into gear and the market turns healthy, we’ll consider getting back in. But like so many things these days, PANW now has a lot of proving to do, with further downside certainly possible. SOLD

ProShares Ultra S&P 500 Fund (SSO)—We’ve come close to selling at least some of our SSO position many days in the past week or two, but so far the fund (and the S&P 500) has clung to its prior lows as the myriad secondary indicators continue to tell us a turn of some sort could come. (See more on that later in this issue.) Of course, with our trend-following indicators negative, we’re not going to be playing around too much longer with a leveraged long fund; we may even trim our position if we see an unimpressive bounce. But right here we think the potential reward of holding on a bit longer is much larger than the risk should the market continue lower (in which case we’d pare back). Hold for now. HOLD

Pure Storage (PSTG)—Pure Storage is another baby that’s being tossed out with the bathwater—all indications are that business remains very healthy and the subscription business is adding a degree of reliability to results going forward, and even the valuation isn’t crazy. But the stock hasn’t been able to find its footing, first pulling back sharply a month ago and then slowly losing ground since, giving up its entire earnings gap and living below its 50-day line, resulting in us pulling the plug on yesterday’s special bulletin. Like some other recent sales, we wouldn’t say PSTG is completely done for—a strong few weeks with a supportive market could do wonders for the chart. But right here, the sellers are still in control. SOLD

Watch List

• Halliburton (HAL 37): HAL’s sharp decline after a solid run likely means shares need more of a rest; another couple of weeks of consolidation would be perfectly normal. But the main trend is up and, we believe, still in the early-ish innings. See more below.
• Halozyme (HALO 40): HALO has pulled back with everything else, but it remains in fine shape ahead of earnings (due May 10)—a strong move on that report would be very intriguing. The fact that most medical stocks have tanked of late isn’t great, but this stock has a unique story and could dance to its own drummer.
• Lantheus (LNTH 64): LNTH reported a great Q1 (sales up 126%, earnings more than twice expectations driven by accelerating sales of its new imaging agent, Pylarify) that has pushed the stock higher--and shares have been able to hold those gains despite the maelstrom in recent days.
• Nutrien (NTR 104): Our main rub with fertilizer stocks like NTR is that it’s hard to tell how long the good times will last—if, for instance, the war overseas tapers off, will potash prices fall significantly? Still, there are indications that supply will be tight even if that happens (one of Nutrien’s peers said it sees this as a multi-year problem), and Nutrien’s own Q1 report resulted in a huge hike to earnings estimates ($17.50 per share for 2022!) this year and the firm is weighing whether to hike supply to boost even that figure. The stock has held its 50-day line (its first dip to that line this year) in recent days and is starting to bounce.
• ZoomInfo (ZI 50): When 85% of Nasdaq stocks are south of their 200-day lines, there aren’t many in position to get up and going right now—and ZI is no exception. Still, as we explain below, the company has many of the right fundamental and technical characteristics of former leaders, and the fact that it’s never really had a prolonged upmove (still within a huge post-IPO base) means its next move should be early-stage.

Other Stocks of Interest
Arch Coal (ARCH 175)—About the only things that are still resilient these days are commodity-type stocks that are following the “new playbook” that we wrote about in the last issue—by limiting CapEx and having already paid down most of their debt, these firms are paying out a big chunk of their massive cash flows to investors (usually via dividends, but also share buybacks). Obviously, oil stocks are the poster children for that, but Arch Coal deserves mention—in a sector that was left for dead by many investors, the firm has spent years shaping up its operations and now its results are, frankly, almost hard to believe. The company is focused on a few low-cost metallurgical coal (used to make steel) mines, though it also has a legacy thermal coal (for electricity) operation that it’s basically spending nothing on and winding down over time. Now that the firm is net-debt free (cash = debt outstanding), it’s returning half of its free cash flow in dividends, with much of the other half likely for share buybacks, and with prices for its coal through the roof, these figures are gigantic—in Q1, Arch’s cash flow is allowing it to pay a total dividend just over $8 per share (payable June 15)! Of course, prices will eventually come down (though there’s more at work here than just Russia, as Australian exports are way down), but what’s interesting is that Q1 was actually hindered by touch-and-go rail shipments; management sees that situation clearing up in a big way starting this quarter, which will lead to much better results in the near term. Amazingly, analysts see earnings north of $60 per share this year (not a typo) and still see nearly $30 in 2023. Translation: Arch is going to be paying out huge dividends and likely buying back plenty of stock for many quarters to come. ARCH broke out from a nice-looking launching pad in February, zoomed for a few weeks, then bobbed and weaved, with a shakeout two weeks ago below the 50-day line. But the Q1 report changed that, with shares surging back to their highs on all-time record volume. It’s not a buy-and-hold-forever stock, but ARCH seems capable of doing well in the months ahead.

Halliburton (HAL 37)—When it comes to energy explorers, the story is about big cash flows even at meaningfully lower commodity prices. However, when it comes to equipment and service providers for that sector, we think the more apt comparison is something like homebuilders from 2012, a group that had been out of favor for years and had cut costs (and capacity) to the bone, so when a new multi-year upmove began, it rained money for the leading firms. Nobody will confuse Halliburton with a young growth outfit, but we think the situation is similar: Not only has the lack of investment in new drilling led to lower industry-wide inventories (supporting energy prices), but many weaker service firms have fallen by the wayside (lower capacity) and explorers are focused on “short-cycle” drilling (i.e., not big deepwater wells that take years to explore, build infrastructure for and tap), which needs lots of the wellbore equipment Halliburton provides; in Q1, the firm’s completion-related order book lifted 50% from a year ago, while the firm’s fracking crews are sold out (the industry is sold out, too, for the second half of 2022). When you combine all that with the fact that North American oil equipment spending is expected to lift 35% (driven by private firms, which are using 60% of the land rigs out there), and there’s no reason Halliburton won’t see years of excellent growth ahead. In Q1, revenues rose 24% (up 37% in North America), while earnings lifted 84% and cruised past estimates—analysts now see the bottom line up 73% this year and 40% in 2023, both of which we think will prove conservative. As for the stock, it broke out of a multi-month base at the start of the year and had a big run to 42 before shaking out after earnings as the group sold off. Based on the move (which was similar to some peers), our guess is (a) HAL probably needs more time to rest after its four-month rally, but (b) the major uptrend is still likely in the early innings. HAL remains on our watch list, and with DVN now a “normal” sized position, we could add a small position in HAL if the stock shapes up a bit.

ZoomInfo (ZI 50)—Occasionally flip through charts of some old names we either owned or had on our watch list to see what they’re doing. As you can imagine, the vast majority are in shambles, especially when it comes to software, with names like Asana, Twilio, Dynatrace and DocuSign looking horrid. However, in some cases the wheat may be separating from the chaff, and that may be the case with ZoomInfo, which is still attracting big investors (859 funds own shares now vs 522 six months ago) thanks to its outstanding growth story: The firm has the industry’s best intelligence platform, providing updated data on 100 million companies and 180 million people for marketing (business-to-business), sales and even recruiters (it recently bought a company called Comparably that is a hub for employee reviews and salary data). All in all, the firm claims to have 100 million data points updated daily! And it’s not just a big database, either, as ZoomInfo provides lots of tools that can rank leads, saving users tons of time—they can spend more time actually selling their wares instead of researching whether the person is a decision maker, or whether the firm recently got bought out or a team changed roles. While the software is complex, the idea is simple and powerful, and there are no signs that business is getting hit—in the just-reported Q1, the firm saw sales rise 58% (excluding some small buyouts revenues were still 49%), while earnings lifted 38%, driven by a 65% rise in the number of six-figure customers. There are some moving parts here, but we’ve always thought ZoomInfo had the potential to be a follow-on play of sorts to Salesforce.com, and the still-strong results back that up. Of course, with all that said, the stock is not the company: ZI plunged 46% from mid-November to late January, which was par for the course for software stocks—but unlike most peers, shares have (so far) held those lows during the past three months and actually caught a small bounce this week on earnings (it’s still up on the week even after today’s plunge). ZI needs work, so we’re in no rush to enter, but it’s worth keeping at least a distant eye on.

What if You Get Stuck with a Loser?
It’s all well and good for anyone to preach about cutting losses short and holding cash during downtrends, but let’s face it: We’re all human, and sometimes something will get away from us on the downside for whatever reason. That’s probably why the most popular question we’re getting these days is: “I still own XYZ stock that’s been hit hard—do you think I should still hold on?”

The specific answer depends on the buy point, the position size and some other factors, but generally speaking our advice is that (a) you don’t want to be playing around too much with big losses in a bearish environment, but (b) you also don’t have to make an all-or-nothing decision (or many all-or-nothing decisions if we’re talking about a few duds).

First, a few points to keep in mind. On the downside, big losses are hard to make up—the math works against you. For instance, a 20% decline requires a stock to rise by 25% to get back to even; a 33% drop requires a 50% rally; and a 50% plunge means the stock must rally 100% just to get back to where it started.

Moreover, the math is also poor with a stock that’s down a lot: Even if a stock is down 60% from its peak, it would take another 25% drop for it to be down 70% from that high. We actually saw that a lot of late, with former glamour names falling another 20% to 40% even after their early-year massacres (Shopify is one unfortunate example; see chart).

And also, remember that the idea is to eventually make back the money you lost—but you don’t have to make it back in the stock that’s collapsed. In fact, the odds favor you having a much better shot at making those losses up in a fresh leader during the next uptrend.

Simply put, the goal in a bad situation is to not let it get much worse—though, if you’re already in a defensive stance, you don’t have to sell wholesale. It’s comparable to suffering a modest injury when playing a sport: You’d be silly to just keep playing with, say, a twisted knee, which could lead to an even worse injury, but you also don’t have to rush to the hospital and swear off the sport forever.

Long story short, if you’re out of gear with the evidence, take a step in the right direction and do at least some selling. If you own one dog, sell half; if you own three, consider selling one or two outright, that sort of thing. Then you can make a calmer decision of what to do with the rest (ideally selling on a bounce). The exact details are less important than taking a step or two in the direction of the evidence.

Bears are Everywhere
Thankfully, we’re proud trend followers, which always keeps us on the right side of the market’s major trend. There are whipsaws and bad signals, of course, but never missing a major upmove and never remaining heavily invested during a major downmove automatically puts you out in front of most investors.

That said, we’re also students of the market, and after nearly six months of horrid growth stock action, along with the worst start to the year in decades and a drumbeat of negative news, we can say with confidence that most investors already know things stink. Simply put, the bear case has become very obvious to most investors, and the obvious rarely works in the market for long.

Extreme readings are popping up all over the place. First, there’s our own Real Money Index, which after remaining stubbornly high has finally caved to 19-month lows (see chart later in this issue). Similarly, the real money equity put-call ratio has seen its 10-day average reach two-year highs (see chart).

On the survey front, the granddaddy measure (Investors Intelligence) saw 9% more bears than bulls this week (largest since the pandemic and one of the lower readings of the past decade), while the AAII survey is showing ridiculous pessimism, with bears outnumbering bulls by an average of around 30% over the past five weeks!

Moreover, all this is happening while the number of stocks hitting new 52-week lows peaked more than three months ago, with the figures (while still large) shrinking on every successive lower low in the indexes—a sign that fewer stocks have been participating on the downside.

As we wrote on page 1 of the last issue, secondary indicators like these are just that—secondary to what’s actually happening in the market, where the action remains awful. That said, one thing we’ve learned is that when investors start thinking something can’t happen in the market, it often does—and right now, with all the worries in the world, many see the chance of a sustained advance as vanishingly small. Maybe that will prove to be correct, but with so many bears out there, be sure to at least keep your eyes open for a change in character.

Cabot Market Timing Indicators
Despite the drumbeat of negative news, there remain many secondary rays of light, including our own Real Money Index, which is finally reflecting some real worry. But we need to see sustained buying pressures—via our trend-following indicators and the action of potential leading growth stocks—in order to come off our highly defensive stance.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines remain clearly negative—the S&P 500 and Nasdaq currently sit around 7% and a whopping 14% below their respective 35-week lines, both of which are the largest spreads in some time. Short-term, such figures could lead to a bounce, but obviously the market has a lot of work to put in before the larger, longer-term trend returns to a bullish footing.

Cabot Tides: Bearish
Our Cabot Tides are back in the soup, with all five major indexes we track (including the Nasdaq Composite; daily chart shown here) below their lower (now 25-day) moving averages. The action is just as bad for our Growth Tides, where growth-oriented funds also probed new correction lows this week. Now’s not the time to stick your head in the sand, but with the intermediate- and longer-term trends pointed down, it’s best to remain patient and hold lots of cash.

Cabot Real Money Index: Positive
After five-plus months of shoddy action, our Real Money Index is finally telling us investors are getting antsy—there have been four straight weekly outflows, and in total during the past five weeks, $29.5 billion has been yanked out of equity funds (mutual and ETFs), the largest total since September 2020, when the pandemic was still raging. It’s not enough to buy but is another indication we’re seeing some throw-in-the-towel action.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on May 19, 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.