December 16, 2021

NEW! Download your copy of Cabot’s 10 Favorite Low-Priced Stocks for 2022 Report - a subscriber-exclusive benefit.

The rally after the early-December low has clearly come under pressure, especially with growth stocks, most of which are in shambles; our Cabot Tides remain negative and we’re remaining cautious in the Model Portfolio, with 50%-ish cash for the past three weeks. We’re not ruling out the fact that, for the overall market, we could have a workable low if things hold up here. But there’s no question that the sellers are in control of most stocks and indexes, so we advise caution and defense while waiting for the sellers to finish their work. In the portfolio, we continue to pare back when needed, though we’re also holding our more resilient names and keeping our watch list up to date; this is still a bull market, but right now it’s about preserving capital and waiting patiently for the next uptrend.

Market Overview & Model Portfolio Update

Lots More Work to Do
Since it’s the holiday season, we’ll start with some potential good news. After the huge market and growth stock selloff into early December, stocks flashed a relatively rare show of buying power—yes, the indexes popped higher, but even better was the under-the-surface action which saw up volume on the NYSE (volume in stocks rising on the day) north of 80% of the total volume on three out of four days.

That’s not a blastoff indicator, so we don’t want to overstate it, but coming after a big selloff, such a breadth cluster usually indicates there’s a bid under the market. It’s early, but so far, it looks like that may be the case for the major indexes, with many having a quick retest of their recent lows and finding support. When you combine with it the fact that we’re starting to see some cracks in sentiment (put-call ratio near a seven-month high; AAII bulls at 16-month lows) and that our Cabot Trend Lines remain bullish, it’s possible the market may be forming a workable low.

That’s encouraging, but as our title today suggests, the market—and especially growth stocks—have lots more work to do to give any sort of green light. First and foremost, our own Cabot Tides are still negative, so even the index action isn’t anything to write home about. We’re still seeing hundreds of stocks hitting new lows on most days, which is not a sign of a healthy market. And our own Aggression Index is weakening and near key levels as big investors pour money into defensive stocks (see more later in this issue).

Perhaps more vital is what’s been a mini-crash in most glamour stocks; the super-volatile ARK Innovation Fund (ARKK) has fallen a ridiculous 28% from its early-November peak, but even broader growth indexes like the Next Gen Nasdaq 100 (QQQJ) dropped 11.5% in just a couple of weeks, and most individual titles we look at have broken down.

To be fair, it’s not quite as bad as it sounds—while we do think some of the post-pandemic winners (those that initially got going way back in April/May or 2020) have topped for a long time, other growth titles that are earlier stage (breakouts from long rest periods this summer or fall) are in the process of building normal-looking launching pads. And we’re also seeing some tempting areas from outside of traditional growth (like homebuilders, which we write more about later), too.

What To Do Now
Overall, then, the evidence tells us that this is a bull market—but there’s also little doubt that, until things change, the sellers are still in control of most stocks, with air pockets still appearing all over the place. It’s not 2008 out there, but we continue to advise a cautious stance, holding plenty of cash and keeping any new buys on the small side. We’ve been cautious for a couple of weeks, and tonight we’re selling the rest of our Cloudflare (NET) shares and placing Ambarella (AMBA) on Hold. That will leave us with around 55% in cash.

Model Portfolio Update
Growth stocks have remained under the gun, with the brief bounce last week leading to another round of punishment this week. We’ve remained cautious, holding between 48% and 58% cash, and our main goal is to stay that way until the next uptrend gets underway.

Of course, there are shades of grey in terms of how exactly to be cautious—it’s still a bull market (Cabot Trend Lines positive), and while some growth names do look longer-term abnormal, many appear to be consolidating normally, building structures for an eventual next leg up.

Thus, we’re dedicated to holding plenty of cash, but we’re not in a 2008-style of mindset. Looking ahead, it’s always important to remember that, once this intense selling finishes up, there will be another uptrend—and that uptrend will have some great leaders to latch onto. Because of that, and the fact that the overall bull market is still intact, we’re not opposed to some nibbling if growth can stabilize for a bit.

Right now, though, our main focus is on playing defense. On today’s special bulletin, we let go of the rest of our shares in NET and placed AMBA on Hold, leaving us with 55% in cash. Details below.

Current Recommendations

Ambarella (AMBA)—AMBA’s volatility so far this month has been enough to make anyone queasy, and in this environment, it’s always possible it joins most other growth stock names on the downside; following yesterday’s big advance, today’s even-larger, decline is certainly ugly and a yellow flag and prompted us to go to Hold on our position. To this point, though, AMBA isn’t a disaster, trading in the vicinity of its 50-day line and still holding a good chunk of its big advance in October and early November (from 160 to 205, round numbers), which is unusual to find these days. Fundamentally, if you’re looking for a worry, we would say that next year’s earnings estimates have actually come down a bit since that quarterly report (“only” 21% EPS growth expected in 2022), mostly because of management’s cautious words about its supply chain. That said, it’s no secret that Ambarella regularly beats estimates (57 cents in Q3 beat by eight cents), and while the next couple of quarters could have some question marks, there’s little doubt the firm’s major design wins in some auto and security camera makers bodes well for a few years of big growth. All in all, we want to give AMBA a chance, as the stock has all the criteria (growth, numbers, early-stage advance, etc.) to be a winner, but given the stock’s hit today and the growth stock environment, we’re going to Hold. HOLD

Arista Networks (ANET)—As we wrote at the start of this section, we’re not going to do any big buying until growth stocks form a meaningful low, but we also don’t view this as 2008, so we’re not opposed to nibbling when our cash position balloons. That’s what we did last week when we started a position in Arista Networks, which was the most resilient growth stock in the market—and remains so today, despite the latest wave of selling. The reason for the action: Demand for Arista’s high-speed networking and related software products is at the front end of what should be a multi-year surge, with the company getting orders it will fill three or four quarters in the future, a rarity in the industry. A dip much below the rising 50-day line (now near 117) would probably have us cutting the loss, but it’s hard not to be impressed with the stock’s action to this point. Hold on if you own some, and if you don’t, consider buying a small stake here or (preferably) on dips. BUY A HALF

Cloudflare (NET)—The good news is that we sold 55% of our position in Cloudflare last week via two separate partial sales—and the stock has continued lower since then. We were holding on to the remaining shares, wanting to see if and how strong any bounce became; even if NET has topped for a long time, we know that many of these high-flyers will eventually recoup half or so of their declines. But during the past couple of weeks, shares haven’t been able to bounce at all, with any one-day uptick met with massive selling that drives the stock lower. If you have a lot of cash, have already taken partial profits and want to give the stock a chance to rebound, that’s fine; we wouldn’t be shocked if it did. But given our defensive mindset when it comes to growth stocks (especially the leaders coming out of the 2020 crash), the stock’s prior huge run and its complete meltdown, we decided to let the rest of our shares go on a special bulletin earlier today. SELL

Devon Energy (DVN)—DVN and other energy stocks recently suffered from what appears to be the “meat on the bone” theory—once a correction gets rolling and the selling spreads to most nooks and crannies, big institutions tend to cut back on things that are still near their highs, which are “easier” to sell compared than things that have already dropped a bunch. In DVN’s case, shares fell from a high near 43.5 (adjusted for the recent dividend) to the upper 30s, even as oil prices are hovering north of $70 (a few bucks above their recent lows) and natural gas is still near $3.85—prices that would roughly translate to about $5.50 per share of free cash flow for next year. Encouragingly, though, as the broad market has bounced since yesterday’s Fed meeting, it looks like bargain hunters are on the prowl, with DVN and its peers rebounding nicely back into the middle of their multi-week ranges. Looking ahead, if the stock does crack near-term support, we’ll likely take some (not all) chips off the table, but until we see that we continue to think energy stocks in general (and DVN in particular) can enjoy good runs once the pressure comes off the market. If you don’t own any, we’re OK starting a small position here. BUY

Floor & Décor (FND)—FND has been doing its best to hold up, though the relentless selling in all things growth is catching up to the stock, pulling it down to our mental stop in the 120 area before it found some support earlier this week. We’ve written a few times about how FND’s “normal” pattern is three steps forward, two steps back, so this decline, while far from fun, doesn’t seem totally out of character. In fact, there should be solid support around here and it’s hard to claim that business is suffering from any hiccups (especially with housing-related names doing well both fundamentally and chart-wise). We’re still optimistic overall given the multi-year cookie-cutter story that’s playing out, but as we’ve been advising for a while, you should continue to follow the plan--above 120 (give or take a few dimes) we’re OK holding on, but a decisive break of that would have us protecting our capital. HOLD

ProShares Ultra S&P 500 Fund (SSO)—Whether it’s our Cabot Tides (negative), the number of new lows (hundreds most days on the NYSE and Nasdaq), or the percent of stocks below their 200-day lines (over 60% on the NYSE and Nasdaq combined), it’s clear that the market is unhealthy right now—the sellers are in control of far more than the buyers. And that weakness is starting to spread … but hasn’t really hit the S&P 500 badly this week, as it remained above its 50-day line during the downturn ... and yesterday’s rally nearly brought the index to new closing highs! Can the S&P (and SSO) remain isolated from the selling? It’s possible, as such a thing has happened during prior growth-led corrections (such as this spring), though we won’t predict what comes. All in all, with SSO itself hanging in there, we’re still OK starting a (preferably small) position here if you don’t own any. BUY

Watch List

• Alnylam Pharmaceuticals (ALNY 185): ALNY has a great story, with new drugs and indications hitting the market and a great long-term growth goal. The stock isn’t picture perfect, but is far from abnormal, too. See more below.
• Snowflake (SNOW 325): It’s getting tossed around by the market, but SNOW has liquid leader written all over it for the next market uptrend. See more below.
• Toll Brothers (TOL 69): As we write later in this issue, we think there’s a decent chance that, as perception improves about the sector’s earnings potential in 2022, homebuilders may be starting a new leg up, with TOL looking like one of the leaders.
• Wingstop (WING 161): It’s flying under the radar, but WING has built a 16-month launching pad, found giant support on earnings in November, has held up relatively well since and has a best-in-class cookie-cutter story. It needs some work but a good week or two could lift it to new highs.

Other Stocks of Interest & Homebuilders: Ready for Another Leg Up

Alnylam Pharmaceuticals (ALNY 185)—We wrote up Alnylam a couple of months ago, but like many biotech names, it got hit soon after when Q3 results were so-so and the CEO decided to depart. But those look like one-off events: Revenues missed expectations (still up 49% from a year ago) as one of Alnylam’s main drugs shifted to a quarterly dosing schedule (instead of monthly), and the new CEO is well regarded by the Street, so the firm should be in capable hands. And that means the underlying story is again taking center stage—Alnylam is the leader in RNA interference technology (RNAi), where drugs silence specific genes that can actually cause/worsen rare diseases. (In fact, it’s the only firm that’s had RNAi drugs approved.) The firm has three drugs on the market, led by Onpattro, which treats a disease that impedes periphery nerves and can cause some awful symptoms. But those three treatments are just the tip of the iceberg, with numerous new launches and label expansions coming down the pike; next year, it will launch vutrisiran (for amyloidosis) in both the U.S. and Europe, while it just submitted a label expansion for its Oxlumo treatment (for those with end-stage kidney disease) while also having a bunch of clinical trial data likely to be released. With so much R&D going on, the bottom line is in the red, but the attraction here is that Alnylam is the rare biotech with a proven technology (RNAi), drugs on the market, a track record of growth and a clear runway to getting much bigger—in fact, management is on record forecasting revenues to grow at a 40%-plus compound rate through 2025, which is certainly something that keeps the interest of big investors. Indeed, ALNY found support quickly after the Q3- and CEO-inspired tumble in October, and while it’s chopped around with the market in recent weeks, it’s held its long-term 200-day line and is perched 14% off all-time highs—solid considering most growth (and biotech) names have been blown to smithereens. Throw in the fact that shares only just emerged from a six-year base in June and we think ALNY can do well once the pressure comes off the market. We’re putting it back on our watch list.

Martin Marietta Materials (MLM 440)—We got a lot of questions surrounding the infrastructure bill that passed Congress a few weeks ago, asking if any stocks would benefit. That’s not really how we select issues, as often these bills don’t have the impact many think (or that impact is already discounted) … but, as we look through the market’s rubble, we are seeing a lot of infrastructure-related outfits that have good stories and act well. Martin Marietta might be the most direct play on any infrastructure boom that takes place: It’s one of a couple of big, national providers of construction aggregates (mix of crushed stone, gravel and sand), as well as types of cement, ready-mix concrete, asphalt and all of that—basically if anything is being built, Martin Marietta’s offerings are needed. Growth isn’t amazing, but from a big-picture point of view, the attraction here is that (a) demand for its aggregates rarely falls unless the economy completely tanks, and (b) prices for those aggregates almost always rise 3% to 5% annually (indeed, Martin implemented a price hike earlier this year and it’s reportedly been well received). Throw in solid metrics for housing and plenty of building going on for big commercial-related projects (data centers, distribution centers for players like Amazon and WalMart) and growth should be solid and, even more important, dependable—which is a big reason why the stock has been acting well. MLM broke out from a six-month consolidation early last month and has held firm since, actually nosing to new highs today! Of course, some near-term shenanigans wouldn’t be surprising to see, but the longer it remains resilient, the greater the odds MLM enjoys a nice run when the market rights itself.

Snowflake (SNOW 325)—Snowflake is a relatively new issue (public for 14 months) with a massive valuation ($105 billion market cap = 52 times next year’s revenue estimates!) that’s had a big run since May. Thus, given the fact that growth stocks have been a hot mess of late, you’d think the stock would be circling the drain—but it’s really not, correcting normally and actually holding near its 50-day line before today’s dip. The reason, we think, is what appears to be a one-of-a-kind story: The firm has what looks to be a breakthrough when it comes to data storage, sharing and usage across big organizations. Right now, so much of a firm’s ever-growing amount of data is split up and hard for some to access, and that’s doubly true when using data from vendors or partners, with data having to be extracted, “cleaned” and then uploaded—creating these “data pipelines” is hard, costly and even if they work, are inefficient. But Snowflake makes it all seamless, with an architecture and access controls that allows the right people, departments and clients to see the data they need when they want; data is live and can be queried at any time, with no need for scrubbing, security or uploading. (There’s even a database marketplace within the platform, with more than 100 data sets able to be accessed by Snowflake customers.) To us, the big idea here is that Snowflake has created something that’s not just a better mousetrap, but has extremely powerful network effects (the more that use it, the more valuable the platform will be)—and when you throw in the firm’s consumption-based business model (the more data you store/share/use, the more you pay), it means growth should be rapid for many, many years as giant firms sign up and expand their usage. Indeed, the numbers here are hard to beat: Snowflake has had many quarters in a row of triple-digit revenue growth (one of our best stock-picking criteria, historically speaking), while remaining performance obligations (all the money under contract due to eventually be received) were up 94% in Q3, and total customer (5,416, up 52%) and seven-figure customer (148, up 128%) growth has been great. Back to the stock, it approached its old post-IPO highs before getting dented earlier this month, but found huge-volume support on earnings and is consolidation since. Sure, SNOW could eventually go down the tubes if the market remains weak, but at this point, it remains near the top of our watch list.

Homebuilders: Ready for Another Leg Up
We’ve seen a pattern play out this year that’s fairly unusual, and it has to do with the after-effects of the pandemic. The virus, of course, changed the landscape for a bunch of industries and companies, hurting some but helping many—and those that benefited saw business boom and, for last year and some of this year, their stocks rise at a good clip.

But then perception changed—for many months, investors began to look ahead toward an easing of the pandemic and an associated decline (or slowing) of business trends, which effectively capped these stocks for many months. And in many instances that was correct thinking, with some of the most popular stay-at-home stocks (like DocuSign (DOCU) imploding as business is headed the wrong way).

However, there are some examples where the perception was wrong. Whether it’s because of the virus’ persistency or in spite of it, some sectors are seeing growth pick up and even accelerate as the new year approaches—and that’s helping the stocks get moving again.

Homebuilders are a perfect example, and we think the group could be starting a new leg up. Obviously, the virus ended up helping business, leading to a surge in orders last year and booming deliveries, sales and earnings this year. Despite that, the group went nowhere from May through November, consolidating their prior run as fears of higher mortgage rates and inflation eating into people’s purchasing power held back the buyers. But now even 2022 is looking bright and the stocks are headed up.

Toll Brothers (TOL), which focuses on the higher end of the housing market (18% of Toll buyers pay all cash, with the average loan-to-value just 69%), looks like a leader and is also a good example of what we’re talking about. Because of the virus disruptions, earnings took a bit of a hit last year, but in fiscal 2021 (just ended in October), the bottom line nearly doubled—but instead of tapering off, there looks to be a lot more growth where that came from. Toll’s backlog on Halloween totaled 10,302 homes, up 32% from a year ago, and in dollar terms, those homes are worth $9.5 billion, up a whopping 49%! Because of that, analysts see the next year bringing about $10 in earnings per share, up 51% from this year! (Before this, Toll’s largest earnings per share tally of the past 10 years was “only” $4.65.)

Like the overall sector, TOL went nowhere for more than six months (May through November) and even dipped below its 40-week line a couple of times despite these good results, as the aforementioned fears mattered more than what was happening on the ground. But now the stock is kicking into gear, enjoying a good-looking volume cluster of late as it breaks out on the upside. Obviously, homebuilders aren’t traditional growth stocks, but they do have a history of making sustained moves when conditions are right, and even counter-trending during some bad markets. We have TOL on our watch list and are thinking the next big move is up. WATCH

Watch Cabot’s Aggression Index
We’ve never been big on inter-market analysis, such as looking at movements in the U.S. dollar and using that to determine what oil prices or pharmaceutical stocks will do—while it can sometimes provide a decent big-picture view, relying on it too much takes you away from the primary evidence (price, volume, relative strength, etc.) that tells you exactly what’s going on with the stock/sector/market you’re interested in.

That said, one exception to that rule is the interplay between growth stocks and defensive stocks. That’s the basis for our Aggression Index, which is simply a relative performance line of the Nasdaq vs. the Consumer Staples Fund (XLP) along with its respective 10-week and 40-week moving averages. It’s a longer-term measure, and when the Index is above the lower of its two moving averages and that average is advancing, growth is in favor—but a decisive dip below the lower line (usually the 40-week) tells you things are shifting to defense. Right now, it’s looking like the latter case is playing out, with the Nasdaq struggling even as XLP has gone vertical over the past two-plus weeks, driving the Aggression Index below its 40-week line.

To be fair, this isn’t a precise timing indicator; in fact, the Index dipped a bit below its 40-week line in May (near a growth stock low point) before turning around. It certainly looks right now that institutions are hungry for safety which, after a big rally, usually isn’t a good sign. But let’s see how things play out over the next week or two--continued shifts toward defensive stocks would bode ill, but a turnaround could prove to be another stick save for this measure.

Cabot Market Timing Indicators

There are a couple of encouraging signs near term, and with the overall bull market intact, we’re not looking to hide in our storm cellar. But most of the evidence is in agreement: Most stocks and indexes are in corrections, so we continue to advise caution.

Cabot Trend Lines: Bullish
While the market’s correction remains in force, the longer-term market outlook remains a bright spot—our Cabot Trend Lines are still in bullish territory, with the S&P 500 (by nearly 6%) and Nasdaq (by 3.4%) standing solidly north of their respective 35-week moving averages. Of course, this isn’t a pinpoint indicator, but until proven otherwise, the overall bull market remains intact.

Cabot Tides: Bearish
Our Cabot Tides did improve last week with the market, but it wasn’t enough to cancel the recent sell signal, and of course the sellers have been back at it again this week. That’s left the broader indexes (like the S&P 600 SmallCap, shown here) below their moving averages, which in turn keeps the intermediate-term trend pointed down. We’re open to anything, but the bulls need to show up in a real way to flip the trend back to positive.

Cabot Real Money Index: Neutral
It certainly hasn’t been a stampede out of the market, but investors have eased up on their equity fund and ETF purchases, which has allowed our Real Money Index to drop down into neutral territory, which goes along with what we’ve seen from some other sentiment measures. As a heads up, year-end money flows can be a bit wonky, but a couple big weeks of outflows (if they occur) could set up a good-looking contrary signal. Right here, though, the indicator is neutral.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on December 30, 2021.