December 2, 2021

The market was in a normal, shake-the-tree correction for most of November, but the past two weeks have seen a massive wave of selling that’s cracked our Cabot Tides and scores of individual stocks. Yes, there’s a chance this could be a big news-driven shakeout (virus and Fed tapering worries, etc.), so we’re not sticking our head in the sand, but there’s no question the sellers are in control and many stocks are going to need a ton of repair work.

We’ve sold a bunch of names from the Model Portfolio in the past two weeks, and while we’re not opposed to adding a half position or two if the market finds its footing, we’re sitting tight with a large cash position tonight.

Market Overview & Model Portfolio Update

The Music Changes
Two weeks ago, we were in the midst of a normal, shake-the-tree correction after a solid October rally. Sure, there were a few potholes, and the rally itself was thinning out (fewer new highs, etc.), but the primary evidence was in good shape—the major trends of the indexes were solidly positive, and the vast majority of leading growth titles looked fine.

But as Edward Johnson (the founder of Fidelity Investments) once said, the market’s music is always changing: Just when you’re used to one thing, the beat shifts. Most of the time, that happens on the bullish side—March 2020 comes to mind, with growth stocks going wild after the crash. But this time, as a normal correction was unfolding, the music changed for the worse.

Indeed, it’s been a long time since we’ve seen this sort of air pocket across so many stocks and sectors: Numerous stocks we were watching for entry points just two or three weeks ago have dropped 20% to 35%, well over half of the broad market is below longer-term moving averages and the number of stocks hitting new lows has exploded—over the previous five sessions, an average of 619 stocks have hit new lows on the NYSE and Nasdaq combined! (We write more about the broad market later in this issue.)

Throw in the fact that our Cabot Tides have also flashed a red light and we’ve quickly raised cash, moving from 20% to 58% (round numbers) in just two weeks. And until we see some improvement in our indicators, in leading stocks and in the broad market, we think it’s better to be safe than sorry.

“But Mike, didn’t you recently write that it’s possible some headline-grabbing bad news could turn sentiment lower and put in a low to this correction?” I did—and I’m not ruling out the fact that this could be a huge shakeout on the virus/Fed tapering news. Something similar played out near the end of 2018, when tapering and trade war escalation caused the market to skid sharply before blasting off in early 2019.

Indeed, the sharp declines of the past two weeks have dented sentiment (AAII bears this week were the highest in 14 months), and while most leading stocks have cracked at least intermediate-term support, there are more than a few fresher names that are still holding up.

What To Do Now
Thus, we’re always keeping an open mind and keeping our watch list up to date should the market storm back. But right now, there’s no question the sellers are in control, and until that changes, it’s best to play defense. Since the last update, we’ve sold our half-sized stakes in Dexcom (DXCM) and ZoomInfo (ZI), as well as another chunk of Cloudflare (NET), leaving us with nearly 58% in cash.

Model Portfolio Update
Growth stocks had been wobbly since early November, and the one-two punch of the new virus variant and hawkish words from the Federal Reserve have sent them (and the broad market) reeling. Of course, we’re less interested in the “why” than the “what,” but the action has led us to pare back and raise cash in the past two weeks.

Going forward, there are two goals. First, of course, is to protect capital for as long as this downturn lasts; as we write later in this issue, the broad market has been horribly weak, with tons of stocks imploding, so staying close to shore is our current goal. We’re comfortable holding lots of cash for now.

However, the second goal is to come out of this correction (whenever it ends) with a portfolio full of fresh leaders. We think we already own a couple of those, and ideally, we can hold on to them and add other future winners (including some from our watch list) once the selling subsides. With so much cash, it’s possible we could add a half position or two if the market stabilizes, but while today’s bounce was nice, we need to see more to conclude the meltdown is over.

Current Recommendations

Ambarella (AMBA)—AMBA was one of a few growth stocks that (a) got hit during the past three weeks, but (b) never really did anything wrong, “only” dipping to its 50-day line after a big run. And the earnings report on Tuesday evening has improved the stock’s position. In Q3, sales rose 64% and earnings were up six-fold, both topping estimates, and while the company said component shortages (read: supply-chain issues) were still a big challenge, the bigger story here is that the company has taken the lead as the go-to leader in automotive computer vision chips. Indeed, the firm said its future automotive business has tripled since a year ago, with one big win (Ambarella’s chips are found in the Rivian R1T truck, which has begun shipping) helping perception. (A European firm also said dash cameras are in a pilot with Uber as well.) There were numerous other customers launching new products using the firm’s chips, including the leading security camera players in Europe and Korea, as well as Johnson Controls here in the U.S. The supply-chain issue is certainly something to watch—the top brass said Q4 results will be constrained because of it—but there’s no question the big picture here is very bullish. As for the stock, the moonshot on Wednesday was bullish, though in a weak market it could easily give a chunk of that back, with some of that happening today. We’d like to fill out our position, but we’re not in the mood (especially in this environment) to chase things higher. We’ll stay on Buy a Half but will be looking for pullbacks or tightness before adding. BUY A HALF

Asana (ASAN)—When we talk about abnormal action, ASAN is a classic case of it—a great, long, extended run, a bit of stalling out for a few weeks and then a complete implosion on huge volume below intermediate-term support. That doesn’t mean the stock is going to zero, of course, and if you’re looking for a ray of light, the CEO again stepped up near the 100 level, buying another 372,000 shares the other day. Plus, earnings are out tonight, so maybe that becomes a stick-save of some sort. But we have to go with what’s in front of us, and after breaking out at 45 in June and running to 145, the evidence tells us the intermediate-term uptrend has cracked and ASAN is likely to need a while to shape up again, even if business remains solid. We sold our position in two chunks last week and think there will be better names to own during the next uptrend. SOLD

Cloudflare (NET)—As we’ve written before, the fundamentals certainly point to the fact that NET could remain a market leader for a very long time to come as it’s firmly in the emerging blue chip camp: Between content delivery and network security, the company’s offerings are perfectly built for the cloud age, and there’s no reason hundreds more huge clients (and thousands of small- and mid-sized ones) won’t sign up in the years ahead. That said, we’re also students of the market, and it’s a fact that NET has enjoyed a ridiculous run-up not just since May of this year but going back to the pandemic crash of March 2020—and along with the recent selling, that raises the possibility that another prolonged rest period could be needed. We sold one-third of our initial stake last week, and after the stock began to crack its 50-day line, we decided to sell one-third of what we had left on a special bulletin this morning. That puts some profit in our pocket and leaves us with around half of our total stake--we’re comfortable giving the remaining shares some rope, seeing if NET can hang in here and resume its longer-term uptrend once the market finds its footing. SOLD ANOTHER THIRD, HOLDING THE REST

Devon Energy (DVN)—Energy stocks have been ricocheting up and down on a daily basis since news of the virus variant hit the wires last week, but believe it or not, we think the action has been pretty solid, with DVN in particular continuing to hold support from the high of its huge September upmove in the 40 area. And all of this is happening while oil prices cascade lower, which is a solid sign of relative strength; we write more about Devon and the sector as a whole, but it certainly seems like perception is improving in the sense that more are recognizing the cash flow potential of these names even at current (or lower) prices. To be clear, we’re not complacent here—if the correction gathers steam and DVN cracks support, we’ll probably take partial profits. But so far, so good. If you own some, we advise hanging on, and if you don’t, we’re OK starting a position here or on dips. BUY

Dexcom (DXCM)—Nothing has changed with Dexcom the company, but the stock has gotten caught up in the market’s selling wave, at least partially on fears that the reaction to another Covid spike could crimp business—we’ve already seen New York state limit elective procedures, and the fewer (non-Covid) doctor visits, the slower uptake could be for Dexcom’s glucose monitors if other states follow suit. We’ve given the stock plenty of rope here, even holding through the dip below the 50-day line earlier this week, but the lack of any support (no ability to bounce yet), our growing loss and the weak market had us cutting bait on the special bulletin this morning. SOLD

Dynatrace (DT)—We sold our entire position of Dyntrace a week and a half ago and, not surprisingly, shares haven’t been able to get off their knees since; the stock is actually below its 200-day line even after today’s small rally. Beyond that is the fact that it has given up most of its post-breakout upmove in June (from 55 to 80 back to 59). Of course, we have no reason to doubt the story is intact, though it’s possible that management’s choice to spend heavily next year on sales and marketing (earnings expected to be just flat) could be an anchor on the stock. Either way, we’re out and are looking for greener pastures when the bull market resumes. SOLD

Floor & Décor (FND)—FND has actually been mostly flat since its earnings dip earlier this month, which is nearly heroic given the destruction seen in so many stocks out there. Fundamentally, the company seems to be on track—it presented yesterday at an investor conference with nothing new, good or bad—and the fact that the virus has reemerged as a worry isn’t necessarily a bad thing for Floor & Décor, as it saw business mushroom late last year. (Sinking interest rates doesn’t hurt business, either.) Still, we’re just going to play it by the book: The long-term growth story is intact and, with the stock holding up relatively well, we’re sitting tight, though a dip toward 120 could have us changing our mind. HOLD

ProShares Ultra S&P 500 Fund (SSO)—The big-cap indexes have certainly taken on water, but the S&P 500 really isn’t acting badly—it’s currently north of its 50-day line and has given back “only” about half of its gain off the early-October bottom. That said, we can’t ignore the action from our Cabot Tides, which turned negative earlier this week on the back of super-weak action in the broader indexes (we write more about the broad market, including the massive numbers of stocks hitting new lows, later in this issue). We’re not panicking with SSO, especially as we’ve already taken partial profits a couple of times and some big-picture signposts (such as the seasonally related measures mentioned a couple of issues ago) look fine. Still, given all the evidence, we think it’s prudent to switch to a Hold rating and see how this market correction plays out. HOLD

ZoomInfo (ZI)—As we’ve written before, ZoomInfo has the story and numbers that should eventually create a durable, sustained run as big investors build positions. But right now, the stock has fallen apart, caught up in the market’s slide and, this week, the hammering of all things software (Salesforce.com’s big earnings gap down yesterday didn’t help matters). It’s never fun to sell so quickly after entering, but we think that’s the right move; we pulled the plug on our half-sized stake earlier this week to make sure a bad situation doesn’t get much worse. SOLD

Watch List

• Arista Networks (ANET 123): ANET remains incredibly resilient given what’s going on out there, holding the vast majority of its massive earnings gap and trading just south of its 25-day line.
• Coinbase (COIN 285): COIN is back to its 50-day line, which is tedious but not enough to change our optimistic thoughts on the stock. Overall, the stock has etched one huge post-IPO base and, if crypto remains in good shape, could help lead the next market uptrend.
• Enphase Energy (ENPH 235): Solar stocks are a mixed bag, but Enphase looks great. It’s the leading provider of microinverters to the residential market, and is a big player in the commercial installations, too. Shares are holding most of their post-earnings rally, and analysts see earnings up another 34% in 2022 (likely conservative).
• Roblox (RBLX 117): We’ve been following RBLX for a while now, and it looks like our original thesis—that the firm’s platform is much more than just a gaming app—is now playing out. The stock is wild but remains in good shape. See more below.

Other Stocks of Interest & A Silver Lining for Energy Stocks

GXO Logistics (GXO 92)—GXO Logistics, which was spun off from giant transport outfit XPO back in August, is the largest pure-play contract logistics provider, with 869 warehouse locations (totaling 208 million square feet!). Of course, transport outfits aren’t our usual targets, but GXO has a solid growth story: Short term, of course, the supply-chain issues are headline news, and longer term, the mix of more e-commerce and move toward outsourcing logistics are huge opportunities. GXO’s client base includes names like Disney, H&M, Ross Stores and a bunch of international giants (Zoloando is one of Europe’s largest e-commerce outfits), and business is good and getting better—so far this year, the company has expanded operations with 16 of its largest 20 customers, and in Q3 alone, it added $1 billion of contract value, with average contract duration numbering a few years in length, adding reliability to its growth outlook. Indeed, that reliability is a big part of the story: While GXO isn’t going to grow at lightning-fast rates, it has visibility into 2022 and even 2023 given its long-term contracts, looking for double-digit-ish organic revenue growth (M&A should add to that) with cash flow and earnings (analysts see the bottom line up 44% next year) growing even faster. Better yet is the big-picture view that, especially with so many supply snafus this year, the desire by big companies to outsource part or all of their logistics operations should spike. The stock recently marched up six weeks in a row before hitting resistance near 100, and its pullback since then has been very reasonable, which is impressive given the market and the action of its peers. It’s not a traditional growth name, but GXO has the makings of a winner.

Roblox (RBLX 117)—We took a shot at RBLX earlier this year to no avail; it was a solid setup and breakout (including three straight weeks of big-volume buying, which normally leads to good things), but the stock evidently didn’t have enough post-IPO seasoning, the herky-jerky environment for growth stocks didn’t help and fears that the company was just a kids’ gaming app that would suffer post-pandemic all served to sink the stock. But perception has now changed on a couple of fronts. First, in terms of the user base, 28% of the 1,000 most popular metaverse “worlds” on the platform are being used mostly by those 13 and older, while that same figure was just 10% a year ago; thus, Roblox’s reach is broadening. Second and more important, more are coming around to the view that the company isn’t a gaming app but a broad platform—one in which new worlds can be used for far more than just games, including as marketing tools and virtual events (like concerts). In fact, according to management, in the next three to five years all brands and artists will have a “Roblox strategy,” where they’ll want to maintain a presence similar to Facebook or Instagram today—think of it as another, more interactive type of social media. It’s still early on the virtual events front, but early returns are interesting; a Lil Nas X virtual concert (four shows over two days) had 33 million attendees and ended up selling $10 million of virtual content! The only fly in the ointment here comes from expectations for decelerating growth—while revenues were up triple-digits in Q3, October saw the top line up “only” 32% (because of tougher comparisons) and analysts see revenues up just 20% in 2022. The stock, though, seems to disagree: It blasted out of a multi-month post-IPO structure on earnings, followed through nicely after that and is still in good overall shape. Volatility is extreme here, but RBLX is back on our watch list; if the market can stabilize and RBLX can continue to hold up, we could take a swing at it.

Wolfspeed (WOLF 119)—Years ago we made good money in Cree when the LED lighting revolution was getting underway. But that business became commoditized, so Cree took its expertise in the chips used in those LEDs and applied it elsewhere—today, the company has sold off its old lighting business and changed its focus to advanced chips. But these aren’t just any chips: Wolfspeed is the largest provider of silicon carbide chips, which are far more efficient at transferring electricity, can handle higher temperatures and have superior performance at high voltages compared to “regular” silicon chips. And that makes them perfect for many next-generation applications that demand more power, from solar arrays to electric chargers to EV batteries to newer 5G towers and much more. The company has been doing well for a while and has put a lot of effort into expansion, and that’s about to pay off in a big way: Wolfspeed had an $18 billion backlog at the end of Q3, double that of two years ago as auto makers especially look to lock-in secure supplies. (Interestingly, the 2022-2024 backlog is “only” 40% auto-related, as clients in other fields are ordering a bunch of supply for the next couple of years, but after that it’s mostly auto-related.) And that visibility comes with a great long-term growth forecast: At a recent Investor Day, the top brass said that revenues should triple over the next three years and expand at 20%-plus rates for a couple of years after that, with margins gradually improving as production plants come online. As for the stock, it was a nothing burger for many months but then soared on earnings near Halloween before pulling in (reasonably) with growth stocks and the market of late. It still has some work to do, but WOLF looks like a “new” name in the chip sector that could be a leader of the next advance.

A Silver Lining for Energy Stocks
In normal times, it’s hard to trust any pure commodity stock, as so much of their business is dependent on something that’s outside their control (the price of the commodity). And that’s especially true now, with a weak, news-driven environment that’s being pushed and pulled by rumors and reports surrounding the new virus variant.

However, amid the volatility, we are finding a few encouraging signs, and one of the biggest ones involves energy stocks. They’ve gone haywire (both up and down) along with everything else, but there’s evidence that our thesis is playing out: As the leading explorers have slashed debt and focused on shareholder returns, they’ve effectively “stress tested” their businesses so they’ll continue to do well even if oil and natural gas prices fall further from here and fail to bounce. In other words, the firms’ outlook has become much more reliable (less downside if the sector hits a speed bump), which in turn is likely attracting more big investors that are willing to start or add to positions on dips.

That seems to be playing out now: Oil prices hit a recent peak on October 26, and since that time they’ve fallen as much as nearly 23% ($84 to $65 per barrel, ballpark) on a closing basis. However, during that time, the broad S&P Oil and Gas Exploration Fund (XOP) fell “only” 15%, and that includes a lot of secondary, speculative operators that still swing wildly with energy prices.

If you drill down to what we consider the four leading big-cap exploration names, they all held up even better than the sector as a whole: From oil’s peak through today, EOG Resources (EOG) is down just 9%, Pioneer Natural Resources (PXD) is off 8% and Diamondback Energy (FANG) has fallen just 4%—and remember, all of these were up solidly in the two months before that.

And what about Devon Energy (DVN), our pick of the litter in the sector? It’s actually flat! Next year, even at $55 oil and $4 natural gas, Devon is likely to earn around $4.40 per share in free cash flow, more than half of which will be paid out in dividends with the rest going to debt reduction or buybacks. And it’s a similar story with other energy names, too.

Of course, as quickly as things are changing, we’re certainly not complacent—if oil give up the ghost from here, we could take partial profits in DVN (and if you own some of the others, you could consider setting mental stops for partial profits, too).

But altogether, it certainly looks like there’s a willingness among institutional investors to support these energy cash cows on dips, with the thinking that even if oil prices dip further, they’ll still provide reliable, bullish payouts and cash flow—and if energy prices resume their uptrend, things could end up better than even the bulls believe.

It’s Time to Watch Our Two-Second Indicator Closely
For much of 2021, we’ve seen the big-cap indexes do fairly well (with plenty of chop, of course), but much of the broad market struggle. Some of that struggle is with growth stocks, which we’ve obviously written a lot about—things like the Next Gen 100 (QQQJ), which includes a lot of stocks we follow, has made no net progress since late January.

But more recently we’re seeing the rest of the broad market struggle even as select mega-cap names do well. Some of this can be seen from a top-down perspective—the S&P 600 Small Cap and S&P 400 MidCap (shown in our Cabot Tides later in this issue) indexes look similar to the QQQJ, with little to no net progress.

Possibly more telling is our old Two-Second Indicator, which looks at the number of stocks hitting new lows each day—and this week it showed some of the broadest, most intense selling pressures we’ve seen since the pandemic crash in March 2020. On the NYSE, new lows reached 280 on Tuesday, the largest reading since the crash. The Nasdaq has been even worse, with a peak of 628 new lows (!) on that same day, with the readings in the hundreds even when the market bounces.

We’re keying most off our market timing indicators and the action of growth stocks. But there’s no question that when hundreds of stocks are hitting new 52-week lows it’s an unhealthy situation for the overall market—a sign of very broad selling pressure. We’ll be watching to see if the readings can taper off in a meaningful way; if so, it could tell us the worst has passed, but if not, it’ll be hard for the market to do well.

Cabot Market Timing Indicators

It’s not 2008 out there, and our still-bullish Cabot Trend Lines (and some other factors) tell us not to stick our head in the sand. But there’s no doubt the evidence has taken a sudden change for the worse, so we’re selling broken stocks and waiting for the bulls to return.

Cabot Trend Lines: Bullish
The correction has arrived, but despite the virus’ latest attempt at wreaking havoc, our Cabot Trend Lines are still clearly in bullish territory—as of this morning, both the S&P 500 (by 3.5%) and Nasdaq (by 4.4%) were still a few percent above their respective 35-week moving averages. In other words, the evidence suggests the major bull uptrend is still intact, so while we’ve sold many broken stocks, you want to keep your eyes open for a resumption of the bull trend.

Cabot Tides: Bearish
Our Cabot Tides gave up the ghost earlier this week, when the three broader indexes we track (including the S&P 400 MidCap, shown here) decisively broke their 50-day lines. And while today’s bounce was obviously welcome, we’ll need to see much more upside to turn the intermediate-term trend back up. With the Tides negative, you should be staying close to shore.

Cabot Real Money Index: Negative
While nobody predicted another virus variant, the elevated Real Money Index in recent weeks told us the risk of a near-term decline was rising, which was a reason we at least kept some cash on the sideline before the latest selling wave. The Index has begun to pull in as fear grows, but it’ll probably take a little time to set up a bullish signal.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on December 16, 2021.