December 30, 2021

The market remains challenging and divergent, and few growth stocks look ready to start a sustained upmove just yet. But the evidence has slowly improved since the start of the month, including the fact that our Cabot Tides (which have admittedly been on-again, off-again of late) have returned to a bullish stance. We don’t think it’s time for a major buying spree, but we are putting some of our large cash hoard to work by filling out one of our positions and starting a small stake in a new, resilient growth name. Last but not least — all of us here at Cabot wish you and yours a happy, healthy and prosperous New Year.

Market Overview & Model Portfolio Update

Will the Real Stock Market Please Stand Up?
We used the above title in this advisory way back in mid-1999, not long after I started at Cabot. The title referred to what was then a period of great divergence among stocks—the broad market was acting awful and most major indexes were struggling, but the Nasdaq was strong and growth stocks were lighting up the sky, soon to embark on their massive run to finish off the Internet bubble.

We’re not sure anything will ever rival that chasm between different areas of the market, but the past few weeks share some similarities. Right now, we have the S&P 500 at new highs (even the unweighted S&P 500 is at new highs, so it’s not just a few mega-cap names doing the heavy lifting), our Cabot Tides have returned to positive territory and many sectors are just behind, a few good days from virgin turf.

However, we also have most growth-oriented indexes and funds stuck in intermediate-term downtrends, many former leaders that look awful and very few individual growth stocks set up for a sustained run. Meanwhile, secondary measures like the number of new lows (still elevated, though year-end selling could be exaggerating that a bit) and our Aggression Index (below the 40-week line) aren’t encouraging, and many defensive sectors are ratcheting higher.

As always, we’ll see how things play out—it’s always possible the wacky 2021 environment will continue for a while longer, though we think the flip of the calendar (along with some early-month investor conferences and earnings season) should provide more clarity.

For the here and now, though, our main thoughts are (a) the environment is clearly mixed and challenging, especially in the growth arena, but (b) the evidence has slowly improved since the early-December meltdown, with some positive internal happenings (new low divergence), the Tides buy signal and even some brief buying bursts that, while not traditional blastoff indicators, historically bode well for the months ahead.

Putting it together, and we’re modestly more optimistic than we were two or four weeks ago, which is enough to do a little buying—but we continue to think the market has a lot more to prove before it’s time to get aggressive on the long side.

What To Do Now
In the Model Portfolio, we’ve been cautious for a few weeks now, and we’re going to remain that way, but with a cash position of 53% and the Tides buy signal, we’re making two modest moves. First, we’re filling out our position in Arista Networks (ANET), and second, we’re starting a half-sized position in Datadog (DDOG). We’ll keep our remaining 43% cash position on the sideline.

Model Portfolio Update

The market has bounced nicely of late, which has been enough to flip the Cabot Tides back to positive, and it’s showing strength with some other evidence (like seeing the S&P 500 registering four straight gains of at least 0.5%; see more later in this issue). That said, there are clearly still air pockets out there, with most growth-oriented funds and indexes struggling to get their head above water and other secondary evidence telling us that risk is elevated.

Putting it together, we’re not eager to do any major buying this moment; we’d rather see how things handle themselves after the calendar flips, and of course, to see more legitimate setups. That said, we’re also not in the business of ignoring our system—if you do that, you have no system—so with the Tides buy signal we’ll take a small step back into the market’s waters.

In the Model Portfolio, we came into the week with 53% in cash, and tonight we’ll put 10% of that to work—first by filling out our position in Arista Networks (ANET), and second by adding a half-sized position in Datadog (DDOG), which is probably the most resilient growth stock out there (excluding any we already own).

As always, if the rally peters out, we’ll hold onto our large remaining cash hoard (will be about 43%) and make sure our remaining holdings don’t run away on the downside. But, while we’re far from raging bulls, we’re turning a bit more optimistic given some of the positive tidings.

Current Recommendations

Ambarella (AMBA)—AMBA has made the roundtrip from looking great to looking iffy a couple of times this month, thrashing between 180 and 230 (round numbers), though after its latest bump higher, shares are beginning to settle down a bit, which is a plus. Fundamentally, nothing has changed here, with the odds favoring years of big growth as the firm’s computer vision chips are adopted en masse by many automakers (especially electric vehicle makers, which have far more cameras) and next-generation security camera makers, both of which allow for much greater automation. We will say that next year’s earnings estimate (up only 21%) is a bit light, though we think that’s most due to near-term supply-chain worries—and, at day’s end, Ambarella generally surpasses those estimates, so the real figure could prove to be much larger. The next big event comes next Tuesday, when the firm will host an Investor Day; any 2022 (or longer-term) forecast and/or deal announcements have the potential to move shares. As always, we’ll take it as it comes—a drop back to its recent lows would be a yellow flag, though a solid rally on good news could have us restoring our Buy rating. Right here, though, we’ll stay on Hold and wait for the stock’s reaction. HOLD

Arista Networks (ANET)—Arista is acting about as bullishly as possible, with a reasonable dip during the worst of the initial selloff (it fell less than 12% and held the top of its huge earnings gap, which was rare strength during the mini-crash in many growth titles) and a great advance to new highs since, basically ignoring the mid-month selling and spiking higher as the indexes have shaped up. Obviously, nobody can rule out another dip if the market runs into a wall, but if this rally gains steam, it’s possible ANET’s uptrend (which really only began on the earnings gap in November) could accelerate. Combined with a rapid, reliable growth story as the cloud titans ramp spending, the stock certainly looks like a winner, so we’ll follow the plan and fill out our position tomorrow, adding another 5% stake, while using a loss limit a bit under 120 (near the prior low, under the 50-day line) for the combined position. BUY ANOTHER HALF

Datadog (DDOG)—We admit that the broad application performance management industry is one of our favorites—Dynatrace (DT) is certainly a top fundamental performer, but the stock is still lagging, and peer Datadog looks better and actually sports better sales/earnings/projections, too. Back to the macro story, it’s hard to imagine anything but a multi-year period of rapid growth for the sector: As technologies used by companies have become more diverse, as those technologies are changed/updated more rapidly and as more departments (security, operations, etc.) are reliant on them, things are becoming incredibly complex, making it difficult to make sure every app and software suite is working as it should. Datadog’s platform is an all-in-one solution for companies that need to monitor their infrastructure, security data, log management, compliance, error tracking, user experiences and more—and it can be used by everyone in the firm, not just a choice few. The value can be seen in the firm’s numbers: North of 95% of clients stick around, and same-customer revenue growth has been north of 30% for each of the past 16 quarters (!), partly thanks to a per-use revenue model (sales grow as clients’ workloads do) but mainly due to the fact that companies are signing up for more of Datadog’s offerings (28% use at least four products, up from 15% a year ago and 7% two years ago). In Q3, sales rose 75%, earnings were up 160% and analysts see both figures up more than 40% next year—which we think will prove conservative. As for the stock, it went nowhere for a full year (July 2020 to July 2021), broke out in August and had a great run into the November peak. And since then, DDOG has shown solid resilience, falling a maximum of 23% but snapping back quickly after each plunge; it currently sits “only” 10% off its high and north of its 50-day line, which is rarified air in growth land. We think DDOG wants to go higher if the market keeps rallying—we’ll start a half-sized stake here (5% of the portfolio) and use a loss limit near the recent lows (150 to 155). BUY A HALF

Devon Energy (DVN)—Despite a rush of new virus cases (yesterday’s daily case count was more than 50% of the prior peak!) and news that the Fed is quickening its tapering schedule, oil prices could “only” dip as low as $65 per barrel (closing basis) in early December and $69 last week before spiking back into the mid-$70s in recent days. That, of course, keeps the tremendous cash flow story for Devon very much intact. In fact, despite the worries out there, the numbers suggest that Q4 is likely to be more fruitful than Q3: Oil prices have averaged about $7 more this quarter than in Q3 ($77 vs. $70 or so), while natural gas prices averaged about 40 cents more than the prior quarter (~$4.80 so far in Q4 vs. $4.40 in Q3). Whatever that exactly means for the dividend (announcement likely in early February), it’s clear big investors think good things are coming—DVN has spiked to new highs in recent days, a sign that perception of the dividend, share buyback and debt reduction story continues to gain steam. (Since the peak in oil prices in late October, crude is down about 8%, but DVN is actually up around 12%—another telling sign.) Near-term virus news could move DVN and the sector, but it certainly looks like the stock wants to continue higher. We’ll stay on Buy, though as always, aiming for dips is best for new buyers. BUY

Floor & Décor (FND)—FND tickled our mental stop in the upper 110s a few days in a row two weeks ago, but it closed above it each time and has since rallied 10 points or so, which is obviously good to see. Looking at the overall picture, we think it’s possible FND is ready to move—at last week’s lows, shares had made no net progress for eight months (wearing out the weak hands with lots of ups and downs) and tagged their 40-week line, which is a support line that’s kicked off some solid rallies for the stock in the past. Fundamentally, there’s no doubt cost inflation and supply-chain issues could be bugaboos, but those worries are well known; if indications show up that those problems are easing, the stock could look ahead to re-accelerating earnings growth. Long story short, we’re optimistic, but we need to see other investors agree with us (pushing the stock higher) to conclude the next upmove has begun. Hang on if you own some, with a mental stop just under 120. HOLD

ProShares Ultra S&P 500 Fund (SSO)—SSO continues its amazing action, with a higher low last week and a spurt all the way to new highs on Monday (the S&P 500 remains the strongest major index out there). Moreover, while not a traditional blastoff indicator, the latest push higher—which saw the S&P 500 rally at least 0.5% on four straight days—was somewhat rare and generally portends good things (see more details on that later in this issue). Just as important as that is our Cabot Tides, which have returned to positive territory; granted, they’ve been back and forth for a while now, but there’s no question the latest rally has been a good thing. All in all, the intermediate-term trend of the market has tilted up, the long-term trend is also up, the S&P 500 is hitting new highs and some recent buying spurts should bode well—if you own some, just hang on, but if you don’t, we think you can start a position here or (ideally) on a bit of a pullback. BUY

Watch List

• Snowflake (SNOW 341): SNOW is sitting in no man’s land, which is fine for now; the stock could easily need a bit more seasoning after its strong May-November run. We still think this name will be a favorite of institutions next year, but we’re waiting for a more proper setup, including some signs big investors are stepping in.
• Toll Brothers (TOL 72): TOL’s relative performance (RP) line is a bit short of its old highs, but that’s about the only dart we can throw at it—shares are emerging from a multi-month base, growth is very strong and the backlog is large and growing.
• Trade Desk (TTD 94): TTD has the leading platform for automated, programmatic advertising, so much so that even some big players (like Walmart) are building offerings on top of it. Shares are base-building after a big, positive earnings move in November. See more below.
• Wingstop (WING 176): You know we love a great cookie-cutter story, and WING has one of the best, aiming to be a top 10 global restaurant brand in the years ahead. The stock has begun to tighten up in recent weeks, possibly putting the finishing touches on a giant 16-month consolidation.

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

Applovin (APP 94)—Applovin is a name we’re keeping an eye on, as it’s newly public (this past April), has shown the ability to go up (had broken out nicely before the growth stock correction) and has a unique big-picture story that should produce great growth for many years. Interestingly, it also has a story that (mostly) revolves around advertising (like Trade Desk, below), but in this case it involves apps: Applovin’s platform and machine-learning software (dubbed AXON) is used by app developers (mostly game developers) to market and monetize their apps, helping them to match apps to users who are likely to download them. The company also operates more than 200 free-to-play apps (including 11 of the top 200 grossing games in the U.S. via in-app purchases; about 37 million daily active users), but its main aim for those is to gather data from them to bolster the “smarts” of its software and platform. The combination of its proprietary mound of user data, some new features (in-app bidding) and its AXON software has clients stampeding to its door: At the end of Q3, 30,000 apps use Applovin to manage their ad inventory, up from 10,000 a year ago, with software platform revenue now making up 27% of total revenue but growing a ridiculous 385% in Q3 from a year ago as more clients sign up (449 at the end of September, up 305% from a year ago; same-customer revenue growth among software clients was 155%!!). Thus, things were going just fine for the company, but the top brass made a bold move in October that could make Applovin a future blue chip—the company has agreed to buy MoPub from Twitter, making the combined operation the hands-down leader in all things app monetization. It’s a big idea, and the numbers reflect that. Overall sales were up 90% in Q3, while earnings were in the black and EBITDA lifted 126%; analysts see the top line up 35% or so next year, and that’s likely before the benefits of MoPub (assuming the acquisition goes through). The stock broke out on that buyout news and was up six weeks in a row before the market yanked APP down sharply, but it’s since found support and is seven weeks into a new launching pad. It needs some seasoning but the odds are high that APP has another, sustained run.

Nucor (NUE 114)—Given that we have Devon Energy in the Model Portfolio, we’re not sure we’re going to pick up a second commodity stock, but we have to admit Nucor intrigues us, and the reason why is similar to what we wrote about homebuilders like Toll Brothers (TOL) in the last issue: Business has gone ballistic this year as steel prices have gone through the roof, partly due to elevated demand, partly to supply chain issues and also in part because China is cutting back on production (down 18% in the first three weeks of December from the prior year). Given Nucor’s #1 or #2 position in many steel products in the U.S., the result has been jaw-dropping earnings, with quarterly totals (it pre-announced $7.70-ish per share for Q4) larger than any year of the past decade! But the stock has been mostly rangebound for the past seven months as investors anticipated things going back to pre-pandemic norms in 2022—but that now appears to be a bearish pipe dream. A few months ago, Wall Street saw Nucor earning around $4 per share next year, but today that figure is north of $16, and with infrastructure spending set to ramp, optimism is growing that the company’s earnings power will stay elevated for a while. More than just the numbers is what Nucor is doing with all the money. First, it’s expanding in a diligent way (a new mill, some small acquisitions, adding new lines at current plants). Second, it’s boosted its dividend by 23% (yield 1.8%), and third, it’s been buying back a ton of shares (nearly 5% of the company in Q4 alone!), with more on the way (another $4 billion authorization approved in early December). And we think the stock might be ready to respond: NUE was actually up eight weeks up in a row in October and November, it’s had some tight weekly closes and a enjoyed a couple of shakeouts of late. A powerful move into the mid 120s would be very tempting.

Trade Desk (TTD 94)—Trade Desk has had a huge, huge run in recent years, which isn’t our favorite setup; we’d prefer a newer name that big investors are pining after. That said, the stock has held its own during the growth stock implosion and the story is straightforward and powerful: The firm has the leading demand-side advertising platform out there, which allows advertisers to buy ads with the help of automation; basically, it’s taking the ad business (be it online, video, connected TV, whatever) out of the stone age, replacing phone calls and handshakes with programmatic ad buying. Things have been coming Trade Desk’s way for a long time, both in the U.S. and overseas, and the pandemic obviously accelerated growth, but it’s still just scratching the surface of its potential (the global ad market should be $1 trillion (!) in a few years, the bulk of which will eventually be purchased digitally), and some big players recognize Trade Desk is in the lead. Walmart recently launched its own demand-side platform so advertisers can better reach its customers, and it’s built on top of the Trade Desk platform. Elsewhere, the firm’s top brass said that “we are starting to see test budgets from some of the largest brands in the world flow through the platform.” Thus, there’s every reason to expect growth to remain rapid and reliable for years to come—in Q3, the top line lifted 39% (was up 47% excluding last year’s election-related ad bump), while EBITDA was up 59% and earnings rose 38% (slower growth mainly as the tax burden rises to normal levels), and analysts see 2022’s top line rising 30% (likely conservative). As for the stock, TTD built a very deep 10-month base and broke out briefly after earnings in November. It’s since pulled back with the market, but volume was light, it held support and is beginning to round out—we think the past few weeks could be the final rest before a sustained run. TTD is on our watch list.

Out With the Old—It’s Best to Focus on Newer Names

There’s no question the market’s comeback of late has been impressive, but there’s also no doubt that we saw a good amount of abnormal selling among growth stocks in November and early December—especially among some of the biggest winners of the past couple of years. And most of those names haven’t bounced much even as everything else has, instead hovering near their lows and looking vulnerable if another market hiccup emerges.

We never predict anything with certainty, but we do think the above factors strongly hint at one thing for 2022: The huge winners that got going soon after last year’s crash (breaking out in April, May or June of 2020) have likely seen their best days, at least for a many months, with next year’s leaders much more likely to come from other areas.

Of course, some of that has been clear for a couple of months—most famous work-from-home names like DocuSign (DOCU), Twilio (TWLO), Zoom (ZM), Peloton (PTON) and Roku (ROKU) have all imploded from their highs and are well below even longer-term signposts (200-day lines).

But now we’re seeing some of the other 2020-2021 superstars change character. Cloudflare (NET) is one that we recently said goodbye to; the stock fell nearly 45% in a straight line over just four weeks and has barely gotten off its knees. Sea Limited (SE), a leading e-commerce player in southeast Asia, is another monster winner that fell 45%-plus in a straight line, which isn’t normal. HubSpot (HUBS) isn’t nearly as bad but also has suffered many weeks of huge selling, while many cybersecurity names are iffy.

To be clear, we’re not necessarily bearish on these stocks. History tells us that a choice few could return to glory down the road, and even for the ones that don’t, many can enjoy solid off-the-bottom rallies at some point.

But our big-picture thought is that, whenever the market gets going in a powerful new uptrend, you’re more likely to find better opportunities in fresher titles—whether they’re familiar names that have already worn out the weak hands for many months, or newer names and sectors altogether that should have further to run when the bulls retake control.

Look for Thrusts

Obviously, with our Cabot Tides turning positive after the brief (but very sharp for most leaders) correction, we’re putting our optimist’s hat back on—there aren’t many growth stock setups, and 2021 has been a year of sharp reversals, but the Tides’ green light and the strong snapback in general bodes well.

That said, as added proof that the rally is the real McCoy, we like to look for “thrusts”—signs of unusual buying pressure in terms of volume, breadth, price, anything that signifies a very quick change in perception. Such action correlates well to sustained rallies going forward.

The best thrusts are our core blastoff indicators—whether it’s the 90% or 2-to-1 blastoff measure, or the Three Day Thrust, these have stood the test of time, working almost perfectly for decades and almost always heralding new, major bull markets. (The most recent signals were the 90% and 2-to-1 last May and June, while the Three Day Thrust flashed last November when the vaccine trials were released, all of which proved to be fantastic buy points.)

We’d love to see one of those flash, of course, but they’re very rare and are normally spotted after bear phases of some sort. For the current situation, we’re looking for “mini-thrusts” that can improve the odds that the rally is real.

We wrote about one of these right after the early-December low: Up volume on the NYSE came in at more than 80% of the total three of four days. We don’t have exact numbers, but generally speaking if it comes after a sharp pullback, back-to-back 80% up volume days are bullish, and three out of four is better.

And now, after the second leg down in mid-December, we saw another mini-thrust measure speak up. It’s an offshoot of the Three Day Thrust—that more powerful measure requires the S&P 500 to rise at least 1.5% on three consecutive days, and it has a sterling track record. But a less strict measure just flashed on Monday: The S&P 500 rallied at least 0.5% on each of four consecutive days. It seems rather vanilla, but it doesn’t happen often, triggering an average of less than once a year since 1978. But despite the simplicity of the indicator, it has historically produced solid results.

During the next six months, the S&P’s median max gain was 12%, while the max loss was just 3%. And looking out a full year, the median max gain rose to nearly 21%, while the average max loss was just shy of 7%. Not bad.

To be fair, there were some stinkers among the signals (a couple of signals came soon before or during bear phases); this certainly isn’t as reliable as the aforementioned blastoff indicators. But it’s a feather in the bulls’ cap, and if we see some more mini-thrusts going ahead, it would add to the evidence that the dip in the indexes (and meltdown in many growth stocks) has ended.

Cabot Market Timing Indicators

There are still headwinds out there, and we think going slow makes sense, but the evidence has improved during the past two weeks, with a green light from the Tides and some secondary measures that point to higher prices. We’re putting a little money to work and seeing how it goes.

Cabot Trend Lines: Bullish
We’re still up in the air concerning the market’s recent rally, but longer term, we have a good amount of conviction that the bull market is alive and well. And our Cabot Trend Lines are a big reason for that thought—they remain clearly positive and really haven’t been “tested” too much of late; currently both indexes stand 6% to 8% above their respective 35-week lines. Until proven otherwise, odds favor the next major move being up.

Cabot Tides: Bearish
Our Cabot Tides have returned to bullish territory, as three of the five indexes are currently in positive stances (and, barring a meltdown, the other two should follow suit on Friday or Monday). Granted, the Tides have been on-again, off-again for a while, and with few growth stocks set up to go, we’re not piling in based on this signal. But there’s no question the recent strength is a checkmark in the bulls’ column.

Cabot Real Money Index: Neutral
We continue to see some sentiment measures tell us that investors bailed on the market during the past month, but interestingly, those are mostly surveys, oversold measures and options-related indicators. By contrast, our Real Money Index is still on the high end of neutral, with money generally coming into equity funds and ETFs at a steady clip—it’s not a headwind, per se, but we can’t say investors are uneasy, either.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on January 13, 2022.