In tonight\'s issue, we write about the importance of following your plan, especially soon after you buy a stock. We dive into our new \"7.5% Rule,\" which is another in a long line of studies that show higher prices to be very likely in the months down the road.
Growth Stocks, Long-Term Outlook Remain Bullish—CGI
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Growth Stocks, Long-Term Outlook Remain Bullish
March has been a challenging month for stocks. The major indexes topped on the first of the month and immediately began flashing some breadth-related yellow lights, turning our Two-Second Indicator negative. Then came last Tuesday’s huge selloff, which left our Cabot Tides on the fence and cracked a couple of key sectors, including financials.
But something interesting has occurred in recent days amid a hail of negative headlines (especially from Washington, D.C.). First, the major indexes have bounced nicely after a sharp shakeout on Monday morning. And, even more encouraging, growth stocks are acting great! Most took hits with the market last Tuesday, but have since been resilient, including a few that have exploded higher in recent days.
Moreover, our long-term view of the market is still very constructive. The Cabot Trend Lines remain on their Buy signal that flashed nearly one year ago (April 8, 2016), which, in and of itself, is a sign that higher prices are likely in the months ahead. Moreover, our 7.5% Rule (see page 7), which we mentioned a month ago, is another in a long line of studies that point to the simple fact that it’s a bull market, and thus, solid gains are likely down the road.
So it’s party time, right? No, or at least, not yet. While growth stocks look peppy and the outlook for the months ahead is bright, we’re not going ignore what’s right in front of us—a market that has many sectors and indexes in rocky shape and whose intermediate-term trend is on the fence.
None of that is to say we’re flat-out expecting another selloff. But we do know that, in a tricky environment like this one, further potholes are possible, and if they come, you’ll often see good stocks go bad in a hurry. Thus, going hog wild on the buy side doesn’t make sense.
However, we’re not ready to turn passive. Our goal is to ditch losers and laggards that break down and hold some cash until the sellers go back into hibernation, while looking to do some buying as opportunities arise. That’s exactly what we’re doing in tonight’s issue.
[highlight_box]WHAT TO DO NOW: Pull in your horns by selling your worst performers, but don’t get overly defensive. In the Model Portfolio, we sold Texas Capital (TCBI) last week, and in tonight’s issue, we’re selling Charles Schwab (SCHW). However, we’re also buying Veeva Systems (VEEV), one of many strong stocks on our Watch List, leaving us with about 26% in cash.[/highlight_box]
Model Portfolio Update
First off, let’s start with two housekeeping notes. If you use Twitter, you can follow me @MikeCintolo—
I usually Tweet a couple of times during the day on stuff I’m looking at. And check our home page
www.cabotwealth.com every weekend for our Cabot Weekly Review—a brief video on our market view, leading stocks and various setups we see. It’s free!
Moving to the Model Portfolio, we’ve pulled in our horns a bit since the last issue because our Cabot Tides are on the fence and (more importantly) a couple of our stocks hit a wall. We sold Texas Capital on March 21 when financial stocks first broke down, and tonight we’re letting go of Charles Schwab, which slipped below support.
That said, we’re extremely encouraged to see a host of growth stocks acting resiliently—we’ve been adding to our Watch List because of all the good-looking charts! Because of that and our growing cash pile, we’re adding Veeva Systems (VEEV), which leaves us with about 26% in cash. We think that’s a reasonable stance given the evidence, though we’ll continue to fine-tune the portfolio by listening to the message of the market and leading growth stocks.
Current Recommendations
SELL—Charles Schwab (SCHW 40)—Our SCHW recommendation was snakebit from the start, first getting blasted by Schwab’s commission rate cut, then falling again when its competitors (especially Fidelity) responded, and finally this week, breaking lower as the financial sector’s uptrend cracked. Once the financial group regains its footing, we could look for another Bull Market stock to jump onto, but the time for that isn’t now. We’re selling SCHW on its current bounce.
BUY—Facebook (FB 143)—FB has handled itself very well in recent days, remaining in the tight, controlled, persistent advance it’s enjoyed since the start of the year. Good tidings on the company’s video strategy, along with expectations that Facebook will transition from investment to monetization of its newer platforms, led a couple of analysts to hike their ratings in recent days. And it hasn’t hurt that the firm’s current moves (it’s taking dead aim at Snapchat by introducing new capabilities in its mobile apps) and metrics (Instagram just surpassed one million active advertisers, quadruple the figure from a year ago and miles ahead of social competitors like Twitter, which has 130,000 advertisers) are meeting with applause. The one snafu remains the relative performance (RP) line, which has yet to eclipse its October peak, but the RP line has been trending up for three months. Combined with the stock’s action, we’re staying on Buy. FB remains a flag-bearer of the bull move in growth stocks.
BUY—Lumentum (LITE 54)—Our move to follow the plan (see more on page 6) with LITE is finally starting to pay off, as the stock surged off its 50-day line two weeks ago and, despite sloppy market action, touched new highs this morning. The stock is very volatile so another shakeout of some sort is possible (especially if the market remains under pressure), but we’re optimistic that the path of least resistance is up. Fundamentally, Lumentum was busy on the news front last week, announcing two new families of 100G transceivers for its datacom product line (targeting so-called hyperscale data centers), one new product for 100G short-reach data links and the industry’s first small form factor line card for optical applications. Earnings estimates have been nudged higher, too. Hold on if you own some, and if you don’t, you can buy here or on dips of a point or two.
HOLD—Netflix (NFLX 146)—We placed Netflix on Hold last week, not because the stock was under any great stress, but because it hadn’t made much progress in a couple of months and the market itself was turning weak. Happily, the sellers haven’t been able to put up much of a fight here, as NFLX only fell to 140 (5% off its peak) before bouncing back toward its highs. If the stock can continue to hold up, we believe it has great upside in the months ahead as the firm’s earnings explode. But right here, we’ll stay on Hold until we see the stock make a decisive liftoff and/or some clear improvement from the overall market.
BUY—ProShares Ultra S&P 500 Fund (SSO 85)—Our plan remains the same for our good-sized position in SSO: Should the fund close below 82 or thereabouts (which would correspond with a break of the 50-day line in the S&P 500 and almost certainly a new Cabot Tides sell signal), we’ll likely take partial profits and hold the rest through any intermediate-term correction that develops. But until then, we’re not going to anticipate further weakness; in fact, the dip in SSO to its 50-day line this week is the second since the November blastoff, which usually results in a decent entry point. (The first test was near the end of January, just before it moved to new highs.) If you already own some, just sit tight, but if you want in, it’s OK buying some around here.
BUY—Shopify (SHOP 73)—SHOP has been a leading growth stock all year, and its action during the past couple of weeks confirms that it still is, with the stock recovering from a brief shakeout last week to nose to new highs on Tuesday. In a recent article on the company, a couple of unique nuggets caught our eye. First, Shopify offers cash advances to its clients (dubbed Shopify Capital), but instead of charging interest, it gets a small cut of sales going forward. (It lent $30 million last year and that figure should grow from here.) Second, the company believes less than 4% of its target market has signed up with it, so as long as its platform stays at the head of the pack technologically, there should be years of growth to come. If you’ve yet to buy, you could buy a small position on a dip of two or three points.
SOLD—Texas Capital Bancshares (TCBI 81)—TCBI broke down badly last week when financial stocks fell apart. Longer-term, the company is probably fine, but the combination of the sector’s correction and the stock’s first meaningful drop below its 50-day line in seven months (something that frequently leads to a prolonged base-building effort) had us selling last week. If you still own some, we’d advise selling either here or on a further bounce.
BUY—Veeva Systems (VEEV 51)—We took a stab at Veeva Systems last year, but got knocked out during a correction in October; six months later, the stock was at the same level. But now the buyers are back in control and the story is better than ever—the company’s cloud-based software is the hands-down leader for the life sciences industry, helping firms more efficiently handle their clinical, regulatory, quality control and sales efforts. (Some of Veeva’s products are integrated in Salesforce.com’s suite.) But it’s also starting to sell its quality control and content management software into other industries, and while it’s early, the signs are very encouraging. The valuation isn’t for the faint of heart, but the company’s growth (sales and earnings up 31% and 47%, respectively, in the fourth quarter) has been solid and above expecations, and management believes there’s a clear path for it to become a multi-billion dollar company in the years ahead. (It had $544 million of revenue last year.) VEEV has turned strong during the past two weeks, registering new price and RP peaks. We’re adding it in this issue, and will use an initial loss limit in the 43 to 44 range.
HOLD—XPO Logistics (XPO 47)—Transportation stocks have been even weaker than financial stocks, and that’s been the big factor that dragged XPO down to its prior support area in the mid-40s. The bounce since Monday’s low is good to see, and we still believe XPO can be a big winner due to its exploding free cash flow (which isn’t dependent on a booming economy) if it comes out of its funk. But given its sluggish action, we’re staying on Hold and using a mental stop near 45.
Watch List
Alibaba (BABA 110): BABA is choppy but has been crawling higher in recent weeks, ignoring the market’s softness. A clear leap above 110 and a healthier market could be a great Buy signal.
Arista Networks (ANET 133): It’s looking more and more like ANET’s earnings blastoff last month was the kickoff to a sustained advance. Big investors seem to think earnings estimates are conservative and the Cisco legal battles won’t damage the story.
Pulte Homes (PHM 24): Homebuilders haven’t been dented at all recently, and we continue to think PHM is the leader in the group thanks to its strong earnings estimates and large share buyback program.
Square (SQ 17): SQ is trading a bit wide-and-loose, which isn’t ideal, but the overall consolidation in recent weeks is reasonable. Fundamentally, we think its market potential is larger than many investors expect.
Universal Display (OLED 85): We’re growing more intrigued of OLED’s upside potential as organic light emitting diodes become commonplace in smartphones, TVs and, eventually, lighting applications. The stock remains very firm.
Wynn Resorts (WYNN 115): Both fundamentally (Macau gaming revenue up seven straight months; Wynn’s new resort topping sales expectations) and technically (the stock has leapt out of an 11-month base), WYNN appears to be turning around strongly after a couple of tough years.
Other Stocks of Interest
The stocks below may not be followed in Cabot Growth Investor on a regular basis. They’re intended to present you with ideas for additional investment beyond the Model Portfolio. For our current ratings on these stocks, see Updates on Other Stocks of Interest on the subscriber website or email mike@cabotwealth.com.
Melco Crown (MPEL 19) — Melco Crown is a Hong Kong company that runs major resort casinos in the enclave of Macau, the only place for legal gambling in China. Like all casino owners, Melco was hurt by the downturn that hit Macau when the Chinese government clamped down on gambling a couple of years ago. But gambling revenues are on the rise again and Melco’s Q3 2016 results showed a 22% jump in revenue, followed by a 13% gain in Q4. EPS, which jumped 18% in Q3, soared by 33% in Q4. Wynn Resorts is a bigger-cap leader in this space, but MPEL is up from 11 in July 2016 to 19 in recent trading and its huge City of Dreams resort on the Cotai Strip is holding its own against Wynn’s newest casino. A breakout above 19.5 would be a good sign.
Momo Inc. (MOMO 34) — Momo Inc. is a Chinese online social platform that allows the usual exchanges of texts, pictures, videos, music and the like. What sets the company’s service apart is 1) location-based information that can tell users when there’s another user with a similar profile in the area, and 2) the ability to stream live video. The appeal of Momo’s service is such that the company has booked triple-digit revenue and earnings growth for three consecutive quarters (including 633% EPS growth on a 524% gain in revenue in the latest quarter). And MOMO’s gap-up in early March came on trading volume that was 10 times its average. MOMO is small and speculative (fewer than 100 institutional investors are on board), but the company’s success in China makes sense, and that ridiculous growth is hard to ignore. If you decide to take a position, keep it small.
Snap (SNAP 23) — Snap is the company behind Snapchat, the photo- and video-sharing, photo manipulation social networking service. The Snap IPO on March 2 was a sensation, raising $2.6 billion and soaring from 17 to 26 on its first day of trading and to 29 a couple of days later. SNAP’s post-IPO droop pulled it to 19 on March 17, but the stock has rebounded to around 23. We’re not pleased by the company’s lack of profits (and estimates that it won’t attain positive EPS in 2018), but this is a big, mass-market idea and revenue growth has averaged over 800% in the past four quarters. The stock has been boosted by a spate of Buy ratings from banks, but we need to see the stock set up a proper post-IPO base before we can recommend taking the plunge.
Tesla (TSLA 277) — Tesla is the perfect definition of a glamour stock, with a high-tech product that sports dazzling performance, a charismatic CEO with ambitious plans and the courage to make them happen and a monster run from 32 in January 2013 to 291 in September 2014. Romance Phase runs like that often lead to big corrections, and TSLA dipped briefly to 141 in February 2016. But the real news from TSLA’s chart is that the stock has been heading sideways since 2014, trading mostly in a range with support at 180 and tightening resistance at 290. The numbers are good: deliveries are expected to rise 65% in the first half of 2017 and orders for the Model S and X combined in Q4 were up 49% over 2015 levels. Plus, volume deliveries of the Model 3 are expected by year-end. A breakout to new highs by TSLA would be a very tempting proposition.
Follow the Plan (Not Your Gut)
One thing we see all the time is investors who start out with a plan, but after a little adversity, quickly get out the eraser and change tactics. Nowhere is this more common than with stops and loss limits; even if a mental stop is put in place soon after purchasing a stock, most investors will throw the stock out the window after a couple of bad days.
Take Lumentum (LITE), for example. We added the stock to the Model Portfolio last month at a price near 51, writing at the time that “LITE is a bit extended and will be volatile (our initial loss limit will be in the 41 to 42 area), but given the power behind the move, we think any dips will be supported.” At the time, the 50-day line was down near 40.5 (but rising quickly), plus there was price support near 42.5. Throw in the elevated volatility of stock, and we thought a loss limit in the 41 to 42 area was proper.
After our buy, the stock got off to a rotten start, initially pulling back when a couple of industry peers hit the skids. During that time, the 50-day line pushed higher, so we nudged our loss limit up to the 42 to 43 area. After a few days of calm trading, LITE fell further after pricing a dilutive convertible note offering. By March 14, the stock closed just above 43 and its 50-day line.
So what was the right move? To follow the plan! Of course, LITE could have easily continued falling and stop us out; many times, that will happen. But if a stock hasn’t broken support and hasn’t hit your stop, it’s best to give it a chance—it could still morph into a big winner. And that could be happening now, as LITE has surged off support, even advancing through last week’s market hiccup.
Something similar played out with Five Below (FIVE) last year. After our buy in early April 2016, the stock rose a bit but then entered a correction, falling more than 15% from high to low. However, we had a stop in the 36 area, which FIVE never touched, so we held on—and shares cruised nicely higher during the next couple of months.
The bottom line is that if you invest only by how you feel, there’s almost no chance you’ll be able to hold onto a winning stock. Instead, barring a major change in the evidence (such as a market timing sell signal), it’s usually best to handle a stock mechanically for the first few weeks, sticking to your loss limit and giving it a chance to get moving.
More on the “7.5% Rule”
In the March 1 issue, we introduced what we’re now calling our “7.5% Rule.” Specifically, when the S&P 500 closes a week at least 7.5% above its Cabot Trend Line (i.e., its 35-week moving average) for the first time in
nine months, future returns tend to be solid. That’s important because the rule flashed another green light on February 21.
We took a deeper look at the data in recent weeks and tweaked the rules a bit, but the topline results are similar. Since 1980, there have been 10 instances (about once every four years or so) where the 7.5% Rule flashed. Three months later, the S&P 500 was up an average of 5.0%; six months later, up 9.2%; and a year later, the index was up 15.4%. Moreover, the index notched an average gain of 21% sometime during the following year. Not bad!
Plus, we were struck by the lack of pullback that generally occurred after each signal—the average maximum drop from where the signal flashed during the ensuing year was just 2.5%! Of course, sometimes there were steeper retreats (2009’s super-volatile market actually pulled back more than 7% before exploding higher), but some showed no pullback at all.
Thus, the data reinforces lots of other evidence (such as our bullish Cabot Trend Lines) that indicates (a) the market could have some short-term wobbles, possibly pulling back further, but that (b) this is very likely still a bull market, which should lead to higher prices down the road.
In our portfolio, then, we’re adjusting as necessary during this weak spell in the market by getting rid of stocks that are breaking down. But we’re certainly not sticking our head in the sand because the odds strongly favor that the larger, longer-term uptrend will eventually reassert itself and lead to solidly higher prices down the road.
Cabot Market Timing Indicators
The market’s evidence has turned mixed, with one of our indicators bullish, one on the fence, and the third negative. The good news is that leading growth stocks have been holding up very well, and the longer-term outlook remains bright. Thus, we’re stepping lightly for now but aren’t getting too defensive.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines are still firmly bullish, with the S&P 500 (by 5.2%) and Nasdaq Composite (by 7.3%) closing well above their respective 35-week moving averages last week. As we write on page 7, the strength of the S&P 500 in recent months bodes well for further gains over time. Suffice it to say that, with the longer-term trend up, you shouldn’t get overly negative here.
Cabot Tides: On the Fence
Our Cabot Tides are now on the fence, as two of the indexes (including the S&P 600 SmallCap, shown here) are sitting below their 50-day lines, while two indexes (S&P 500 and NYSE Composite) are within a stone’s throw of their own 50-day lines. Because we don’t anticipate signals, we still consider the intermediate-term trend to be up, but the next big move will likely tell the story.
Two-Second Indicator: Unhealthy
The Two-Second Indicator isn’t a horror show, as the number of new lows hasn’t expanded in a huge way during the market selloffs, and has dried up nicely when the indexes bounced. But we’ve yet to see a long enough string of sub-40 readings to conclude the sellers are back in hibernation, which tells us the broad market is still unhealthy and that risk remains elevated.
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All Cabot Growth Investor’s buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special bulletins via email and the recorded telephone hotline. To calculate the performance of the portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
Charts show both the stock’s recent trading history and its relative performance (RP) line, which shows you how the stock is performing relative to the S&P 500, a broad-based index. In the ideal case, the stock and its RP line advance in unison. Both tools are key in determining whether to hold or sell.
THE NEXT CABOT GROWTH INVESTOR WILL BE PUBLISHED APRIL 12, 2017
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