January 13, 2022

While some major indexes are hanging in there and many cyclical areas look pretty good, growth stocks have suffered another sharp leg down, with many with crash-type declines last week. With that said, there are some rays of light, including a minor new lows divergence, continued buying bursts that usually portend solid long-term results and the fact that some cyclical areas are trying to get going from big consolidations. Monday’s panic selling might be a workable low, but still, we need to see more before putting much money back to work.

Market Overview & Model Portfolio Update

After the (Mini-)Crash
In our last issue we talked about the growing chasm between growth stocks and the rest of the market—basically the polar opposite of 2020—and said, “It’s always possible the wacky 2021 environment will continue, though we think the flip of the calendar should provide more clarity.” And so it did, in a bearish way—growth stocks keeled over in crash-like fashion even as many cyclical areas actually perked up.

Indeed, while those that just look at the Dow or S&P 500 see this as just more choppiness, growth investors have seen damage that rivals or exceeds any of the modest bear phases in recent years—the best-performing growth-oriented fund (QQQJ) fell “only” 16% from its mid-November peak, while things like the Russell 2000 Growth (IWO; down 19%) and IBD 50 Fund (FFTY; down 23%) did worse and a ton of individual former leaders imploded 40% or more—all in just eight weeks.

We certainly took our share of lumps during this period of time, though having north of 40% in cash since early December helped. The focus, though, is on what comes next. Here’s what we see:

First off, while today was ugly, Monday afternoon had the look and feel of a short-term climactic low, with most everything (even the Dow and S&P) in free fall and nearly 1,000 stocks on the NYSE and Nasdaq combined hitting new lows. Second, we actually saw a couple of minor positive divergences during that selloff—the net new lows on the Nasdaq was slightly better than seen in December, while fewer stocks dipped below 50-day or 200-day moving averages. (See more later in this issue on that.) And third, we have little doubt sentiment took a hit—while some measures (like the Real Money Index) tell a different tale, our own email was filled with worry and even a little panic, while weekly measures are showing the same thing (today’s AAII survey showed the second fewest bullish investors in the past 15 months).

In other words, it’s possible Monday will represent a workable low—especially considering the fact that, outside of growth, there’s actually a decent number of good-looking charts. Things like energy (looks great), financials and metals, in fact, may be emerging from big, early-stage rest periods, which we write about more below.

What To Do Now
All in all, then, we do think there’s a chance the crash phase is over, and the repair phase has begun—but, to be frank, it’s too early to be sure (today’s growth stock drop wasn’t encouraging), and that repair phase is likely to take some time given the damage among growth stocks. We’re open to putting some of our large 58% cash hoard back to work (possibly in a strong cyclical name), but tonight, we advise standing pat and patiently waiting for signs the buyers are really stepping up.

Model Portfolio Update
Well, 2021 is in the books, which we’re fine with as it was far from a fruitful growth stock year—effectively payback for the amazing 2020 environment. Not surprisingly, we underperformed the indexes, and there are plenty of lessons to be learned, but the big-picture performance is still solid, with the Model Portfolio up 74% total the past two years, up 113% the past three and up 188% (23.5% annually) the past five.

However, what really counts is the here and now, with 2022 getting off to a horrid start for growth stocks. Indeed, people can talk all they want about the major indexes, but when it comes to growth, there is a huge dichotomy: While the S&P 500 and NYSE Composite are near their highs, and some cyclical sectors look pretty great (see more on that later in this issue), growth stocks have been in a bear phase, with growth-oriented indexes sinking 20% or more and tons of former leaders crashing 40% or more.

We’ve taken some lumps for sure, and the nibbles made at year’s end were ill-timed, but thankfully we’ve been cautious since the start of December (never less than 40% in cash) and are currently just shy of 60% in cash.

On a more positive note, we do think that (a) Monday’s low could be a workable one, and (b) that some cyclical areas look pretty tempting on a big-picture basis. Thus, we’re not opposed to putting a little money back to work if this rally can develop some power, but it has to be a solid setup and be showing some real buying volume. Either way, right now, we’re content to remain defensive—we’re all for a massive rally from here, but given the damage to growth stocks, the odds favor some repair work is needed.

Current Recommendations

Ambarella (AMBA)—As we wrote about last week, AMBA had a solid Investor Day on January 4, with guidance that implied a doubling of its computer vision chip business this year (despite supply issues) and new products that should keep automakers coming to its doors in the years ahead. However, the market environment was just too much to overcome, especially after profit margin guidance was a bit light, with shares going from essentially new closing highs on January 3 to three-month lows two days later! Big picture, we do think AMBA could eventually have another run, as the stock’s coming out party wasn’t until September 1 and there’s little doubt its multi-year R&D efforts and industry-leading vision chips have a bright future. Thus, as opposed to some splattered former growth leaders, Ambarella is a name we’ll keep a distant eye on for a fresh, high-odds setup. Still, as with most growth titles, shares are likely going to need a good amount of time to base-build and chew through a lot of resistance above here. We sold our stake in two chunks last week and are holding the cash. SOLD

Arista Networks (ANET)—While most of the growth stocks that had extended runs have come unglued, networking-related names really just got going in the Q4 timeframe as indications of accelerating demand reached Wall Street. So, it makes some sense that ANET, while taking on water during the worst of the selling, is still holding up pretty well, currently right on its 50-day line, which is heroic in this environment. (Other plays like Ciena (CIEN) and Juniper (JNPR) are also acting well.) Fundamentally, one analyst said this week that it’s “all systems go” for networking with cloud, enterprise and 5G-related spending all likely to pick up this year. For Arista, hyper-scale spending should be the main driver—data-center CapEx was up 22% last year even with supply issues, that growth rate should accelerate this year and Arista has exposure to rising spending at Facebook, Amazon, Google and Apple. Back to the stock, we’re not just holding and hoping, and if ANET and other networking stocks crack during another market leg lower, we’ll go to Hold or possibly cut bait. But right here, it certainly appears that big investors are hesitant to dump shares, with the stock “only” 10% off its high and still near where it gapped up in November. Hold on if you own some, and if you already have plenty of cash, we’re OK nibbling on some shares here. BUY

Datadog (DDOG)—DDOG was holding up great through December, but it put us on the defensive as soon as the calendar flipped, imploding with the rest of its peers and eventually tripping our loss limit earlier this week. Similar to Ambarella, we’ll be keeping a distant eye on Datadog going forward, as the story should play out for years and the stock emerged from a huge consolidation in August; if all goes according to plan, the stock will round out a normal-looking consolidation in the weeks and months ahead. But there’s no sweet talking the stock’s action of late, with the 19% decline last week (!) clearly abnormal and likely to require plenty of repair work. As for the end result, it’s frustrating (we can’t remember the last time something came and went so quickly), but at day’s end our loss was around 1% of equity of the entire portfolio—not good, of course, but also not something that’s overly damaging and can’t be made up quickly when new leaders emerge. SOLD

Devon Energy (DVN)—We remain very bullish on energy stocks, which have gotten off to a great start in 2022 as our thesis continues to play out: Investor perception is changing for the better as most leading names (including Devon) will be paying out big dividends, buying back stock and further reducing debt even if oil and natural gas slip 20% or so from here. We’ve written a lot about that (cash flow remaining solid even in less fruitful times), but given that oil prices have already bounced back above $80 despite virus worries and Fed hawkishness (natural gas has also popped with the cold weather), along some bullish forecasts from sharp industry players (Pioneer Natural Resources has liquidated its remaining oil hedges for 20220), we may have to start discussing what happens if energy prices remain elevated—at $80 oil and $4 natural gas, Devon’s free cash flow would likely be around $7.50 per share in 2022 (!), a bunch of which would surely be returned to shareholders in dividends or buybacks, with the rest kept to retire future debt or fund small, accretive acquisitions. That is probably one reason the stock has been acting great, with DVN lifting to new highs above 44 late last month and rallying all the way above 50 this week. Short term, we do think the risk of a pullback for whatever reason (oil price dip, market rotation) is growing, but we also think the sector strength bodes well when looking at the weeks and months to come. We could average up in the stock if a orderly retreat comes soon, or we could even add a second energy name to complement DVN. Right here, though, we’re standing pat—if you own some, hold on, and if not, we’re OK starting a position here or preferably on weakness. BUY

Floor & Décor (FND)—If you know us, we’re not one to vary from the methodology too much because it puts the odds in our favor over time and keeps us out of big trouble. However, when just about everything is cratering, sometimes we’ll take a broader look at the portfolio and make judgments based on that. So far, FND is an example of that, as it blew through our mental stop in the upper 110s late last week and on Monday—but because things were getting hot and heavy on the downside, and because of our large cash position, we’ve held on and want to see how well the stock can bounce from here. To be fair … the bounce hasn’t been great so far, and if that continues, we could sell and look elsewhere. But at this point, if you already held FND all the way down like us, we think hanging on a bit longer makes sense assuming you’re already in a cautious stance. HOLD

ProShares Ultra S&P 500 Fund (SSO)—In the last issue, we wrote about a couple of encouraging shows of strength in the market that should bode well for the S&P 500 in the months ahead—and then, in early January, we got another, with a minor breadth thrust on the NYSE. (Read more about it later in this issue.) These aren’t major blastoff indicators, and they all apply to the NYSE or S&P 500, but that plays into the hands of SSO, which did take a quick, sharp hit (74 to 68 intraday) but has bounced decently since. (As a heads up, the fund split 2-for-1 today.) Could the recent retreat be just the tip of the iceberg, the first leg down of sorts? Sure, it’s possible that the selling will spread and/or there could be a rotation back into beaten-down growth names. But for months, we’ve been simply playing it by the book with SSO—and until proven otherwise, the major trend here remains up, and the S&P 500 is the strongest major index. We advise holding on, and we’re not opposed to a small purchase here if you don’t own any. BUY

Watch List

• Freeport McMoRan (FCX 44): Many cyclical areas appear to be getting going after long rests, and FCX is in the same boat, with earnings very strong and getting stronger. See more below.
• Marathon Oil (MRO 19): We’re not sure we’ll add a second energy name, but if we do, it could be MRO, which operates in different areas than DVN but also has a very powerful cash flow story. See more below.
• Planet Fitness (PLNT 90): PLNT is an old favorite of ours, and it grew solidly last year despite the repeated virus worries, with 2022 likely to be an all-time best year. See more below.
• Snowflake (SNOW 292): At some point, we think SNOW is going to be an institutional-quality leader, as the liquidity, story, sales growth and long-term potential is all there. The stock needs work, of course, but it held its 200-day line (more than 75% of Nasdaq stocks did not) and the overall correction isn’t abnormal.
• Wolfspeed (WOLF 105): WOLF is a “new” chip name that has years of rapid growth ahead of it as its silicon carbide chips are far better suited to new applications like solar, EV batteries, new 5G towers and more. The stock held its December low during Monday’s plunge, a sign of relative strength.

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

Dutch Brothers (BROS 46)—Just about everything in growth land has crashed; if a name fell 25% off its high, it was outperforming most of its peers. So while we always look for relative strength (that will become more of a tell when the growth stock wheat separates from the chaff), we’re also focusing on fresh, dynamic ideas that could be leaders of the next upmove, even if the chart needs some work. One of our favorite ideas on that front is Dutch Brothers, which has a cookie-cutter story that’s easy to enthuse about: The company operates 538 small shops (average new location is 908 square feet) that serve hot and cold beverages (80%-plus are cold; energy and expresso-based drinks popular), with a huge emphasis on customer service, with speed (runners with an iPad meet customers in the drive-thru lane to take orders) and attention to detail paramount (most of the new store openings are company-owned so the culture remains top-notch). It’s a simple idea, but having been around 30 years, Dutch Bros.knows what it’s doing, and that’s shining through with their numbers: On average, a new store recoups 80% of its initial cost in the first year, which is about the best store economics we’ve ever seen (second only to Five Below), and that allows for a rapid expansion plan, with 21% store growth last year and with management just announcing plans for a 23% store bump in 2022—and long term, it thinks it can have 4,000 shops across the U.S.! Just as important, though, is that current shops are doing well (same-store sales up 10% in Q4, though mid-single digits is more likely going forward), and even with the rapid expansion (sales up 49%-plus the past four quarters), Dutch is solidly profitable (in the black seven of the last eight quarters), with analysts seeing the bottom line rising to 27 cents per share in 2022 (up 59%). To be fair, even after a big dip, the valuation ($7.7 billion market cap) is up there, but BROS has the type of rapid, reliable growth story that should attract a bunch of big investors down the road (158 funds already own shares). BROS is on our “back burner” watch list—a decisive rally on earnings in a better market environment would be tempting.

Marathon Oil (MRO 19)—If someone said a couple years ago that we might own two oil stocks in the Model Portfolio, we’d have giggled. But here we are, with Devon Energy doing very well for us and we’re considering another pick. One name that appeals to us—partly due to its operating in some different areas of Devon, and its smaller size—is Marathon Oil; in fact, we’d say it’s our favorite mid-cap name in the space. The firm has operations in the Permian like Devon, but most output comes from the Eagle Ford and Bakken with SCOOP (in Oklahoma) and some payments from Guinea also helping the cause. The firm earned a ton of money last year, slashing its net debt by more than 25% in just the first three quarters of the year, and while it still has a decent debt balance ($4 billion), the firm is comfortable paying off future debt at maturity … which means it’s set to pay a ton of dividends and buy back a truckload of shares. In fact, that’s already begun—Marathon pays an OK base dividend (1.3% yield), but likely bought back $500 million in stock in Q4 alone (nearly 4% of shares outstanding!), and 2022 could be even bigger: At $60 oil and $3 natural gas (25%-plus below where we are now), the firm will return a minimum of $1.45-ish per share to shareholders next year, while at current energy prices, that figure would likely be more like $2 per share—and again, these are minimums, which probably tells you why management approved a $2.5 billion share buyback plan (18% of the current market cap!) just a couple of months ago and why the top brass repeatedly stated that stock “is a tremendous value” in its Q3 conference call. To be fair, shares have perked up a bit since then, but that’s part of the attractiveness—while many mid-cap energy names are still in no-man’s land, MRO has lifted to new price and relative performance highs after the industry shook out in mid-December, and this came after three tough pullbacks since March last year (27%, 27% and 19% deep). Given the market’s uneasiness, we doubt it will be up and away from here (a shakeout wouldn’t be shocking to see), but we think higher prices are likely.

Planet Fitness (PLNT 90)—As opposed to Dutch Bros., Planet Fitness has been around for a while and is an old favorite of ours—we owned it previously and made some solid money on it into 2019, but shares stalled out a year before the virus showed up and of course went through the wringer after that. But now, two and a half years later, the stock is setting up nicely as 2022 and beyond should see the powerful underlying story kick back into gear. The firm, of course, is a top nationwide operator of fitness centers, built on a “judgment free” promise (obnoxious muscle heads not welcome), affordable prices (as low as $10 per month) and top-notch equipment—basically, it appeals to those wanting to hit the gym but aren’t obsessed with it or want personalized training. Obviously, business cratered during the worst of the pandemic, but the firm stayed in growth mode partly due to its franchise model (90% of locations are franchised), opening new stores (store base was up 6% last year) and growing its membership base (up 12.5%) and same-store sales (up 7% in Q3). Even better, management said recently that Omicron hasn’t affected sign-ups or traffic, the first virus wave to be “ignored” by members. And that has Wall Street thinking big things are ahead: Analysts see sales up 33% in 2022 as business continues to recover, with EBITDA and earnings gains likely to outpace those figures. Longer term, Planet Fitness still thinks it can have north of 4,000 locations, so this is more than just a turnaround play. As for the stock, it actually broke out on earnings in early November but was yanked down by the market—and now it’s set up a shallower, proper-looking two-month launching pad. A strong upmove from here could be buyable.

A Couple Rays of Light
As we’ve written a few times, it’s been nothing short of a mini-crash for growth stocks since mid-November, which argues for a cautious stance as (ideally) things begin to repair themselves in the weeks ahead. But we’ve all had our dose of bad news and action, so we wanted to take a minute to write about a few green shoots that are starting to appear out there.

The first has something to do with what we wrote in the last issue—we continue to see some mid-shelf blastoff-type indicators flash green, which historically bodes well for the overall market when looking down the road. We talked about two last time, and another may have flashed just before the recent selling wave: Without getting too technical, the 10-day breadth average on the NYSE (advancing stocks divided by declining stocks) went from oversold (below 0.55) to overbought (above 1.77) within 25 trading days, as of January 4.

That’s only happened six times since 2008 (and didn’t happen for a few years before that), and the longer-term results were solid: The maximum six-month gain for the S&P 500 was nearly 18%, while the max loss during that time was 5.4%. On a 12-month basis, the gain (up 27%!) vs. loss (also 5.4%) ratio is even better.

To be fair, this (and the other studies written about two weeks ago) have to do with the NYSE, S&P 500 and broad market; maybe that’s why those areas are holding well even as growth stocks have gone over the falls. There’s nothing magic here, but the string of unique action (80% up volume days, four solid days in a row for the S&P 500 and now a mini-breadth thrust) hint that some broad market sectors (like those below) could do well.

As for the here and now, one thing that caught our eye related to the Nasdaq came in the selling wave on Monday—even as the Nasdaq plummeted a couple percent below its December lows that day, the “net” new lows (new highs less new lows) actually had a minor positive divergence. That’s not a buy signal by any means, but it seems as if the broad market is beginning to resist some of the selling pressure, which usually leads to a bounce (as we’ve seen) and is the first sign of waning downside momentum.

As always, these aren’t primary indicators—we’ll need to see some legit setups among growth stocks to do a bunch of buying, for instance. But in sharp declines, these types of thrusts and divergences are often the first sign of spring; the new low picture in particular will be worth watching as the days go by.

Cyclical Areas: Long-Term Breakouts Coming?
We’re growth investors, but we’re also students of the market, and every few weeks we like to really broaden our screens and take a look at the entire market to see what’s going on in areas we normally don’t focus on. And one thing we’re seeing today that’s somewhat exciting is the potential for a powerful leg up in many cyclical areas if the market can hold itself together.

First off, remember that areas like financials (XLF), transports (IYT), materials (XME) and others were mostly the dog’s dinner for a few years before the pandemic—XLF and IYT, for instance, went nowhere for nearly three years before getting going in late 2020, while XME was even worse. In October of 2020, it had made no net progress in 12 years!

However, all of these areas got going after the vaccine announcement and enjoyed great runs into the middle of last year before beginning multi-month rest periods. And this is where the student of the market stuff comes into play: It’s very rare that, after years-long launching pads and big, sustained breakouts that entire sectors (or the market) will just up and die after a few months of rallying. In other words, these groups should have another solid leg up—and as you can see in the monthly charts, those moves may be starting now.

The ETFs will probably work well, but we’re also looking for some ideas in the group. Two that caught our eye:

Freeport McMoRan (FCX) is one of the top copper producers, though it also has a lot of gold output, and after years of earnings in the breakeven to $1.50 per share range, the bottom line leapt over $3 last year with more upside in store in 2022—possibly a lot more upside if copper prices break out on the upside.

Among financials, take a gander at LPL Financial (LPLA), which is the nation’s largest independent broker-dealer, supporting more than 19,000 financial advisors and hundreds of advisor firms. It’s not usually a fast mover, but it’s pushed to new highs this year and, as opposed to many peers, earnings are predicted to soar 35% in 2022 as business expands (total brokerage and advisory assets up 34%, thanks in part to the acquisition of Waddell & Reed last April) and interest rates rise.

Our focus is always on growth titles because, in the long run, that’s where the biggest money can be made. But given what we see, there could be some solid intermediate-term opportunities in some cyclical stocks if the market finds its footing.

Cabot Market Timing Indicators

It’s possible Monday will represent a workable low for the market, allowing some cyclical stocks to go higher and growth stocks to repair the damage from their mini-crash. Still, while it remains a bull market, we need to see more positive action before believing the sellers have moved on.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines show the divergence going on in the market: Currently the S&P 500 is nearly 6% above its 35-week line, while the Nasdaq is just 2% above its own trend line. Even so, what matters here is the overall signal—it would take two straight weeks of both indexes closing below their 35-week lines for a signal, so the Trend Lines are still solidly bullish, telling us the bull market is intact despite the crosscurrents out there.

Cabot Tides: On the Fence
Our Cabot Tides have been on-again, off-again for a while, and that’s the case again today as they’re effectively neutral, with some indexes (S&P 500 and NYSE Composite) still positive, one index (the Nasdaq, daily chart shown here) negative, and the other two (small and mid-caps) in no-man’s land. Going forward, we’ll be looking for a decisive move (up or down) for a clear picture of the overall intermediate-term trend.

Cabot Real Money Index: Negative
Our Real Money Index has surged as investors have actually poured money into equity funds and ETFs in recent weeks, leading to a negative reading. That said, the end/beginning of years often results in some funky money flow numbers, so while we won’t ignore it, we think the next couple of weeks of money flows will be more telling.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on January 27, 2022.