January 27, 2022

The market remains under pressure, with our Cabot Tides and the “Growth Tides” (see more in this issue) negative, and even our longer-term Cabot Trend Lines on the verge of a sell signal. To be fair, we are starting to see some “real” extremes in terms of some sentiment and oversold measures, so we’re hopeful a bounce could get underway soon; we’re not ruling out some nibbling or re-jiggering in the Model Portfolio. But the main trends remain down, so our main advice is to stay mostly on the sideline and keep your watch list updated with potential fresh leaders.

Market Overview & Model Portfolio Update

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Not Much to Do
One of the toughest things about the stock market even for professional investors is that it’s so contrary in nature—many of the things that are emotionally satisfying in real life often work against you when investing. We learned one of these the hard way early on: When the market gets volatile, the number of dramatic predictions grows, and so too does the desire to take action, with people looking to play the wild swings (often to get “bargains”) one way or the other.

Ironically, though, the opposite is usually your best course: When it’s a bull market, there is definitely the occasional shakeout and rotation to keep you on your toes, but for the most part, the uptrend is generally smooth and leading stocks act in a persistent and relatively controlled manner. In a bearish environment, though, not only is the trend down, but the action can often be like a kid scribbling on a piece of paper.

That’s why, right now, assuming you’re in a defensive stance, we don’t think there’s much to do—for the most part, doing much buying of late has been like picking up nickels in front of a bulldozer, meaning the risk-reward has been horrible and probably not worth the effort, leading only to more frustration (and likely losses).

That’s not to say we’re crazy bearish and think further huge declines are a sure thing. Of course, we can’t rule that out—our Cabot Tides are clearly negative, the “Growth Tides” (see more later in this issue) are in the dumps and even our long-term Cabot Trend Lines are on the fence, with a red light possible tomorrow. That’s reason enough to tread lightly.

But there’s also no question that we’re beginning to reach levels where a bounce at the very least is possible—what we think could be the start of a repair phase, where the best stocks of the next advance will start to repair the damage on their charts as big investors take positions. We write more about this later on, but suffice it to say that we’re starting to see very stretched oversold readings, especially when looking at this Monday’s big dip and turnaround; that’s no guarantee of a bounce (and there’s been little sign of one yet), but we think it’s reasonable to say that the odds of one are growing.

And if that bounce happens, we can’t rule out a little movement in the Model Portfolio. We’re currently 68% in cash, so if something catches our eye (big earnings mover, or maybe a cyclical stock sets up), we may nibble. Plus, we could re-jigger things a bit in the portfolio, possibly trimming one of our stakes or swapping into a more resilient situation.

Even so, (a) that’s a lot of ifs, mays and possiblys, so we have to see how things play out, and (b) all of that involves movement around the edges—for a major buying spree, we’ll need to see a good amount of repair work and legitimate setups among growth titles.

What To Do Now
In the meantime, we’re content to remain mostly on the sideline and see if, short-term at least, the selling pressures can let up. In the Model Portfolio, we have no changes tonight—we’re holding three positions, and while we could make some small adjustments, we think staying close to shore is the best bet until we see some character change in the market.

Model Portfolio Update
There’s not much to really report on when it comes to the Model Portfolio of late—we’ve had north of 42% in cash ever since early December, bumped that to north of 50% early this month, and while we tried to give a couple of names some extra rope, the unrelenting implosion in growth titles has knocked us out of even more issues, leaving us with our current cash hoard of 68%

Obviously, we’d love to put some of that to work, but we’re also not going to throw money into what has been a waterfall environment simply to be more invested. While we won’t rule out a nibble here or there, especially in a cyclical or commodity name, we’re going to need to see the intermediate-term trend in growth funds (what we’re calling the “Growth Tides”—see more later in this issue) turn up, as well as some legitimate setups and breakouts among individual stocks.

One thing we’re not ruling out, though, is a bit of portfolio re-jiggering—depending on how any bounce progresses, we could sell or trim a holding or two, and replace it with something else that’s showing some gusto, all while keeping a bunch of cash on the sideline. Ideally Monday will be a workable low for the market and lead to the start of the “repair phase,” but obviously the market (and especially growth stocks) are still having trouble getting off their knees.

All in all, we’re not looking too far ahead at this point—at some point (probably when more people are bearish and convinced the market is headed even lower), there will be big money to be made in new leadership, but until then, it’s best to stay safe and let others fight it out on a daily basis while we patiently wait for the big investors to step up.

Current Recommendations

Arista Networks (ANET)—ANET has been caught up in the tsunami of selling like everything else, and if the stock doesn’t bounce soon, we might have to throw it overboard. But at 21% off its peak, it’s about as good as you’ll find out there among growth stocks, likely because big investors still see a reliable 30%-ish growth year coming as demand from hyperscale cloud players picks up steam. Of course, it’s always possible the market may be sniffing out a big decline in technology-related CapEx—after a boom the past few years (and especially after the virus forced many to work from home), purchases of software and such may level out for a bit. Still, part of the attraction with Arista is that (a) demand for its wares already leveled out the prior couple of years, so a new upcycle in orders has just gotten underway, and underscoring that is (b) the fact that these huge cloud firms are ordering equipment months ahead of time (a rarity in the industry) to make sure they have the supply they need, adding clarity to Arista’s outlook. As with most stocks, earnings will be key—Arista will release its quarterly report on February 14, with analysts looking for sales to rise 21% and earnings of 73 cents per share (up 18%). Far more important will be the outlook for 2022, which management has already guided toward accelerating growth. If you’re craving cash, we’re not opposed to trimming some ANET on any bounce, but given our large cash position, we’ll just hold on and see how things develop. HOLD

Devon Energy (DVN)—DVN remains one the best-performing stocks in what is probably the top sector in the market. Shares did take a stumble as the selling pressures spread late last week and on Monday (a downgrade from one investment house didn’t help the cause), but after tagging its 50-day line, shares have rocketed back to new highs on big volume (Monday’s volume was the second largest of the past 12 months!)—that’s classic action and tells you big investors are taking advantage of shakeouts and pullbacks to build positions. Interestingly, Devon did update its 2022 outlook earlier this month—at $65 oil and $3.75 natural gas, the firm sees around $5 per share in free cash flow this year, while at $75 oil that figure reaches ~$6.30 and at $85 oil it’s north of $7.50. Those figures are actually down a smidge from its outlook in November (possibly because of cost inflation? Just a guess), but in no way does it change the overall story here—even in the middle case, DVN would likely be paying out a minimum of $3.30 per share in dividends, with a few percent of outstanding shares repurchased on the open market, too. The firm’s quarterly report (due February 15) could be a catalyst; given that prices were up in Q4 vs. Q3, it’s possible the dividend tally will be greater than last quarter’s, and we wouldn’t be surprised if the company hiked its so-called base dividend (currently “only” 44 cents per share, per year) or committed to returning a higher percentage of its cash flow in dividends (currently up to 50% for Devon, but some peers like Pioneer are at 75%), both of which could entice buyers. As for the stock, another wobble or two is certainly possible after the recent spike, with the market or a dip in oil possible culprits, but until proven otherwise, we think DVN’s uptrend has further to go. We’ll stay on Buy, but if you don’t own any, aim for weakness to enter. BUY

Floor & Décor (FND)—We gave FND every chance to find support but were forced to sell when the stock cracked 100 during the market’s implosion late last week and on Monday. Now, to be fair, the stock did turn around with the market on Monday, rallying on heavy volume (one of its heaviest days of the past year, in fact), so maybe there are going to be buyers under this level. Still, like the overall market, that turnaround hasn’t led to anything noteworthy (it’s back under the century mark), and bigger picture, barring a massive turnaround on earnings or some major news, FND is likely to need a lot of repair work, as it’s still 18 points below its 200-day line and the valuation (41 times trailing earnings) could be a headwind given the growth stock environment. All in all, we think there will be better names to own in the next uptrend (possibly some newer cookie-cutter names like Dutch Bros. (BROS) or Sweetgreen (SG), written about later in this issue). SOLD

ProShares Ultra S&P 500 Fund (SSO)—SSO was holding up well enough through the middle of last week, but it’s since cracked with everything else as the selling spread. On one hand, we’ve been playing this position by the book, holding on as long as the major uptrend was intact (taking a few rounds of partial profits taken on the way up), but willing to bail if that changed—on the other hand, we already have a ton of cash and it’s still possible Monday will represent a workable low. We’re cognizant of the fact that we don’t want to hold a leveraged long fund in a market meltdown, but right here, we’re going to sit tight; we may trim our position (or sell outright) down the road if the fund can’t bounce (or maybe even if it does), but we’re not anxious to have even less exposure to the market at this point. As with ANET, if you are looking to raise more cash, trimming some SSO after this modest bounce is OK, but for our part, we’ll hang on and see if this rally can develop some strength. HOLD

Watch List

• Dutch Brothers (BROS 48): We’ve actually seen a bit of resilience among some newer cookie-cutter stories, and BROS is by far our favorite; chart-wise, it’s actually back above its December lows (a rarity among growth stocks), and fundamentally, growth should remain rapid and reliable (and profitable) for many years to come. Sweetgreen (SG) is another (newer) name to watch; seem or more on that below.
• Marathon Oil (MRO 20): MRO certainly acts like an energy leader, following a similarly strong path as DVN has, including a move to new highs this week. Even at $60 oil and $3 natural gas, the firm is likely to pay out $1.50/share this year either via dividends or buybacks—and that figure should rise meaningfully if prices remain elevated in the $80/$4 range like they are now. Better yet, the top brass sees years of huge free cash flow even at low energy prices, all of which is likely being factored into the stock here.
• Planet Fitness (PLNT 81): PLNT’s breakout failed earlier this month, but that’s par for the course in this environment—we still like the overall setup with the stock holding its 200-day line, and fundamentally, we think the overall steady growth story will be back on track in 2022 and beyond.
• Snowflake (SNOW 245): SNOW has pulled in further with everything else in recent days, but we still think the chart looks much different than most of the glamour stocks out there—the action looks like a normal base-building effort within the context of a giant post-IPO base, as opposed to a complete meltdown and long-term top from other names. We think it’s a matter of time before SNOW is a leading stock.

Other Stocks of Interest & What to Watch For: “Growth Tides”

Albemarle (ALB 205)—As just about every growth stock and sector has hit the toboggan slide, some of the things we’re looking for are (a) charts that are at least not completely exploding, (b) stocks that didn’t run too much during the past couple of years, and (c) have a great, long-lasting growth story that should re-attract big investors during the next bull run. One of those trends is clearly electric vehicles—but the question is, with increasing competition, what automaker will really shine from here? A better avenue, we think, is to look at firms that supply the parts to those vehicles, be it chips or materials—which is where Albemarle comes into play. The company has long been a leading chemicals outfit, doing a good business in bromine (35% of sales) and certain catalysts (25% of business). But the growth here is all about lithium, as the firm has 13 production, resource and conversion facilities around the world. Thanks to EV batteries, lithium demand is expected to grow more than 10-fold from 2020 to 2030 (a bit faster than the production of EV cars, in fact), and with supply already tight, the upside potential here is huge if management can successfully expand its capacity. To be fair, that’s probably the big risk here—Albemarle is likely to spend a couple billion dollars during the next three to five years to more than double its output, and any snafus and/or political headaches (a lot of its facilities are in China) could create potholes. Still, management has a history of meeting its goals on expansion, including a good-sized project last year and two that are underway and should be completed in 2022. All told, the firm thinks EBITDA (cash flow) can triple over the next five years. As for the stock, it’s not pretty, but ALB is hanging around its 200-day line and the correction isn’t abnormal given the run-up since late 2020. It needs work, but a positive earnings reaction (due February 16) would go a long way toward telling us a bottom is in.

Star Bulk Carriers (SBLK 21)—Drybulk shipping obviously isn’t a traditional growth sector—in fact, it’s probably about as cyclical as you will find—but we think there are similarities between this area and energy: Years of slow demand and increased emission standards led to a lack of investment in new ships, with the industry’s orderbook currently sitting at 25-year lows and with 2022 and 2023 likely to see extremely slow fleet growth. Meanwhile, firms like Star Bulk (the largest U.S.-listed dry bulk shipper) survived by slashing costs and boosting efficiencies. And so when demand picked up last year (along with all the supply chain issues and port congestion around the world), shipping rates went bananas; in Q3, this firm’s net voyage charter rate (after ship expenses) was north of $30,000 per day (compared to expenses of around $5,300 per day!), leading to a ridiculous $2.19 in earnings and a quarterly dividend of $1.25 per share, all while it continued to pay off debt (down 13% in Q3 alone). To be fair, shipping rates have come down a bunch (partly due to seasonal factors), with quoted rates down to around $20,000 per day—but here’s the thing, even at those rates (which are still more than twice pre-pandemic levels), Star Bulk thinks it will crank out something like $3.30 in cash flow per share for the year … and that says nothing about the fact that most believe shipping rates will rally back in the direction of last year’s highs after the winter months. Granted, it’s not as clean-cut a story as energy stocks in our view, partly because of the volatility in charter rates, but historically speaking, when shippers get moving, they often stay in favor for a couple of years simply because it takes time for new ships to hit the water. In this case, the uptrend lasted from late 2020 through the middle of last year, and SBLK has gone basically straight sideways since, with nothing abnormal from a long-term perspective. Obviously, if the global economy tanks, all bets are off, but the longer the stock can hold in there, the greater the chance SBLK could be another cyclical winner after the market finds its footing.

Sweetgreen (SG 28)—We remain on the lookout for recently-public stocks that may have messy charts right now due to their youth and the overall market environment, but have outstanding growth stories that should entice big investors to slowly build positions as time goes on. Dutch Bros. (BROS) is one that we think has tremendous potential, and Sweetgreen is another cookie-cutter name to keep an eye on: The firm operates fast food joints that serve only fresh, healthy fare, with a changing, seasonal-based menu thanks to a top-notch supply chain with hundreds of local bakeries and farms. It’s a simple idea, and one that doesn’t sound that unique frankly, but Sweetgreen seems to have hit on something, especially with environmentally and health-conscious city folk who are willing to pay a few extra bucks for good food; it sort of reminds us of Chipotle Mexican Grill a few years ago, except instead of Mexican food it’s salads, warm bowls and plates and the like. The pandemic and other factors hurt results last year, but the underlying business has always been attractive—same-store sales growth averaged 10% before the pandemic, and in terms of store economics, Sweetgreen aims to recoup 45%-ish of the opening costs in year two of operation (on top of more modest returns in year one as things ramp). Throw in a leading digital ordering platform (two-thirds of sales) and it all should lead to restaurant-level margins near 20% down the road. In terms of the store count, it likely expanded from 119 to at least 149 last year, and the top brass expects to double the store count “over the next three to five years,” so we’re safely talking about a 12% to 20% growth rate, if not something faster. The one bugaboo here is the bottom line, which remains in the red, though some of that is lingering pandemic effects and, given its small size, we’ll make an allowance for it. The stock itself is young, wild and wooly—it came public in November near the market top and proceeded to tank more than 50% before finding some noteworthy support this week ... before falling sharply again today. Clearly, it’s not ready to get going from here (and the stock is still thinly traded for our taste), but if business continues to pick up steam and the losses shrink, we think it’s a matter of time before SG has a good run.

What to Watch For: “Growth Tides”
I had a big part to play in the creation of our Cabot Tides back during the three-year bear market of 2000-2003—during the preceding internet bubble, our market timing system decayed, mostly because there was no need for it. That left us with some out-of-date and/or secondary indicators that really didn’t do a great job of measuring the kind of stocks we focus on. The Cabot Tides was and still is a big improvement from that, and I have every confidence it will be our key intermediate-term model down the road.

However, it’s also important to remain flexible, and there’s no question the market has been highly bifurcated for the past couple of years—growth stocks have danced to their own drummer, first during the moonshot of 2020, then as they flopped around last year (while cyclicals did pretty well) and recently, of course, as they’ve gone over the falls. Thus, the action of, say, the NYSE Composite or S&P 600 MidCap really doesn’t have much to do with the action of the stocks we focus on.

Because of that, for at least the next few weeks (maybe longer depending on how it goes), we’ll be putting at least as much attention on what we’re calling the Growth Tides—it has the same rules as the regular Tides, but instead of focusing on a variety of major indexes, they feature many of the growth-oriented indexes and funds we’ve been writing about in recent months.

Specifically, we’ll be looking at the Next Gen Nasdaq 100 (QQQJ), which is fairly well diversified and contains many of the stocks we look at; the IBD 50 Fund (FFTY), which generally has stocks with the same characteristics we hunt for (decent liquidity, solid sales and earnings growth, good earnings estimates); the Russell 2000 Growth Index (IWO), another diversified fund that owns a bunch of small-ish growth outfits; and the Renaissance IPO Fund (IPO), which owns a collection of the most liquid stocks that have come public over the past few years.

Together, these indexes and funds give us a direct view of how growth and glamour stocks are acting—if all are kiting higher, it shouldn’t be hard to find solid-acting titles that we’d like to sink our teeth into in traditional growth areas like technology, networking, storage, software, cybersecurity, retail and medical. Conversely, when all of these are acting poorly, like for the past many weeks, it’s a good bet the tide is going out on growth.

As usual, we’ll be looking at the 25-day and 50-day moving averages: For an index’s intermediate-term trend to be up, it has to be (a) above the lower of the two lines, and (b) that moving average has to be advancing. In this case, that means these funds effectively need to reach five-weeks highs, something that will take some work from here.

(We do like to have an odd number of things to watch, just in case there is a near-term conflict among the funds and indexes—so we might add in something like the general Nasdaq to be a tiebreaker of sorts. That said, we’d guess these funds will swim pretty closely together.)

Bigger picture, if the “growth stocks vs. everything else” environment remains in place during the next sustained uptrend, it’s possible we could make the Growth Tides (or something similar) a permanent staple in our market timing system. For now, though, let’s just deal with what’s currently happening—everything (including growth stocks) is in an intermediate-term downtrend now, and that will have to change before it’s safe to put meaningful money to work.

Oversold? Yes with a Maybe, No with a But
The crash-like environment for growth stocks that began in mid-November and accelerated in January has spread to most other nooks of the market, and this week we finally saw things really cascade, which has led to a few questions about capitulation and oversold indicators—and whether we’re close to a bottom.

When looking at broad measures for the Nasdaq, there’s little doubt we’re very oversold—on Monday, a full 25.8% of all Nasdaq issues hit new 52-week lows on the day, and coming into today, a huge 84% of Nasdaq issues were below even their longer-term 200-day line! Meanwhile, a few sentiment measures like the equity put-call ratio (15-day average is the highest since May 2020) and AAII survey (most bears in more than five years) tell us many are throwing in the towel.

So by some measures, we’re definitely oversold—but the issue is that these measures can always get more extreme. For instance, since the financial crisis, the Nasdaq saw a greater percentage of its membership hit new lows, and more of its members below its 200-day line, in October 2011, February 2016, December 2018 and, of course, March 2020 (see chart above)

What does it all mean? Nothing definitive, and that’s the point—the way we like to look at things like this is that the environment is ripe for some sort of workable low, but you still have to see the market rally strongly to conclude that a workable low is in. What’s far more reliable are positive divergences in these readings over time (fewer new lows even as indexes struggle), which is something we’ll be on the lookout for once a rally begins.

Cabot Market Timing Indicators

A few secondary-type indicators tell us there’s a decent chance that the extreme selling this week could soon result in a workable low. But bigger picture, there’s no question most of the evidence is bearish—the intermediate-term trend remains firmly down, the longer-term trend is in question and most stocks have cracked.

Cabot Trend Lines: On the Fence
Our Cabot Trend Lines have been bullish since June 2020, more than a year and a half, but now, for the first time since then, things have gotten dicey—last week, both the S&P 500 (by 2%) and Nasdaq (by 8%) closed under their respective 35-week lines, and if they both repeat that this week, it would turn the longer-term trend down. At Friday’s close, we’d need to see either the S&P close above 4,490-ish, or the Nasdaq above 14,925-ish, to avoid the red light, which are pretty far away. We’ll see how it goes.

Cabot Tides: Bearish
Our Cabot Tides have been mixed for a while, but there’s no question the bears are in control right now—all five of the indexes we track (including the S&P 400 MidCap, shown here) are well below their lower (50-day) moving averages, confirming that the intermediate-term trend is down. Going forward, we’ll also be watching the “Growth Tides” for a cleaner look at what growth stocks are doing, but today, no matter what you look at, there’s no question the tide is going out.

Cabot Real Money Index: Negative
The waterfall decline in growth and the Nasdaq hasn’t been enough to shake investors’ confidence in the market—our Real Money Index is still up near multi-month peaks! Of course, other sentiment measures do point to growing worry, which is a plus, but to this point there’s been no sign of panic when it comes to actual money flows.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on February 10, 2022.