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Cabot Growth Investor Bi-weekly Update

Remain bullish, but keep your eyes open. For the first time in months, we’re seeing some yellow flags, including from our Two-Second Indicator. That said, the trends of the market and most stocks are still positive, and pullbacks have been normal thus far.

WHAT TO DO NOW: Remain bullish, but keep your eyes open. For the first time in months, we’re seeing some yellow flags, including from our Two-Second Indicator. That said, the trends of the market and most stocks are still positive, and pullbacks have been normal thus far. We have no changes in the Model Portfolio tonight, which continues to hold about 18% in cash.

Current Market Environment

The major indexes have been slipping lower since Monday, but losses haven’t been alarming. The Nasdaq is down about 1.3% from last Wednesday’s close and was very narrowly higher today. The S&P 500 is down a hair more in percentage terms and the Dow a tad less since last week, with the Dow off a third of a percent today and the S&P 500 down a quarter percent.

Overall, the market looks to be on solid ground. Our two key trend-following indicators—the Cabot Trend Lines and Cabot Tides—are both bullish, and most stocks are in the same boat despite some recent pullbacks. Moreover, we’re seeing two more groups (biotechs and builders) begin to emerge, which is a good thing.

However, for the first time in many weeks, we’re starting to see a couple of dents in the market’s armor. Our Two-Second Indicator has now recorded three straight days of more than 40 new lows. Some of that is due to a few interest rate securities (preferred stocks and the like), but most of it is “real” stocks. A few more days of elevated readings and we’d have to conclude that sellers are doing damage to the broad market.

We’re also seeing continued lackluster action among small- and mid-cap indexes (the S&P 600 Small Cap closed below its 50-day line yesterday and hasn’t made any progress since early December) and strength in defensive areas like consumer staples and utilities.

These are yellow flags worth watching—after four months without a meaningful retreat, it’s certainly possible a correction could unfold, especially with some uncertainties (Fed rate hikes, politics, etc.) floating around.

Even so, we’re trend followers, and it’s hard to be too panicky when most major indexes (especially the S&P 500 and Nasdaq) are just a few days off all-time highs and relatively few stocks and sectors have broken down.

Overall, then, we remain bullish, though we also think it’s best to keep some cash on the sideline (we’re still holding 18%) and being selective on the buy side makes sense. Tonight, we’ll stand pat in the Model Portfolio.

Model Portfolio

Charles Schwab (SCHW 42) has suffered a couple of sharp selloffs due to the industry’s price cuts, but now that most firms have lowered their commissions, it’s likely investors will refocus on the fundamentals, especially given the likelihood of higher interest rates and greater trading activity from a bull market. With the stock near its highs, we’ll stay on Buy, thinking the next major move is up. BUY.

Facebook (FB 138) continues to push higher, even with the market’s gyrations of the past couple of weeks. We’d like to see the relative performance (RP) line a bit stronger (it’s still well shy of its late-2016 peak), but overall, we’re putting more weight on the steady price action and impeccable fundamentals. Try to buy on dips toward its 25-day moving average, which is now at 134.7 and rising. BUY.

Lumentum (LITE 46) might end up being a failed breakout, but we’re still optimistic—despite some analyst downgrades and a decent-sized convertible share offering, LITE’s pullback hasn’t broken any key levels and is finding support near the stock’s prior highs. Fundamentally, the firm’s quarterly report topped estimates and the conference call pointed toward strong demand for many products. A drop to 42 or 43 would have us throwing in the towel, but right here, we actually think it’s OK to pick up a few shares if you haven’t bought yet. BUY.

Netflix (NFLX 140) is just a couple of percent from all-time highs, but the stock also hasn’t gone anywhere for a few weeks, which isn’t what we’re looking for. Given the positive market trends and NFLX’s overall uptrend, we’ll stay on Buy, expecting the buyers to reappear soon. But we will be closely watching support in the mid-130s should the stock dip from here. BUY.

While the market is waving a couple of yellow flags, ProShares Ultra S&P 500 Fund (SSO 85) has remained in a firm uptrend, as the S&P 500 is in good shape. The current weeklong pullback could easily go further, but until proven otherwise, we think dips are buyable. Looking ahead, we would consider taking partial profits on a break of the 50-day line (now near 81 but rising steadily), but would aim to hold the rest, thinking the bull market has farther to run. BUY.

Most highflying stocks began pulling back two weeks ago, and Shopify (SHOP 61) is a good example of that. But the retreat has been totally normal thus far, with selling volume mostly in check and the pullback small compared to the prior run. Some more fidgeting in the short-term is possible but we think SHOP’s action since its breakout in early January is very encouraging. Hold on if you own it, and if not, you can buy some around here or on dips of a couple more points. BUY.

Texas Capital Bancshares (TCBI 88) has been hovering around the 90 level for the past few days, which is fine by us—both the rising 25-day line (at 87.6) and 50-day line (83.5) should offer support on any dip. The prospect of a quarter-point Fed rate hike this month will only boost the firm’s bottom line, with every 0.25% interest rate hike boosting the bank’s interest income by the equivalent of 35 cents per share annually. BUY.

While XPO Logistics (XPO 50) had a wild reversal the day after earnings, the bottom line is that the stock ran from 45 to 53 in three weeks, and is now pulling back a smidge on light volume. Transportation stocks aren’t looking great here, which is a headwind, but we think big investors are more focused on the firm’s huge free cash flow outlook (at least $350 million this year and another $550 million next) and the accelerating U.S. economy. BUY.

Watch List

Alibaba (BABA 103): BABA has gone quiet, but that’s fine by us—its tightness during the past month (100 to 105) could be setting the stage for a new uptrend. We’re still watching closely.

Arista Networks (ANET 124): The specter of legal battles is a big turnoff, but the stock’s earnings gap to new highs and its position as the leader in newer, faster data switches for the cloud era is very attractive. It’s worth watching.

Pulte Group (PHM 23): It’s hard to love homebuilding stocks, but the group is emerging after a two-year rest, and PHM is leading the way thanks to its excellent earnings estimates (up 33% this year, up 20% next) and generous capital return program (dividend yields 1.6%; share count was down 7% in the fourth quarter).

Square (SQ 17): SQ has pulled back in recent days following its big earnings gap to new highs. We think the firm’s payment and add-on services have great growth potential.

Universal Display (OLED 83): If the world of display technology has finally reached an inflection point (led by Apple’s next iPhone), then Universal Display’s business should boom in the years ahead. Analysts see that happening, with earnings expected to rise 39% this year and another 57% next.

That’s it for now. You’ll receive your next issue of Cabot Growth Investor next Wednesday, and, as always, we’ll send a Special Bulletin should we have any changes before then.