WHAT TO DO NOW: Remain defensive. The market has been bouncing decently during the past four trading days, but our Cabot Tides remain clearly negative and most growth stocks are still in steep corrections. Longer-term, we’re optimistic this bull market will eventually resume, but right now, it’s best to hold plenty of cash, cut back on new buying and patiently wait for a new uptrend to being. In the Model Portfolio, we still have a couple of stocks on tight leashes, but we’ll stand pat tonight with our five stocks and cash position of 62%.
Current Market Environment
Stocks finished modestly lower today after yesterday’s solid rebound. At day’s end, the Dow was down 92 points while the Nasdaq slipped 3 points.
The market has enjoyed a modest bounce during the past four trading days following a horrific first couple of weeks in October. Overall, the Nasdaq fell from around 8,100 to 7,300 (round numbers), and thus far bounced back to 7,650 or so, or just less than half the decline. It’s a similar story with the S&P 500, though the small- and mid-cap indexes have staged weaker bounces, recovering just one-third of their drop (again, ballpark figures).
Given some of the short-term extremes seen late last week and early this week (very few new highs, massive ETF volume, etc.), we do think the market and many stocks could continue to rebound in the days ahead. And with earnings season now upon us, we’d expect plenty of volatility, too.
But, intermediate-term, our Cabot Tides are clearly negative, and the vast majority of growth stocks are in downtrends. Until that changes, a defensive stance remains appropriate.
Going forward, we’re open to anything, including a V-shaped recovery in the weeks ahead. But given the widespread damage and the fact that most stocks have only recently broken down (just at the start of this month), odds favor the correction taking some time (usually at least a few weeks) to wear out weak hands, allow stocks to build launching pads and create more worry among investors. Again, we’re open to anything, but there are likely many investors (big and small) that want to lighten up and/or rotate to other areas on the next bounce.
Longer-term, we still have a lot of conviction that the overall bull market is intact—our Cabot Trend Lines are still positive (though this week’s close will be key) and we didn’t see any of the classic bear market warning signs before the recent meltdown. So we wouldn’t read too deeply into the worrywart articles you see all over the place these days.
But it is a time for patience as we wait for the market to etch a bottom (remember, bottoms are usually a process, not an event) and for new leadership to show its face (the wheat will probably separate from the chaff during earnings season). In the Model Portfolio, we’re standing pat tonight with our five stocks and 62% cash position.
Model Portfolio
Five Below (FIVE 118) has definitely been caught in the pull of the market’s decline, but even now it’s only a bit below its (still rising) 50-day line, which is dazzling compared to most growth stocks. The dollar store sector got a boost yesterday after Carl Icahn reportedly took a stake in Dollar Tree, though we don’t see that as a major catalyst for FIVE; the stock will live or die based on the execution of its expansion plan and whether the U.S.-China trade war affects costs. (Management has been adamant any impact next year will be negligible to results.) FIVE could certainly pull back farther if the market decline gets even uglier, but we continue to think the stock has a good chance of holding up relatively well and continuing higher over time given its combination of growth and dependability, which is very attractive to institutional investors. Hold on if you own some, and if you don’t, we’re OK buying a small position here if you have plenty of cash on the sideline. BUY.
Fundamentally, it looks like the Grubhub (GRUB 121) story continues to play out just fine. The company announced this morning that it expanded its delivery services into 19 new markets, with the expansion for all of this year hitting the goal of 100 new markets set out by management, which only expands the firm’s leading position in the industry and increases its attractiveness to all sorts of restaurants that don’t offer delivery services. That said, the big report will be next Thursday morning, when the company will release Q3 earnings before the open. A poor reaction that takes the stock decisively below its 200-day line (now around 108.5 and rising) would probably be enough for us to bail out of the rest of our shares, but above there we’re fine giving the longer-term uptrend a chance to resume. HOLD.
Ligand Pharmaceuticals (LGND 203) could be the next stock on our chopping block—its decline from new highs straight down to its 200-day line on huge volume certainly looks abnormal, and even yesterday’s halfway decent bounce was quickly erased. That said, there should be a good amount of certainty in its business and the stock is hovering in an area of support (the 200-day line is around 196 or so). Thus, we’ll keep our remaining shares rated Hold, but we’d like to see some real upside power soon to show that dip buyers are active. Earnings are due out November 8. HOLD.
Okta (OKTA 62) got clocked with every other growth stock during the first two weeks of October, but its bounce thus far has been solid—the stock actually kissed its 50-day line from below this morning, albeit on light volume. While it didn’t get much press last week as the market imploded, Okta’s investor day was well received by analysts. The five-year outlook included 30%-plus annual revenue growth, which was generally expected, but management also laid out some very bullish margin targets—the top brass laid out how, after lots of spending to bring a customer in, that spending drops way off and margins jump in a big way. (Customers that came aboard in 2016, for instance, brought Okta revenues of $39 million in that year vs. $72 million of costs; two years later, revenue from these clients rose to $64 million while costs fell to $25 million.) Because of that, management believes it can achieve free cash flow margins of 20% to 25% by 2023 (about $350 million of free cash flow by then). Back to the stock, we’re trying to give it rope because of our already-large cash position and because the stock is relatively early-stage. If you own some, sit tight. HOLD.
Teladoc (TDOC 70) has bounced in recent days, which is good to see, but the chart looks a lot like the market—a big-volume selloff, lower-volume rally and plenty of overhead to chew through on the way up. Fundamentally, CVS’ MinuteClinic, which leverages Teladoc’s platform, rolled out virtual care services in seven new states this week, and backed up by the firm’s bullish Investor Day in September, we don’t think the underlying story has changed at all. That said, the company is not the stock, so we’ll be watching to see if this bounce can sustain itself. So far, we’re comfortable holding our remaining shares. HOLD.
Watch List
Canopy Growth (CGC 51): CGC poked its head up earlier this week before pulling back, but that’s normal action in a tough market. It’s still a stock we think has big potential, but like many names, probably needs more time.
Centennial Res. Development (CDEV 21): CDEV is our top pick right now among energy stocks. It’s a fresh idea near the top of a two-year base with huge growth and potential. Earnings are likely out in early November.
Dexcom (DXCM 133): We got out of DXCM near breakeven, but the stock stopped falling soon after and has bounced decently. We’re not afraid to get back in if the stock sets up properly and the market rights itself.
Exact Sciences (EXAS 66): EXAS hasn’t bounced much in recent days, which isn’t ideal, but it’s still holding support from its Pfizer-induced surge. We think Cologuard is revolutionary and could take Exact very far. Earnings are due out October 30.
PetIQ (PETQ 35): Similar to Exact Sciences, PETQ hasn’t bounced much in recent days, but it’s holding support from its giant earnings surge in mid August. We think this is a unique retail story (pet meds and wellness centers) that could have years of 15% to 25% sales and cash flow growth. Earnings are likely out in mid November.
Twilio (TWLO 74): We missed TWLO earlier this year, and after a big run from February though August, it’s finally having its first meaningful correction. Encouragingly, it showed some support last week, and after a decent-sized acquisition, found support again after an initial dip. The stock still needs work but this is a great growth story. Earnings are likely out in early November.
Vertex Pharmaceuticals (VRTX 185): VRTX’s breakout failed, but that’s not a black mark given the environment. It’s still just a few percent from all-time highs with a dominant cystic fibrosis franchise and solid earnings estimates. If biotech stocks do well in the next market advance, VRTX could be a liquid leader. Earnings are likely out near month-end.
That’s it for now. You’ll receive your next issue of Cabot Growth Investor next Tuesday, and, as always, we’ll send a Special Bulletin should we have any changes before then.
