June 8, 2023

While everyone has been watching the highlight reel of top performers with leverage to the AI theme lately, the real story this week is that more areas of the market are shaping up.

Yesterday, while the Nasdaq sold off, we saw the S&P 600 Small Cap Financial ETF (PSCF) pop 3%. That came on the heels of a 4% rally Tuesday.

Yes, yes, I know. Nobody really cares about this ETF. But small banks make up almost a third of total U.S. deposits. They matter, bigly.

That space has been in turmoil since SVB went under (PSCH fell 25% from early February through mid-May). We need it to come back somewhat for a healthy market rally to take shape.

Moving beyond financials, I took a few minutes yesterday to chart out YTD performance for large and small-cap stocks across comparable sectors. That chart is below.

As you can see, large caps are up about 12% while small caps are up just 5%. Looking at the sectors, large-cap tech (28% weight) and consumer discretionary (10% weight) have been absolutely crushing it.

Looking at small-cap stocks, technology (14.6% weight) and consumer discretionary (13.7% weight) are also the largest performance contributors. But industrials (17.8% weight) and materials (5.6% weight) are outperforming too.

The “problem” is the relative performance and higher weight of large-cap tech and consumer discretionary is just that much more powerful. And for small-cap stocks, the heavy weighting and big underperformance of financials (15.7% weight) and, to a lesser degree, energy (4.3% weight), are holding the small-cap index back.

In my view, for the market to mount a sustainable rally we need to see more stocks in these underperforming sectors get in gear. And help the small-cap index get back in the fight.

Recent Changes: None

Updates

Alphatec (ATEC) has been chopping along in sideways fashion for a couple of months now, with only a little giveback after its secondary offering in April (priced at 14, stock now at 15.25). This up-and-coming spine specialist only has around 5% market share, but surgeons continue to adopt Alphatec’s portfolio. Longer term, the REMI robotic acquisition should pay off, and in the shorter term, the company’s 20%+ revenue growth rate and steady progress toward profitability should draw more investment. Management spoke at a Jefferies conference yesterday and will present at Goldman Sachs next Wednesday. BUY

Duolingo (DUOL) is our latest new addition. The company’s mobile-first, gamified language learning platform offers courses in over 40 languages to more than 20 million daily average users (DAUs) and over 70 million monthly average users (MAUs). It is the top-selling education app in the Apple App Store and on Google Play. And the company is leveraging AI to roll out new products (Math, Duo MAX) that management isn’t yet factoring into guidance. These products are a bit of a wild card. They could grow slowly or explode in the coming quarters. Either way I think the growth trajectory of the company should be relatively consistent, with upside potential. We’re looking for full-year 2023 revenue of $510 million (+38%) and EPS of -$0.56 (a 63% improvement). Shares will likely trade up and down some based on AI enthusiasm/hype/etc., so just be prepared to roll with some volatility here. BUY HALF

Enovix (ENVX) announced this week that it has agreements with both a Japanese and a South Korean distributor (Elematec and Semicomtech, respectively), to help support shipping, distribution and market expansion across Asia. I expect we’ll hear more about management’s distribution plans in time as they continue to lay the groundwork for significant production growth in the coming quarters. As I said a few weeks ago, I also think it would be helpful for the stock if the financing deal with YBS in Malaysia could be finalized. The next major milestone for the company is Factory Acceptance Testing for Gen2 in August, to take place at the equipment provider’s site. If all goes well, equipment goes to California and Malaysia for Site Acceptance Testing. HOLD

Expensify (EXFY) has not been a great performer since we picked up the stock in February. And the recent boom/interest in AI, while helping software stocks in general, isn’t helping EXFY much. My concern here is that, while the company is profitable and has a compelling freemium business model that can drive user growth when businesses are out grabbing new solutions, it’s not a best-of-breed expense management platform (yet). And while the company is launching new solutions, it’s still kind of a one-trick pony. I am considering letting the stock go, however, the broader market is acting relatively well so we’ll stick with it for now and see if we can make up some lost ground. And give management time to impress us with some news. HOLD

Flywire (FLYW) is still pushing up against its 12-month high. Overall, there’s nothing to complain about here, but would like to see shares punch through and move into the mid-30 range. That said, the stock’s doing a fantastic job staying above its 50-day moving average line. The company just announced a strategic partnership with DISCO, an international recruitment and career development company working with students studying in Japan. Management’s presentation at the J.P. Morgan TMC Conference a couple weeks ago focused on the resilience of the business and potential for profit growth (margin expansion). BUY

Inspire Medical Systems (INSP) reached another new all-time high earlier this week. If it’s not at the top of the chart of small-cap MedTech performers lately it’s darn close. One thing to be aware of from a really big-picture perspective is that there’s a new generation of weight loss drugs coming out. I don’t know exactly what that will mean for treating obstructive sleep apnea (OSA), but one would think that if more people are losing weight there could be somewhat less demand for OSA treatments. I don’t think that happens tomorrow, or in 2024. But it’s been in the back of my mind. HOLD TWO THIRDS

Intapp (INTA) has been on a nice run after closing its secondary (priced at 36.5), partly because of the stock’s leverage to the AI theme. The company has been pulling AI tech into solutions for years. No major news to discuss. The stock is back above its 50-day moving average line and 8% off its recent high. HOLD

Repligen (RGEN) has moved sideways over the last two weeks on no news. Continue to hold. HOLD HALF

Si-Bone (SIBN) is one of the few MedTech stocks that might just look better than INSP. That’s especially impressive given the company completed a stock offering in early May, priced at 22 (stock at 27.5 now). Morgan Stanley recently upped their price target on SIBN, from 27 to 30. BUY HALF

Terex (TEX) has had a great week as have a number of other machinery stocks (CAT being one). While the stock has been a bit tough to hold on to, recall that Q1 results smashed expectations, management raised full-year guidance, and there appears to be some baked-in conservatism in case there are cost pressures. BUY HALF

TransMedics Group (TMDX) has come up nicely over the last week. The big question with this company is exactly how it will build out its aviation business and what the impact on the core TMDX business will be. With the recent $400 million convertible note offering, TransMedics is clearly getting ready to do something. Timing isn’t precise, but I’d expect something will be announced before the end of the year. HOLD THREE QUARTERS

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.