Small caps fell 2.4% this week with almost all sectors declining. Energy was the biggest outlier, as small-cap energy stocks rose 4.5% on the back of oil prices. Technology was the hardest-hit sector, and was largely responsible for the 5% decline in our portfolio.
Despite the down week, small caps still lead large caps year-to-date, and most sectors have notched gains thus far in 2018.
Technically speaking, small caps still look good. The S&P 600 Index continues to trade above its 50-day line.
The positives that have helped small caps outperform through the first half of the year, including exposure to the U.S. economy, outsized benefits from tax cuts, rapid revenue and earnings growth, etc., should continue to keep big investors coming back, barring an all-out trade war (which would probably be bad for all stocks).
I also think that, while there’s been a decent pullback in software stocks (both big and small), the attractiveness of the SaaS business model, coupled with rapid growth and rising profits for many small companies that are either nearing or over the break-even threshold, will pull money back into the group. The cloud-software trend is massive, and it’s not going away. Yes, there will be corrections. But ultimately, these stocks should find support and begin to move higher again. We want to be there when they do.
As far as what to do about all the trade war talk, let’s not make any major moves based on speculation about what may or may not happen. This administration is too unpredictable. Our strategy is to make gradual moves and take our cues from the market. Right now, we’re getting mixed signals, so we’ll continue to stick with our strongest stocks and pull back on those with faltering performance.
We could see some funky trading action next week since the Wednesday Fourth of July holiday will mean a lot of people out of the office. But then the market will start looking forward to Q2 earnings reports, which will begin to come out in late July and early August. The beginning of another earnings season will drive a pickup in investor interest and plenty of catalysts. And if we head into it with stocks still searching for direction we could easily see dramatic jumps in price, especially if management teams are as bullish as they were right after Q1!
In other words, stay the course. This volatility probably isn’t over. But the trade-war saber rattling hasn’t yet translated to lowered growth expectations.
There are no ratings changes this week:
Updates
AppFolio (APPF) is a provider of cloud-based software solutions for small and medium-sized businesses in the property management and legal industries. I moved the stock to hold a few weeks ago, then recommended taking partial profits last week to lock in a roughly 115% gain. Shares closed down just 3% this week so not a lot of movement here, and the stock is still comfortably above its 50-day line. But it’s still trading at quite a premium (EV/2019 estimated revenue is 9.1). Given the competing perspectives of strong technical strength but downside potential based on valuation, the smart thing to do here is sit pat on your remaining shares. If you haven’t yet, take partial profits soon, and hold the rest. SELL HALF, HOLD HALF.
Apptio (APTI) helps IT leaders analyze, optimize and plan technology investments and benchmark financial and operational performance against peers. It’s a hot space thanks to the trends toward cloud and digitization. The stock is reasonably valued from my perspective and with shares holding up OK and above their 50-day line I’ll keep at buy. Just be sure to average in with relatively small purchases given broad market volatility. BUY.
Arena Pharmaceuticals (ARNA) is our only biotech stock and is developing treatments for a broad range of immune and inflammatory conditions. Ralinepag (APD811) is intended to treat pulmonary arterial hypertension (PAH) and etrasimod (APD334) is a candidate to treat both ulcerative colitis (UC) and, in the future, will enter a program in Crohn’s Disease (CD). Both drug candidates are entering Phase 3 trials. Arena is also moving olorinab (APD371) into Phase 2 for the treatment of visceral pain associated with Crohn’s disease. We’re in a quiet period so there’s not a lot to keep investors engaged. But the Arena story is still quite bullish. I recommend taking advantage of the dip and adding shares. Continue to average in. BUY.
AxoGen (AXGN) is a rock star, and while shares haven’t advanced at all over the past month, they haven’t fallen either! The company makes implantable products for peripheral nerve injuries. Revenue has been growing by more than 40% and analysts project the trend continuing through 2019, if not longer. I continue to think dips in the share price will draw in buyers, so I’m keeping at buy. BUY.
Everbridge (EVBG) is another rock star, even though shares have been declining for the past two weeks. At least, they were up until yesterday. The company sells cloud-based critical communications software that help keep people safe and businesses running. Earlier in the month a number of firms upgraded price targets to the high $50s and given the strength of yesterday’s bounce off the 50-day line I suspect the selloff is mostly over. That said, until things settle down the prudent thing to do is give Everbridge a little space, so I’ll keep at hold for now. This week management announced the integration of its IT Alerting solution with Ayehu, a leading provider of intelligent automation and orchestration powered by artificial intelligence (AI). I’m not familiar with Ayehu, but I have commented a number of times in recent months that Everbridge is making a more concentrated push to grow its IT Alerting service, and this is more evidence of that initiative. Continue to hold. HOLD.
Instructure (INST) was on the verge of breaking out to fresh highs two weeks ago but the broad pullback in tech stocks killed that rally for the time being. The good news is that shares found support in the 40 to 41 area again and jumped above their 50-day line yesterday on decent volume. I’ve kept at buy since I think the next move will be significantly higher, and I’m sticking with that rating today. Instructure sells cloud-based learning management and collaboration software solutions to schools (K through higher ed) and corporations. BUY
IntriCon (IIN) is digesting its spring rally. A couple of dips have held firm at around the 37.5 level. I moved shares to hold last week given the outsized move since early June (we’re up around 20%) and we’ll stick with that rating for now. IntriCon has a mix of stable business from large medtech companies, including Medtronic, to whom it mostly sells continuous blood glucose monitoring device parts. And it has potential to disrupt the hearing aid market through sales to other manufacturers, and through its own eCommerce platform, Hearing Health Express (HHE), as growth in the Over-the-Counter OTC hearing aid market evolves. This revenue mix gives investors exposure to a rapid-growth, stable business (diabetes) plus the optionality of the hearing aid business. And Medtronic’s diabetes business is going great. Diabetes is Medtronic’s fastest growing business, and approval of the MiniMed 670G system for children seven and over is another incremental positive. I expect to move the stock back to buy at some point, but for now just hold on to what you have. HOLD.
LogMeIn (LOGM) is our biggest stock, with a market cap of more than $5 billion. At least it was our biggest stock. I sent out a Special Bulletin this week advising you to sell your shares and hold the capital for an upcoming opportunity. LogMeIn is a great business with talented management, but the lackluster performance lately is impossible to ignore. SELL.
MGP Ingredients (MGPI) is our whiskey and food ingredients stock the trend has been one of higher highs and higher lows, with most dips finding support at the stock’s 50-day moving average line. That pattern is holding true again now, and as a result this looks like a great time to add exposure. As I mentioned last week, the EU has threatened tariffs on whiskey, which could potentially be bullish for domestic producers. On the other hand, Canada recently threatened tariffs on U.S. whiskey, so who knows where the dust will settle. MGP also has a thriving food ingredients business and booming sales of premium proteins are one of the reasons. According to the NPD Group, 60% of U.S. consumers want to get more proteins in their diets, and they are doing so through both meat- and plant-based proteins, including almond milk, tofu and veggie burgers. I think this trend will continue to benefit MGP. BUY.
MiX Telematix (MIXT) is our South African-based provider of fleet management, driver safety, and vehicle tracking software solutions. Shares have pulled back to just below their 50-day moving average line and are searching for support, which should be rock solid around the 17 level. That said, I moved to hold last week until we get more evidence. HOLD.
Q2 Holdings (QTWO) broke out to fresh highs in June but has fallen to its 50-day line over the past two weeks. This looks like a good place to buy. Shares consolidated around this level in May, and that base should provide support now. Q2 sells cloud-based virtual banking software solutions and is well-positioned to keep growing as deregulation, rising interest rates and positive industry growth spur financial institutions to increase spending on technology. BUY.
Rapid7 (RPD) sells cybersecurity software. Shares are hunting for support between their 50- and 200-day moving lines after a couple of high-volume down days early in the week. Valuation is reasonable, and with a broader set of solutions to sell as part of its entry into the emerging SecOps movement, and a transition to an easy-to-deploy Software-as-a-Service (SaaS) pricing model, Rapid7 should pull out of this correction just fine. Keeping at buy. BUY.
Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.
