The Japanese phrase, hara hachi bu, translates into something like “belly 80 percent full,” or “eat until you are eight parts full.”
It is a Confucian teaching that gained visibility in the west after Dan Buettner went into some detail on the practice in a cover story he wrote for National Geographic in 2005 entitled, “Secrets of Long Life.”
He talked about how the Japanese archipelago of Okinawa is a Blue Zone, a place where people live extraordinarily long and healthy lives. Part of the reason this Blue Zone exists is due to a lower calorie intake, which can be partially attributed to the Okinawan people’s practice of hara hachi bu.
Buettner’s research suggests they are in tune with their bodies and know there is a roughly twenty-minute delay between the time they stop eating and the time it takes a signal to travel from stomach to brain saying, “Hey, I’m full!”.
The stock market is having a hara hachi bu moment.
On the surface the economy appears to be doing great. Growth is good, unemployment is down, income is up, healthcare costs aren’t surging anymore, and inflation appears modest, right around the Fed’s long-run target of 2%.
So why is the stock market going down?
In simplest terms, there’s a timing issue. Economic data is backward looking, while the stock market is forward looking. The stock market sees all the good news in the economy as a signal that things can’t get much better.
The economy appears at least 80% full. With little room left for growth, productivity gains, etc., things must be about to get worse, right?
How long it will take for things to get worse is up for debate (but longer than 20 minutes!). With belly-full signals appearing (especially when you look for them) investors are pushing back from the table and kicking up their feet. Hara hachi bu.
One of the commonly-voiced frustrations with the economy-being-too-full-to-get-any-better perspective is that growth-limiting factors appear self-imposed.
The market endures years of the slowest recovery on record and then right when things get good the Fed steps in, kills the party, and Trump starts a trade war!
It’s one thing to push back from the table because you know you’re about to be full. It’s quite another to have food pulled out from under your chin while your fork is in mid-air and you’re enjoying every bite.
Of course, the practical challenge with broad sweeping generalizations about the stock market is that there’s always more than meets the eye.
The secret to finding your own Blue Zones in the stock market is to listen to what it’s telling you and make incremental moves. Realize that you don’t know when it’s 20%, 50% or 80% full until historical data proves that it was.
Balance the timing issue between backward-looking data and the forward-looking market by spreading your investments out over time. Average in, average out.
Also, and especially with small caps during tricky markets, focus on secular growth stocks with potential to do well in a variety of market conditions.
This is how our current portfolio is positioned. While it doesn’t mean all our stocks will do fine regardless of how the economy and stock market does over the next 12 months, we have put the odds in our favor by steering clear of the most cyclically sensitive stocks and focusing on those with exposure to secular growth trends.
In terms of what specific actions to take now, continue to average out of stocks that aren’t performing and/or that you want to protect gains in, and into those that are holding up relatively well and which you would be comfortable averaging down into should they drop. Keep all purchases small as capital preservation remains a top priority.
And remember, while things took a sour turn this week there is historical precedent for the market to perform well over the next three quarters. It’s not too late for a Santa Claus rally!
Changes this week
Q2 Holdings (QTWO) Moved to BUY
(From Thursday’s Special Bulletin)
IntriCon (IIN) Moved From Hold to Sell a Quarter, Hold a Quarter
Axogen (AXGN) Moved From Hold to Sell A Quarter, Hold a Quarter
Altair Engineering (ALTR) Moved From Hold to Sell A Half
Updates
Altair Engineering (ALTR) sells simulation software and is a play on the digital twin theme. The big picture is that demand for simulation software is on the rise and Altair’s solver business is well-positioned to grow. It does have significant exposure to the automotive market which isn’t looking great from a macroeconomic perspective, but management has said the ramp-up in activity from non-conventional players (electric, autonomous, etc.) has been so significant that it’s not seeing any slowdown. We’ll see.
The stock has been under pressure since the dilutive Datawatch acquisition (just closed this week), which has raised doubts about integration and cross-selling potential given Datawatch’s largest exposure is in the financial services industry. That said, if you take a glass-half-full perspective and realize Datawatch was acquired for just over 3X sales and/or forget about Datawatch’s customer base and just consider the technology acquired, there appears to be quite a lot Altair can do with it. Long story short: Altair is an attractive company with an unattractive stock. We cut our position by a half yesterday to balance these two realities. Continue to Hold Half. HOLD HALF.
AppFolio (APPF) sells cloud-based software tailored to two industry verticals; property management, and small legal businesses. It has an efficient business model characterized by relatively low customer acquisition costs and high revenue/profit per customer. It’s also an expensive stock. It sold off with most software stocks but appears to have stabilized and is moving sideways around the 60 level. Be patient and keep Holding. HOLD.
Arena Pharmaceuticals (ARNA) was one of our better-performing positions this week, posting an 8% gain. The development-stage biotech just out-licensed its ralinepag asset to United Therapeutics (UTHR) for up to $1.2 billion in exchange for an $800 million upfront payment, a $400 milestone payment, and tiered low-double-digit royalties on global sales. That cash will help Arena move etrasimod, olorinab and other early-stage assets through the pipeline. No new news this week. Keeping at Buy. BUY.
AxoGen (AXGN) is a medical device stock that sells nerve repair solutions. The company is working to expand its market with new applications (breast reconstruction, pain, etc.) and has been tweaking its go-to-market strategy by hiring more direct sales reps (80% of revenue) and decreasing reliance on independent sales agencies (20% of revenue). Revenue should be up around 40% this year and 35% in 2019. We reduced our exposure yesterday (alert sent via Special Bulletin) from a half position to a quarter position since the stock seems to be grinding along around the 30 level without any evidence of upward momentum. If that changes for the better, we can ramp our position size back up. For now, Hold a quarter-sized position. HOLD A QUARTER.
Bottomline Technologies (EPAY) is one of those stocks that you want to buy now if you never bought too many shares when it was trading above 60. It’s essentially a play on digital business-to-business payments with a little digital banking exposure mixed in. Revenue should be up around 8% this year and 10% in 2019, while EPS should expand from $1.45 this year (up 14.2%) to $1.69 next (up 16.6%). I think the stock was unfairly punished in November. Keeping at Buy. BUY.
Chefs’ Warehouse (CHEF) supplies independent restaurants with food and other supplies. It’s a very difficult business model to emulate and while there are larger competitors (like Sysco and U.S. Foods) Chefs’ plays in a segment of the market where most customers have well under 50 locations. The stock has been strong lately, and given it just hit a 52-week high I moved to Hold last Friday. I still like it but given the recent outperformance it seems prudent to just sit back and hold tight with the shares you currently own. HOLD.
Codexis (CDXS) is our most recent addition. It is a protein engineering company that specializes in the discovery, development and commercialization of novel proteins. Engineered proteins (also known as biocatalysts and/or enzymes) are used in a wide range of industries to make manufacturing processes faster, cleaner and more efficient. Codexis’ CodeEvolver platform helps it engineer novel proteins that are better than naturally occurring ones, and it’s finding success in drug development, novel biotherapeutics, food and nutrition, and molecular diagnostic markets. Check out the full Issue (published last Friday) for all the details. The stock rallied in the two weeks prior to publication so we’ve started with a half position. You have the luxury of a more flexible purchasing timeline so just keep averaging in until you get to a half-sized position. As I wrote in the report, I’m looking for a pullback to around the 19 area (the stock’s September high) before I’ll consider filling our other half. BUY A HALF.
Everbridge (EVBG) sells critical event management software and is one of the few good-looking SaaS stocks out there right now. I’ve had the stock at Buy since I think you can pick away at it here. That said, I wouldn’t go in with a huge position (with this or any stock, for that matter). Everbridge still looks good this week after moving 4% higher. BUY.
Goosehead Insurance (GSHD) sells personal lines insurance and is disrupting the market by deploying a cloud-based sales and support platform coupled with a hybrid corporate and franchise distribution model. Most policies are either homeowner or auto policies, both of which are relatively sticky products. Goosehead represents over 80 carriers (Progressive, Travelers, Safeco, MetLife, etc.) so it’s able to offer clients the best policy for their situation. It’s also growing at a blistering pace; revenue should be up over 40% this year and next and has potential to accelerate as Goosehead scales the business up. It’s also profitable, with EPS expected to hit $0.27 in 2018 and $0.35 in 2019. There’s a lot to like here, and the stock has climbed back up into its “comfort trading range” from the summer (26 to 30). Keep averaging in. BUY.
IntriCon (IIN) makes components for Medtronic’s (MDT) blood glucose monitors, among other small medical device parts. It also has a hearing aid manufacturing business through which it sells to major brands, to companies selling direct-to-consumer (DTC) and through its own DTC channel, Hearing Health Express. The stock was great earlier in the year, not so much today. We’ve reduced our position to a one-quarter size (I sent a Special Bulletin yesterday advising selling your “third” quarter) and will sit pat here if the stock can stop going down. Otherwise, we’ll step aside completely. HOLD A QUARTER.
Q2 Holdings (QTWO) is a digital banking software stock that’s enjoying strong end-market dynamics as financial institutions are enjoying improving net interest margins. Revenue is expected to accelerate from 24% in 2018 to over 27% in 2019 as it goes live with larger installations. This should also help margins and drive EPS up from $0.11 this year to $0.28 in 2019. Usually a stock with accelerating revenue and EPS growth does well, but anything is possible in this market!
The biggest concern is industry consolidation in the customer base and given Q2’s target is at the smaller end of the size curve its customers are more likely to be the absorbed ones (meaning Q2’s platform could be cast aside). Still, the risk vs. reward potential here is attractive and the stock’s been moving sideways for a few months without any big rallies or dips. I’m moving back to Buy. You don’t need to go buy up a full position today; instead start pecking away if the story sounds good. Pull up my full Issue from our online archive (April 2016) for more details on the business. BUY.
Rapid7 (RPD) is a security software stock that’s on the tail end of a transition to the SaaS business model and has expanded its portfolio with new products that increase its addressable market. Security is one of those areas of software that’s a must have, which makes it somewhat defensive. That’s not to say there’s no competition and the stock can’t suffer from multiple compression, but Rapid7 has been doing well and 20% revenue growth this year and next, along with an estimated $0.45 EPS improvement in 2019, means it should be at about a $300 million annual revenue run rate and break-even profitability a year from now. That’s not a bad profile, and the stock trades at a comparatively reasonable valuation (EV/trailing revenue multiple of under 6). Keeping at Buy. BUY.
Repligen (RGEN) finally succumbed to selling pressure yesterday and dipped below its 50-day line. We got into the stock in early November, right after a post-earnings report rally, so we only added a half position, assuming we would eventually see some selling pressure. I can’t say exactly when we’ll step in to fill the other half position, but you should continue to average into your first-half position (if you haven’t filled it yet) or just sit pat (if you have).
Repligen is a pure-play supplier of bioprocessing technologies that make it more efficient to manufacture biologic drugs, while ensuring high quality and safety standards. It is a leader in areas such as filtration, pre-packed chromatography columns and Protein A ligand manufacturing. These solutions help customers overcome capacity, cost, quality and time pressures. It’s been doing very well due to innovation and growth in single-use technologies, which reduce capital spending for customers. Keeping at buy a half. BUY A HALF.
