December 16, 2021

A quick housekeeping note. Cabot’s offices will be closed next Friday (12/24) and the Friday after (12/31) for the Christmas and New Year’s holidays. My work schedule over the next two weeks will also have me working odd hours (two young kids) and trying to spend some time with my family, to the extent market conditions allow. During these times it’s easy to keep abreast of the market but harder to find blocks of uninterrupted time to sit and write. Bulletins and/or Weekly Updates will likely be brief!

On to the market …

The biggest thing happening is the change in fiscal stimulus and interest rate policy.

Yesterday the Fed said it intends to accelerate the tapering process by reducing purchases by $30 billion a month (from $90 billion to $60 billion) starting in January. This is half of what was being purchased a few months ago. The program is on track to end by March 2022.

The faster taper sets the stage for a rate hike cycle to begin in spring. Most central bank officials are calling for at least three one-quarter-percentage-point rate increases in 2022 and roughly the same number in 2023.

In response to the Fed’s statement and Powell’s press conference yesterday, the market rallied. The small cap index came off its lows, which were roughly in the middle of the trading range that’s persisted for most of 2021 (since March). For reference, that level is around 110 on the iShares Core S&P 600 ETF (IJR) or 1,355 for the S&P 600 Index.

In the early going, it’s a mixed bag today. Several small and mid-cap growth names are looking modestly stronger while the mega-cap tech names are a little weak.

My immediate interpretation is that investors believe the biggest current risk out there is inflation, and that by trying to tame it, the Fed is doing what’s good for the economy and the market.

By Powell’s own admission, the expectation of higher inflation can drive real inflation up. As the market is forward looking, the enactment of the “Powell Pivot” has the potential to lower inflation expectations as well as actual inflation back towards more palatable levels. We will see.

My best guess is this will help the market firm up and set up little end-of-year rallies in some beaten down names. But as always there’s no guarantee.

The surge in coronavirus cases is alarming. Yes, we’re learning to live with it (as Powell repeated during his press conference). But living with something is different than thriving with something. Work, vacation, social and/or medical treatment plans have been disrupted by Covid and those instances are become more frequent again. There’s an economic cost of some sort.

On the flip side, the digital economy is booming! While the recent destruction in growth stocks – many of which are plays on cloud, digital transformation, e-commerce, Internet and fintech themes – suggests investors aren’t so high on the digital economy as they were even three months ago, the reality is these big-picture trends remain very much intact. Software and Cloud 2.0 investments are expected to continue, if not accelerate.

Finally, data from past rate hike cycles suggests growth-oriented stocks can do quite well during these periods even though higher interest rates initially tend to put downward pressure on analyst price targets for high-multiple stocks.

The following data from Bank of America shows sector returns during years with an aggressive Fed.

As you can see, while there has been some variability in certain sectors in different years, there are pockets of relatively consistent opportunity (highlighted in green).

Specifically, growth, pharma and tech have typically tended to do very well during years with aggressive Feds. In 15 scenarios there was only one year in which one of these factors delivered a negative return (tech in 1979).

Energy stocks haven’t been as reliable, but the dramatic gains in certain years (1979 and 1980) pulled that factor’s average up.

Overall, stocks haven’t been awful, delivering an average gain of 3.2% in the five years with aggressive Feds.

As always, historical high-level data isn’t anything to bet your life savings on. There are different things happening during each rate hike cycle and with individual stocks. And the current environment is pretty messed up.

In terms of our current portfolio, I believe we should see a decent rebound in many of our stocks over the coming weeks. We’ll just have to take it as it comes after that. And remember, there’s always funky trading at the end of the year and around Christmas.

Recent Changes
Kornit Digital (KRNT) moves to BUY
Revolve (RVLV) moves to BUY

Updates
Arena Pharmaceuticals (ARNA) surged to all-time highs this week on news that Pfizer (PFE) will buy the company for $6.7 billion (implied price of 100 a share). ARNA closed yesterday at 92.85. The discount to the takeout price likely implies risk that the deal won’t go through as Pfizer has some assets in the market that could be competitive to etrasimod (the main asset they’ll get from Arena), albeit with somewhat different mechanisms of action. Those assets include Xeljanz, Cibinqo and TL1A. One question that has popped up is why Arena would agree to a buyout with the Phase 3 ELEVATE studies set to release data in Q1 2022. If that data is as good as is expected, we would hope to see ARNA trade well above the 100 price. On the flip side, the market has been iffy lately (especially in biotech) and a solid offer from PFE may afford more price stability in ARNA stock for investors to sell into than a post-trial announcement surge (assuming good data). In response to the PFE offer and subsequent stock surge I advised selling half of ARNA (136% gain from our entry price). We’re continuing to hold the other half as this story unfolds. There are deal breakup fees due if either Arena or Pfizer backs out. SOLD HALF, HOLD HALF

Avalara (AVLR) was moved to buy a couple of weeks ago. On Tuesday JP Morgan upped the stock’s price target to 190 given “defensive nature of its solutions and potential for either better growth or margins.” The stock also remains a top pick at Bank of America and is well liked at Morgan Stanley. If software names get a bit of a bounce here the stock should do well. BUY

CS DISCO (LAW) is still trading at depressed levels (from the all-time high) and modestly above the IPO price of 32. No change. I still think this stock has the potential to rip higher. BUY

Everbridge (EVBG) was beaten up by news of the CEO’s departure and I detailed the news in a Special Bulletin last week. I apologize for how late in the day that bulletin came. Staff at Cabot had a holiday event, and I wasn’t aware there would be a period of time when nobody was available to send alerts. Still, there was no way to get out of the way of the price fall as EVBG opened lower and stayed down for the day. We saw a little bounce on Monday. In reading up on the name since the news broke, there has been some speculation that David Meredith could be leaving for compensation reasons, with the biggest concern being that growth won’t be sufficient enough in 2022 for him to earn performance-based incentives. That would suggest Everbridge isn’t well-positioned to capture EU countrywide deals, as we have expected/hoped. Are other key people looking to leave as well? On the other hand, people leave companies for all sorts of reasons. I moved the stock to hold (instead of sell) as it seems like we could recapture some of the lost ground before selling, which I do expect to do before long. Continue to hold. HOLD

Inspire Medical Systems (INSP) remains near its 200-day line. The ongoing concern here is that a Covid surge curbs elective procedures. That seems at least somewhat likely in the near term. If it’s a short-term thing INSP should be just fine. If it goes on (and gets worse) for two quarters or so that could cause a little softness in the stock. For now, keeping at buy. BUY

JOANN (JOAN) at 10 remains a buy. Yes, it’s beat up, but investors looking to load up on small-cap value stocks with significant upside potential in the next 12-24 months should like the mix of capital gains and yield (4%) potential here. BUY

Kornit Digital (KRNT) hasn’t come this close to its 200-day line since mid-May (it’s up 65% since), and at 24% off the high, the pullback is in the neighborhood of the worst we’ve seen in a year (33% was the spring 2021 retreat, most pullbacks are in the 10% to 16% range). We’ll take a swing at the stock here while acknowledging that there’s still 7% downside to the 200-day line at 127 and a break below the 125 – 135 zone could signal even more downside. BUY

Rani Therapeutics (RANI) has come way back down over the last two weeks. There’s nothing that’s changed about the story. Remains a buy. BUY

Revolve (RVLV) has now pulled back 35% from its recent high. Shares are barely below the 200-day line and bounced yesterday at 54.70, which also happens to be where the stock turned north after a 27% drawdown in August. We’ll step up to the plate here. Returning to the buy list. BUY

Repligen (RGEN) has been consistently bouncing off the 250 level for two months now. The 113-day consolidation phase from this past summer suggests this third test will be the last and RGEN can start to make upside progress again. I’m not sure the tea leaves always tell such a clear story, so we’ll keep at hold for now. HOLD

SiTime (SITM) has been trading in a wide range since we added the stock two weeks ago but thus far has held above its 50-day line. There is no new news. The company is a play on the shift from quartz to silicon-based timing systems as well as the need for more of these types of devices in electric vehicles (EVs), datacenters, 5G infrastructure and other applications. Management has been calling for at least 30% growth in 2022. Given the trends in the business, that seems appropriately conservative. BUY

Shutterstock (SSTK) was added on November 4 and is down 8% since then. I think that’s a testament to how high-quality growth + value stocks are viewed by investors these days (yield is less than 1%, but it’s still something). There’s been virtually no news on the company since we added it, which is fine with me. Recall that Shutterstock has a global marketplace for digital commercial imagery (video, images, music) that is sold to marketing agencies, large and small businesses, media and broadcast companies, etc. Customers pay to license content while content contributors get a cut. BUY

Sprout Social (SPT) continues to trade near its 50-day line. This pullback is consistent with previous corrections in the stock, most recently last spring (shares fell 40% and took 83 sessions to get back to their previous high). A price target cut out of Morgan Stanley (from 146 to 110) today might keep a lid on the stock in the near term (firm cites rising interest rates and valuations in slashing a number of software stock price targets), even if other software stocks rally. Keeping at buy. BUY

Thunderbird Entertainment (THBRF, TBRD.CA) continues to move sideways with little drama. As I stated last week the relative calm in the stock has been welcome, though I’d like to see some sustained momentum above the 5 level. BUY

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