June 16, 2022

While the market began to show some encouraging signs later in May and into early June, the past week and a half has been a mess.

The S&P 600 Small Cap Index slipped back to its May low near 1139 on Monday and was holding OK there, until today.

The culprit is the potential implication of inflation data from last week (too high and too persistent) and the accelerated pace of rate hikes.

The Fed took the gimme by raising 75 bps (basis points) yesterday (the market had adjusted quickly to expect that) and there’s now an 84% chance of another 75 bps hike in July (had been 50 bps a week ago).

On the latter, in a way speeding up the pace is a good thing as the market has priced that in anyway.

But one of the more troubling takeaways/reminders from the last week is that despite the Fed’s efforts to rein in inflation there are elements beyond its control. Supply chain issues and energy prices come to mind (we really need gas prices to come down).

That has spooked the market (even more than before) into thinking the only way to address inflation is to induce a recession that really slows down demand.

There is a lot more to it, but that’s it in a nutshell. So recession risks go up, forward earnings estimates and EPS estimates go down, and stock prices fall.

The million-dollar question is – how much of this is already priced in?

That totally depends on how bad things get. At the moment, you go out into the world and if you don’t read the front page of the newspaper or watch the news things seem pretty good. People are out doing things and spending money.

To me it seems like a much more fun economy than we had over the last two years!

But the news is awful, and the market is garbage. The reality is this is probably a good time to be buying stocks, but you have to have patience and conviction to hold through whatever comes next.

For now, we’ll trim a little more today and hope it’s a horrible mistake. But really I’m spending more of my time looking at what we can buy for the next year or two. Not so much at stock prices but at businesses.

Things are pretty bleak at the moment, and the path out of this is murky. But it’ll come into focus, and we’ll go higher again. The economy slows down, stocks take a hit, and at some point growth picks up and stocks go higher again. Rinse and repeat.

Recent Changes
CS Disco (LAW) moved from BUY to SELL HALF
Revolve (RVLV) moves from HOLD to SELL

Updates
Avalara (AVLR) has slipped back to the early-May low (roughly 67) this week. Suffice to say we’re looking for shares to hold here and I’m keeping a close eye on it. Avalara should deliver revenue growth in the low- to mid-20% range this year and next and 2022 should be its last year of negative EPS (-$0.06 expected this year, $0.21 expected in 2023). The stock’s trailing EV/Revenue multiple is currently 7.5. That’s just above the record low of around 7.2 from 2019. HOLD A QUARTER

CS DISCO (LAW) slipped below the May low of 20 this week and we’ll heed that action and sell half the position. I think the price down here makes LAW incredibly attractive, but we can’t fight the big-picture battle. SELL HALF, HOLD HALF

DigitalOcean Holdings (DOCN) slipped this week with the market. There has been some bullish options activity in the name (August call options, which likely expire soon after Q2 earnings are reported). DigitalOcean offers a cloud computing platform, sort of like AMZN, GOOG and MSFT, but tailored more toward small businesses. Most of the new customers come in through the website. Management held an investor day last week and reiterated its goal to get to $1 billion in revenue by fiscal 2024 (estimated 2022 revenue is $570 million). The company also continues to see immense growth potential in higher-value customers (sees twice as much growth in +$50/month customers). However, despite price increases there was no guidance raise. That could be interpreted as conservatism or some erosion of growth. Either way we’re starting with a half position because the potential is here, despite a horrible market. BUY HALF

Ingles Market (IMKTA) has gained some altitude this week along with other grocery store stocks. There’s no news to speak of here, it’s just that grocery stores are pretty reliable during economic contractions. BUY HALF

Inspire Medical Systems (INSP) was moved to buy last week and responded by moving down over the next three sessions. Given that the move was in lockstep with the market and had nothing to do specifically with INSP, I’m maintaining at buy. INSP is trading around its summer 2021 lows. BUY

Procept BioRobotics (PRCT) was hit hard on Monday on no news (shares closed down 19% on the day). Three days later the stock has regained most of that lost ground. Recall we had some good news last week. Five new regional private insurance plans have issued positive coverage policies of Aquablation therapy. These include three BCB Association healthcare plans, Medical Mutual (Ohio) and Presbyterian Healthcare Services (New Mexico). Total new lives covered is 8.5 million. HOLD HALF

Rani Therapeutics (RANI) remains in a downtrend but just attracted the attention of Wedbush who initiated coverage with a buy rating and 28 price target. The stock is up nicely today and back above where it was trading late last week. We’re moving into the second half of the year when we should get an update on the Phase 1 clinical trial of RT-102 (treatment of osteoporosis) and also see a second Phase 1 clinical trial start. Management should also provide incremental updates on RaniPill HC (high capacity). With the standard RaniPill and the HC version the company expands the number of potential applications, including larger biologics such as Cosentyx, Keytruda, Herceptin and more. Rani has $107.8 million in cash, which should get it through the end of 2023. These types of stocks can move quickly so, while I certainly don’t like the slide, I’m also mindful that RANI could pop any day and we still have half a position to fill, if we wish. BUY HALF

Revolve (RVLV) gave up a little ground last week but even in the face of a horrible market Monday and Tuesday the stock held up fine. That’s not the case today as shares are off 11%. My concern now is that the current quarter will likely see some consumers really pulling back (all the news they are hearing is about how awful things are) and RVLV will have a high bar post-earnings for the stock to work. A break below 24 for RVLV will get really ugly and we’re going to step aside before that happens (it’s not guaranteed, but also seems unlikely RVLV will rally in the face of this market). Ultimately, I think RVLV will be one of the e-commerce winners, but we need a better consumer picture for the stock to work. SELL

Repligen (RGEN) revisited the May low near 137 this week. No news. HOLD

Sprout Social (SPT) held above the May lows this week (an encouraging sign even though the chart doesn’t look great). Continue to hold. HOLD HALF

Xometry (XMTR) has taken this week’s volatility in stride and is still just moving sideways near its 50-day line. HOLD

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