Most growth stocks have lagged behind amid the ongoing rally. But one that caught our eye a month ago has gotten a nice head start, and despite hitting new highs is still a buy in our eyes.
I’ll reveal the stock in a bit. But first, let’s examine how this rally came about by going back in time to something I wrote in January.
Update on the 5 Characteristics of a Market Bottom
It’s been two months since I initially wrote about the five characteristics of market bottoms, and things have gone swimmingly since!
Here’s the status of the five characteristics right now:
1. Extremely Negative Breadth and Sentiment Measures
This measure clicked in late January and early February, with numerous indicators flashing green—investor surveys, put-call ratios, number of stocks hitting new lows … there was real panic during that time.
2. A Bottom-Building Process
This didn’t play out as most bottoms have in the past—the bottoming lasted just three weeks. It’s possible that the market will back off here for a few weeks and the three weeks will become part of a larger bottom-building process, but to this point, it’s been an unusual situation.
3. Positive Divergences as the Bottom is Built
We saw the number of stocks hitting new 52-week lows dry up to around 1,400 (NYSE and Nasdaq combined) on February 11, after spiking to 2,300 on January 20. More important to us is that the broad market has now turned healthy—we’ve had more than 15 days in a row with fewer than 20 stocks hitting new lows (including many single-digit readings), which is bullish for the market.
4. The Trends Turn Up
This remains a split decision—our intermediate-term indicator (we call it the Cabot Tides) turned bullish in late-February, but our longer-term indicator (Cabot Trend Lines) is still negative.
5. Growth Stocks Powerfully Breaking Out of Trading Ranges
This is what I’m watching most closely today. So far, off-the-bottom stocks (industrials, transports, commodities) and dividend stocks (REITs, consumer staples, utilities) have led this rally. For the five-week rally to morph into a five-month rally, some growth stocks will have to get going. To this point, I’ve seen many stocks set up nicely, tightening up near the top of multi-month ranges, but few have actually lifted off.
That’s not bearish, exactly, but it’s the big item to watch—if a bunch of growth stocks get going, it should give the market the added juice it needs to reach new highs (and even rise further than that). If not, then the market would likely need to back and fill.
Is a “Blast-Off Indicator” Flashing?
When I was a kid just getting into the stock market, I really enjoyed market timing—the ability to get out of big bear markets and back in when the getting was good always appealed to me. And, of course, it’s helped us a lot at Cabot in recent years on both the bull and bear side.
Trend following is the biggest key to our current market timing system, but I’ve always had a special place in my heart for so-called “blast-off indicators.” Each blast-off market timing indicator is different, but they’re all based on the same theory—when the market shows extreme and unusual power over a period of a few weeks, it often leads to higher prices over the coming weeks and months.
What I like about these indicators is that they’re so contrary to human nature. Most investors get scared away from buying after the market has romped higher, especially when that move comes after a big decline (and thus most of the news remains bad). But in reality, these indicators show you a sudden positive change in investor perception … and that change tends to persist for many months, driving prices higher.
I remember the first time I took action on a blast-off indicator—it was October 1998, after the Long-Term Capital Management/Russian Ruble fiasco, and it got me invested early in a huge bull move that eventually led to the Internet bubble 18 months later.
I can’t promise another lucrative bubble is coming, but the good news is that one blast-off indicator is flashing now. At the end of last week, more than 93% of all S&P 500 stocks (93.4% to be exact) closed above their respective 50-day moving averages. That’s one of the highest readings in years!
On the flip side, less than 90% of S&P 500 stocks were above their respective 200-day lines—so the market isn’t hugely overbought from a longer-term perspective.
When you combine the two (>93% above their 50-day lines, but <90% above their 200-day lines), you have a relatively rare signal—it’s flashed just five times since 2000. And all of them have led to solid gains in the following few months.
Specifically, the median return six months later for the S&P 500 was a solid 12.5% (all five instances were up at least 9.2% six months later), while the market was higher by an average of 16% one year later. Moreover, on average, the S&P 500 rose as much as 19% at some point during the year following each signal.
The caveat, of course, is that five instances don’t make an exhaustive study—there’s not overwhelming evidence that such a signal will definitely lead to higher prices. And, short-term, these signals often led to a market pullback of two or three weeks. So I’m not saying now’s the time to put all your money to work.
Still, my gut tells me this kind of buying power is relatively rare, especially when it comes right after a multi-month decline. I’ll be looking for more historical data to see if the bullish results from the past 15 years played out similarly in past decades. For now, I’m considering it an arrow in the bulls’ quiver.
Bottom line: It’s looking like the next few months (at least) will be a great time for the market, and an even better time for leading stocks. I’ve been adding new leaders to Cabot Growth Investor’s Model Portfolio—if you want my best ideas (and follow-up on when to buy more, hold, and eventually sell), sign up today! Click here for details.
A New Leading Stock at New Highs
As I mentioned above, most growth stocks are still on their launching pads, which I think is a good thing, at least for now. If the market strengthens from here, my guess is we’ll see some rotation into exciting new growth ideas.
That said, I’m also seeing many “follow-on” opportunities in growth stocks—names that soared to new price highs in recent weeks (often following a great earnings report) and have since traded very tightly on light volume … a constructive sign that higher prices are ahead.
A perfect example of this is Texas Roadhouse (TXRH), a steady cookie-cutter story. Here’s what I wrote about the stock in Cabot Top Ten Trader back on February 29:
“The new trend in the restaurant industry is fast-casual, but Texas Roadhouse is doing great business in the full-service arena, offering an assortment of steaks, ribs, chicken, pulled pork and the like, along with unlimited in-shell peanuts and yummy made-from-scratch rolls. The stock has been a long-term winner as earnings have cranked higher many years in a row, and is strong today as the fourth-quarter report topped expectations and most investors expect 2016 to show a marked acceleration in earnings growth (partly thanks to falling food costs). In the fourth quarter, margins rose 1.1% from the year before, while same-store sales growth rose more than 4%. And analysts see more where that came from: revenues are expected to rise 12%, but earnings are expected to rise 25% thanks to falling costs (1% to 2% food deflation) and a modest share buyback program. (The company also pays a decent 1.6% dividend, which has been raised for five straight years.) As for footprint, Texas Roadhouse has 485 restaurants open, and plans to add about 37 new locations and should have plenty of room for growth from there. It’s not the fastest growing cookie-cutter concept, but management has pulled the right levers for years and there’s no reason to think that will change.”
The stock soared after its fourth-quarter report, gapping to new highs on six times average volume near the end of February. And since then, TXRH has traded very tightly, moving straight sideways on the chart on low volume. A short-term shakeout is always possible, but this action is very constructive and should lead to higher prices. I think TXRH is buyable here or on dips of a point or two, with a stop near 38.
Find out more about momentum stocks featured in Cabot Top Ten Trader. The advisory has a 97% win ratio year-to-date and handed our investors 62 winning trades since the beginning of the year.
Sincerely,
Michael Cintolo
Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader
