Cabot Growth Investor Issue: April 18, 2024

Short-Term Pain, Long-Term Gain

After a very smooth and profitable three-and-a-half-month advance, we started to see leading growth stocks churn in February, all while near-term sentiment was very complacent as the major indexes were quiet and there were no shakeouts to speak of. While the trends remained up, such a combination—big run, churn, complacency—raises risk, which is why we were holding some cash in recent weeks.

Sure enough, as the second quarter got underway, the sellers stepped up to the plate, helped by rising interest rates and Middle East uncertainty: Coming into today, April has seen 4%-plus drops in the big-cap indexes, while equal-weighted indexes (RSP, QQQE) and growth measures are down about 6%, all in just half a month. More important for our purposes, our Cabot Tides and Two-Second Indicators have turned negative while many leaders have dipped below support, telling us the intermediate-term upmove has ended.

All of that leads us to the first part of today’s title: While we’re always open to anything, including this recent action being one big shakeout (there are some intriguing oversold measures out there such as a dry-up in the number of new highs; see more on that later in this issue), the Tides sell signal and breakdowns among leaders tell us the odds favor some more short-term pain and/or consolidation ahead in order to raise the fear level and shake out some late comers. We came into the month with 25% in cash, and we’ve pruned further since that point, leaving us with 37% on the sideline.

We’re willing to raise more cash, too—but we’re not eager to, because of the second part of the title above. Our Cabot Trend Lines are still clearly bullish, and while stocks have taken on water, we haven’t seen much big-picture abnormal action; we’re seeing many stocks have fallen 12% to 17% on light volume, but this comes after 75% to 100% rallies during the recent upmove. Not fun, but also not screaming trouble at this point. Thus, after this correction, it’s much more likely than not we’ll see a resumption of the overall upmove.

Put it together and we’re following the usual script in these scenarios—selling our weakest names and holding some cash but also trying to give our winners (most of which we’ve taken partial profits in) some rope while building a watch list for the next rally phase, with earnings season likely to reveal many future winners.

What to Do Now

In the Model Portfolio, we cut bait on our half-sized position in Celsius (CELH) earlier this week, which was our biggest laggard, while also selling one-third of Pulte (PHM), which has taken on water with the spike in interest rates. Tonight, we have no new buys or sells, though we are placing Applovin (APP), Arista (ANET) and DraftKings (DKNG) on Hold as we look to wait out this downturn.

Model Portfolio Update

We were been hesitant to get overly bullish during the past couple of months due to the churning in the market’s leaders—lots of ups and downs but with no progress—and now that our Cabot Tides are negative and the market has spilled into its first “real” pullback since last October, we’ve trimmed our sails further, holding more than one-third in cash and putting off most new buying.

As for the game plan, we’re letting the market itself tell us what to do—selling our weakest names (we threw our small position in CELH overboard earlier this week), though we’ve also taken more partial profits than normal (including PHM earlier this week) given some of the gains we had, and are aiming to give those names a chance to hold up—and eventually resume their longer-term advances. While not every leader will hold up, of course, the ones that do could still have plenty of gas left in the tank.

In terms of new buying, we’re content to mostly hold the cash we have until the market turns back up; we have some new names on our watch list today, but it’s likely earnings season will be key in terms of telling us which areas of the market want to lead the next advance. For now, though, we think playing a little defense makes sense as the correction runs its course—we now have most names on Hold and will be busy fine-tuning the watch list as earnings season revs up.

CURRENT RECOMMENDATIONS

AppLovin (APP)—APP has fallen off with the market in what looks to be a meat-left-on-the-bone situation—investors raising cash by selling off whatever growth names were holding up relatively well. Even so, the retreat has come on light volume, and overall it’s much more resilient than most stocks, growth or otherwise. (About two-thirds of names are south of their 50-day lines at this point, whereas APP is firmly above that line.) In terms of a game plan, we had a profit of just over 20% at the recent high, and one of our rules is to not let that kind of gain turn into a loss—thus, we’ll be using a mental stop on our stake near the 50-day line (near 64 and rising), which is a bit above our cost basis. That said, given ttheeh Tides sell signal and APP’s quick drop in recent days, we think it’s prudent to go to Hold and see how things play out. Earnings are due May 8. HOLD

Arista Networks (ANET)—ANET was acting just fine up until last Friday, when an analyst “double downgraded” the stock, believing the firm’s AI potential was overstated. That didn’t help the cause, and then came the breakdown in tech stocks as a whole (and this week, chip stocks in particular—Arista tends to trade in tandem with chip names) chipped in to create the sharp decline we’ve seen in recent sessions. The stock is certainly weaker than most other leaders; we took partial profits in February, and we’re changing our rating back to hold here and will use a relatively tight mental stop near 250 (give or take a couple of points). If ANET can hold up, we do think it can eventually regain its lost ground as signs of AI demand appear, but it’s up to the buyers to step up soon. Earnings are out May 7. HOLD

Cava Group (CAVA)—CAVA has certainly taken its lumps, but so far we’re seeing some encouraging signs: After its initial dip, the stock recouped half of the decline in just a few days (a sign buyers were lurking), and this second leg of weakness has found support so far at the 50-day line. We’ll see how it goes, of course—if CAVA really caves in we’ll cut our loss—but we never averaged up here so still have a small-ish stake, and there’s little doubt the growth story will play out as the store base grows 15%-ish annually and same-store sales likely perk up, too. We’re OK with a small buy here if you don’t own any, though be aware that a drop into the mid- to upper 50s could have us pulling the plug. BUY A HALF

Celsius (CELH)—There’s not much to say when it comes to Celsius—we started a half position after the stock pulled back a few points, but the re-do of the Pepsi deal changed perception just as the sellers started to flex their muscles in the overall market in April, leading to a rough downturn. That doesn’t mean CELH can’t eventually round out a new launching pad, but as opposed to many stocks that have had tedious but normal retreats (usually in the 15% range from their highs after big runs), CELH has fallen much more than that and has given up nearly all of its post-breakout move from early March. We cut bait earlier this week, are holding the cash and think there will be better stocks to own when the market is ready to get going. SOLD

CrowdStrike (CRWD)—CRWD is one of the names we took partial profits in and are trying to give our remaining stake room to breathe given the pristine short- and long-term story (including a very bullish free cash flow outlook for the next few years), though admittedly, it’s losing altitude along with most growth names, sitting about 14% below its highs (not including the brief post-earnings spike in early March). Fundamentally, there haven’t been a ton of new, concrete items from the firm, though it did add a few modules for use within the Google Cloud Marketplace, and we find it interesting that it formally released a product to help CEOs and big businesses with SEC disclosure rules surrounding breaches (something we wrote about near the start of the year). Our patience isn’t limitless, but big picture, CRWD’s action doesn’t look abnormal, so we’ll hold onto our remaining shares. HOLD

DraftKings (DKNG)—DKNG remains a tricky trader, deflating below its 50-day line as the market has been weak and some lingering worries remain out there in terms of regulations and the like (NCAA looking to ban some prop bets, etc.); it doesn’t help that its main peer (Flutter Entertainment, the parent of FanDuel, symbol FLUT) looks terrible, too. Because of the action, we’re moving to Hold, but with a solid profit still on the books and the firm’s super-bullish multi-year outlook released late last year, we’re OK giving the stock a bit more rope—though the 40 level looks key should the sellers should stay at it. HOLD

Nutanix (NTNX)—NTNX had an amazing run during the past few months, registering just one down week from the market low in October to the stock’s top in early March. Following that, some giveback was going to happen, which is what we’re seeing—though, so far, the damage has been tamer than many leaders, with the stock actually testing new high ground last week before retreating. Obviously, anything is possible, but we remain optimistic that the firm’s tech platform—which can operate at any scale in any type of cloud with any apps, including those for AI—will continue to produce rapid and reliable growth for a long time to come. And thanks to the subscription model that’s in place, that will keep free cash flow (which more than doubled in the January quarter) kiting higher. Much more weakness could have us moving to Hold, but right here, we’ll stay on Buy, thinking those that aren’t yet in could grab a few shares on this dip. BUY

PulteGroup (PHM)—There’s no question the backup in interest rates since February has dented PHM and other homebuilders, and that caused us to sell a portion (one-third) of our position earlier this week. Some good news arrived today, though—D.R. Horton, the largest builder in the country, reported a solid March quarter that included a 17% hike in new orders (in dollar terms) and, despite acknowledging higher mortgage rates, the firm upped its guidance for the next six months as well, bringing in some buyers to the group. Ideally, that helps investor perception, but Pulte’s own report (April 23, next Tuesday) will be key. Having already sold some, we’ll use a mental stop around the stock’s February lows (near 100, give or take a point or two) for the rest of our stake. SOLD ONE-THIRD, HOLDING THE REST

Uber (UBER) is like a lot of leaders—shares are down 13% from their highs, which isn’t pleasant, but the downturn has come on light trade and, of course, occurs following a huge move (the stock basically doubled from its late October low to its March peak). As we wrote on page 1, short term, the odds favor some more downside probing or consolidating, possibly allowing longer-term moving averages to catch up a bit, but the major trend is positive for the stock and for business, with the exploding free cash flow outlook released earlier this year likely to keep big investors interested. Earnings, of course, will be key (due May 8), but have taken a few chips off the table recently, we’ll simply sit tight. HOLD

Watch List

• Axon Enterprises (AXON 299): AXON actually tested new high ground last week before slipping to its 50-day line, but taking a step back, the stock has basically moved sideways since its big late-February earnings gap, while the story remains pristine.
• Core & Main (CNM 55): Core & Main is an infrastructure stock that has a long-lasting growth story, buoyant shareholder returns and a strong chart. See more below.
• Datadog (DDOG 125): DDOG may be one of the few “old” leaders that leads again this time around—bolstered by its leadership position in infrastructure and application monitoring. See more below.
• Natera (NTRA 87): NTRA has pulled back with most growth titles, but remains in decent shape as its cell-free DNA tests continue to gain share as more tests look likely to be approved.
• Robinhood (HOOD 17): HOOD remains in good shape despite some growth stock and cryptocurrency wobbles of late. There’s little doubt the trend of business is up, and the firm’s new rewards credit card (heavy incentives if you deposit and use their brokerage) could be a winner. Earnings are due May 8.
• TransMedics (TMDX 87): It can be a hot potato, but TMDX has a revolutionary story, rapid growth and, after a correction and consolidation the past two months, is acting well. See more below.

Other Stocks of Interest

Datadog (DDOG 125)—After a bear market, most former leaders never really regain their former glory, or if they do it takes multiple years—but the few that do snap back right away almost always have something unique fundamentally that re-attracts big investors. That’s what we see with Datadog, which looks like the leader in infrastructure monitoring (about $1 billion in annualized recurring revenue), application performance monitoring and log management (continuously collecting and parsing data from a variety of programs to boost performance), the latter two each having a bit over $500 million in recurring revenue. While the details can give you an ice-cream headache, the solution here always made sense: With all the varying (and ever more complex) apps and pieces of technology firms use these days, it’s vital to make sure everything is working as it should, both on its own and together with other IT assets, which is where Datadog comes in. As with everyone these days, the company is boosting the performance of its platform by integrating AI functionality; its Bits AI is a conversational offering that answers questions expansively and helps users more quickly identify and deal with issues. All in all, demand for Datadog’s wares is only headed higher as technology moves to the cloud and becomes more integrated (11% to 20% annual growth rate for the industry as a whole), so while the pandemic boom times are in the past, the future looks likely to produce steady, reliable growth in both sales and free cash flow for years to come: At year’s end, the firm had north of 27,000 clients (up nearly 18% from a year ago) and, when combined with a mid-teens same-customer growth rate, has been producing sales growth in the mid-20% range for the past few quarters. Meanwhile, free cash flow was up a big 69% for 2023 as a whole (and with a 28% margin!)—analysts see the top line lifting a bit more than 20% both this year and next, though our guess is that will prove conservative as the mega-trends underlying this business continue. As for the stock, DDOG changed character with a humongous-volume earnings reaction in November and ran to nearly 140 in February before stalling out—but the pullback wasn’t bad at all, and the stock is holding well so far even in what’s turned into a rough growth environment. It’s not the young buck it once was, but Datadog has an emerging blue chip feel to it.

TransMedics (TMDX 87)—We wrote up TransMedics three months ago on this page, and we said some sort of rest or retrenchment wouldn’t be surprising—and that’s exactly what happened, egged on by a kerfuffle with one House representative who accused the company of some bad practices. That doesn’t sound good, but management refuted the claims step by step, the stock held support, and now it’s under accumulation again as the underlying story remains fantastic. The company is revolutionizing the organ transplant field thanks to its organ care systems (OCS)—instead of cold storage where organs are flushed with a solution and transported on ice (resulting in tons that go bad), OCS is able to mimic real-life environments for lungs, hearts and livers, helping them “stay alive” longer and resulting in far more successful transplants (liver and heart transplants were up 12% last year, the fastest growth in at least eight years, and the company thinks OCS has a lot to do with it). Perhaps more impressive is that the top brass here isn’t content to just be a medical device outfit—after being frustrated with air charter brokers (the firm was unable to fill 20% to 30% of possible transplant missions), it’s built its own logistics network including new, longer-range aircraft that’s greatly boosting efficiency. Growth here has been amazing (revenues up between 156% and 162% each of the past four quarters!) and Q4 even turned a profit, though that’s unlikely to stick near term. Looking ahead, sales are expecting to increase about 50% this year (likely conservative), and long term, there’s huge potential as massive amounts of donated organs (especially lungs and hearts) go unused. TMDX had a giant decline last summer and fall, and an equally large recovery into February before finally pulling back. As mentioned above, though, the stock found support in late March and, encouragingly, spiked to new recovery highs last week (even as the market was weakening) on a string of big-volume buying. We’re intrigued—if the market can find its footing and earnings are pleasing (earnings are due April 30), we think TMDX can do very well.

Core & Main (CNM 55)—We’ve been looking around for an infrastructure stock that meets our growth criteria, as that segment of the economy (after years of over-promising and under-delivering) should be in boom times for many years thanks to both long-term municipal spending and incentives combined with years of under-investment in a variety of areas: Both non-residential and residential construction has been below trend for many years, while water utilities suffer an average of 16% water loss due to old piping (now averages 40 years old) and other factors. Core & Main isn’t a household name, but it’s an increasingly dominant distributor of everything from pipes, valves and fittings (two-thirds of revenue) to storm drainage products to fire protection offerings as well as meters (mainly for water usage); it’s one of only two national players (the firm has 17% of the total market) with about 80% of its products sold into municipal and non-residential applications (with residential making up the rest). Of course, the industries here are growing slowly, but Core & Main is gaining share and, as one of the big players, it’s active on the M&A front, adding small local players to boost market share, completing seven last year and four so far in 2024 with another two announced. (For those that have been with us for a while, it reminds us a bit of SiteOne Landscape on the M&A front, basically one of the only industry consolidators.) Moreover, the top brass has a very solid longer-term outlook based on what’s should be resilient demand no matter the economic environment: Between 2023 and 2028, it expects revenues to grow a total of 50% and EBITDA to lift 65%, leaving room for upwards of $1 billion of M&A and $2.5 billion of share buybacks/dividends during that time (market cap is around $12 billion). Translation: While not as rapid as a pure growth stock, Core & Main should see reliable expansion for many years to come. The chart is interesting, too: CNM built a giant post-IPO base from late 2021 through last October then broke out and staged a massive multi-month rally as sponsorship has boomed (795 funds own shares, up from 542 six months ago). Now the stock is pulling back with the market—it certainly has earned the right to rest for a while longer, but our guess is that this dip will eventually prove to be the pause that refreshes. CNM is on our Watch List.

New Highs Can be a Short-Term Contrary Measure

We obviously follow the number of stocks hitting new 52-week lows every day, especially on the NYSE—while not perfect (nothing is), we’ve found it to be a great measure of the health of the broad market, which is information that’s useful at most times and can be especially helpful near major market tops. Right now, the latest readings confirm the rest of the evidence—that the sellers are in charge right now but there aren’t many big-picture warning signs. (See our Two-Second Indicator write-up later in this issue.)

New highs, on the other hand, tend to work as near-term contrary measures. In a sense, the total number of new highs are indirect measures of greed and fear, and when combined with the market’s overall trend, it can help you be on alert for a turn: In an overall bull move like now, very elevated readings tell you there’s a lot of exuberance, whereas a big dry-up in the figures for two or three weeks lets you know the excitement has faded. As we wrote on this page a month ago, we don’t obsess over shorter-term indicators like this—but we do keep an eye on new highs when the market shakes out during a bull trend, like we’ve seen of late.

Shown here is the 15-day average of the number new highs on the Nasdaq during the past few months—notice how the surge into year-end led to a near-term pullback, while the dip toward the 100 level in January coincided with the market ramping up again. Again in March, the pattern played out, with elevated new highs leading to a lot of churn in growth stocks—and now the 15-day line has dipped back near the January lows.

That certainly isn’t a “buy signal,” as the decline can always continue—but it does tell you that a lot of wind has already come out of the buyers’ sails with the February/March churning action and, especially, due to the decline of the past two weeks on headline news (inflation and the Middle East). In other words, the bullish cannon is reloading fairly quickly it seems, so while we’re staying cautious right here, it’s important to remain open to a snapback given the longer-term positives that are out there.

Still Waiting on IPOs

We regularly run our IPO screens, as it’s common in a new bull phase to see some new issues morph into real leaders. The only issue is that, for much of the past couple of years, there haven’t been many IPOs! According to Renaissance Capital, the 2020 and 2021 period saw a ridiculous boom in new issues (a combined 618 IPOs that brought in $220 billion of proceeds), but since the start of 2022, “only” 215 have priced for a total of $36 billion, with 2024 showing no meaningful pickup from the prior two sluggish years.

That said, if something can come public when the IPO market is very dry, it’s often worth investigating. Cava Group (CAVA) is an example of a name we obviously like, and there are two more we’re keeping an eye on, including one that just came public.

The first is Maplebear (CART), which is the firm that runs Instacart, the grocery delivery service that offers consumers convenience while broadening the customer base for many large grocery chains, all while taking a 5%-ish cut of orders. Instacart is the hands-down leader in the field, yet online grocery delivery still makes up less than 5% of the total, so there’s plenty of long-term potential, both from transactions and advertising Growth here isn’t amazing, but analysts see high single-digit sales growth and expanding profits (EBITDA is solidly positive yet makes up just 2% of revenue) ahead, while the stock remains in a solid uptrend.

The second one we’re watching is very young—Astera Labs (ALAB) is essentially a chip firm that has some of the latest and greatest connectivity solutions (a combination of microcontrollers, sensors and the firm’s proprietary software) that play into the AI boom, significantly boosting the speed and efficiency of AI workloads and training. It’s a small fry, with just $51 million in revenue in Q4, but that was up 148% from the year before and analysts see the top line more than doubling this year while profits move into the black. Shares came public just a few weeks ago so they need some seasoning, but there is bound to be new leadership over time among AI stocks, and Astera could be one of them.

Cabot Market Timing Indicators

After weeks of churning and elevated sentiment, the inflation and Middle East news combo cracked the intermediate-term uptrend this week, causing our Cabot Tides and Two-Second Indicator to flip to negative. With further short-term pain more likely than not, we’re playing some defense now—but keeping our eyes open for signs the bullish longer-term picture reasserts itself.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines have lost a little altitude, but remain firmly bullish—even with the 5% or so haircut in the major indexes (from high to low), the S&P 500 and Nasdaq both standing about 7% above their respective 35-week moving averages. There is no surety in the stock market, but the bullish long-term trend (combined with the rare strength seen from November through February) tells us the odds favor higher prices when looking months down the road.

Cabot Tides: Bearish
For the first time since last November, our Cabot Tides now stand on the bearish side of the fence, as all five indexes we track (including the Nasdaq Composite, the daily chart shown here) have cracked their lower (50-day) moving averages—which turns the intermediate-term trend down. We’re open to anything, but the Tides sell signal tells us to be cautious for now, with further short-term pain more likely than not in the days and weeks ahead.

Two-Second Indicator: Negative
Our Two-Second Indicator has also turned negative, effectively confirming the weakness seen in the major indexes, with five straight days of new lows greater than 40 (including today). Of note, the readings didn’t pick up when the indexes were near their highs (which would have been a sign of a more meaningful top), so the evidence here goes along with the rest of what we’re seeing—that the market is weak today, but not flashing any big-picture abnormal action yet.

The next Cabot Growth Investor issue will be published on May 2, 2024.

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