Cabot Growth Investor Issue: August 22, 2024

Unexpected Action Tells You a Lot

While most investors don’t dig into the history books or take in-depth courses on market action, they intuitively know the difference between normal and abnormal action—i.e., when the market is acting “as it should” compared to when it’s not. In fact, most people face this every day when logging into their brokerage accounts at day’s end: If the Dow was up or down by 75 points, nobody bats an eye, but if it moved 750 points, they click to the news page to see what’s what.

In terms of analysis, it’s usually the unexpected action that tells you much more than the normal, run-of-the-mill stuff. For instance, when there was a huge divergence brewing in late June into July, that was unusual action—hinting that the underpinnings of the market were much weaker than the strong big-cap indexes suggested. The result was a correction that morphed into a mini-panic culminating in the early-August low.

A rally from that oversold area was expected, but the odds favored some sort of move back into resistance and then a bottom-building process that included pullbacks and news-driven, whippy trading. Instead, the market bounced … and kept bouncing, recouping most of the losses—and all the while, potential leading growth stocks led the way, with tons of upside earnings gaps and many moving back to new high ground.

Now, none of that means the market is completely out of the woods or that some sort of bottom-building action has been ruled out. Let’s not forget, September can be a tricky month, there’s still overhead to chew though (today finally brought some selling) and as we write about later in this issue, defensive stocks have been quite strong, which isn’t ideal and has capped our Aggression Index (our favorite growth vs. defensive measure).

That said, other indicators have improved rapidly as the sellers have been unable to make a stand. Our Cabot Tides and Growth Tides have moved back up to neutral, though a few more days in this area (or higher) would put them above where they were five weeks ago—and turn the intermediate-term trend up. Our Two-Second Indicator (which admittedly has been off-and-on for a while) is looking good, and we already wrote about the peppy action in many growth titles.

All in all, it’s not the perfect setup out there, and the V-bottom raises the risk of shakeout-type action at some point, but the evidence has obviously improved, and the unexpected nature of the rally is a good sign.

What to Do Now

That doesn’t tell us that we should pile in, but with a lot of cash on the sideline, we’re going to extend our line a bit more tonight, with the idea of steadily putting money to work if the market and stocks cooperate. Last week, we added half-sized stakes in Axon Enterprieses (AXON) and Palantir (PLTR), and tonight we’ve decided to quickly buy more of both—adding another half-sized position in both—while still keeping a good-sized 38% in cash. We’re also restoring a Buy rating on AppLovin (APP). Details below.

Model Portfolio Update

When the market is falling and pulling down everything—and especially volatile growth stocks—it’s tempting to just sell everything and hide in your storm cellar … and, don’t get us wrong, we definitely did some selling. But we’ve repeatedly found that giving your more resilient names a chance (even when they’re looking iffy) will pay off eventually. And, hHappily, it has, with most everything we held onto not just bouncing, but roaring back to (or close to) new high ground (though we’d note that Cava reports earnings tonight, so that’s still a wild card).

And with the evidence improving, we’re slowly putting money to work. We were thinking of adding two new names (half-sized stakes), but tonight, we decided to simply fill out the positions we started last week—both AXON and PLTR are essentially as the same level as we entered, so we think making them full positions and using reasonable loss limits (near 50-day lines, etc.) keeps risk in check while giving us exposure to two of the stronger growth titles out there. We’ll also restore our Buy rating on AppLovin.

With that said, our cash position will still be around 38%, so we’re hardly flooring the accelerator, but we think taking a couple more steps into the market’s waters is appropriate and then seeing how things progress from here.

CURRENT RECOMMENDATIONS

AppLovin (APP)—AppLovin continues to bask in the glow of its quarterly report, which has brought in the buyers who see not only big cash flow today but the potential for years of solid growth within the firm’s current mobile game advertising business (the top brass says 20%-plus annual growth is possible just within that segment), not to mention the potential to expand its platform to other areas. (Web ad campaigns for online shops are in pilot and reportedly going well, with a potential impact on the business sometime next year.) As for the stock, the rebound has been very impressive, with a rush to new closing highs yesterday, though its relative performance line (not shown here) is a bit shy of virgin turf. We’re a bit torn here, as we do think a short-term shakeout is possible, but given the strength, we’ll restore our Buy rating—though ideally new buyers can start a position on dips of two or three points from here. BUY

Axon Enterprises (AXON)—We started a half-sized position last week in AXON, which is becoming the leading technology provider for law enforcement agencies both in the U.S. and overseas. A big part of the story here is the business model, with the firm’s various software offerings leading to an ever-increasing stream of recurring revenue (up 44% in Q2), though in terms of catalysts, there’s a ton of excitement from Axon’s Draft One offering—it uses generative AI and body camera footage and audio to draft police reports automatically (requiring a sign-off from the actual officer, of course), which saves massive amounts of time (at least a few hours per week) and cuts down on burnout and attrition, too. Because of that, it’s had the best launch of any Axon software offering ever and should lead to plenty of add-on purchases, too. AXON broke out beautifully from a big base on earnings and has held all of its gains; it’s not our usual move, but the action is pristine, so we’ll quickly fill out our stake here, using a loss limit near the 50-day line (just under 320) and below the prior highs to keep risk in check. BUY ANOTHER HALF

Cava Group (CAVA)—CAVA will report earnings after the close tonight; official analyst estimates call for sales of around $220 million (up 27%) and earnings of 13 cents per share, more than double last year’s six cents, though same-store sales growth (up 2.3% in Q1) and margins (especially restaurant-level margins) will be keyed off as well. The stock has been extremely strong during the market’s rebound, rallying all the way to new closing highs (and a new relative performance high) this week, even nosing above round number resistance near the century mark. We’ll take it as it comes after the report, though CAVA’s recent advance does give the stock some leeway to shake out if it wants to after the report. Right now, we’ll simply stay on Hold but will update you with any changes if need be after the report. HOLD

On Holding (ONON)—ONON continues to act constructively, shaking off some post-earnings nervousness to approach its June high this week. While the Q2 report had a couple of flaws, they appeared to be over and done with or due to a few currency fluctuations (not uncommon for a Swiss outfit selling globally), and the overall view is one of a healthy, well-rounded business: Currency-neutral revenues were up 29% overall in the quarter, and that was spread across nearly every channel (up 30% direct-to-consumer, up 29% wholesale), region (Europe/Middle East up 22%, Americas up 26%, Asia Pacific up 85%) and product line (shoes up 28%, apparel up 67%, accessories up 26%)—and this was with some less-than-ideal operations at its Atlanta facility, where the firm is building a fully automated warehouse (good) that’s leading to short-term capacity constraints and late deliveries (bad). Bottom line, the underlying growth story here looks to be on track, and the stock itself is back near the top of an 11-week base. We’re not opposed to a nibble here, but officially we’ll stay on Hold and see how ONON reacts to resistance. HOLD

Palantir (PLTR)—We’ve written a few times in depth about Palantir, so we won’t rehash it all here, but we think the fundamental upside is that it becomes something akin to the Microsoft of the AI movement, with its platform for businesses (mostly with the U.S. these days, but international should bring up the rear) and government agencies (where it has major inroads) becoming the standard that AI systems are built on. We like, too, that even among U.S. firms, growth here is very rapid (sales in that segment up 55% in Q2, while remaining deal value more than doubled) but it’s still early days (295 U.S. commercial clients as of the end of June). Shares actually made no net progress from their spike high near Thanksgiving last year to their recent correction low, but PLTR has been acting terrifically since, booming to new highs after earnings on big volume and refusing to give up much ground. We added a half-sized stake last Friday and are going to quickly fill out our stake with the stock basically at the same level, using a loose loss limit under the 50-day line (call it 26 to 27 area) for the combined position. BUY ANOTHER HALF

ProShares Ultra Russell 2000 Fund (UWM)—Our theory when entering UWM was that small-cap stocks might finally be ready to get going after years wandering in the wilderness. The early-August air pocket obviously threw a wrench into that idea, but now the Russell 2000 has recouped more than half of its decline (on a closing basis), is back above its springtime highs and is hanging around its 25-day line. Don’t get us wrong, there’s still a way to go here before declaring the all-clear, but we’re hanging on to our half-sized stake in UWM and would love to average up if small caps (and the market as a whole) really kick into gear. HOLD

TransMedics (TMDX)—TMDX remains in good shape, perched near new high ground as big investors start to discount what’s likely to be years of strong growth for both the firm’s organ care systems (that keep hearts, lungs and livers alive for much longer) and logistics operation (that should include 20 planes by year-end, along with pilots and other staff) as the firm’s operations taketm a much larger share of the transplant market; the firm accounted for 2,300 transplants in the U.S. in 2023 and is aiming for 10,000 annually by 2028. All told, the company thinks transplants is a potential $8 billion market in the U.S. and that doesn’t take into account logistics and flights, which is also likely to be huge. There is competition, but there’s no doubt TransMedics is out in front, and we love that the bottom line has ramped into the black much sooner than expected despite heavy investments into transportation. As with most strong names, near-term gyrations are possible/likely, but the main trend is up. We’ll stay on Buy. BUY

Watch List

• Argenx (ARGX 520): ARGX has a super-blockbuster drug on the market that itself should bring huge, profitable growth for many years—and that doesn’t even include many new indications for it and one other drug in trials likely in the years to come. See more below.
• Credo (CRDO 35): CRDO is a fresher name in the AI and technology infrastructure space that’s showing classic tennis ball-like action after the recent plunge. See more later in this issue.
• Freshpet (FRPT 133): FRPT oozes rapid, reliable growth as it dominates the fresh dog food market (which itself is gaining share among all dog food). The stock has set up a nice three-month launching pad.
• GE Aerospace (GE 169): GE continues to creep higher, approaching resistance in the mid-170s. The stock has been mostly sleepy since early May, but we think it’s playing possum and can enjoy a steady advance thanks to its pristine multi-year outlook.
• Halozyme (HALO 62): HALO tagged its 50-day line ahead of earnings but has zoomed higher since, nosing to new highs in the process. The firm has three more potential drug approvals this year (including two in September), which should continue to boost royalties.
• Neurocrine Biosciences (NBIX 153): NBIX continues to set up on top of its prior giant base, which is normal to this point, though we’d like to see the buyers show up.
• Samsara (IOT 41): IOT is challenging its highs ahead of earnings, which are due out in two weeks. We love the story and the numbers, the only question is if big investors truly step up, or if the stock continues its choppy ways.
• Shift4 Payments (FOUR 79): FOUR has been a tease in the past 16 months, with steadily growing sales, EBITDA, cash flow and payments volume—but the stock hasn’t been able to get going. Now, though, it’s showing some enticing strength after earnings. See more below.
  

Other Stocks of Interest

Clear Secure (YOU 28)—Clear is an idea that just makes sense, especially if you (like thousands of people every day) get stuck in long security lanes at the airport, even before a TSA member checks your ID. Clear Secure uses biometrics—it was mostly iris scans and fingerprints, though this year the firm has upgraded many machines and systems to do full facial recognition—that allow paying members to quickly tackle the ID verification part of the security process at 58 airports (160 total lanes), allowing them to quickly move to the security area. (Clear is also up and running at many stadiums, too, though you only need to be registered with them to use it; no fee.) As time has gone on, the firm has added more benefits; it’s now a reseller for TSA Precheck online and at 46 airports (it even offers deals on bundled Clear and PreCheck packages), which obviously maximizes the ease with which you get through to your gate, as well as introducing many perks for paying members (expedited passport services, advance shipping of items like golf clubs and even a Scout service, where a Clear worker will hunt for something you forgot at the airport), too. In terms of costs, it’s reasonable, especially for those that fly a decent amount—$200 per year, and an additional $119 per family member, not including any TSA PreCheck bundle savings—and as the service has become better and available at more locations, more are signing up: In Q2, the firm added 2.3 million overall members (dubbed Clear Verified), including 197,000 more Clear Plus (paid) members, with the paid tally now just over seven million users, up 15% from a year ago; overall, Clear Plus members use the offerings more than seven times a year, which is one reason why most (80% to 85%) stick around year after year. The business is very high margin (19% pre-tax margin in Q2), with big free cash flow that’s expected to rise 40% this year; they’ve been buying back tons of shares, including gobbling up four million that Delta owned earlier this month, and the stock even pays a 1.4% dividend too. And the top brass says it has plenty of room to grow even within the airports and areas it operates in (newer places have low-single-digit penetration vs. high single digits in more mature locations). The numbers here are solid (should be 15% to 20% revenue growth and faster earnings/cash flow growth), and as with many names, perception has only recently turned up—YOU had been languishing for years but the Q2 report caused shares to melt up on their heaviest weekly volume ever (IPO in 2021). It’s a solid story.

Argenx (ARGX 520)—Argenx has always quacked like a future blue chip in the biotech space, thanks to one blockbuster drug that’s already growing like mad and is likely to have various indications treating different diseases down the road. That drug is called Vyvgart, and it got approval for generalized myasthenia gravis (gMG for short), a rare, progressive autoimmune disease that causes weakness in various muscles (can affect speaking, chewing even swallowing), in late 2021 in the U.S. and most other big global markets in the following year (it also has a Halozyme-enabled subcutaneous version that’s selling well); trials showed a huge improvement in patients’ ability to perform daily functions, and as a result, sales growth for the treatment has been massive, going from basically nothing three years ago to $1.2 billion last year, and with many years of growth ahead (42,000 patient potential today that could rise meaningfully going ahead, compared to the fewer than 10,000 it treats now). But the big idea here is that Vyvgart looks like a “pipeline-in-a-product”: The same drug recently received approval to treat a disease known as CIDP (the first new indication for that disease in 30 years) that causes numbness in the arms and legs and occasionally a loss of balance, among other things—combined, many analysts think Vyvgart could bring in $11 billion or more from just these two indications by 2030. But even that doesn’t capture the full potential, with Argenx saying at its recent R&D Day it aims to have 10 indications approved (mostly for Vyvgart, though some for one other drug in trials) approved, up from three today, with the firm’s offerings treating 50,000 patients. That’s all to the good, but it was the CIDP approval (a big one on the heels of a couple of dud trials last year) in June and the Q2 report (which showed a surprise profit of 49 cents per share and another quarter of big sales growth, up 74%) that seems to have changed investor perception—analysts now see the bottom line north of $5 per share next year (up from an estimate of $3 or so two months ago), with Wall Street looking for $25-plus by 2027. Shares made no net progress (including a huge head fake last summer) from early 2021 until this June, but ARGX has since marched higher 12 weeks in a row (seven on above-average volume) and is holding near all-time highs. We’re very intrigued as Vyvgart looks like rare merchandise and the new approval validates the pipeline-in-a-product idea.

Shift4 Payments (FOUR 79)—For whatever reason (maybe because the broad market has been stagnant for the past few years, net-net), we’ve seen a bunch of stocks whose story or theme has played out pretty much exactly as we thought it would, with great, estimate-beating numbers and execution … and yet the stocks languish, unable to make any progress as big investors refuse to buy in with any persistency. Shift4 Payments has been the poster child for that—it’s a stock we first started following in late 2022/early 2023 as it was showing big relative strength and, fundamentally, it had all the makings of a new payments leader, with innovative end-to-end offerings (often cloud-based) that can make life easier for everything from a takeout restaurant (a few point-of-sale devices) to a big stadium or golf course (tons of vendors and different types of products)—in fact, that was a huge part of the growth story, as the firm was branching out from its core restaurant clientele (which is still growing and a big part of business) to things like sports and entertainment, big hotel resorts, casinos, nonprofits and much more. As those deals have come online, growth has remained brisk despite those newer areas having lower take rates (the cut Shift4 takes from every transaction): Sales growth has been in the 25% to 35% range with EBITDA and free cash flow growing faster, and that continued in Q2, with payment volume up 50% from a year ago, while revenue less network fees rose 41%, EBITDA lifted 48% and free cash flow has totaled something like $3.30 during the past year—and this comes after years of persistent growth (even back during the Great Recession when the firm was private). And how has the stock responded to these numbers and tons of big client wins during that time? By going from 75 in March 2023 to … 60 as of two weeks ago. We’ve taken a couple of swings at FOUR during that time, to no avail, which admittedly makes it hard to dive back in—but at the end of the day, the market doesn’t care if you’ve previously owned a stock, and now Shift4 looks like it might finally, really be changing character; after retesting its lows in the mid/upper 50s, the stock has not just rallied after earnings, but shown two huge, accelerating-volume buying weeks that have taken shares back to their old highs. Bottom line: All the pieces are in place here for a sustained run, driven by real, honest-to-goodness growth (earnings expected to rise 28% next year, too) for years to come. FOUR is back on our watch list.

Defensive Stocks Picking up Steam; Aggressive Index Near Key Levels

In the last issue, we wrote about our Growth Tides and how they should hold one of the real clues as to when the market is ready to let leaders rip on the upside. So far, their action on this rally has been good … though like a lot of things, we wouldn’t say it’s decisively left the correction behind it.

The equal-weight Nasdaq 100 Fund (symbol QQQE) is a good example: Has the rebound been very solid and encouraging? Yes, with the fund recouping as much as three-quarters of its decline, rising back above its 50-day line. But is the trend definitively up? No, with the 50-day line essentially moving sideways and the fund back to the upper 80s, an area that has stifled it since March.

However, one thing we like to keep an eye on at all times—and especially when the market is attempting to come out of a steep correction of some sort—is defensive stocks, and the reason is simple: If big investors are piling into the safest names out there while the indexes rally, it’s often a sign that they’re not being as risk-on as it may appear. So far, they’re not screaming higher, but there’s no question things like the Consumer Staples Fund (XLP) and iShares Healthcare Fund (XLV), which features mega-cap health names, are stronger than the market, both hitting new highs of late.

Of course, what we really like to do is compare the two—the action of growth stocks (we like to use the Nasdaq Composite, but there are others) relative to defensive stocks (XLP is our favorite, but again, there are different measures out there), the ratio of which we call our Aggression Index. We like to track it mostly on both an intermediate- to longer-term basis, and interestingly enough, the huge decline and subsequent recovery have left the indicator at key levels.

Shown below is the weekly chart of the Aggression Index (Nasdaq divided by the XLP), along with its 40-week moving average, goign back a few years. (Note that the value of the ratio is meaningless; what counts is the trend.) You can see that the Index was above its 40-week line from the pandemic low through late 2021 … was negative for essentially all of 2022 … and after getting off its knees, turned decisively positive again in May/June 2023 and stayed north of its long-term trend line—until the recent few weeks have seen a test of that longer-term trend line.

Zooming into the daily chart for the intermediate term (using 25-day and 50-day lines), you can see the Index has rallied back—but “only” into the falling 25-day line.

What’s the point? Simply that the Growth Tides and Aggression Index are currently singing the same tune—things have improved, but not enough to conclude the correction is definitively over. More important, both are likely to give us the best clue as to whether that changes—for some growth-oriented indexes like QQQE, that means possibly pushing above resistance near 90-91, while for the Aggression Index, it would mean a Tides-like buy signal (further upside followed by the 25-day line turning up). Of course, the flip side would be bearish—a big run into defensive stocks while growth stocks get hit.

We’re still keying mostly off individual stocks, a bunch of which have shown peppy action, but the Growth Tides and Aggression Index are likely to tell us whether these names are likely to run higher from here … or if a few more weeks of digestion are in order.

Eggs vs. Tennis Balls

Nobody likes a down market if they’re long, but as a student of the market, sharp drops bring one big advantage: They allow you to see what stocks big investors are truly pining after. Hence the “eggs vs. tennis balls” moniker, which is an old market truism—whether it’s a brief, sharp shakeout or a longer decline, when the market starts to poke its head up, you want to look for stocks that bounce back the strongest (tennis balls), and usually avoid those that can’t get off their knees (eggs, which splatter on the floor). Really, it can provide a simple test as to whether a name is worth going after (or holding if you already own it) or not.

We recently applied this analysis to the popular AI infrastructure space, which, as a whole, probably needs time to digest the 15-month run it enjoyed. In fact, we wouldn’t be surprised if some names, after huge runs, have topped out for a long time.

That said, a few names in the space are looking like tennis balls, and one that is noteworthy is Credo Tech (CRDO); we wrote about it in the July 11 issue if you want to look up more details, but suffice it to say the firm’s electrical cables, optical processors and the like connect servers within data centers to switches and routers, with its unique technology and architecture balancing top-end speed with low power consumption.

It took a while to catch on, but Q2 (sales up 89%) was a coming-out party, and analysts see similar growth in both the top and bottom lines for many quarters to come. CRDO soared on that report for a few weeks before giving it all back during the correction—but you can see the stock has come roaring back, exploding to new highs this week on a pickup in volume. Earnings, out September 4, will be key, but the ducks are lining up for this name to move higher. WATCH

Cabot Market Timing Indicators

As we wrote on page 1, it’s the unusual and unexpected that really tell you something about the market’s tenor, and while a rally off the mini-panic low of August 5 was by the playbook, the straight-up rally in most indexes and buoyant action among many growth stocks was not. We’re not completely free and clear, with the intermediate-term trend still mostly sideways, but we’re stepping back into the water as long as the evidence improves.

Cabot Trend Lines – Bullish
Our Cabot Trend Lines had their first major test of their uptrend since earlier this month, and the rebound has obviously been encouraging—as of this morning, the S&P 500 and Nasdaq are both about 8% above their respective 35-week lines, giving the indicator plenty of wiggle room should we see some selling finally appear. As has been the case for a year and a half, the market’s larger, longer-term trend remains up.

Cabot Tides – Neutral
Our Cabot Tides have obviously improved their standing, with all five indexes we track (including the Nasdaq Composite; daily chart shown here) rallying back in a big way. That said, to us, it hasn’t been enough to produce a green light—the intermediate-term trend remains neutral, as the lower (25-day) moving average continues sideways. (It’s the same story for our Growth Tides, too.) A few more days up here or higher could do the trick, but we never anticipate—for now the market still has more to prove.

Two-Second Indicator – Positive
Our Two-Second Indicator has been ping-ponging back and forth for a while now, but it’s still good to see the broad market do well during the market’s rebound—despite the selling, in fact, today was the eight straight day of fewer than 40 new lows on the NYSE, including five of the past six south of 20. Obviously, if the market pulls in here that could change, but it goes along with the other encouraging data out there.

The next Cabot Growth Investor issue will be published on September 5, 2024.

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