Cabot Growth Investor Issue: January 10, 2025

Pattern of Evidence Favors Defense … for Now

These days, with alerts, notifications and dramatic headlines, it’s easy to get caught up in and react to what’s happening right now, but it’s better to take meaningful action based on a collection of evidence, not just a day or two of trading action or a single fundamental announcement. Right now, that pattern of evidence going back many months (as well as what’s happened in recent days) tells us to favor defense.

It starts with the blastoffs seen in many growth names in late August and early September and includes the huge run (both in price and time) during the following three-plus months—which resulted in near-term sentiment lifting to extremes with speculative stocks rallying hard. But December 9^th and 10^th brought a huge selling wave in leading growth stocks, with sloppiness through month’s end … and now we’re seeing more selling to start the year, with today’s action (after the jobs report) bringing more downside.

That entire pattern—a big, prolonged upmove, buoyant sentiment, followed by leaders (and the broad market) getting hit—usually leads to a rough patch, which is exactly what we’ve seen for the past month, and that selling could easily continue for a longer period of time going forward. Thus, with most growth stocks under pressure and the market’s overall intermediate-term trend pointed down, we’re playing defense.

Now, with that said, we want to highlight something we just wrote: The market is now a month into this corrective process, which has dented sentiment (a good thing) and has actually produced a couple rays of light. First, as we write about later in this issue, big investors aren’t rushing for safety in defensive stocks, which leaves the door open to a stampede back into growth names. And second, many individual stocks have flashed relative strength (in this case, by not falling much) and etched fresh (albeit brief) launching pads in recent weeks, which is constructive action.

Throw in the fact that early January is known for shakeouts and fakeouts as everyone repositions their portfolios, and we’re keeping an open mind—it’s possible that, after a huge run, the past few weeks have been a necessary evil, separating the wheat from the growth stock chaff, getting rid of the weak hands and setting a foundation for another leg up.

But, simply put, there’s a lot of proving to do for that to be the case: Right now, the evidence tells us the sellers have gained control, so we’re continuing to hold lots of cash on the sideline while pruning names that weaken and remaining patient when it comes to new buying.

What to Do Now

Remain cautious. In the Model Portfolio, we came into the year around half in cash, but as growth stocks have faded, we’ve trimmed more, booking the rest of our profit in Axon Enterprises (AXON), taking another round of partial profits in Palantir (PLTR) and, tonight, we’re placing On Holdings (ONON) on Hold. Our cash position is now around 60%.

Model Portfolio Update

From late August through early December, the Model Portfolio mostly rode our winner higher, but early December brought a character change, with most leaders getting hit—causing us to pare back then, and then cut back further as the weeks have passed and it became clear that growth stocks were in a corrective phase.

Of course, we’ve held that cash since then and had most stocks rated Hold, with around half the portfolio on the sideline coming into the new year. While we’re not necessarily aiming to be more defensive, this week, our cash hoard grew to 60% via the sale of AXON and partial sale of more PLTR.

Still, while it sounds cliché, we really are flexible: A decent number of growth stocks are bending but not breaking, while some secondary evidence (no rush into defensive stocks) tells us big investors aren’t exactly going into hibernation. For now, then, we’re content to hunker down, but if the selling storm passes and the sun comes out, we’ll likely add a couple of resilient names and take it from there. Our only change tonight is placing On Holding (ONON) on Hold, mostly due to the overall environment.

CURRENT RECOMMENDATIONS

AppLovin (APP)—APP’s action has been poor this week along with just about every glamour stock, with its rally into the 360 area bringing a wave of selling on Tuesday. That said, we’ve already sold most of our initial position and shares are still holding within their range of the past month. On the analyst front, there’s been some conflicting commentary: One said the firm’s apps business might have shrunk in Q4 vs Q3, worse than expected, though that’s a tiny, non-core part of the business. Meanwhile, another analyst hiked its outlook after doing a deep dive into the e-commerce opportunity for AppLovin’s advertising engine, saying that side of the business could exit 2025 at a $1 billion revenue run rate, much larger than expected. (There was even some online short seller getting a little press, attacking the firm’s ad business.) As always, we’ll let the stock tell the story—a drop through support in the 300 to 305 area (where the 50-day line currently sits) would probably have us trimming even further, though above there we’re willing to give APP room to maneuver, as we’re not ruling out shares having another run higher if the market and growth stocks can find their footing. HOLD

Argenx (ARGX)—ARGX has been a port in the recent storm, moving to new price and relative performance highs thanks in part to a very bullish analyst note that discussed Vyvgart’s potential in its currently approved indications (for gMG and CIDP in the U.S., he sees revenue potential of $7 billion a decade from now, up from $2 billion or so today). And he thinks ongoing trials for new indications in the U.S. are largely de-risked, with any positive trial results this year or next likely to help perception of the overall upside here—all in, he sees the firm’s outlook for 50,000 patients using its treatments by 2030 as possibly conservative. Of course, drug firms are always risky (if trial results disappoint the stock usually gets hit), but it’s obvious that investor perception here continues to gradually improve. With the market still acting funky, we’ll simply stick with our position for the moment, but stay tuned—we’d like to average up if the environment improves. HOLD A HALF

Axon Enterprises (AXON)—AXON had a great run from our entries last August into its peak in December, but after hitting nearly 700, the stock has been steadily bumping downhill, with just one- or two-day rallies along the way—and then this week, it cracked its 50-day line on elevated volume. Could this be an early-January shakeout that leads to another push higher? It could, and if so, we could revisit the name—the overall growth story obviously isn’t over, especially as its new AI-related products gain acceptance. That said, AXON has a history of running nicely for a few months ... and then consolidating for a few months (our initial buy here was after a base breakout in August), and with the broad market on the outs, we thought it best to take the rest of our solid profit off the table earlier this week. SOLD

Flutter Entertainment (FLUT)—FLUT and its peers have been steadily softening in recent weeks as more and more data points came out suggesting this fall’s NFL season was a historically good one for favorites (best in two decades reportedly), which are popular among bettors. And on Tuesday night, Flutter confirmed just that, saying U.S. Q4 revenue and EBITDA would come in well below expectations due to unfavorable (for them) betting outcomes. However, the firm also said the international business looked good in the quarter, and that its “structural” revenue margin (which strips out abnormally good or bad luck) was 14.5%, in line with expectations, so the underlying business is very likely healthy. As for the stock, we’re not going to let our profit completely evaporate here (cost basis just under 231) and shares have been weak … but we also have a ton of cash, and the action is more tedious than awful. Long story short, we’re holding our stake here, though if all’s well we’d expect FLUT to find support around this area. HOLD

On Holding (ONON)—We’re moving ONON to Hold in today’s issue, mostly because of the overall environment—shares are actually holding near their 50-day line (better than 70% of all stocks), though have sagged recently on more tariff uncertainty with the new administration and the general soft tape. The company will present next Monday afternoon at the ICR Conference, which features a ton of top retail names; occasionally presenters will release some guidance (official or not), so we’ll have to see what (if anything) comes with that. Should the market find support soon, we think ONON could easily move to new highs, but we always go with what’s in front of us, so we’ll move to Hold. HOLD

Palantir (PLTR)—PLTR had been showing some relative strength in December, holding firm while many names turtled, even hitting new highs around year’s end. But that move was quickly given up, and when you step back, the stock has now been churning for a month (after a big run, lots of up-down-up-down action but no upside progress) and, this week, has come off sharply. We took some of our position off the table in November, and we sold another third this week, leaving us with about 40% of our original stake. From here, we’re willing to give the stock some rope, but probably not a huge amount given that there’s support (including the 50-day line) in the low- to mid-60s. All in all, having trimmed more this week, we’ll hold onto the rest here and look for buyers to reappear. SOLD A THIRD, HOLDING THE REST

Shift4 Payments (FOUR)—FOUR has been handling itself about as well as could be hoped for given what most growth names are doing, with gruding upside since its low in mid-December as it continues to hover a bit above its 50-day line and round number support near the century mark. The company will present next Monday at the ICR retail Conference, which could move the stock, though given that the company has its own Investor Day in February, our guess is any big 2025 and long-term guidance will be saved for that. Bottom line, we think the story here is sound, and having already taken partial profits last month and with the portfolio already having a lot of cash on the sideline, we advise holding on and giving the stock some room to consolidate. HOLD

Watch List

• Astera Labs (ALAB 131): ALAB remains in decent shape but is becoming increasingly volatile, swinging between 125 and 145 a couple of times just in the past two weeks. We’re still intrigued but would almost prefer to see a big shakeout first to clear the decks, followed by supportive action. Credo Tech (CRDO) is another name in the general theme that we’re watching—see more below.
• DoorDash (DASH 174): DASH has been sloppy of late, but the action looks resilient to us, with shares hanging around the 50-day line and with the stock just 6% off its high in the midst of a tight, six-week zone. Given the prior strength and fundamental positives, we’re optimistic the next big move will be up.
• Dutch Bros. (BROS 56): It could use some more sponsorship, but after years of bottoming action and some false starts, BROS completely changed character after earnings in October, with investors finally focusing on the underlying cookie-cutter story. The firm presents at a big retail conference next Tuesday.
• GE Vernova (GEV 366): GEV looks like it wants to get going, with shares moving straight sideways for weeks before breaking out on Monday, though not surprisingly in this environment, the breakout has run into selling. Further wobbles are likely near-term, but the rapid, reliable cash flow growth here is enticing.
• Reddit (RDDT 172): RDDT certainly could get hit hard given its monstrous run—but the fact that it actually kissed new high ground this week (while so many glamour names are getting mauled) intrigues us. This one-of-a-kind social media platform is tailor-made for targeted advertising and data licensing.
• Rubrik (RBRK 63): RBRK moves an average of 5%-plus per day from high to low, so it’s not for the faint of heart—but we love its fresh cybersecurity story (cyber resilience and recovery, not just prevention) and think the firm could easily grow many-fold in the years ahead. Shares are in their fourth week of a volatile but normal correction.

Other Stocks of Interest

Credo Technology (CRDO 73)—Credo Technology is one of many new-age networking and connectivity players that are finally seeing the benefit of AI spending in the data center and elsewhere hit the bottom line—and in Credo’s case, dramatically so (more on that in a minute). The firm’s product line can read like a tongue twister (SerDes chiplets, line card retimers, etc.), but suffice it to say that the company is a major supplier to a few key giant clients who are starting to gobble up as much of the company’s offerings as they can. Credo’s active electrical cables are the big draw: While cables sound run of the mill, the firm has built them in a special way (around the aforementioned SerDes technology, which is a high-speed communications standard) that maintains signal integrity (critical for keeping systems up and running at max efficiency), optimizes power use and has top-notch reliability, making them big sellers for connecting clusters of devices for AI workloads; Credo is the market leader in this field, with two huge clients and an emerging hyperscaler buying them up. Credo also has optical processors that are, again, in the lead for power efficiency and performance and have turned the corner in terms of sales. There are other products, too, but the big attraction here is simple: For a few quarters, management has been talking about a coming inflection higher in business, and that had the stock generally doing well, albeit with ridiculous volatility. But after the latest quarterly results, management’s guidance blew the doors off even the most bullish forecasts: The last three quarters saw revenues grow 64%, 70% and 89%, turning up from a dry stretch, but now the top brass sees 125%-plus growth each of the next three quarters while earnings go vertical. Indeed, quarterly sales, which bottomed out at $32 million in the spring of 2023, should lift to $137 million this spring, just two years later! The main risk here is that Credo, along with many of its peers, is a down-the-food-chain story: Three customers make up more than half the firm’s revenues, and while it has been diversifying its client base a bit (less concentration), if a big customer pulls in on its purchases for whatever reason, business would take a big hit and investor perception could tank. Even so, the opposite appears to be happening for at least the next few quarters, which is why CRDO went wild after earnings last month and has held up well during the growth stock air pockets of late. We like it.

Taiwan Semi (TSM 207)—One of the most common emails we get when a broad theme is working in the market is whether there’s an exchange-traded fund that tracks it, making it easier to ride a trend rather than picking a winner among a bunch of 20 or 30 names. Taiwan Semi, of course, isn’t a fund, but its reach is so pervasive in the chip sector—which is now being driven by AI-related demand—that it essentially represents a broad way to invest in that theme: The company is by far the largest chip foundry out there, making a variety of semiconductors for pretty much every major chipmaker out there; in fact, the firm’s global market share in the foundry industry is north of 60% (!), which means it’s going to move broadly with the trends of the chip sector (sales boomed with the pandemic before easing in 2023). That doesn’t mean, though, that growth here is stodgy, as the company naturally ramps production for the most in-demand chips from the most in-demand clients, and that’s exactly what’s happening now, with sales growth accelerating hugely (11%, 34%, 41% during the past three quarters) as all things AI-related see growing demand, while earnings likely lifted more than 30% in 2024 and should do the same this year. Again, this is a huge firm (sales last quarter were $23.9 billion) so the stock isn’t going to be the absolute hottest name, but we think the action is solid: TSM originally broke out a year ago and had a big run into July before etching what looks like a base-on-base (two rest periods, with the second sitting on top of the first) for six months, followed by a breakout earlier this week. Not surprisingly, that breakout attempt led to some selling on strength (par for the course in this environment), but TSM remains in great position if earnings (due January 16) please investors.

Birkenstock (BIRK 58)—One of our core stock-picking tenants is that big institutional investors—who essentially control the market given how much money they have under management—are looking for firms that have a long runway of rapid and reliable growth (what we loosely call the 3 Rs). Because of that, retail outfits are favorites of big funds as the growth story often plays out over many years (even with the occasional quarterly hiccup), and so we like to keep an eye on any established, growing retail brands that come public; if the top brass executes, it’s a great bet to be accumulated by hundreds of funds over time. That long preamble leads us to Birkenstock, which is an old German company, having been around more than two centuries, but it’s thriving today, offering hundreds of different types of durable sandals and other footwear that are based on a single type of sandal silhouette (which reduces costs); the company’s offerings span the gamut from base level to luxury, and it often will create scarcity among some items to boost appeal, leading to very solid margins (30%-plus on an EBITDA basis). Business has been growing steadily for years and that continued in Q3, with currency-neutral revenue growth of 19% (including a 41% gain in Asia Pacific), thanks in part to strong demand for closed-toe offerings (grew at twice the rate of the rest of the business), while EBITDA lifted 15% despite some investments into capacity expansion; for 2024 as a whole the latest outlook was for top-line growth of 20%, and most see that kind of growth continuing for many years to come. As is often the case, the stock (which came public in the fall of 2023) has had some ups and downs in the first year-plus of its life, including an ugly earnings-induced decline in August. But BIRK bottomed out after that, perked up in November and then ramped on its Q3 report in December before settling back down. It’s a nice setup overall, and if the stock ramps from here, it could kick off what would be its first real sustained advance.

No Appetite for Defensive Stocks is a Plus

While the big-cap indexes and a handful of big-cap stocks continue to do OK and grab the headlines, the vast majority of the market continues to struggle. That can be seen in a variety of measures, including some broader indexes (equal-weight S&P 500, shown below) and various internal measurements (like our own Two-Second Indicator, which hasn’t been able to dry up despite the upside in the major indexes of late).

Likely one of the biggest reasons the sellers have stepped up is interest rates: Shown here is the 10-year note and its six-month rate of change (bottom panel), which is our Power Index of old. Notice how, after a brief test in mid-November, the rate of change turned decisively positive (read: the 10-year yield was clearly higher than it was six months before) in early December, which coincided with air pockets showing up among leading stocks.

Throw in our negative Cabot Tides and we’ve been cautious for a few weeks and remain so in this issue. However, as the days have passed, we’ve been following one of our favorite market “tells” for signs big investors are truly heading for safety. We’re talking about defensive stocks, our favorite measure of which is consumer staples, which offer products everyone has to buy regularly. If we saw outsized strength in that group combined with under-the-surface weakness in the broad market and fading growth stock leadership, it’s almost always a red flag that leads to a longer correction.

But so far that hasn’t happened—in fact, not only has there been no rush into stodgy names, these “safe” titles have actually been acting worse than most growth indexes and funds. Shown below are two charts, starting with our traditional Aggression Index, which is the relative performance of the Nasdaq compared the consumer staples fund (XLP)—basically, big-cap tech, software and chips vs. toothpaste and toilet paper. Amazingly, despite growth sloppiness, the Index actually hit a new high this week.

“But Mike, isn’t the Nasdaq strong because of a couple of mega-cap names doing well, while most of the market struggles?” That’s fair, so let’s look at the equal-weight Nasdaq 100 versus XLP. While not as strong overall, this index leapt back toward multi-month highs this week, too. It’s a similar look when compared against things like the IBD 50 as well.

Of course, you can always reason why consumer staples are so weak (the fund itself is south of its 200-day line), starting with the fact that the U.S. dollar has been strong in recent months, which usually hurts big, multinationa outfits. But the bottom line is that, if the Fidelitys, T. Rowe Prices and Vanguards of the world wanted to position themselves defensively, they wouldn’t hesitate to buy up things like Proctor & Gamble (PG), Coca-Cola (KO) and Phillip Morris (PM)—but they’ve been doing just the opposite.

Clearly, weakness in the XLP is no reason to ignore the iffy-ness in many growth stocks and the rest of the market—but, to us, it is a reason to keep an open mind and to keep your watch list up to date, as big investors are leaving the door open to returning to the broader growth arena soon.

Bottom Fishing in Former Winners?

Recently we’ve seen some up action in beaten-down issues, which isn’t an uncommon occurrence around year-end—and that’s brought up some questions regarding former winners we owned, including stuff like TransMedics (TMDX), which lagged badly in recent months but has bounced sharply during the past week, or Uber (UBER), which is in a similar position.

In general, the key when thinking about whether it’s time to go back into these sorts of names is to examine any past winner the same as you would any stock you don’t own. (Translation: Don’t make excuses for it because the stock was good to you in the past.) In TMDX’s case, when we recommended the stock, sales were up 133% in the latest quarter—but now, sales are expected to rise “only” 35% and 23% in Q4 and Q1 (granted, those figures could be conservative, but it’s still a big slowdown), so the growth momentum as clearly changed. Moreover, the stock itself is buried miles below its 200-day line, so the long-term outlook is in doubt. Not surprisingly, the upmove did run into a wall this morning, with shares down sharply.

Now, to be fair, TMDX did see a nice volume cluster during the latest upmove, so the recent low could hold, and there’s no question shares are oversold after falling off a cliff. Thus, short-term, some off the bottom names could see upside sometime in the weeks ahead if the market doesn’t get into huge trouble … but the odds also favor the stocks running into selling again in the relatively near future given the downtrends and overhead on the chart.

Eventually, some of these fallen angels could etch bottoms over many weeks or months, which would be a different situation—such action (assuming the fundamentals are strong) would raise the odds that a new, sustained advance could begin. But unless you’re a trader, we believe it’s best to build a watch list of more resilient names.

Cabot Market Timing Indicators

The big-cap indexes are looking OK (albeit chopping up and down), but most of the rest of the market is having a rough go of it, with the intermediate-term trend down (or neutral-to-down if you prefer), the broad market weak (70%-plus of stocks south of their 50-day lines) and many leading growth stocks struggling. There are some rays of light, and a good few days could change the landscape, so we remain flexible—but we’ve been cautious for a few weeks and remain so today.

Cabot Trend Lines – Bullish
There are plenty of kinks in the market’s armor these days, but the long-term trend isn’t one of them—and given that this is our most reliable indicator, that’s something to keep in mind. Our Cabot Trend Lines remain clearly bullish, as both of the big-cap indexes (the S&P 500 by 4%, the Nasdaq by 7%) remain solidly above their respective 35-week moving averages. That will change someday, but until then the odds favor higher prices in the months ahead.

Cabot Tides – Bearish
Our Cabot Tides, on the other hand, are still pointing south—yes, the big-cap indexes are hanging in there, but the three other measures we track (including the NYSE Composite, shown here) are still buried below their lower (50-day) moving averages. (Growth measures look a bit better, but most are neutral at best.) Thus, the intermediate-term trend is down (or at least not up) until proven otherwise.

Two-Second Indicator – Negative
The Two-Second Indicator’s readings were likely artificially worsened around year-end (due to tax-loss selling), but they haven’t improved in the New Year, with the number of new lows continuing to come in north of 40 for all but one day so far this year. That backs up what we’re seeing elsewhere, confirming that the sellers are doing damage to the broad market.

The next Cabot Growth Investor issue will be published on January 23, 2025.

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