Cabot Growth Investor Issue: July 25, 2024

Staying Close to Shore

We were thinking this week of the unusual market environment we live in and what popped into our head was an obscure passage in the classic book Reminiscences of a Stock Operator: “An old broker once said to me: If I am waking along a railroad track and I see a train coming toward me at sixty miles an hour, do I keep on walking on the ties? Friend, I sidestep. And I don’t even pat myself on the back for being so wise and prudent.”

Of course, we didn’t sidestep all the damage, but the tongue-in-cheek line has a lot in common with our actions of late: With the market’s July rotation, all three of our key market timing indicators were positive thanks to the broad market’s rally—but individual growth stocks, which were having issues getting going for weeks, began to come under the gun, with names getting hit left and right. We weren’t targeting a specific cash level (actually, we usually don’t, letting the action of stocks pull us in or push us out) but despite the OK top-down evidence, the result has been us jettisoning some names, no fresh buying … and a cash hoard north of 50%!

That seemed like too much, but in recent days, the selling has only intensified, with the big-cap indexes skidding sharply—Wednesday was the worst day for the Nasdaq since October 2022—while our Growth Tides have turned negative (led by the IBD 50 Index, which is down more than 7% this month and well below its 50-day (orange) line) and numerous more growth titles have fallen by the intermediate-term wayside.

Stepping back, then, we remain in unusual times—at this point, our market timing indicators are still positive (though our Cabot Tides bear watching), but it’s clear growth stocks and measures have cracked (our Aggression Index looks to be turning down, too). In these situations, we defer to the action of stocks—after all, that’s what we’re usually buying—and that means we’re going to hold onto our cash position given the action.

However, as has been the case for weeks, we do think flexibility is key, as there are still many positives out there: Most major indexes are in decent shape, the broad market’s surge is holding (and could provide an opportunity; see more on that later in this issue) and interest rates are beginning to trend down (the market actually sees a small chance of a rate cut this month), so earnings season has a chance of quickly repairing some damage, if not launching some fresh breakouts.

What to Do Now

For now, though, we remain cautious, waiting to see if this recent wave of selling exhausts itself—or if the long-awaited correction is finally hitting our shores. In the Model Portfolio, we have a cash position of 54% and are trying to give some remaining stocks (most of which we’ve already taken partial profits in) a chance to find support, while we keep our watch list up to date in case this morphs into an April-like shakeout-and-recovery. We’re placing recent purchase Robinhood (HOOD) on Hold as it’s been caught up in the market’s dip, but are otherwise standing pat.

Model Portfolio Update

As we wrote above, we’ve hopped off the train tracks of late due to a deluge among many growth stocks—which, after a brief bounce earlier this week, has continued. Indeed, many growth measures (such as the IBD 50 Index, shown on page 1, but also the iShares Momentum Fund and the equal-weight Nasdaq 100) have cracked intermediate-term support, and there’s no question many individual growth titles are deflating.

On the flip side, much of the market is holding up relatively well, as depicted by our market timing indicators, which are still positive. And as earnings season moves on, there are still many stocks (growth or otherwise) that have set up reasonably well ahead of their reports. We still see the potential for fresh leadership to take hold if the buyers show up.

That last part is key—right now, we’re holding tons of cash (54%!), which, frankly, makes us a bit uncomfortable given the action of our indicators. But at this point, we want to be pulled into the market through strength (from the market, earnings gaps, etc.), which we’re not seeing much of yet. We’ll hold onto our huge cash hoard tonight, then, and see if the tenor of growth stocks changes in the days ahead.

CURRENT RECOMMENDATIONS

AppLovin (APP)—APP continues to struggle, with the latest tech-heavy selloff (especially in advertising names like Google, Meta and Trade Desk) bringing around sellers here, too. Ever since the Apple advertising-related hubbub in June, it’s been mostly quiet on the news front for AppLovin, with analysts having already said their piece, too, so the next major move may come down to earnings on August 7. Deep down, we still have high hopes here, with the firm’s Axon 2.0 advertising engine having big potential to take share within gaming as its machine learning capabilities ramp (more usage = more learning = higher return on advertising spend = more clients)—and of course, management sounded bullish (though there have been fewer details) on it being used outside of gaming, too. As it stands, though, we already sold one-third of our stake a few weeks back, and the rest is on a relatively tight leash: Shares have moved toward their Apple-induced lows from a few weeks ago, which is acceptable for now, but if all is well we’d expect buyers to show up in this area. Thus, we’re holding here but watching things closely. HOLD

Cava Group (CAVA)—CAVA remains weak in the short term along with most peers (including growth-oriented restaurants; Chipotle (CMG) has knifed below its 200-day line!) on some fears of slowing traffic and sales; the stock has been living under its 50-day line as volume dries up. (Even yesterday’s down day as the Nasdaq plunged saw volume 40% less than its average.) We had sold a third of our stake and are eying the late-May spike low in the mid-70s (when the stock gapped down the morning after earnings before ramping) as a logical line in the sand. Big picture, we are convinced Cava is probably as close to “the next Chipotle” as you’re going to see, with rapid, reliable growth likely for years to come—but we’re also not going to simply “hold and hope” if the sellers stay at it. Thus, we’re sitting tight but, like all our names, seeing if buyers show up to support the stock. HOLD

CrowdStrike (CRWD)—As one market saying goes, “the unexpected happens frequently in the stock market,” which is a big reason why risk and damage control is a part of any good system. CrowdStrike had everything going for it fundamentally, and while the stock had been sagging with other growth titles, the major trend was decidedly up. But then came last Friday morning, with a bad update causing havoc among clients across the globe, causing the stock to completely give up the ghost—and, even worse, stage another meltdown earlier this week. In our bulletin last Friday, we asked the question of whether this would be a black eye that could be handled … or more of a Chipotle 2015 situation when bad quality control led to a couple of years in the wilderness to gain back trust. Obviously, the situations are different, but we think it’s more likely the latter situation, with CrowdStrike likely to need lots of time and effort to win new clients (and keep existing ones). We sold a third of our stake last Friday and the rest on Monday morning. SOLD

On Holding (ONON)—ONON certainly still has work to do, and when the market is weak, shares are still getting tossed around pretty good. But after a tough retreat (44 to 36) as retail stocks (and Nike) went cold, the stock not only perked up last week but did so on accelerating volume, a sign that big investors were buying the dip. The Olympics are a possible near-term catalyst given that On is supposedly going to lean forward on the advertising front, but more likely, it’s simply going to come down to the market as a whole; if the broad market can find support, we think ONON can do very well, but if not, the recent lows make for a logical stop. At this point, ONON is in the middle of a normal, seven-week base-building effort, so we advise holding your shares. HOLD

ProShares Ultra Russell 2000 Fund (UWM)—The upturn in the broad market has held firm thus far, with our Two-Second Indicator still positive (no plus-40 readings of late) while small-cap indexes refuse to give up much ground. Could the weakness in growth and tech stocks negate the broad market’s strength? It’s certainly possible. But as we write later in this issue, there are many reasons to think the nascent upmove will continue, especially for small caps, and we like the risk-reward situation here in general. We started a half-sized stake in UWM—which moves twice the percentage of the Russell 2000 daily, up or down—a couple of weeks ago and would like to average up if the market can stabilize somewhat. If you own some, hang on, and if not, we’re OK starting a position around here. BUY A HALF

Of note: It’s not unusual for your brokerage firm to tell you to sign (or click online) a note that warns of these leveraged funds; over a long period of time, they can “decay” and don’t track the indexes perfectly at 2x. But we’ve used these funds on major indexes (not on small, volatile sectors) before and they’ve worked just fine—and if small caps have a run, UWM will do very well.

Pure Storage (PSTG)—PSTG was sold last week when the stock’s rally essentially failed, with the stock falling below its recent lows and its 50-day line, and since then it’s faded more along with most technology and AI plays. It’s not the worst chart out there, and the story remains fine; when growth has its next sustained upmove, we’re not opposed to taking another swing at Pure. But the repeated selling on strength in the upper 60s capped the stock, and now it’s fading with the overall growth side of the market. We sold last week and are holding the cash. SOLD

Robinhood (HOOD)—We took a half-sized stake in Robinhood two weeks ago and, not surprisingly, it’s been up (initially) and down (past week) with the market, albeit mostly on very light volume. We knew shares would be volatile, hence starting small and using a looser lease (in the 20 area), so we’re fine holding on here and seeing how it goes. Given the recent action (in HOOD but also growth stocks), we’re going to quickly move to a Hold rating and we’ll obviously cut the loss if the market’s recent correction gets more severe—but HOOD’s overall rest period of the past few weeks looks normal to us, and we think the eventual upside will be big if/as the bull market moves higher. Remember, to us (as opposed to Wall Street analysts), Hold actually means Hold, so if you started a position with us last week hang on. HOLD

TransMedics (TMDX)—TMDX has earnings next Wednesday, with analysts looking for revenues of $99 million (up 88%) and earnings of 21 cents per share (up from a loss a year ago), though there’s a history of topping estimates here so “real” expectations are likely higher. Being a small-ish-cap name, there’s obviously risk on the report of a big move, and a slice back into the 120 area would certainly be a red flag. But at this point, it’s hard not to be impressed the stock’s resilience (it nosed to new highs earlier this week) as well as its relative calm given the wild action seen among growth stocks. Given the positive evidence, we’ll stay on Buy, but as usual, we advise keeping new commitments small this close to the report. BUY

Uber (UBER)—Our plan was to give UBER down to around its 200-day line (near 65 today), but after shares tried to lift above resistance and were immediately and strongly rejected last week, we decided to let the rest of our small holding go—which turned out to be the right move as the stock did nose below that long-term support area this morning. We’ll still be watching what comes on earnings (August 6), and some sort of huge gap up could change the stock’s landscape. But we have to go with what’s in front of us, and the rally attempt has failed, leaving the stock open to more downside—especially if growth names remain weak. SOLD

Watch List

• Coinbase (COIN 232): Coinbase moves something like 6% each day, meaning it’s hard to handle, but we’re intrigued that crypto is showing some relative strength of late despite the growth stock weakness, and COIN has built a solid base for the past few months. See more later in this issue.
• Credo Tech (CRDO 28): CRDO is smaller and more volatile (three customers make up most of its business), but it’s in a stronger position than most other AI/networking stocks, still above its 50-day line, probably thanks to its massive growth outlook. If it can resist further selling, the latest dip will look like a shakeout.
• GE Aerospace (GE 165): GE’s Q2 was mixed as expected due to some engine delivery issues, but orders (up 18%) were strong and profits (up 62%) were well ahead of expectations, while the firm boosted its full-year free cash flow outlook (now up to about $4.90 per share). Shares briefly broke out on the upside but have been yanked down by the market—even so, a couple of good days would have it near new high ground.
• Guardant Health (GH 32): GH has turned up after a horrid long-term decline, with a great core testing business and a new product that could be big. See more below.
• Halozyme (HALO 56): HALO continues to act well, stair-stepping to new recovery highs of late. There’s still some overhead to contend with in the upper 50s, as well as earnings (due August 6), but we think the E.U. patent decision in June likely changed investor perception. Earnings are due around August 6.
• Neurocrine Biosciences (NBIX 146): NBIX has had a nice, very flat consolidation in recent months and is hanging out just shy of all-time highs ahead of earnings (due August 1). A powerful breakout—egged on by continued Ingrezza growth and any analyst outlooks for sales of Crinecerfont (approval likely by year-end)—would be tempting.
• Palantir (PLTR 27): We’ve written a few times about Palantir’s bullish fundamental story (including in last week’s issue), and while the stock has fallen off this week with peers, it’s remained north of its 50-day line and the dip doesn’t look abnormal. Earnings are out August 5, but we might roll the dice and take a small (half-sized) position ahead of it if growth stocks settle down.
  

Other Stocks of Interest

Guardant Health (GH 32)—Guardant Health came public in 2018 and we always thought it had a great, borderline revolutionary story: The firm is a leader in liquid biopsies, with its flagship Guardant 360 allowing patients with advanced stage (III or IV) tumors to get vital information that can guide treatment options (either initial treatments or adjustments to what’s already in process)—and, best of all, it’s non-invasive (just a couple vials of blood needed; the test picks up on the very minor genomic information released by the tumor into the blood), which makes it a great option for people where regular biopsies are impossible for one reason or another. At this point, that offering can scan more than 70 different genes for mutations and has been used by thousands of hospitals—and the uptake has been solid, with consistent revenue growth both over the years and recently (up 22% to 31% each of the past four quarters), and that business should continue to grow for a long time to come. However, the bottom line has been stuck in the red, so despite the growth the stock went from nosebleed levels in 2021 (180) then plunged consistently until a few months ago—when it hit 16! But GH has perked up in recent months as a new product could be a big seller: Dubbed Shield, it’s a colorectal cancer test with solid detection results, about the same as stool-based tests (like Cologuard), yet requires just a vial or two of blood, so compliance will be even higher (vs. Cologuard or standard colonoscopies); an FDA advisory panel strongly backed the firm’s offering a few weeks ago, making it likely a full approval will come later in the year. The opportunity for that is gigantic, and of course Guardant is working on other potential cancer detection tests as well. It’s somewhat speculative, but we like the solid core business and the upside of Shield—and after the aforementioned decline, the stock’s momentum has turned positive (13 weeks of positive relative performance) and shares are holding up well given the maelstrom in growth stocks. GH is on our watch list, with earnings due August 1.

Samsara (IOT 37)—We admit that Samsara is something of a binky for us, a stock we’ve been watching on and off for a long time but haven’t yet pulled the trigger on—in this case because of the stock’s hectic up-and-down action over the past year. However, the story has emerging blue chip written all over it, and we’d guess the stock, which is already picking up institutional support (637 funds owned shares at the end of June, up from 376 six months before), could be a core holding of well over 1,000 funds in time. The idea here is simple but very powerful: Samsara’s cloud software suite dramatically boosts the efficiency of firms with huge amounts of physical assets—think clients in waste management, construction, transportation, delivery and wholesale operations—by creating a single system of record that tells COOs how equipment is being utilized, which assets need repairs (from trucks to warehouse machinery to everything in between), how to take more direct routes in vehicles (GPS or Bluetooth tracking cuts down on idling time and traffic for fuel savings; also tax optimization depending on where assets are stationed), boosts safety (driver training) and lowers insurance premiums. From a business perspective, what we find interesting is that Samsara is usually selling into a client’s operations budget, which is far more stable than the IT budget, and big customers (at least five of the top 10 equipment rental, waste management, chemical carriers and food service outfits are signed up) have been steadily beating a path to Samsara’s doors. The company’s annualized recurring revenue has been leaping year after year ($382 million, $607 million, $856 million, $1.18 billion the past four Q1s), and yet the firm has captured just 5% of its global potential customers. We like that those already signed up are buying more and more (Samsara’s 100^th largest client is paying it $900k per year now, up from about $500k two years ago), which has pushed earnings and free cash flow (which totaled 7% of revenue in the recent quarter) into the black—we think years of 25% to 35% growth is possible from here. The trick has been the valuation, which is massive ($21 billion market cap!) and caused the aforementioned gyrations in the stock; IOT actually shook out below support in June, and at that point, had gone nowhere (net-net) for a year. Now shares are coming back some—a move over 40 or so (ideally with renewed strength in the software area; ServiceNow’s (NOW) earnings move today is a good start) would be very tempting.

Viking Holdings (VIK 34)—Leading cruise liners such as Royal Caribbean have had great runs as the initial post-pandemic cabin fever and travel boom has had legs, driving sales and earnings higher while bookings remain strong looking into next year. Viking Holdings looks like a potential follow-on play to that: It’s a leader in the sector with just over 90 vessels on the water, albeit with a focus on luxury river cruises (80 owned and on the water) that generally have just a couple hundred passengers, no gambling and usually no kids, as well as a general focus on cultural vacations (especially as these cruises often dock at major cities in Europe). That focus, as well as far less competition than ocean cruises, leads customers to book well in advance (11 months on average), which promotes more stable pricing and better gains in revenue-per-passenger than most peers. The firm is also diving more heavily into ocean cruises (9 ships as of now), and altogether, business is good (revenues up 14% in Q1, occupancy was over 92% for both river and cruise voyages) and the future looks bright, with 91% of 2024 and 39% of 2025 capacity already booked as of mid-May. (Ocean and river bookings for next year are running 30% and 19% (respectively) above their levels from a year ago.) Combine all of this with some capacity expansion (5% this year, 12% in 2025) assome new ships hit the water and the future should be bright. VIK just came public in May and has been steadily advancing since then—the uptrend looks solid, though dips of a couple of points would provide better entry points.

Trust the Thrust?

It’s not often that nearly two years after a major bottom in the indexes (October 2022) and nine months after things truly kicked off on the upside (October 2023) you’ll see a potential “fresh” kickoff from a large swath of the market—but given the unusual situation of late, with the extremely narrow environment, it might be happening right here.

We’re referring to the broad market, in particular small caps, which, on balance, haven’t gone anywhere for three and a half years. But now, thanks mostly to the Fed possibly, maybe, finally becoming a tailwind, we’ve seen some very rare, powerful action from the broad market. A couple of examples:

Starting after the tamer-than-expected inflation report earlier this month, breadth (which was very laggy during June) came alive in a rare way, with advancing stocks outnumbering declining stocks by three-to-one for three straight days. (In fact, that ratio pretty much held over a five-day stretch.) What’s interesting is, despite such a short period of time, such action has portended good things longer-term (S&P 500 up as much as 18% during the next year) with limited drawdowns (max loss of 2%), and the broad market usually did even better than that during these occasions.

Then there’s the fact that the Russell 2000 small cap index posted a gain of more than 10% over a span of 10 days. That’s happened a couple dozen other times since 1980, and while there were definitely some poor signals, the small-cap index was up 17%-plus on average during the next year (including some much larger gains).

More important to us is the overall stance of small caps: Whether you’re looking at the S&P 600 (which we use in our Cabot Tides) or the Russell 2000 (which has more liquid, tradable ETFs), neither has gone anywhere for the past three-plus years—below is a multi-year (replacing weekly) chart of the Russell 2000 ETF (symbol IWM), which essentially peaked at 234 in early 2021, a few percent above where it is today. The S&P 400 midcap fund (MDY) has done a bit better (up 4% since its late-2021 highs) but is certainly nothing to write home about.

To be clear, it would be a much higher-odds situation if the entire market was coming off some sort of big decline, followed by the short-term breadth thrusts—that would have us salivating. At this point, with so many crosscurrents out there, another rug pull of sorts for the broad market is always possible. Even so, the fact we’re seeing these signals after a multi-year setup for small- and mid-caps has us very intrigued, and the risk-reward situation (a modest drop would tell you the move has failed, but if things work, the upside could be many-fold as large) looks right, too.

We started a position in the ProShares Russell 2000 Fund (UWM) last week—and are looking to average up if the recent upside thrust follows through.

Is Bitcoin Getting Ready for Another Run?

We’ve written very little about crypto over the years, mostly because, fundamentally, there’s still not much there yet—while bitcoin, etherium and the like is accepted for payment at more places, its usage remains on the very fringes of society … though the market, for good reason, sees adoption as a bigger thing down the road, as there’s no question crypto is becoming more mainstream. (Etherium spot ETFs just began trading this week.) Bitcoin itself, via the iShares Trust (symbol IBIT), has been consolidating normally since mid-March.

That said, instead of ETFs of the coins themselves, we continue to favor growth companies that could be major players of any crypto economy. Coinbase (COIN) remains a name we’re intrigued by—sort of a Bull Market stock of crypto, offering trading tools (revenue of which can swing wildly up and down) as well as subscription and services (more stable revenue producers like stablecoins, staking, Coinbase One for better trading tools and interest income). Business has grown over time, and in the past couple of years, the top brass got serious, slashing costs (non-transaction-related costs down 17% in Q1 from a year ago), allowing any boomlet in trading to fall to the bottom line ($4.40 per share in Q1, though likely just $1 or so in Q2 as crypto fell).

The stock is very crazy on a day-to-day basis, and like many things, is having issues with resistance of late, but the overall rest period since March has been reasonable compared to the humungous prior run—if COIN (earnings due August 1) and bitcoin can break out on the upside, we think each could have a fruitful upside move.

Cabot Market Timing Indicators

It remains unusual times in the market: Our top-down market timing indicators are all positive (though our Cabot Tides bear watching), with the broad market’s resurgence helping the cause. But growth measures (like our Growth Tides and Aggression Index) look sick, as do individual stocks. All in, we’re cautious here, but staying flexible if this is yet another sharp shakeout that gives way to a fresh rally as earnings season continues.

Cabot Trend Lines – Bullish
The big-cap indexes are finally deflating a bit, but our Cabot Trend Lines are firmly positive, with the S&P 500 (by 6%) and Nasdaq (by 7%) still handily above their respective 35-week moving averages. Will the indexes move lower for an eventual test of their 35-week lines? We can’t rule it out, but it’s best to just go with the message in front of us: While growth stocks are correcting, the overall bull market is intact, so the odds continue to favor higher prices down the road.

Cabot Tides – Positive
Our Cabot Tides have nearly reversed their standing in the past month—whereas the big-cap indexes were strong and broader indexes were struggling back then, now the broader indexes (like the NYSE Composite) are positive, while the S&P and Nasdaq test or dip below their lower (50-day) lines. Of course, the NYSE and its broader peers don’t have much daylight above support, so we’ll be watching to see if the growth stock selling spreads, but so far, the market’s overall intermediate-term trend remains up.

Two-Second Indicator – Positive
Our Two-Second Indicator has handled the market’s latest wobbles in stride, with 11 straight days of sub-40 new lows. While that doesn’t mean we’re going to ignore the maelstrom in growth stocks, it is a good sign that the sellers aren’t running wild across the entire market, which in turn, opens the door for a renewed rally if earnings season goes well.

The next Cabot Growth Investor issue will be published on August 8, 2024.

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