Cabot Growth Investor Issue: May 4, 2023

Failure to Launch

If you think of the market in terms of actions taken by big institutional investors as we do, it certainly seems like the distribution phase ended a while ago—for glamour stocks the selling began in the spring of 2021, with everything going over the falls in early 2022 as the Fed started on a warpath. You could even say lots of stuff continued lower into last fall, especially the “leading” names on the downside (back then, the Ark Fund, etc.).

But since that point, the major indexes—even the weaker ones, like small- and mid-cap indices—have held their own, and that’s despite a bevy of Fed rate hikes, multiple signs of recession and, of course, the current rolling bank panic, which has seen some major banks go under (the assets of those that have failed is already more than seen in 2008) while a few others walk the plank.

The overall market’s ability to hold up (or, said another way, that the lack of persistent selling among big investors) plays into what we wrote in the last issue on this page—it’s one of many small positives out there that bode well, at least from a big-picture point of view. But “not going down” isn’t where the money is made; what we’re waiting for is the start of the real accumulation phase, where mutual and pension funds have confidence that the economic rug won’t be pulled out from them and start buying hand over fist.

Right now, though, that’s not happening. In fact, we’re seeing just a relative handful of stocks holding the big-cap indexes near their highs (see more on that later in this issue), and of the many growth stocks that had set up well, most have seen a distinct failure to launch, with many having fallen flat on earnings—with more than a few really collapsing during the past week and a half.

To be fair, there have been a few growth stocks this week that have popped (including a couple we know well), and some of them have repopulated our watch list. Even so, the message is clear: While the major indexes and other factors offer encouragement, the overall evidence is mixed at best—if and when that changes, we’ll change, but in the meantime, we remain cautious while holding a handful of resilient stocks should things kick into gear.

What to Do Now

Because of that, we continue to urge caution when it comes to individual growth names—less remains more in a sense, given the meat-grinder environment. That doesn’t rule out a nibble or two if growth stocks start to perk up, but it’s best to stay safe until big investors put money to work. We’re standing pat in the Model Portfolio tonight with a cash position of 63%.

Model Portfolio Update

We wrote more than a few times that the #1 trait we saw last year that’s a hallmark of rough environments was selling on strength, especially when stocks approached key resistance—time after time in 2022 stocks would test or nose out to new highs, only to quickly get rejected as buyers turtled and sellers pounced.

That pattern faded for a few months, but in recent weeks it’s come back with a vengeance with growth stocks, as a bunch of great-looking setups that took weeks or months to build are being blown apart on earnings or some other news or rumor. The number of names that have failed to launch even on good news is a big reason why we aren’t in a hurry to put much money to work.

That said, these things can change in a hurry—and when they do, there are so many people leaning in the bearish direction that we think the move could be violent. This week we’ve finally started to see some growth names show real power after earnings and if that can spread, we’ll be on it.

In the meantime, you know us: We always go with what we see, and the very narrow market environment and large number of growth stocks that are wobbling have us staying mostly safe. Tonight we’re going to stand pat with a 63% cash position while keeping our small position on Shift4 on a tight leash.

CURRENT RECOMMENDATIONS

Academy Sports & Outdoors (ASO)—After chopping up and down for a month, we sold one-third of our shares of ASO last week, thinking the sell-on-strength action seen in many names could carry over to here—and indeed, the stock did break its 50-day line earlier this week supposedly on news surrounding a CEO transition, though we think it had much more to do with the general market. Really, though, the damage wasn’t all bad (basically gave back the mid-March earnings move) and shares have bounced a bit since then; with the on-again, off-again market and the still-sterling fundamentals, we’re OK holding our remaining shares here and seeing if they can resume their uptrend now that some holders have been shaken out. A dip into the mid/upper 50s could have us thinking differently, but we think holding your remaining shares is your best move. HOLD

Allegro Microsystems (ALGM)—Chip stocks as a whole have taken on some water, but ALGM completely unraveled, giving up its entire breakout move from February (a red flag in and of itself) on fears that EV demand will slacken, hurting demand for its chips. (Axcelis (ACLS), which we had also been following, held up better until falling sharply on earnings today.) Allegro does report earnings next week (May 9), but even a sharp rebound would still leave the stock buried on its chart—and in much worse shape than some other potential leaders out there. We sold our half-sized position about mid-way through the recent plunge and think there will be better places for the money when growth stocks get going. SOLD

Axon Enterprises (AXON)—AXON had a tough go of it last week, with the sellers appearing near resistance (which is being seen in most stocks) and driving the stock straight down to its post-earnings lows—before, this week, shares perked back up, thanks in large part to news that the stock would replace First Republic in the S&P 500 today. We’ll certainly take the action (the fact that it found support above its breakout level is a plus) and still think the underlying story has huge potential (especially with new Taser and body camera products rolling out), though earnings are due May 9, and as with most names, that will probably tell the intermediate-term tale. Right now, with AXON acting well and with buisness likely inoculated against just about any economic uncertainty, we’ll stick with a Buy a Half rating, though obviously keep any new purchase small this close to the Q1 report. BUY A HALF

On Holding (ONON)—Given all the air pockets out there of late, we’re very encouraged with the resilience of ONON, which has been holding its 25-day line of late and has even started to quiet down a bit. There are never any sure things, but in a “normal” market environment, our confidence here would be very high that the stock is a new, fresh leader that is probably just starting a sustained advance. Given the current environment, though, we’re still optimistic ... but are also not in a rush to push the envelope, especially with earnings due out May 16. We’re holding on tightly to our half-sized stake and think you can start a position here (or, preferably, on dips) if you’re not yet in—but will hold off averaging up for the time being. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—As we write later in the issue, it’s been an extremely narrow market, with relatively few stocks hitting new highs or even above their 50-day lines despite the fact that indexes like the S&P 500 (and, hence, SSO) have recently been within a stone’s throw of their summer 2022 highs. Still, that’s more descriptive than predictive in our book when it happens after a big decline, and in the meantime, it’s helping SSO remain in decent shape. As with most things, we aren’t giving this name a giant leash; a decisive drop going forward (including a clear sell signal from our Cabot Tides) would raise the prospects of a retest of last fall’s low, which we don’t want to stick around for. But overall, it is what it is: SSO’s resilience in the face of numerous uncertainties and a rolling crisis in regional banks is a positive sign for now—if you own some SSO, sit tight. HOLD

Shift4 (FOUR)—Shift4 was walloped today after earnings, though there was no obvious reason why: Q1 was a great one for the company, with revenue less network fees up 34% on a 66% gain in transaction volume, once again thanks to both its core restaurant and hospitality clients and many newer industries, too. (In that new category, the top brass said Shift4 went live at a mega-resort in Arizona, two “large Las Vegas properties,” the Chicago White Sox and the Washington Commanders while inking a deal with Six Flags to run their food and beverage payment system.) Meanwhile, EBITDA doubled, earnings topped estimates and management actually nudged 2023 guidance higher, including the fact that it now expects free cash flow of at least $225 million (well over $2.50 per share). Of course, the fear is that the Fed is going to crush the economy, which will crush consumer spending, which would in turn crimp Shift4’s growth. That’s always possible, but given our small position (4% of the portfolio) and the fact that FOUR is down in an area of support, we’ll stick with our position a bit longer and see if we see any snap back action in the days ahead. HOLD

Wingstop (WING)—We took partial profits in Wingstop last week, mostly to cut back on a big-sized position (it was around 15% of the account) in what has been a very tricky environment (and treacherous earnings season for many leaders). Happily, though, the good vibes continued this week after another barnburner of a quarterly report: In Q1, system-wide sales rose 30%, with domestic same-store sales rising a whopping 20% (!!), both of which propelled revenue to a 43% gain, while EBITDA rose 60% and earnings cruised past expectations. The cookie-cutter story, too, remains in fifth gear, with 1,996 restaurants open at quarter end, up 37 from the prior quarter and up 11% from a year ago. (Interestingly, Wingstop is starting to get some gravity overseas, with 243 locations now, up 20% from a year ago—long term the firm thinks it can have thousands of locations internationally.) Shares had a great day yesterday, though it gave back a chunk of that today. Having already sold some, we advise sitting tight and giving WING some wiggle room. HOLD

Watch List

• DraftKings (DKNG 21): Having already been taken apart last year, most of the weak hands are likely out of DKNG—which is one reason the stock has remained strong (albeit choppy). Earnings are due out tonight, with the conference call Friday (May 5) morning.
• Duolingo (DUOL 120): DUOL was divebombed on Tuesday after another education stock (Chegg) was destroyed when it said some users are using AI offerings instead of its own. We doubt this will affect Duolingo much—in fact, the top brass said it was integrating AI stuff into its offerings last quarter, and the entire platform appeals to users thanks to a unique game-type style. Shares are iffy, but there’s no harm in watching DUOL and seeing how it reacts to earnings May 9.
• Freshpet (FRPT 69): FRPT has set up a very nice-looking six-month launching pad, and with business turning around and costs coming under control, we smell a growth-oriented turnaround brewing. Earnings are due May 8.
• HubSpot (HUBS 449): HUBS reported a very strong first quarter last night, with sales (up 27%) and earnings (up 122%) easily topping expectations while management meaningfully raised guidance despite the tough economic environment. Shares are now trading at multi-month highs.
• Inspire Medical (INSP 267): INSP cracked with the market a couple of months ago, but has rounded out a nice base and, yesterday, reacted well after another outstanding quarterly report. There’s still resistance to chew through, but it’s back on our watch list—and a decisive breakout (and a better growth stock environment) may finally kick off a sustained rally.
• Intra-Cellular Technologies (ITCI 62): On one hand, ITCI is a money-losing biotech, but on the other, it has a one-of-a-kind potential blockbuster drug, and the stock has come alive after a long rest.
• Las Vegas Sands (LVS 62): LVS is still being jerked around, but it actually nosed to new highs last week after a solid earnings report that confirmed (a) the Chinese reopening is super-bullish for its Macau properties and yet (b) Macau’s cash flow is still less than 50% of pre-pandemic levels. Plenty of growth ahead.
• Uber (UBER 37): A lot of names that cracked in February are still in the dustbin, but three of the ones we had have bounced back after deep retreats … hopefully a sign we’re on the right fundamental track. UBER is one of them that’s come back to life after a great Q1 report this week—with the underlying story still intact, we’re not afraid to dive back in if the market ever shapes up. See more below.

Other Stocks of Interest

Celsius (CELH 100)—We dipped a toe into Celsius last year and it didn’t work out, but we continue to keep an eye on it given the outstanding long-term growth story here and, at this point, the stock’s 18-month consolidation (and numerous tough corrections)—eventually, we think it has another run. The story, of course, revolves around the firm’s energy drinks, which are healthier (no preservatives, aspartame, high fructose corn syrup, etc.) than competitors’ and studies show they actually help you to burn calories by turning on thermogenesis (body produces heat). Following in the footsteps of Monster Beverage and Redbull before that, Celsius was consistently gaining market share and expanding its distribution to tens of thousands of locations (including big gains in the club and fitness markets), which was great—but now that expansion is being supercharged by Pepsi, which took a stake in Celsius last year, leading to a few months of rejiggering inventory and distribution to Pepsi’s platform. That messed with some of the numbers during the past two quarters; costs went up during the multi-month transition (an extra $200 million or so!), which pulled the bottom line into the red, and some sales were pulled forward to make sure there was enough product for sale across the monstrous distribution network. That caused a bit of uncertainty, of course, but there’s no doubt that underlying demand remained strong—as of year-end, Celsius was #3 in the energy drink market, though its share of 6.4% (up from 3.4% the year before) leaves tons of room for growth, especially as Pepsi opens up many avenues that Celsius hadn’t touched before (think Hilton and Marriott locations as well as many airports and casinos) and, long term, helps the firm expand internationally. Big picture, after a couple of “messy” quarters numbers-wise, now that the distribution switch-over is complete in the U.S., it’s likely both sales and earnings will begin to kite higher from here—and attract big investors in the process. Indeed, analysts see earnings leaping back into the black in Q1 and soaring from there, while the top line is anticipated to grow 55% this year and another 34% next. Back to the stock, CELH stormed all the way back to its old highs last summer but has since been stuck in a wide 35% range—and after some tightness, shares have begun to find some buying. Earnings are due out May 11, and a positive reaction would be noteworthy.

Uber (UBER 37)—While the market (and especially growth stock) action remains sour, one pattern we’re seeing all over the place is this: A stock got slashed early last year, then basically bottomed out for many months before staging a solid rally for a few weeks or even months—but then it backed off again (but in a relatively shallow way) during the past three months as the market pulled in and the banking issues have grabbed the headlines. With fundamentals still looking great, this represents the vast majority of setups we’re seeing out there, and if the market can get out of its own way, we think many can and will launch into sustained uptrends. That long preamble leads us to Uber, which has this exact pattern and is a name we had high hopes for earlier this year—but were forced to sell when shares cascaded more than 20% from their highs when the market keeled over. However, the big-picture story—that the firm is the leader in ride sharing and also does huge business in delivery, all while the top brass was now focused on earnings and cash flow—hasn’t changed at all, and after a fantastic Q1 report this week, the stock is again showing intriguing power. In the quarter, bookings were up 22% on a currency-neutral basis (ride sharing up 43%, delivery up 12%), with monthly active users totaling more than 2.1 billion (up 24%) and adjusted revenue for those two businesses up 33%. More important was that EBITDA continued its climb ($761 million, up 14% from the prior quarter) while free cash flow was around 27 cents per share—and the Q2 outlook was very solid, too. UBER responded very powerfully on Tuesday and Wednesday (even as the market was getting slapped around), and really, the action since last August looks like one big proper launching pad with many big weeks of buying volume. Of course, the market is an issue, but UBER is back on our watch list, and we think it can be a liquid leader of sorts if and when the market finally turns up.

Wheaton Precious Metals (WPM 51)—Nobody will ever confuse me with a gold bug, but every now and then there’s a growth-y precious metals play with a bullish backdrop, as we have today with gold prices north of $2,000 per ounce and rising. That’s the case with Wheaton Precious Metals, which is a great business in and of itself—the firm is one of the largest streaming firms, which is similar to a royalty in that it seeds money to miners (Wheaton does no mining of its own) in exchange for a deal to purchase a chunk of the production of that mine at a set price once things are up and running; as of the last tally, it has stakes in 21 operating mines and another 13 developmental projects that provide it with potential upside down the road, and it frequently adds stakes along the way. It is leveraged to a couple of big mines (one by Vale, one by Newmont) that together provide nearly half of streaming revenue, yet while that’s a risk, those firms are busy trying to make profits—all the more so with prices elevated. Overall, it’s a great business, with after-tax profit margins well over 40% and with operating cash flow likely to average $1 billion per year (north of $2.10 per share) even with gold at $1,850. And better yet, the firm sees growth ahead: While total output should be up just 1% or 2% this year, Wheaton sees output over the next five years averaging 30% more than current levels due to deals it already has in place. Thus, in a stagnant world, Wheaton’s cash flow and earnings should do well … and if gold and silver (the firm is leveraged to both) can power ahead, the sky’s the limit. Indeed, WPM has had a good run since the low last fall, including a strong performance in March and April—bringing it just shy of its highest levels since mid-2020. The Q1 report is out tonight, though more important will be the banking, Fed and geopolitical developments of the next few weeks, which will impact the price of gold.

Narrower and Narrower

The biggest characteristic of the market right now is the incredibly narrow nature of it—meaning that just a handful of stocks are propping up the big-cap indexes, with stuff like Microsoft (MSFT) and Meta (META) keeping the Nasdaq and S&P 500 near multi-month highs—even as most of the rest of the market fails to participate.

Check out the chart below of the number of new highs on the Nasdaq this year—when the major index raced into its early February top (bottom panel of the chart), about 200 stocks hit new 52-week highs. When the Nasdaq returned to those levels after the banking panic, though, just 95 stocks hit new highs. And in recent days, as the index again tested new high ground, new highs again were stuck near 100 or below. Overall, the figures play directly into the sell-on-strength theme that has continued to pop up.

Then there’s the percent of stocks above their 50-day lines—interestingly, even with the S&P 500 (bottom panel) testing its highest level since last summer, less than half of all stocks on the NYSE ever got above their 50-day line, compared to 80% to 85% readings the last couple of times the S&P had a head of steam behind it. Meanwhile, broader (small-cap and mid-cap) indexes are still 11% to 15% below their February highs!

Last but not least for us is our Growth Tides—a collection of funds and indexes that are (usually) a more direct representation of the types of stocks we hunt for. We’re talking things like the Renaissance IPO Fund (IPO), which tracks most IPOs that have come out during the past couple of years; the iShares Russell 2000 Growth Fund (IWO), which covers the small-cap growth area of the market (shown below); and the IBD Mutual Fund Index, which tracks the performance of a bunch of growth-oriented mutual funds. All of them are meandering at most and floundering at worst, with no real progress in recent weeks.

You get the idea then—the market is riding on the backs of a handful of massive, liquid names right now. But what does it mean? That’s where things get tricky.

Normally, when the market is very narrow, it leads to bearish things; most market tops, in fact, occur over time, with fewer and fewer names participating until the last remaining blue chips give in to the bear.

However, it’s far less common to see that after a meaningful decline, like the one we saw last year … and there have actually been some prior bottoms where some “safer” blue chips perked up first, and after the fact, growth stocks and the rest of the market kicked into gear.

All of that is a way of simply saying that the market’s narrowness right here isn’t overly predictive—things can change in a hurry, especially during earnings season. But it is very descriptive, and we like to go with what we see: Until something changes, it remains a less-is-more environment, especially when it comes to growth stocks.

Housing Stocks Can Trend

We obviously prefer fresh growth stocks with revolutionary new products and services, as those have historically made up the lion’s share of the market’s big winning contingent. But, obviously, those are in relatively short supply for the time being, which has us looking at other areas that can trend when conditions are right, are coming into favor, have a bullish fundamental backdrop and are breaking out on the upside.

Today, that includes housing stocks … which, admittedly, might seem to make no sense, with mortgage rates holding near multi-year highs and with the economy looking iffy. But this isn’t just a contrary play: As we’ve written before, the trend of market-based interest rates has turned flat-to-down (our Power Index), and while prices are easing some, they remain elevated—partly because the higher rates are keeping many from moving, which is crimping supply. The long and short of it is that earnings for homebuilders and many housing-related names will ease for the next two or three quarters—but far less than had been feared, and should the Fed reverse course (becoming more a possibility every day), a new growth phase could actually kick into gear.

Interestingly, the granddaddy of the group actually looks the best: D.R. Horton (DHI) is the nation’s largest builder, and while business is sloughing off (earnings down 32% in Q1), those figures crushed estimates and the forward-looking measures (orders were down “only” 7%) were also much better than feared—all of which means this year will see earnings nearly twice the pre-pandemic peak (north of $11 per share), with growth possibly resuming later this year. DHI itself built a big launching pad and lifted to new all-time highs a couple of weeks ago.

As for a more growth-y housing stock, there’s one of our old favorites: Floor & Décor (FND) is sort of the Home Depot of hard flooring: Via its 191 warehouse locations (it also has six design studios), it has everything that professionals and DIY’ers need in stock, with well over a thousand products (floor tiles, laminates, wall tile, wood, natural stone, you name it) usually available, compared to just a couple hundred for most competitors. Thus, the firm is taking share in a growing market (hard flooring vs. carpet), and it has a great cookie-cutter story as well—it sees the store count growing to 230 or so this year and 275-ish next year, on its way to 500 down the road. And we’re not the only ones who think highly of the story—at last check, Berkshire Hathaway owns more than 4% of the company after buying some chunks in 2021 and 2022.

Once again, earnings are expected to flatten this year, but FND appears to be setting up for better times—the stock rallied to 100 last summer, rallied back to the century market this February and has been hovering just shy of that level for the past few weeks … just ahead of tonight’s quarterly report. Let’s see if FND can follow DHI and some other housing names higher. WATCH

Cabot Market Timing Indicators

The story remains mostly the same: The big-cap indexes and longer-term picture offer encouragement, but the near-term trend is wobbly while the broad market is relatively weak and growth stocks are having trouble. We remain cautious, but flexible, as we wait for big investors to step up.

Cabot Trend Lines: Bullish
We wrote about how narrow the market has been, which is one reason why our Cabot Trend Lines remain bullish—both the S&P 500 (by 3%) and Nasdaq (by 6%) are holding solidly above their 35-week lines in large part because of some mega-cap stocks. But that doesn’t negate the signal: The fact that the market’s two major indexes are holding above long-term support despite all the bad news and worries is a good thing—and a definite difference from what we saw last year.

Cabot Tides: Neutral
We’re going to continue to call our Cabot Tides neutral, as some indexes (like the Nasdaq, daily chart shown here) look good, others (like the S&P 600 SmallCap) look poor, but most everything is still stuck in a wide trading range going back a few months. A decisive move up or down would likely be meaningful, but at this point, the intermediate-term trend is effectively sideways.

Two-Second Indicator: Negative
Our Two-Second Indicator is also close to no man’s land, though we’ve now seen six of the past eight trading sessions with plus-40 new lows, most of which were in the triple digits—enough to consider the broad market unhealthy. We’ve seen the readings change in a hurry, so we’re keeping our eyes open if the market turns up, but right here it’s clear there remain lots of sellers.

The next Cabot Growth Investor issue will be published on May 18, 2023.