Cabot Growth Investor Issue: November 2, 2023

Keep Your Antennae Up

Every bear phase in the market fits into one of two categories. The first is scare-you-out declines, which often are relatively brief but implode for some factor the market freaks out about. The pandemic crash of 2020 was obviously the ultimate example, but there are many others, such as the late 2018 nosedive of 20% or so on Fed rate hike fears and lots of China trade war worries.

The other kind of bear is more of the wear-you-out variety—there can also be big losses, especially under the surface, but just as important is the time factor, with months going by without any sustained rally, effectively givign off the feeling of an ongoing bleed as the news gets worse and worse. The past couple of years certainly fits in this category, with the late-October action (including lots of implosions among names like CFLT, PCOR and RELY today alone) grinding investor patience down to the nub.

However, that action is the big reason why many secondary measures (like sentiment, including today’s AAII survey that showed north of 50% bears, the largest total of the year) have been at levels that usually occur near market lows—which, in turn, is why we wrote in the last issue that we saw a decent setup in the market despite the tedious action

Today, our antennae remain up as we’re wondering if the market’s piles of dry tinder have caught a spark—yesterday’s Fed meeting didn’t make any dramatic headlines, but today, we see Treasury rates falling sharply, with some (like the five-year note yield, shown here) even testing their key intermediate-term 50-day lines, which have contained the entire multi-month upmove. That’s a big reason why the market has shown some solid power this week, with some indexes (like the Nasdaq) quickly recouping their late-October declines.

Of course, as we’ve seen countless times over the past three months (not to mention over the past two years), three or four up days isn’t enough to conclude the sellers have left the building—right now, our Cabot Tides and Two-Second Indicator are still negative and the number of names at or near new high ground remains tiny, so we don’t advise cannon-balling back into the pool at this point.

What to Do Now

However, we are intrigued, and while not doing anything major, we are nibbling on one name in the Model Portfolio tonight given our monstrous cash hoard—we’ll buy a half-sized stake in Nutanix (NTNX), though that will still leave us with around 70% (give or take) on the sideline. There are no other changes in our ratings, though we’re glad to see some of our remaining names pop. Details below.

Model Portfolio Update

Nobody gets into the business of the stock market thinking, “Hey, maybe in the next year or two, I’ll buy just small positions here and there and hold tons of cash!” But that’s been the gist of things since the Nasdaq peaked nearly two years ago (Thanksgiving of 2021)—we’d love nothing more than to latch on to a ton of potential leaders and start a major buying spree, but trying to do so has been like throwing money into a meat-grinder as the vast majority of stocks falter. The result: We’re still holding a huge cash position in the Model Portfolio as we wait for the buyers to step up for more than just a couple of days.

All that said, our antennae remain up: There are many secondary measures that are showing action typically seen near market low points, be it sentiment, breadth or even our own Two-Second Indicator (see more on that later in this issue). And then, of course, we have the latest upmove, which hasn’t proven itself by our measures but is certainly intriguing. Might the rally fail again if, say, interest rates continue to crank ahead? Sure. But after two years mostly in the doldrums and a horrid last three months, now’s not the time to stick your head in the sand.

In the Model Portfolio, we still believe the positions we’ve been able to hold onto can do very well if the market gets out of its own way; indeed, we’re pleased to see most pop higher this week. That said, their intermediate-term fates will come down to earnings season, where we’re still seeing a large number of blowups. So far, Noble (NE) has reacted positively, though we have DraftKings (DKNG) tonight.

In terms of changes, we’re making one—given our huge cash hoard, the negative sentiment and some encouraging recent action, we’re going to start a half-sized stake in Nutanix (NTNX), which has acted well for weeks and is bouncing off support. That will still leave us with around 70% in cash, give or take—we’re open to deploying that quickly if the bulls follow-up on this week’s buying in a big way, but right now we’re most practicing patience and seeing if the market can prove itself.

CURRENT RECOMMENDATIONS

CrowdStrike (CRWD)—There’s been nothing much new from CrowdStrike itself in recent weeks, though there have been a couple of analyst tidbits, with one saying the firm will be a big winner when it comes to generative AI and another simply saying the cybersecurity spending environment looks healthy for 2024, with CrowdStrike likely to gain more than its fair share of any sector boost. Like most resilient names out there, this stock finally took on water during the market’s late-October slide, though it found support where it “should” (above the 50-day line and near prior highs), which is much stronger action than the vast majority of stocks out there, and it’s bounced modestly (and on very light volume) since. CRWD certainly quacks like a stock that can move nicely higher if the market allows it—if so, we could even quickly average up on our half-sized stake given that earnings aren’t out for nearly a month (November 29). Today, given the environment, we’ll stay on Hold, but we’re watching closely for signs the buyers are stepping up. HOLD HALF

DraftKings (DKNG)—We’ve ridden DKNG up and down for months, waiting patiently with our half-sized position for the stock to show its hand—which makes tonight’s quarterly report (and the reaction—not just tomorrow, but over the next few days) important. Analysts are officially looking for $686 million in revenue (up 57%) and a 70-cent per share earnings loss (EBITDA will be much stronger than that), though most think those are conservative, and of course the outlook (especially regarding questions surrounding the upcoming launch on November 14 of the ESPN/Penn product) will be key. Even beyond that, there’s a mid-November Analyst Day that should provide some financial targets for the next two to three years, but let’s deal with earnings first: DKNG still has a solid launching pad in place, so if it can react powerfully it could finally be ready to move—but, of course, a meaningful move lower would tell us perception is heading south. Right here, we’ll hold our small-ish stake and see what comes. HOLD HALF

Noble (NE)—Fundamentally, there hasn’t been much doubt that the offshore drilling area is in the midst of a sustained upmove—some of that has to do with stubbornly high-ish oil prices, but most of it is structural, with supply waning in a big way during the multi-year bust cycle and with big oil majors looking for reliable, low-cost output. Noble’s Q3 report, released Tuesday evening, was reflective of that: Revenue was up a whopping 128% from a year ago and up 9% from the prior quarter, with EBITDA up 50% from the June quarter (!) and earnings of 87 cents per share topping by three cents. Not surprisingly, utilization continues to increase, with the 16 floaters having a huge 92% utilization rate last quarter, and while the non-deepwater fleet (jackups) was only 61% utilized, that was up from 59% in the prior quarter. In Q3, CapEx was a bit elevated and led to only 21 cents of free cash flow in the quarter, but that’s not going to last—the writing is on the wall for much higher earnings and cash flow, with management saying re-contracting going ahead should be at very solid rates (this will be on top of the solid $4.7 billion backlog) and, partly as a result, they lifted the dividend by a third (now 40 cents per share quarterly, yield of 3.2%). Shares aren’t out completely of the woods, but NE has reacted very well to its report, racing back above its 50-day line today. We’re going to stay on Hold tonight, but the action is obviously encouraging, and if it can hold or build on the move, we’ll likely restore our Buy rating (and possibly even add back some shares). HOLD

Nutanix (NTNX)—We’ve written plenty about Nutanix in recent issues so we won’t rehash everything here—suffice it to say that the firm’s platform has become a go-to for big enterprises to effectively power their entire IT stack, allowing them to run and switch everything between clouds, boosting efficiency and saving money. And thanks to the firm’s switch to a subscription model, it appears that rapid and reliable growth is on the horizon—the numbers are already solid, and the top brass thinks free cash flow can expand nearly four-fold during the next five years, and it’s worth noting that the last time management released a longer-term outlook (three years ago), it easily surpassed its goals, and that was despite a very tough tech spending environment the past couple of years. As for the stock, it actually broke out on earnings on September 1 and rallied toward 40 last month before a tough retreat with the market to end October. But NTNX held its 50-day line and has begun to bounce, albeit on light volume. Is it the perfect setup? We won’t say that, as those don’t exist in this environment—but the relative strength and story are both impressive. Given our huge cash hoard, we’ll buy a half-sized stake in Nutanix and go from there. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—We sold the rest of our SSO position last week for one main reason—with the market in freefall, we couldn’t justify simply holding and hoping with a leveraged long index fund, even if it was a small position. Now, looking ahead, we definitely could buy SSO back (or one of its peers—maybe the ProShares Ultra Russell 2000 Fund (UWM) if small caps start to reverse their years of underperformance) if we feel the market is taking a definitive turn up, possibly with some blastoff indicators confirming any green lights from our market timing indicators. Even so, while we’re intrigued by the rally of late (and today’s dip in interest rates), we need to see some primary evidence turn up before going back into an instrument like this. We sold SSO and are holding the cash for now. SOLD

Uber (UBER)—UBER has had a tedious past three months, but the top-to-bottom correction hasn’t been awful (just under 20%) given the destruction in the broad market, and now it’s bouncing impressively, leaping above its 50-day line with today helped by a strong earnings reaction from delivery peer DoorDash (DASH). The main tell, though, should come from the firm’s own report, which is due November 7—all of the tidings of late have been positive, both shorter- and longer-term, so if bookings and EBITDA can again come in strong, we still think the stock has a shot at kicking into gear. Right here, it’s hard not to love the rebound, but we advise holding your remaining shares and seeing how it goes after the report. HOLD

Watch List

• Arista Networks (ANET 211): Arista has continually grown faster than expected as demand for its networking switches, routers and relays has been robust—and while next year may bring a slowdown, AI-related Ethernet gear in late 2024 or early 2025 could be a big story. See more below.
• Elastic (ESTC 71): ESTC has a powerful Big Data platform that ingests any type of data and allows corporate users to easily search it. There’s upside from the standard data analysis angle, but it’s also perfectly suited for AI, too, which could be a powerful tailwind. The stock is still pulling back but is near an area of support. See more below.
• Eli Lilly (LLY 581): LLY was dragged down by the market the past couple of weeks, but shares never came close to their early-October low (a sign of relative strength), and this morning’s quarterly report was solid, helping the stock to rally some. It’s not a sure thing, but the potential for Mounjaro (sales of $1.4 billion in Q3) to be a mega-blockbuster is there, which could drive earnings through the roof. We’re also keeping an eye on Novo Nordisk (NVO) with its own weight loss drug, dubbed Wegovy—both stocks have generally swum together and have huge potential.
• Gitlab (GTLB 42): GTLB is on the edge here, testing intermediate-term support, but it has most of the characteristics of a new leader. A drop under 40 would have us looking elsewhere, but so far, it’s acceptable.
• Nvidia (NVDA 435): Yes, it’s a mega-cap, but NVDA is the flag bearer of the AI movement and, really, for all growth stocks as well—and while shares have taken on water, the pullback was very reasonable (20%, give or take) given the huge advance and it’s recouped a third of that drop in the past two days.
• ServiceNow (NOW 600): OK, OK—ServiceNow isn’t the young buck it once was, and ideally, if/when the market really gets moving, there will be fresher merchandise to own. That said, if you just look at the evidence, there’s a lot to like, including a tight, controlled rest period the past three months, very strong sales and earnings and the post-earnings romp back to its highs.
• Vertiv (VRT 40): We thought VRT was likely toast after it experienced some very wild, toppy action following earnings—but the drop was never that damaging, and the stock has moved back near its highs since. The Q3 report was another great one, and analysts now see 2024 earnings up 27% to $2.17 a share—so this isn’t an expensive stock by traditional measures.

Other Stocks of Interest

Elastic (ESTC 71)—There’s obviously been a ton of hubbub about AI this year, with millions playing around with ChatGPT and many speculating on how AI may change the workings of businesses and consumers. However, as with the Internet boom 25 years ago, the biggest beneficiaries likely won’t be the AI providers themselves, but the infrastructure players, who will come out winners no matter who has the best model. To this point, a lot of that has revolved around hype surrounding chips (Nvidia) and some networking hardware, but we think Elastic may build on what’s already a very solid business to become a key cog in the AI world. Starting with the here and now, Elastic is effectively a Big Data outfit, making hay over the years with its offerings that allow giant organizations (like Microsoft, T-Mobile, Pfizer, Comcast, Home Depot, Booking.com, Cisco, Adobe, Uber, etc.) to ingest any type of data (text, numbers, unstructured, geo-spatial and more) and quickly search it for all types of purposes, including for security and observability of IT assets—as management said, the firm has become the data analytics platform of choice for real-time corporate search, with the firm;s cloud-based offering (now 41% of revenues) growing nicely. The AI kicker here, though, could be an even larger opportunity, as search is going to be key to the AI world: Simply put, all of what the platform does (ingest and store huge amounts of data, real-time search, enforce data privacy) can be integrated with proprietary or third-party machine learning models to create AI tools that boost productivity for employees and create new customer experiences, so it should have a leg up as giant enterprises look to quickly make the most of the AI wave. As for the here and now, business is solid—sales growth has slowed some but rose 17% each of the past two quarters, with the cloud-based product growing faster (up 24% in the July quarter) while earnings are powering ahead ($1.08 expected in the fiscal year ending next March, with 2024 likely to see $1.50 per share), though even those could prove conservative. The stock was basically a nothingburger until the recent quarterly report on September 1, which gapped the stock to multi-month highs—and while it’s still pulling back (it dipped a few percent today), the overall pattern certainly doesn’t look abnormal. It’s on our watch list.

SharkNinja (SN 44)—We used to have a tongue-in-cheek joke in bad markets, where 80%-plus of stocks are below long-term moving averages. The solution—look for stocks that don’t have long-term moving averages! The point is to look for recently public issues, which, if the timing is right, can morph into new leadership when the bulls retake control. SharkNinja is actually a spin-off from a Hong Kong operation, but the point is the same: It’s a new issue with a unique consumer product story that has led to great growth and, if management executes, should get much larger over time. About half of the firm’s sales come from Shark cleaning appliances (mops, all sorts of vacuums, hair dryers, air purifiers, etc.), while 30% is cooking and beverage makers and 16% is food preparation devices; nearly 80% of the firm’s $3.6-ish billion of revenues come from North America. Of course, there might not appear to be anything special here, but the secret sauce is the firm’s broad R&D engine, which includes not just its 700-plus engineering and design specialists but importantly involves continuously engaging consumers to find out what they want, while rapidly testing new products. The result is that SharkNinja brings innovations to these mundane-sounding industries (its outdoor mini grill, powered by wood pellets, looks pretty neat), consistently takes market share (its share in nearly all of its categories rose from 2019 to 2022) and has a history of successfully entering adjacent markets; the firm launched a new hair dryer in 2021 and it quickly became the #1 seller in the $100 to $300 price range in the country, and it did the same with an ice cream maker, grabbing the top spot in 2022. Thus, SharkNinja isn’t changing the world, but it’s succeeding by adding a little flair to many ordinary product lines, with premium pricing helping it to grow nicely and crank out very healthy margins. Last year was a pothole for the company (the move away from corded vacuums was one reason), but all is well now and looking good going forward—sales (up 22%) and earnings (up 42%) rose nicely in Q2, and this summer management expected total sales to rise 10% or so this year, with EBITDA lifting in the upper 20% range; the Q3 report is due November 9, which will obviously be important. The stock had a wild first few days after the spin-off, but it quickly started to march higher, with the latest pullback to the 50-day line looking normal and finding buyers as the market has bounced. A solid earnings gap would be tempting.

Applovin (APP 37)—Applovin’s business is all about data and advertising, with a focus on marketing and monetizing app and mobile users. But it’s undergone a big change over the past couple of years. When the firm came public in 2021 (stock reached a peak of 116!), most of the business revolved around making free games for people to play, and then using them to collect information about users ... and then using that (and its burgeoning ad software offering, dubbed Axon) to sell ads. Apple’s move to restrict tracking on apps threatened the business in a big way, and for that and other factors, Applovin’s apps business has struggled—while profitable, revenue was off 25% from a year ago in Q2, with both advertising and in-app purchases sliding in a big way. So why has the stock been strong in recent months? Because of a newer, AI-powered Axon release (Axon 2.0), which uses machine learning and the like to quickly tweak an ad or ad program for better results—basically, it looks like Axon is able to target mobile game ads better than any other firm out there (producing higher returns for advertisers) , which is leading to a rush of demand, especially as the mobile game industry itself looks to be finding a bottom after a tough stretch. The end result is that Applovin’s software (Axon) division is growing nicely (up 28% in Q2 from a year ago and up 14% from the prior quarter) and has unreal profitability (67% EBITDA margins!), which are much higher now than previously given the AI angle. (There’s also a potential connected TV ad engine some analysts think will catch on, expanding the opportunity.) Big picture, the app business looks to be stabilizing and should expand going ahead, while the software business should soar and drive profits higher. The stock, while in a correction, looks normal to us—APP had a huge comeback from its lows late last year until a September peak, and now it’s seven weeks into a consolidation that broke the 10-week line but is hardly a big deal on the weekly chart, shown below. Earnings are due November 8, and a positive reaction could start the repair process and lead to good things down the road.

The “Never Say Die” Chart Pattern

Arista Networks (ANET)

We wrote about spotting relative strength in the market a few weeks ago, with one “easy” way to compare lows and highs in the market—if a growth stock is hitting higher highs while the indexes are doing the opposite over a period of weeks, it’s clear big investors are hesitant to let shares go at the very least, if not buying on most dips.

Usually, that analysis works best during an intermediate-term (a few months) downturn—however, you can sometimes see it even if you’re in a longer-term tough strength, like we’ve been in for the past couple of years. It’s less precise, but we refer to that sort of action as the “never say die” chart pattern, which simply refers to a stock that gets pushed and pulled for a long time … and yet, over many months, the stock refuses to keel over, setting higher highs and lows in a bear phase, giving the impression it wants to really move when the market finally does.

All of that leads us to Arista Networks (ANET), which has become something of the Cisco of the cloud (and now AI) age, with faster/better/more efficient networking (switches, routers, relays, etc.) gear and software that helps giant operators (Microsoft and Meta make up something like 40% of revenues) rapidly build their data center and cloud operations, while many enterprises buy gear to expand campus networks. And because it’s hitched to these wagons, business has remained spectacular—in this week’s Q3 report, sales boomed another 28% and earnings lifted 46% ($1.83 per share vs. $1.58 expected) even as there are a few signs of easing CapEx (at Meta, for example).

Moreover, it looks like Arista should be the networking winner in the AI field—most analysts are coming around to the view that, while it’s not leading just yet, Ethernet-related equipment should be the backbone of AI data center buildouts, which is the technology that Arista specializes in. Granted, these types of sales should be a late-2024, early-2025 story, but the market always looks ahead.

So what’s the worry? Mostly a couple of things we just wrote—we’ve just seen a couple of big-spending CapEx years from the so-called Cloud Titans as they upgrade to 400-gigabit switches, and while 800 gigabits are next, it’s possible spending is reeled in if the economy wobbles further. Plus, the AI opportunity is down the road, so there’s some proving to do. Add it up and, while management said it’s optimistic about double-digit growth in 2024, Wall Street is looking for 10%-ish earnings growth next year, which would be a big slowdown.

Even so, we write about those factors as something to keep in mind, yet you don’t have to go down the rabbit hole trying to figure out the future—the stock itself will tell us what big investors think. So far, the action is pristine: On the weekly chart below, you can see that, while very volatile, ANET hit new all-time (not just multi-month) highs in March, June and August/September of this year, which is obviously miles ahead of all major indexes. And following a good-sized shakeout last week, shares stormed back on the Q3 report this week, notching another new high. The market isn’t out of the woods, but ANET and its longer-term “never say die” pattern is certainly attractive. WATCH

A (Very?) Early Ray of Light from the Two-Second Indicator

We always take a gander at the number of stocks hitting new lows—on the NYSE, this is our Two-Second Indicator—but, while it may seem backwards, we pay even closer attention to the (usually large) figures once an intermediate-term decline (or worse) is underway. The reason: It’s usually one of the first indicators out there to reveal a slight easing of selling pressure.

Right now, we’re looking at the past few weeks of action—in the charts below, you can see that the NYSE Composite (along with everything else) nose-dived into an early October low, and after a brief bounce, slid to clearly lower levels late last month, with a nadir coming on Monday of this week.

Interestingly, though, the number of new lows on the NYSE effectively didn’t expand (454 vs. 443 earlier last month) despite the lower low; the peak reading came back on October 23, a week before the latest low; and the reading this Monday was “only” 238—a pretty big drop-off despite further declines in the indexes.

Admittedly, this is all very short-term stuff, but we well remember spotting something similar during the pandemic crash, when the peak Two-Second reading actually came seven trading days before the indexes bottomed. Like we said, this is just a ray of light at this point, but something to monitor—the longer it holds up, the more interesting it becomes.

Cabot Market Timing Indicators

For many weeks we’ve seen a growing collection of secondary measures (sentiment, breadth, etc.) reach levels typical seen near market bottoms—but the missing ingredient has been actual buying. This week we’re beginning to see that buying show up … though, as of now, it’s still too soon to conclude the trends have changed. All in all, we remain cautious, but we’re monitoring key indicators for a sign the turn has come.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines have been positive since January, but the indicator is at a key juncture—both indexes closed below their respective 35-week lines last week, and if both did so again at tomorrow’s close (about 4,280 on the S&P 500 and 13,060 on the Nasdaq) it would be a sell signal. Right now, the strong performance of the past two days has us thinking that will be avoided—and, frankly, we’re unlikely to take much action on any signal given our already-huge cash hoard. Obviously, though, the more green lights we have, the better; we’ll be watching closely.

Cabot Tides: Negative
Our Cabot Tides are still negative—though we’re intrigued by the recent rally and are keeping our antennae up. The Nasdaq has again become the strongest index (daily chart shown here), though while it’s back up near its 25-day line, it still has more work to do to get that moving average to turn up … and other indexes are even further behind. Thus, the intermediate-term trend is down, but like many things, we’re monitoring the progress closely given the encouraging action this week.

Two-Second Indicator: Negative
As we wrote earlier in the issue, our Two-Second Indicator is giving off a short-term encouraging vibe, as the most recent push lower into late October didn’t see new lows expand, with the peak reading actually coming a week before the latest nadir in the indexes. Obviously, that’s just a first step—now we want to see the figures dry up in a major way, with today being a good start (looks like the readings dipped to 50 or so). For now, the broad market is considered unhealthy.

The next Cabot Growth Investor issue will be published on November 16, 2023.