Cabot Growth Investor Issue: November 3, 2022

Still Waiting—and Watching

Yesterday was a doozy for the stock market, with yet another sharp decline (2% to 3% depending where you looked) after the Federal Reserve again hiked rates by 0.75% and, more importantly, sounded hawkish at the post-decision press conference; today showed some downside follow-through, too, as the market might be replaying the pattern seen a few other times this year after the Fed spoke up. There’s no question this latest blow isn’t great; we’re going to again stand pat in the Model Portfolio, holding a cash hoard north of 80%.

That said, at least for what we see now, we think yesterday’s Fed statements and accompanying market reaction did a lot more to hurt sentiment than it did to really change anything with the evidence. On the sentiment side of things, there’s little doubt the reasons for the market’s weakness, along with all of the problems out there, are extremely obvious—which has led to a very crowded room in the bear camp. For instance, the October Bank of America institutional money manager survey showed 20-year highs in the amount of cash held, while yesterday’s equity put-call ratio was among the highest of the past two decades.

When it comes to the major indexes, our Cabot Tides technically turned positive for a couple of days recently, and while the dip of the past two days effectively puts it back on the fence, most indexes (especially the broader ones) are still well above their recent lows. And then there are potential leading growth stocks, of which there are many that remain set up in multi-week or multi-month ranges, seemingly ready to get going if the environment can improve.

Now, to be clear, we’re not trying to trumpet sunshine; we’re almost totally on the sideline, after all, and have been for a while. But our point is that, yes, we’re waiting patiently, and you should be, too—there’s no reason to be a hero or catch a bunch of falling knives.

But we’re also watching things carefully as well; now’s not the time to stick your head in the sand or assume the Fed will crush things again. As opposed to some other times this year, we think a few good days from the market and (most importantly) some legitimate breakouts from individual stocks could give us something to work with.

What to Do Now
Tonight, though, we’re sitting tight, holding our positions in Shockwave (earnings next week) and Wingstop (which reacted well to its own report and is in great shape). We’re ready to put a couple of toes in the water, but we’ll wait a bit longer to see if the market can stabilize and potentially resume recent upmoves. We’ll be on the horn if we have any changes in the days to come.

Model Portfolio Update

As we’ve written in recent weeks, we’re ready, willing and able to start moving back into the market—and with the Cabot Tides on the fence here (it technically turned positive before this week’s retreat) and the huge amount of pessimism out there, we’d like to put at least a couple of toes in the water. Indeed, if the market can shake off the Fed’s latest roundhouse, we’ll probably add a couple of small positions, as well as fill out our stake in Wingstop.

That said, while the Tides and widespread pessimism (and the obviousness of the reasons behind the weakness) are leaning in the positive direction, not much else on the market timing front is in the same camp; our Trend Lines and Two-Second Indicator are bearish, and the recent rally was led by defensive-oriented stocks. As shown below our own Aggression Index (growth-oriented Nasdaq vs. defensive-oriented consumer staples) has skidded to new lows!

Plus, while there are many setups, potential leading growth stocks remain corralled—selling on strength is still the norm, especially when something approaches key resistance, which has been one of the most telling aspects of the market for all of 2022.

None of that means things can’t shape up … in fact, we think they can, given the damage done throughout the year, the horrid sentiment and the fact that so many stocks appeared to have bottomed months ago. Long story short, we’re not catching any falling knives, but we’re also not swearing off stocks after the latest Fed move. For now, we remain heavily in cash while we cast a wide net for our watch list.

Current Recommendations

Shockwave Medical (SWAV)—The play of selling strong stocks near their highs is very obvious, and when it ends, there should be a lot of stocks that surprise a lot of investors by breaking out and following through on the upside. But … that time is not yet here, as SWAV’s action last week showed, with the stock powering ahead to test its all-time highs before falling right back into its base. Overall, shares still seem poised to get going if the environment improves, though the quarterly report next week will be vital—analysts are looking for $124 million of revenue (up 90% or so) and earnings of 67 cents per share, but investors likely expect more given Shockwave’s history of topping estimates. All in all, we haven’t changed our view here: We think SWAV can have a nice run if the market gets out of its own way, but at this point we’re content with a Hold rating as we wait to see if the stock can decisively bust out of this range on the upside. HOLD

Wingstop (WING)—WING has backed off some after a great reaction to earnings last week, which isn’t surprising given the market and the chart (the stock bumped up into some old resistance above 160). The dip could obviously go further, but we’re comfortable holding our half position—and, frankly, if the stock and overall market can find their footing in the near future, we’d like to fill out our position by adding another half-sized stake, as the chart looks great (not just the recent earnings move, but some of the clues WING left behind during the summer, too) and we think the Q3 report could be the tipping point when it comes to investor perception: Business is not only picking up steam (same store sales up 6.9% at its domestic locations, a big acceleration from recent quarters) but the store economics are improving (70% payback of the initial investment in year one, a figure that’s headed higher) and costs should be lower for a while given the crash in wing prices. (The move to more boneless chicken offerings over time, like sandwiches, should also cut costs.) Plus, of course, the cookie-cutter story remains all systems go (restaurant count up 13.5% from a year ago; double-digit annual gains likely for many years to come). We’ll keep our Buy a Half rating, and we’ll let you know if we decide to fill out the position in the days ahead. BUY A HALF

Wolfspeed (WOLF)—We sold WOLF last week after it cracked on earnings, able to get out during the rally that day (it’s fallen meaningfully lower since then). The underlying reason for the selling is that the Q3 report effectively was the opposite of Wingstop’s in that it gouged the underlying story and crushed perception: Clients have been racing to Wolfspeed to secure long-term supplies of silicon carbide chips because the firm was handily in the lead of building out capacity (indeed, Q3 orders were up huge again), but now that execution has fallen off (poor yields at one of its chip plants), not only will revenues be much less than expected in the next few months, but it’s also possible current/potential clients look elsewhere when securing future supplies, too. If WOLF can get its act together, we still believe in the overall silicon carbide story, but it’s likely to take at least a couple of quarters to repair the damage to investor perception. We took our loss on our half-sized stake and moved on. SOLD

Watch List

• Academy Sports & Outdoors (ASO 42): ASO remains in a reasonable range perched near its peak, which is about as much as you can ask for in this environment. Earnings aren’t likely out until early December, but we think the stock could get going if the market turns.
• Albermarle (ALB 275): ALB’s earnings last night were great—sales up 152%, earnings up 164%–and the stock is still in solid shape after a big shakeout this morning. We would say the lithium story is relatively well known, which isn’t ideal, but we put more weight on this firm’s excellent long-term outlook and ALB’s overall resilience during a horrible market year.
• Dexcom (DXCM 113): DXCM is an old friend, but after a punishing downturn, it looks like the launch of its latest device (already launched internationally; U.S. launch early next year most likely) is turning perception higher. See more below.
• Celsius (CELH 89): CELH fell from 110 to 40 during the bear market and came all the way back to new highs—which means the recent 32% correction and consolidation (while clearly cracking the intermediate-term uptrend) isn’t unreasonable. The fundamental story remains terrific, so we continue to monitor the stock for signs the buyers are stepping back in. Earnings are out November 9.
• Chart Industries (GTLS 232): It’ll never be a household name, but Chart looks like the best infrastructure-related play when it comes to all things energy, especially green energy offerings. Q3 brought another round of big orders and record backlog, and management’s early 2023 outlook (earnings up north of 60%) is encouraging. GTLS can be herky-jerky, but it’s already moved out to new highs.
• Enphase Energy (ENPH 296): ENPH’s 28% pullback from August through early October was ugly, and any negative earnings reaction could have been worse—but instead, the Q3 report came out in fine shape (sales up 81%, with growth accelerating again, and earnings up 108%) as demand for its microinverters (and batteries) remains super-strong. Shares are back into an area of resistance here, but we’re thinking about re-starting a half position if the market clicks.
• Neurocrine Biosciences (NBIX 124): NBIX has been resilient for months, and now it’s letting loose on the upside a bit after earnings. See more below.
• Progeny (PGNY 39): PGNY remains in a bottoming base and actually found some strength last week, approaching multi-month highs, but as is the norm, shares have quickly backed off. Earnings are due out tonight, though, so no harm in seeing if the buyers return.
• Schlumberger (SLB 52): Energy exploration stocks are just OK, but some service stocks are really catching a bid, and that includes giant Schlumberger, which is likely in the early innings of a long-term upturn in demand and earnings growth. See more below.
• Shift4 (FOUR 41) and Toast (TOST 20): Nothing has really changed with our big-picture thoughts on FOUR and TOST since we wrote them up in recent weeks—both payment names could be leaders of the next bull move, and both have put in months of bottoming work as earnings approach (November 7 for FOUR; November 10 for TOST).
• Xometry (XMTR 56): XMTR made a go at new highs this week before being rejected, which is par for the course in this environment. Even so, it’s rest period of late looks normal, and its story (online platform for clients to buy and sell manufactured goods) is great. Earnings are due November 10.

Other Stocks of Interest

Schlumberger (SLB 52)—The initial leaders in a broad energy sector advance are almost always the explorers, and the past couple of years proved no different, especially with the new playbook of limited CapEx, big dividends and big share buybacks attracting a wider array of investors. But usually, after many months (sometimes longer) of elevated prices, Wall Street begins to favor the equipment and service providers, as the explorers finally loosen their wallets and drilling activity picks up—and this go-round should be more exciting than prior cycles given the prior bust period that saw years of underinvestment. All of that leads us to Schlumberger, one of the big boys in the oil service arena, with a wide array of well construction, completion and data-driven exploration tools needed for onshore and offshore drilling, both in the U.S. and overseas; it also has a small but growing New Energy business to ride that area, too. Business has been picking up, and Q3 was no exception, with sales (up 28%) and earnings (up 75%) easily topping expectations. But the stock went bananas more likely because of the conference call, when management doubled down on its view that the long-term outlook is bright, saying that “we have strengthened our view in a multi-year up-cycle” and that the “growing necessity of energy security … will also drive urgent increases in energy investment,” both of which will result in “a supply-led up-cycle, characterized by resilient [exploration] investment that’s decoupled from near-term demand volatility” with “multi-year capacity expansion plans, lower operating breakeven prices (for explorers) and supportive prices.” Plus, Schlumberger itself is gaining share in the sector, which will add fuel to the earnings fire—its international revenue is already higher than (pre-pandemic) 2019, even as rig counts overseas are 25% lower than back then! Throw in the fact that oil and gas prices remain elevated despite a super-hawkish Fed and pervasive recession fears and investor perception is beginning to price in many years of rapid growth. Indeed, the company just reported its largest EBITDA quarter since 2015 (when the stock was 60% higher than now), and analysts see 38% bottom-line growth next year (likely too low). Moreover, the stock looks to be just getting going—as of a six weeks ago, shares had made no progress since June 2021, but now SLB has powered to new highs on big volume. Despite its size, we think SLB could be among the next liquid leaders of the energy uptrend.

Dexcom (DXCM 113)—We’ve owned DXCM a few times in the past, mostly with decent/good results—the firm is one of (if not the) leader in continuous glucose monitors (CGMs), which offer huge benefits for diabetics compared to normal intermittent monitoring (including sticking your finger a few times per day and taking measurements). The long-term trend here is up as many people who are eligible to use a CGM still don’t, and as technology advances make CGMs better and better. But what’s interesting is that stock moves in large waves, with multi-year upmoves followed by long rests, often driven by new product introductions that broaden the appeal of its CGMs, even into new diabetic categories. We’ve seen that again during the past couple of years, but now the firm is set to launch its new G7 CGM—compared to the current G6 (released in late 2018), it’s 60% smaller, its readings are more accurate, it’s fully disposable and has a quicker warmup time, all of which should broaden its appeal. The G7 launch is actually underway overseas right now, with approval already garnered in the U.K., Germany, Hong Kong and Australia, with U.S. approval likely by year-end and a launch here next year. Beyond just that one product, though, are favorable regulatory tides: Medicare looks set to expand coverage of CGMs, a decision that could add three million potential users to the industry’s tally, and Dexcom’s management thinks this could be the first of many favorable coverage expansions in the years ahead given that the product improves health outcomes. As for the numbers, sales have continued to crank ahead nicely in recent quarters, and earnings and cash flow are set to improve nicely in 2023 and beyond (the top brass sees 20% to 25% annual growth for the next three to five years), starting with a 40% earnings bump next year. Not surprisingly, the stock is acting well—it bottomed back in May, held well above its lows recently despite the market doing the opposite, and has come under accumulation during the past month on the Medicare coverage note and then on earnings last week. There is resistance around here, but our guess is that the path of least resistance has turned up.

Neurocrine Biosciences (NBIX 124)—There aren’t many growth stocks that are in legitimate uptrends, but Neurocrine is one of them as business re-accelerates and earnings are beginning to take off. This biotech outfit is being driven today by Ingrezza, which is a treatment for a relative rare side effect of antipsychotic drugs called Tardive Dyskinesia (TD for short), which causes involuntary movements in the face and body that, if left untreated, can become permanent, not to mention have a negative psychological impact. It sounds like a niche market, but it’s bigger than you might think—in Q3, Ingrezza saw revenues and prescriptions rise in the low 30% range from a year ago, leading the top brass to boost sales guidance for 2022 to north of $1.4 billion! And there’s almost surely plenty of growth ahead: Management believes there is more than half a million undiagnosed TD patients in the U.S. alone (only 15% or so are both diagnosed and treated), and one analyst thinks Ingrezza can see peak sales of $3.2 billion, which itself sounds conservative to us. But Neurocrine isn’t aiming to be just a one-product firm: It’s submitted for approval a drug called Valbenazine, a once-a-day treatment for Chorea, which affects north of 25,000 people with Huntington’s Disease that’s also associated with involuntary movements. And beyond that Neurocrine has some high-potential neurology offerings, including one that’s targeted for a rare pediatric epilepsy that will likely have Phase II data results out by year-end. Q3 was excellent, with sales up 31% and earnings up 69% (both crushing expectations), and analysts see the bottom line soaring to north of $4 next year, about double this year’s figure. While not dynamic, NBIX looks great, and just pushed to two-year highs this week after earnings. It won’t be your fastest horse but our guess is higher prices are ahead.

More “Mini” Blastoffs—but Still Looking for the Real ThingJust about every bear market—whether a punishing 50% to 75% decline, or a garden-variety 20% to 25% drop—ends in concern with some sort of “thrust” higher that produces rare upside power. As we’ve written before, the theory here is very sound and has played out over many decades: As retired technician Walter Deemer has written, the market gets most oversold at the bottom, but it gets the most overbought at the start of a new, major advance. So when you see “hyper-overbought” readings, it usually tells you there’s been a sudden, positive change in perception … a change that leads to further upside over time.

However, when we started following these thrusts (we usually call them Blastoff indicators) 15 to 20 years ago, few others did—and when they flashed, few people believed them, which added to their potency. These days, though, everyone seems to have a thrust they follow, some that can trigger with just a modest amount of strength. We refer to these as “mini” blastoffs: They’re good to see, but far less reliable, which we’ve seen in 2022 when many have failed. The most recent of these came in August, when 90% of the S&P 500 stocks rose above their 10-week lines—historically a bullish event, but this year, it led to weeks of sharp losses.

And a couple more mini signals have flashed of late. The first is a bit odd, coming when 55% of the S&P 500 stocks hit 20-day highs; a year later the market sported an average gain of 16%. The second is a mini Three Day Thrust, where the S&P 500 rises strongly on three straight days (at least 1.5% the first, 1.15% the second, 1.5% the third)—it’s only happened 13 times since 1970, with a 22% average gain a year out. Again, we view both as encouraging, but each has had its share of dud signals when looking out three to six months, too.

What we’ll really be watching is for one of the two grandaddy blastoff measures to flash: Either the 2-to-1 Blastoff measure (NYSE advance-decline line averages 2-to-1 positive over a 10-day stretch) or the 90% Blastoff measure (90% of all NYSE stocks—not just the S&P 500—get above their 10-week lines at the same time). What makes these two special is that not only have they always led to solid gains looking out, but the market rarely pulls back much after the signals flash. Importantly, one or both has flashed at or near most major market bottoms of the past 50 years, including every one of the past two decades: June 2003, March 2009, April 2016, January 2019 and June 2020.

All in all, every major rally usually starts with some of these mini signals, so seeing them is a good thing—but what we’ll really be looking for (whether on this rally or ones later on) is for one of the two tried and true blastoff signals to flash. If they do, it’ll be as good a sign as there is that the bear is over.

Remember: It’s the Outliers that Count

We usually use the above headline in a bullish sense, as a big winner or two in your portfolio can make all the difference in the world—in fact, over many decades, we’ve found the vast majority of trades cancel each other out (small profits and small losses), with the remaining large winners making up the vast majority of your overall gains.

But just as that’s the case on the upside, it’s also true on the bearish side of the fence—a few big positions in stocks that go down huge can really set your portfolio back. That’s why always having an exit plan (even if it’s to “only” to sell a portion of your stake) is so important. Whether it’s cutting a loss short from your purchase, or having some sort of safety net on the downside, it’s vital not to be caught with big positions in downtrending stocks.

Of course, there are many examples of bad stocks in a bear market, but just in the past two weeks we’ve seen widely-held names like Google (GOOGL; scraping new lows and 44% off all-time highs), Amazon (AMZN; gapped down on earnings, down 52%) and Meta (META, which has been a complete mess, now 73% off its peak) come unglued.

There are tons of chart rules and tools you can use as fail-safes for long-term holdings—the 200-day line or a percent-off-the-high stop are two examples. One idea is to cut back on any position that closes at least 5% below its 40-week line on any week, and is also at least 20% or 25% off its peak. We’ve also seen plans from money managers that automatically raise X% cash if their portfolio falls a certain percent from its peak, too, though that’s a bit more involved.

Really, though, the exact rule isn’t nearly as important as having one—you want to be getting out of at least some of your stake when the long-term picture darkens. Even in the case of META, the stock’s first earnings implosion earlier this year (in February) came in the 235 area; selling there would have stunk at the time, but obviously would have been a good move given the action since.

Obviously, there will be times when things get away from you on the downside; that happens to everyone, so don’t beat yourself up over it if you have a couple of stinkers in your portfolio. But, going forward, remember to work to minimize your duds so the winners of the next bull market carry that much more weight.

Cabot Market Timing Indicators

The top-down evidence has actually improved, with the Cabot Tides turning positive for a bit (now on the fence), which is a step in the right direction. That said, the rest of the pieces have yet to fall into place, with the long-term trend down, the number of new lows elevated and, probably most important, growth stocks still unable to get moving. We could do a little buying soon if the market stabilizes, but overall we want to see more before getting aggressive.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines are in the same place as they’ve been since late January—on the bearish side of the fence, as the market’s two most important indexes are clearly below their respective 35-week moving averages, with the S&P 500 (by 7%) and Nasdaq (by 13%!) still having a good amount of work to do to turn the long-term trend back up. The next buy signal here should be a great one, but it’s best to wait for it to come.

Cabot Tides: On the Fence
Our Cabot Tides effectively bottomed in late September, held up in early October and pushed higher into last week—technically turning the intermediate-term trend back up, with broader small- and mid-cap names the strongest of the bunch (see the S&P 600 Midcap, shown here). But the drop of yesterday and today has basically put things back on the fence; a good show of strength from here would likely have us nibbling, but we’ll wait to see if that happens.

Cabot Two-Second Indicator: Negative
While the strongest indexes of late have been broader measures, we haven’t seen that reflected in our Two-Second Indicator yet—the lowest reading to this point in the rally has been 89, with most days still in the triple-digits. Nothing says the readings can’t dry up right quick, but at this point, the sellers remain in control of the broad market.

The next Cabot Growth Investor issue will be published on November 17, 2022.