Cabot Growth Investor Issue: October 3, 2024

Ready—but Waiting

In the past couple of weeks, we’ve seen the Fed cut rates by a half point, China’s central bank launch a liquidity howitzer to bolster its economy and stock market, a major East Coast strike among dockworkers and, of course, a good-sized missile attack in the Middle East that could easily lead to a response, possibly on Iranian oil fields—and that says nothing of the daily economic reports and avalanche of polls about November’s election.

Thus, there’s obviously been a lot of news, but at the end of the day there hasn’t been much movement among the market and leading titles. Indeed, the way we look at things, the evidence really hasn’t changed much: The current market is positive overall, with more bullish factors than bearish factors—but it’s far from powerful, with many stocks, sectors and indexes (especially growth-oriented measures) still battling with multi-month resistance, leading to plenty of ups and downs. Indeed, if you look at a variety of growth funds, they’re essentially at the same levels they were in March. (The equal-weight Nasdaq 100 Fund (QQQE) remains a good example, with consistent selling appearing in the 90 area, give or take.)

Now, big picture, there remain numerous positives—we won’t rehash them all here, but as we wrote in the last issue, the market’s biggest “tells” are bullish, the odds continue to favor the next sustained move being up, and this week’s resilience among many stocks in the face of the news barrage (and higher interest rates—see more on that later in this issue) is a good sign.

Ideally, the market is beginning the final stages of a correction/consolidation that started in July (for the big-cap indexes) or March (for most growth stocks and much of the rest of the market) that raises the fear level for a few weeks while potential leaders hold relatively firm—leading to a liftoff into a sustained run.

We’ll have to see how things play out (we follow the market, we don’t tell it what to do), but for the here and now, the market’s action and the evidence suggest big investors are doing some careful buying, picking their stocks and entry points carefully; they seem ready to pile in but are currently waiting for some clearer skies. We’re following that lead, holding a batch of generally strong performers but going slow on the buy side until we see the bulls truly step up.

What to Do Now

Continue to lean bullish while holding some cash and patiently waiting for a change in the market’s character. In the Model Portfolio, we’re pleased with the overall action of our holdings, but after stepping into the market steadily over the prior few weeks, we held off buying last week and are going to do the same again tonight, sticking with what we have and a 30%-ish cash position—all while remaining flexible as we hunt for entry points on fresh leadership.

Model Portfolio Update

As we’ve written before, we don’t give too much weight to the calendar, but the late-September, early-October time period is almost always tricky, and this year has proven no different, with the Middle East flaring up again and a port strike causing some nervousness.

Even so, as mentioned above, nothing has really changed with the evidence, so we’ve stuck to our stance—we own some good-looking stocks and are looking to accumulate more, but we’re not necessarily in a rush, as most growth indexes and funds we look at are positive but not powerful, with a lot of stocks in the same camp.

We held off making any moves last week, and we’re going to hold off again tonight—though we do have two half-sized positions (ARGX, FLUT) that we could average up on if they show upside power soon. Tonight, we have no changes, but we’re taking things on a day-to-day basis.

CURRENT RECOMMENDATIONS

AppLovin (APP)—We’ve learned over the years that, in a tricky environment, good stocks can go bad (or at least hit large potholes) in a hurry, so we’re not complacent when it comes to APP—after its latest run, some sort of air pocket wouldn’t be shocking. But with that said, the stock certainly quacks like one of the market’s real leaders, with a massive-volume buying cluster (meaning many days in a row of big volume) and no giveback of late (new highs today!) despite a few wobbles among growth stocks. We’ve already gone over the main reasons for the move—the prospects that the core mobile gaming advertising engine should lead to 20%-plus growth for many years, with that engine moving into new verticals like e-commerce next year providing another big opportunity. But there are also the recent numbers themselves: In Q2, AppLovin cranked out $1.33 per share in free cash flow, which translates into an annual run rate north of $5 per share or so, so the current stock price hardly seems unreasonable, especially given that those figures should expand from here. To be clear, valuation is far from our main focus; if we see abnormal selling appear (say, if the market really hits the skids for whatever reason), we won’t hesitate to at least take a few chips off the table—but we’re optimistic that APP will see higher prices if/when the market allows it. We’ll stay on Buy, though we suggest keeping it small if you’re entering up here. BUY

Argenx (ARGX)—As we wrote about in last week’s update, ARGX has been hacking around between 510 and 550 on some trial results surrounding a potential competing drug treating generalized myasthenia gravis (gMG) from Amgen; suffice it to say, the market didn’t think much of the results (AMGN took on some water), and while volatile, ARGX is still holding within its tight range and, in fact, tested new high ground today. Biotech stocks have been sagging a bit (they’re a group that tends to be affected by interest rates; see more on rates later in this issue), but we continue to think this company’s huge runway of growth, led by Vyvgart’s current, expanded and new indications down the road, can create a big run. We’ll stick with our half-sized position and follow the plan—a drop into the upper 400s may have us looking for greener pastures, but a decisive (not just a few points) upside breakout could have us averaging up. If you don’t own any, we’re OK grabbing a small position here or on modest dips. BUY A HALF

Axon Enterprises (AXON)—AXON doesn’t get much press, but the stock remains in great shape, marching to new price and relative performance highs this week. There’s been no news from the firm in a few weeks, but business appears on track, and the underlying potential here remains enormous—whether it’s evidence collection (via body and dashboard cameras) and management (through its cloud software suite for cops, prosecutors and defense attorneys), real-time operations (dispatch and response software modules) or productivity enhancements (its AI-powered Draft One offering looks huge here), the firm thinks it’s captured just a fraction of the potential market. Indeed, in the Q2 investor deck, it thinks its body cameras have just 14% of the addressable market in the U.S. market, while its cloud offerings have just 4%—and penetration is even lower overseas. Essentially, all the pieces are in place for a long runway of rapid and reliable growth. Back to the stock, it’s a bit extended here (50-day line near 360), so some type of wobble is possible if the market’s iffy start to October continues, but the path of least resistance is up. BUY

Cava Group (CAVA)—CAVA impressively marched to marginal new closing highs two weeks ago, shrugging off the huge post-earnings rally that was followed by selling from insiders and of closely-held shares. While the stock has come back down a bit, volume’s been light and shares are hanging around its 25-day line. (There was a bearish write-up from a short seller about the cleanliness of the firm’s locations, but that really never caused much movement.) Now, we do think the stock can rest a while longer, and if the market suffers further geopolitical indigestion, a sharper downmove is possible. But so far we’re encouraged, with the stock correcting through time rather than price as the moving averages (50-day line near 108) catch up. We’ll continue to stay on Hold, but the longer CAVA stays up here, the greater the odds it has another run. HOLD

Flutter Entertainment (FLUT)—We have high hopes for Flutter, which runs FanDuel and other betting sites (like BetFair), as its international operations are growing at a decent clip and are very profitable, while the U.S. business is roaring ahead, even in places where it’s been up and running for more than a few years. At last week’s Investor Day, the top brass laid out a very bullish update and outlook, saying it believes the U.S. market in 2030 will be $70 billion, 50% larger than its estimate from just two years ago and miles larger than it stands today. Other enticing stats: Cost per impression for its U.S. marketing spend is down a whopping 45% from 2022, a great sign the Wild West days of market share grab in the sector are in the past; it has an industry-leading payback on new customer acquisitions; of its largest 20% of clients, 91% have stuck around, with the number of bets by them increasing 11% year-on-year; U.S. gaming market share has moved up seven percentage points since 2021 despite numerous competitive launches; and all customer cohorts by year (those that came in during 2020, 2021, etc.) are still growing their revenues to Flutter by double digits this year. All told, the firm sees revenues (including overseas) lifting 14% annually through 2027 while free cash flow compounds at a 36% rate and the firm returns well over $1 billion per year (likely via buybacks) during that time. Fundamentally, then, the story looks great—and the stock did pop nicely on the news—but it’s since sagged back to where it was before the Investor Day. We held off averaging up last week and are glad we did, though FLUT still is above all moving averages (25-day line nearing 212) so we remain optimistic another upmove is in front of us. Long story short, we’re holding our half-sized stake but are waiting to buy more until we see follow-on strength. If you’re not yet in, we’re OK grabbing shares on this dip. BUY A HALF

On Holding (ONON)—ONON has pulled back on light volume to its 25-day line in recent days; giant peer Nike (NKE) released another dud of a quarterly report (sales down 10%, earnings down 26%), which dented that stock and pulled down the entire group yesterday. Still, it’s possible/likely some of that lost business is flowing On’s way as the firm’s footwear for running, tennis and other sports, as well as its apparel and accessories business, is gaining in popularity and taking share. The market’s near-term movements will obviously have an impact, especially as ONON regularly is subject to some wiggles, but we think the dip is providing a solid entry point. BUY

Palantir (PLTR)— Despite the S&P 500 addition rush of buying leaving it extended to the upside and some weakness in AI-related stocks, PLTR continues to act extremely well, holding right near its peak in recent days before moving to higher highs today. While most are undefined, the company continues to announce deals with many names, the latest being a multi-year, multi-million-dollar extension of a deal with APA Corp., a mid-sized oil explorer, which comes on top of a few other expansions and some deals with the U.S. Army. (There have also been reports of numerous small deals with U.S. departments and sub-agencies ahead of Uncle Sam’s fiscal year end in September, but we’ll see how that adds up.) The underlying story here remains sound, and the stock continues to look like the August earnings move changed its character. We’ll stay on Buy; ideally, new buyers can get in on dips of a couple of points. BUY

Shift4 Payments (FOUR)—The payment sector remains somewhat tricky, with a few names gyrating around a bunch, but FOUR looks like it wants to get going if the market can show some upside power. A fear over recent quarters here has been the company’s falling take-rate (the cut it gets of every transaction); in Q2 2022, the take-rate was 0.78%, but this Q2, it was down to 0.62%, a meaningful drop. However, big investors seem to have digested the fact that the drop isn’t because of competition, but instead due to the firm’s major move into verticals like resorts, stadiums and ticketing, which have lower take-rates than restaurants—and where Shift4 is grabbing tons of huge deals. Broad economic worries may have an effect on FOUR and the group near term, but we’re staying on Buy, thinking the next big move should be up. BUY

Watch List

• Arista Networks (ANET 390): On the one hand, ANET is very well known, which means there may be less upside than other, fresher titles—but on the other hand, the firm is on the front edge of a huge new growth wave thanks to AI, and the stock has remained resilient and recently has pushed to new highs.
• DoorDash (DASH 142): DASH remains in good shape, stretching above resistance and holding most of its gains during the recent market volatility. We love the growth profile here in both sales and EBITDA and think the increasing move into non-restaurant deliveries (grocery, drug, convenience and even liquor stores) will boost growth and keep margins moving up.
• Freshpet (FRPT 136): FRPT has been resilient, but like a lot of names in September, it “only” marginally hit new highs, and now this week’s market decline has pulled it down to the 50-day line. We’re looking at the past few months as one big consolidation, so a big upside move from here would be intriguing.
• Robinhood (HOOD 22): We got slapped around with HOOD back in the summer when the stock cratered with the market—but it’s spent the past couple of months rebuilding the damage while business continues to impress. See more below.
• Samsara (IOT 46): IOT seems to have finally changed character, with not one, not two, but three big-volume buying weeks on and after its quarterly report driving the stock to new price and RP peaks—and the dip since then looks reasonable. We admit that IOT’s valuation (now $25 billion, something like 20x the revenue run rate) is worrisome and might cap the upside, but the story here is very unique. Fundamentally, the firm quacks like an emerging blue-chip software name that will become another core institutional holding like ServiceNow, CrowdStrike or Workday.
• Zillow (Z 64): Z isn’t a classic growth stock, but we think it has a potentially huge turnaround story—if the Fed’s move toward an easier stance kick-starts the housing market. See more later in this issue.

Other Stocks of Interest

Robinhood (HOOD 22)—As you can tell from our recent missives, our general view of the market is that most leadership truly got going early last November and had a huge run into March—but most growth stocks (and a lot of the overall market) have been chopping sideways since then. Given that bull markets don’t up and die that quickly and because there are a variety of longer-term positives, the odds favor there being at least one (maybe two or three) more good-sized, upside runs. That’s why we continue to keep an eye on Bull Market stocks, especially a name like Robinhood, which we owned earlier this year but got knocked out of during its wild summer correction (it fell 33% on a closing basis and 44% on an intraday basis in 14 trading days!)—but the underlying story is the same, with the firm rapidly gaining customers and market share, and if the market becomes a tailwind again, we think growth could be dynamic. Despite a challenging environment for equities and crypto in Q2, the firm did great: Revenues boomed 40% from a year ago (transaction revenues lifted 69%, while net interest revenue rose 22%), with deposits rising to new multi-year highs in Q2 ($24.4 billion of deposits so far this year, up from $8.5 billion a year ago) resulting in assets under custody of $140 billion (up 57%). The firm’s Gold offering ($50 or so a year that brings a slew of major benefits) continues to be a huge draw, with nearly two million subscribers signed up (up 61%) who have massively higher usage rates than non-Gold members. All of this drove a big bottom-line beat, with EBITDA nearly doubling from a year ago and earnings up seven-fold. We will say that lower interest rates will likely eat away at some of the firm’s net interest income (though that should be overwhelmed by any continued increase in deposits and overall assets), and as we wrote about earlier this year, Robinhood does do a good business in crypto, where trading revenues can swing wildly (from $43 million to $126 million to $81 million the past three quarters!) and affect results. But, again, this is a Bull Market stock, and if easier money leads to more risk-on activity, Robinhood’s earnings power could go nuts. As for the stock, it’s recovered nicely since the August maelstrom and is set up near its prior June/July highs—like so many stocks, a powerful breakout (along with a decisive market upturn) would be tempting.

GE Vernova (GEV 255)—On one hand, the leaders of the AI infrastructure boom to this point—chip stocks—have definitely come under pressure and are lagging of late; the Philadelphia Chip Index is currently about 14% off its July highs while Nvidia (NVDA), which has been the flag-bearer for the group (and the entire market) is 13% off its highs even after today’s pop. Still, some of the infrastructure-type names are doing OK, like networking and electrification, and one of the leaders in the latter field is GE Vernova, a huge outfit (well over $30 billion in revenue) that looks like a top institutional way to play the need for more electricity, largely due to AI data center demands. The firm’s power division has offerings for all sorts of hydro, nuclear and gas power companies (gas turbines are big), while its electrification segment (grid solutions, power conversation offerings, etc.) is smaller and faster growing; both are seeing big gains in EBITDA and have huge orders and backlog—in fact, the firm’s total backlog including services is north of $100 billion! (There’s also a lagging wind power division that should see margins pick up in the quarters to come.) To be fair, this isn’t a lightning-fast grower given its size—revenues were up just 1% in Q2—but overall EBITDA more than doubled while free cash flow leapt into the black, leading the top brass to hike its full-year outlook (revenues up mid-single digits organically; free cash flow should be north of $5 per share this year). And that should be the tip of the iceberg, with overwhelming multi-year demand the big attraction for big investors—at its Investor Day earlier this year, the firm essentially said it believes EBITDA can more than double by 2028 with free cash flow likely doing better, and that was before the significant Q2 guidance raise. GEV was spun off in March and advanced into May before chopping around for the next few months. But it nosed to new highs in August and went vertical last month, with no giveback of late despite the recent market shenanigans. With its hands in so many power-related cookie jars, it’s hard not to think business will be great for a long time to come.

iShares China ETF (FXI 35) and Krane China Internet Fund (KWEB 37)—We write a fair amount about sentiment, both short-term and long-term, and sentiment-wise, there is no group that is more hated and shunned than China—and for good reason, as that country has been struggling economically ever since the virus struck, and of course has a well known bad debt problem (government-sponsored overbuilding of real estate, etc.) in the financial system, not to mention a quasi-communist government that’s been known to pull the rug out from investors via regulations. Whatever the reason, various indexes and funds of Chinese stocks were sitting 50% to 75% off their 2021 peaks as of two weeks ago. But that’s the past, and it now appears that China’s central bank is going to do what it takes to get things going by flooding the system with money, the biggest move on its part since the virus initially hit. In fact, it was something of a bazooka, with the package including a modest (quarter-point-ish) reduction in repo rates, a half-point drop in banks’ reserve requirements, a half-point reduction in mortgage rates for existing (!) mortgages, a lowering of the minimum down payment to 15% on second homes, allowing banks to use 100% of a big re-lending facility (up from 60% today) to finance loans for affordable housing flats, along with a couple of programs to bolster equity prices, including a big fund that commercial banks can use to fund public companies’ buyback programs and another one that funds, insurers and brokers can borrow from to buy stocks! The exact timing of when everything goes into place is a bit of a question, but as money floods the system, Chinese stocks have exploded higher. You could look at individual names, though broader funds like FXI (chart shown here) or KWEB (focused on many of the biggest Chinese internet players) look the same at this point—straight up. Of course, the question is whether this rally is for real, or yet another fake-out in this much-hated group. Short term, we’re open to anything—China may need some time to digest and to see what effects the stimulus measures have—but long term, the combination of the horrid action in recent years, awful sentiment toward the group, a multi-year bottoming phase and the recent catapult higher certainly has our attention.

Keep an Eye on Interest Rates (and Rate-Sensitive Stocks)

After years of tightening policy through hiking interest rates and running off their hoard of Treasury and mortgage-backed holdings, the Fed has finally pulled the trigger via its much-ballyhooed half-point rate cut two weeks ago (and, previously, it had slowed the pace of its asset run-off, too). All told, it’s not a secret that rate cuts tend to be a tailwind for the stock market and economy—though it’s important to remember there are plenty of other factors at work, too.

Just looking at the overall history after rate cuts, the returns are good—but also disjointed, and recent experience has been different. According to Investor’s Business Daily, going back to 1982, the S&P 500 rose an average of 9% in the six months after the first rate cut, which is solid. But it’s also a fact that two of the past three initial rate cuts (early 2001, mid-2007) did nothing to prevent huge bear markets as the economy skidded sharply, and even the last cycle (starting in mid-2019) was interrupted a few months later by the pandemic crash (which led to an even larger easing phase).

Again, that’s not to say rate cuts don’t matter or are negative—they’re an overall positive—but they’re not a magic elixir in and of themselves.

Right now, what we’re watching in terms of this topic is the action of Treasury rates, which have been trending lower for months … but, interestingly, have backed up somewhat since the rate cut and are testing some key resistance. Shown below is the chart of the 10-year Treasury yield, which has kissed its downtrending 50-day line the past two weeks. Obviously, a resumption of the downtrend should be bullish overall, while an upside break in the intermediate-term trend could bring some near-term convulsions.

However, the main reason we’re watching that isn’t because of the overall market—we’re more interested in a handful of rate-sensitive names (or at least names that loosely trade with interest rates). One area is the Bull Market stocks, which we always keep an eye on: Old friend Robinhood (HOOD) is written about earlier in this issue; the underlying story there is playing out as expected (huge deposit growth, trading activity up, etc.), and after a wild, wild implosion, shares have come back and are setting up again.

Beyond that sector are housing-related names; obviously things like homebuilders look pretty good, with some making higher highs and higher lows—D.R. Horton (DHI) is the largest player and acts well as earnings, which have remained elevated, are likely to head higher if the housing market firms up.

But we’re more interested in another play that’s more of a turnaround but is hugely leveraged to any upturn in the housing market: It’s Zillow (Z), which is the hands-down leader in terms of online real estate information and leads, with 231 million average monthly unique users that are often referred to client real estate agents and firms, as well as doing the same for rentals and offering some ancillary services like mortgages.

The firm got itself caught up in the euphoria of the last housing boom, starting Zillow Offers, which was essentially a home flipping business, but that turned out to be a mess and the firm shuttered it years ago to focus on its core offerings and to upgrade its website.

Despite very slow times in the industry, those moves and Zillow’s core position have had it more than holding its own: Earnings have remained clearly positive during the entire bust phase and actually haven’t sloughed off much since the 2021 peak, while revenue growth has accelerated a bit lately (up 3%, 9%, 13% and 13% the past four quarters). Not surprisingly, residential-related revenue (71% of revenue) has been up just a smidge over the past year, but rental (up 29%) and mortgage (up 42% off a small base) revenue have picked up the slack.

And then, with the Fed turning easier, the stock broke out on the upside in anticipation of a pickup in activity in the housing market, which would obviously bolster the bottom line; analysts see the bottom line lifting 38% in 2025 to new highs, and the stock has seen big-volume buying in June, again in August (after earnings) and then in September—taking it to its highest level since 2021. As rates have backed up, Z has pulled back, but if a turn really has come in the housing market, we think Zillow is a classic, high-potential turnaround situation. WATCH

Cabot Market Timing Indicators

Right now, there’s more positive evidence (including our three key indicators below) than negative, which continues to have us leaning bullish—but the action is far from powerful and very stop-start in nature, and of course, this week’s global tensions have caused another round of wobbles. We remain on the same path of holding and ideally adding some fresh leaders at decent entries, but we’re also not advising you to push the envelope given the still-tricky environment.

Cabot Trend Lines – Bullish
Despite the big movements of the past couple of months, the market’s big picture view remains constructive—both the S&P 500 (by 6%) and Nasdaq Composite (by 5%) remain solidly above their longer-term, 35-week moving averages, which keeps our Cabot Trend Lines bullish … as it has been since January of 2023. That doesn’t tell us much about the next few weeks, but it’s one of the main reasons why the odds favor the next major move being up.

Cabot Tides – Positive
Our Cabot Tides are in a similar stance as two weeks ago, with two of the five indexes we track (including NYSE Composite, shown here) recently stretching to new highs—but the other three (small caps, mid-caps, Nasdaq), while above moving averages, are still battling with prior resistance. All told, the intermediate-term trend is positive, but it’s not powerful.

Two-Second Indicator – Positive
The Two-Second Indicator is undergoing a test of sorts this week, with the market stumbling given the Middle East attacks—and given the indicator’s on-again, off-again action in recent months, we half-expected new lows to expand. But so far, the data is encouraging, with just 21 new lows on Tuesday’s selloff, 27 on Wednesday, with today looking like another day in the same area. Clearly, the readings could expand if the world lights on fire, but so far we’re impressed.

The next Cabot Growth Investor issue will be published on October 17, 2024.

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