Cabot Growth Investor 1469

The evidence has clearly improved during the past week or two, and that’s a good thing; we’re putting another couple of toes back into the water tonight, adding two half-sized positions in what we think can be leaders of the next uptrend. That said, we’re content to go slow for now, mostly because, while selling pressures have eased, buying power really hasn’t shown up yet, and until it does, there’s a chance the bears could reappear.

Still, overall, we’re increasingly optimistic, so we think putting a little money to work and then listening to the market’s clues makes sense. Get all the latest inside tonight’s issue.

Cabot Growth Investor 1469

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Sellers Fading—but Will the Buyers Show Up?
We’re all about going with the evidence, and when it comes to growth stocks, the evidence was nearly uniformly negative (or at least not positive) for most of the past month. The vast majority of leading stocks, including many of the biggest winners of last year, decisively broke down with the Nasdaq in early March and remained pinned to the mat after that. We raised cash and mostly waited it out for a while.

But during the past week or two, there’s no question the evidence has improved—our Cabot Tides have remained positive throughout the correction thanks to the broad market’s strength, and now the Nasdaq has rejoined the party as many growth stocks have improved their positioning as well. It’s certainly a good thing, and the Model Portfolio is dipping a couple more toes in the water tonight.

However, at least to this point, this appears to be a case where the sellers have begun to exhaust themselves, as opposed to some sort of real buying panic. In the last issue, we wrote about keeping an eye on the number of new lows, and happily, those readings have improved nicely. On the NYSE and Nasdaq, today was the sixth straight day of tame new lows, which is a sign that selling pressures are receding across the board. Our Aggression Index, which we also wrote about, has retained its longer-term bullish signal, too. Both of these are good things.

But it’s also important to realize the buyers have yet to really flex their muscles, which can be seen in a couple of ways, the most glaring of which is the lack of volume—on the Nasdaq, daily volume has come in below its 50-day average every day since March 8, with the past eight sessions all seeing volume at least 25% below average! And beyond the indexes is the action of individual stocks: While things have improved, few names are bounding ahead. In fact, the number of names being rejected at obvious resistance areas remains far larger than the number of successful breakouts we’ve seen so far.

Of course, the key phrase there is “so far.” Many market bottoms initially form from a lack of selling pressure, with the buyers stepping up later on; maybe Q1 earnings season will spur the buyers into placing their bets. But until they do, there’s a decent chance the sellers could reappear.

What To Do Now
So how do you slice and dice this environment? The lack of selling pressures and improving action of many growth names has us doing some buying tonight ... but given the lack of power, we suggest going slow and looking to pile in only if things start really popping on the upside. In the Model Portfolio, we’re adding half-sized positions in Floor & Décor (FND) and SelectQuote (SLQT) tonight, while placing Pinterest (PINS) back on Buy. Our cash position will be a still-hefty 45%.

Model Portfolio Update
We’re now eight weeks into this correction and consolidation for growth stocks, and after a lot of mucking around, the evidence has definitely improved of late, with the Nasdaq perking back up and many individual stocks doing the same. As we wrote above, to this point this seems more like a lack of selling pressure as opposed to a rush of renewed buying. That’s not ideal, but many rallies that persisted started this way.

Big picture, we’re trend followers, so the Nasdaq’s change in character tells us to begin putting money to work … but the lack of powerful breakouts (so far) is a reason to start slow. So that’s what we’re doing—in tonight’s issue, we’re adding half positions in Floor & Décor (FND) and SelectQuote (SLQT), while also placing Pinterest (PINS) back on Buy. We’ll still be hanging onto around 45% in cash after the purchases.

From here, we’ll follow the usual plan—if things kick into gear (especially if earnings season produces a bunch of gaps in new leaders), we can quickly get heavily invested. But if this rally stalls out, we won’t throw good money after bad. For now, though, it’s best to take a step or two back into the market’s waters.

Current Recommendations

DraftKings (DKNG)—DKNG was the latest in a line of growth stocks that got hit after toying with new highs. While the bounce since then has been modest, shares have steadied themselves, the overall chart looks fine (higher lows over time) and the story remains top notch—New York has legalized sports betting, and while the approval isn’t straightforward (the state will grant licenses to two operators that will then sublicense them out; there could be some lawsuits regarding the bill), analysts seem to agree well-capitalized operators like DraftKings are most likely to benefit, with a late-2021/early-2022 potential launch. Big picture, the company’s growth should remain rapid for many years; near term, further wobbles in the stock wouldn’t surprise us, but we’re sticking with our plan of using a 20% loss limit (in the 57 area on a closing basis). Hold on if you own it, and if not, we’re OK buying a small position in this area. BUY A HALF.

Five Below (FIVE)—Nothing has changed with Five Below during the past couple of weeks, either on the news front or with the stock, which continues to hack around generally south of 200. Still, the more times resistance is tested the weaker it gets, so the repeated tests of that round number area (we count six tests since the start of March!) are likely eating away at the potential selling pressures, at least in theory. Overall, nothing has changed with our thoughts—Five Below is back on a great growth path, which is probably better than it was before the pandemic due to its e-commerce investments and new Five Beyond product offerings (up to $10); combined with the fact it only had a four-month rally after lifting from a two-year base in September and we think the next big move is up. BUY.

Floor & Décor (FND)—We’ve been watching FND for a while, and we’re going to snag a half-sized position (5% of the portfolio) here as the stock appears to be putting the finishing touches on a three-month rest. We’ve been looking for another cookie-cutter situation for the portfolio, and this company has one of the best, with a 20%-ish store growth plan and a ton of whitespace longer-term (management thinks it can have at least 400 locations in the U.S. alone, vs. 133 today, and that’s probably a low estimate). But beyond just the store expansion are major tailwinds at its back: First, after years of under-building, housing construction is picking up and should remain elevated for a long time. Second, hard flooring continues to steadily take share from carpets. And third, Floor & Décor’s stores often have more than 1,400 products in stock, while nearly all competitors have a few dozen with the rest having to be ordered, which has led to great same-store sales growth (higher market share) over time. Analysts see sales up 20% to 25% this year and next, and earnings should grow even faster (25% to 30%), with years of expansion likely beyond that. Back to the stock, there is still resistance to get through (same as nearly all growth-related names), but FND has gyrated around the 100 area for a while and has tightened up of late, which is usually constructive. We’ll throw a line in the water here and look to average up if shares can push to new highs. BUY A HALF.

Pinterest (PINS)—We’ve been thinking that Pinterest’s sloppy action the past few months (as of the middle of last week, shares had made no net progress for four months) was a pause that refreshes, and we’re glad to see the market finally beginning to agree with us—while many of its e-commerce/Internet peers fell to (or below) their early-March lows two weeks ago, PINS resisted that decline, and now we see the result, with shares popping 15 points over the past few sessions. As with the overall market, this doesn’t appear to be some sort of blastoff (low volume on the rise; still has some overhead to chew through), so wiggles are obviously possible—but there’s no question the action is positive. Earnings are likely out in early May, which will probably tell the intermediate-term tale, but the evidence is growing that after a tough correction and rest period, the sellers are losing control. Hold on if you own some, and if you don’t, we’re OK starting a position (maybe go with a half-sized one) here or on dips of a couple of points. BUY.

ProShares Ultra S&P 500 Fund (SSO)—Up, up, up … the S&P 500 continues to glide higher with a few potholes along the way, keeping its uptrend (and that of SSO, which moves twice the S&P 500 on a daily basis, percentage-wise) intact. To be fair, the rally of the past week has brought SSO a bit out of trend on the upside—coming after a few months of solid progress, that often leads to some trouble, or at least a bit of stalling out. Plus, given the action so far this year, it wouldn’t shock us to see a bit of rotation out of cyclical/financial names (and, thus, the S&P 500) if the Nasdaq’s recent strength continues. Because of that, it’s probably a good idea to buy on weakness if you want to start a position or add to an existing one. But big picture, with the trend up and the market looking better in recent days, we’ll stay on Buy. BUY.

SelectQuote (SLQT)—We always like to play the odds, and when it comes to individual stocks, that means having as many pieces in place that correlate with great performance as possible. That’s why we’re taking a swing at SelectQuote, which has all the makings of a winner—the story is outstanding, as it operates the biggest insurance marketplace out there, and the firm has legitimate barriers to entry thanks to the network effect and its own technology and history (one billion data points it integrates into its lead generation and routing efforts). Numbers-wise, sales and earnings grew at triple-digit rates in Q4 and analysts see the bottom line up 83% this fiscal year (ending in June) and another 48% next year, both of which are likely conservative. The only hitch here is that about three-quarters of revenue comes from senior-related health plans (especially Medicare Advantage), but SelectQuote is taking share rapidly in that field and, of course, it’s a solid long-term growth area as long as the government doesn’t get overly involved. As for the stock, it’s wild and wooly, but it held its 50-day line twice during the Nasdaq’s downturn and recently popped back toward its old highs. Granted, it’s backed off since then, but that’s par for the course these days. We’ll start a half-sized position (5% of the portfolio) on this dip with a stop in the mid-20s. BUY A HALF.

Twilio (TWLO)—TWLO fell right down to its 200-day line at the end of last month before benefiting from the rotation back into some pandemic/technology stocks in recent days. We’ll definitely take the bounce, of course, but so far it’s nothing to get overly excited about—TWLO fell from around 450 to 300 (using round numbers) and has since bounced as high as 370, recouping ~45% of its decline. As with many stocks, the upcoming quarterly report (likely out in early May, but no set date yet) will have a big impact, especially regarding the bottom line—analysts see Twilio’s earnings falling back into the red this year even as revenues crank ahead (Wall Street sees Q1 revenue up 46% but a loss of 10 cents per share), but if that proves overly conservative, it could attract many big investors that pared back in recent weeks. Bigger picture, we’re still concerned that the stock’s three straight big-volume declines right off the top (after what was a massive run) could cap the stock for a longer period. All in all, though, TWLO’s correction to this point has been tedious, but acceptable, and we continue to advise giving your remaining shares room to breathe. HOLD.

Uber (UBER)—UBER’s roller coaster ride continues, with a dip two weeks ago leading to another pop higher … before some choppy action this week. While we’re open to anything and will cut bait if necessary (our mental stop remains in the upper 40s), we’d have UBER on our own watch list if we didn’t already own it—fundamentally, the firm has both a true growth platform in Delivery and an economic reopening play in Rides, while technically, we’re thinking the endless ups and downs in recent months (a) have likely worn out many non-believers even though (b) shares haven’t done anything “wrong” following the massive November/December blastoff. The stock isn’t strong enough for a Buy rating, but the odds favor patience eventually paying off. HOLD.

Watch List

• 10x Genomics (TXG 190): 10x Genomics has a powerful story as it provides the systems that are driving the next generation of research into biology. See more below.
• Diamondback Energy (FANG 75): FANG and other oils are now five weeks into normal-looking corrections. We think the consolidation could last longer, but they’re worth keeping an eye on.
• Inari Medical (NARI 113): NARI has been up and down of late but the big, bullish earnings reaction four weeks ago bodes well.
• Shake Shack (SHAK 114): SHAK is beginning to “live” under its 50-day line (and in the lower portion of its consolidation), which isn’t ideal. But a good couple of days would make a big difference, and nothing has changed with its cookie-cutter story.
• Wayfair (W 332): W is still choppy but has tightened up nicely just shy of all-time highs—it’s another growth name that looks ready if the market cooperates.

Other Stocks of Interest
10x Genomics (TXG 190)—The more we study 10x Genomics, the more we think the firm has the potential to be “the next Illumina”—a firm that provides the best tools for researchers to unlock the mysteries of human biology and genetics. 10x’s claim to fame are its products that allow unmatched resolution, allowing users to analyze things on a cell-by-cell basis. The main draw is Chromium, which lets scientists partition things into millions of individual cells, while the company’s Visium offering uses DNA arrays and sequences so that biological substances can be tested in a single cell, special context. The technology is a bit of an ice cream headache, but we think the upshot is simple: 10x has come up with a far better mousetrap when it comes to analyzing biology, which is leading research organizations and biopharma players to stampede to its door—10x has sold 2,412 Chromium systems so far (all provide a stream of recurring income due to the consumables they use), but that’s just a fraction of the 15,000-plus next-generation gene sequencing machines out there, and management has stated that it sees its potential market as far greater than just the number of gene sequencers. Growth has been rapid for years, and while there was a hiccup early in the pandemic, the company is back on its prior path, with sales up 49% in Q4, and management guiding to a big 65% revenue gain this year. Earnings are still in the red, but underlying margins are healthy, and as more systems are placed (leading to more high-margin recurring revenue), we have no doubt big earnings are coming down the road. As for the stock, it broke out around 100 last August, ran to 200 in February and then pulled in; as of early last week, shares had made no progress for about six months, which is a reasonable rest. And now TXG is pushing back toward its highs, albeit with lots of volatility. We have it on our watch list.

FedEx (FDX 284)—FedEx isn’t our usual cup of tea, but there’s no question transport stocks are strong, and looking at the chart (and a precedent), we think the stock is likely to reward those looking for a slower, steadier advance. The company, of course, is a giant in the delivery field, and it’s always been highly profitable with a slight growth tilt as more and more packages are sent as e-commerce takes market share. Despite that, shares went through a horrid decline with the sector starting in early 2018—from a high of 275 in January of that year, the stock didn’t bottom until it hit 88 after the pandemic and it was still more than 50% off its peak in June of last year. Then came the rally, and it showed unique strength: FDX not only rallied strongly, but very persistently, rising 12 weeks in a row (and 15 out of 16) on its way to hitting 300 last December. (If you’re a history nerd like us, go check out a chart of Home Depot back in 2012—its initial blastoff as the housing market recovered had a similar string of up weeks.) Of course, there’s more to it than the chart—earnings growth is accelerating (up 60%, 92% and 146% during the past three quarters), with the current fiscal year (ending in May) bringing a huge (88%) rebound in the bottom line, with more growth likely after that. FDX has etched a beautiful, cup-shaped consolidation during the past few months, with earnings pleasing Wall Street a couple of weeks ago. Obviously this stock isn’t going to make you rich, but FedEx seems like a long-term turnaround situation that’s next big move should be up.

Upstart Holdings (UPST 123)—Upstart is a newly public outfit that has a powerful, simple story. It all starts with lending, which is obviously a lifeblood of the overall economy, yet for many banks, the process of evaluating a customer’s creditworthiness is relatively simple (FICO is the main consideration) and often fails to really get at the risk level of a prospect, leaving many top-notch potential borrowers on the sideline or paying too much in interest. Upstart has a better way, having developed and refined (over the past eight years) one of the leading artificial-intelligence-based lending platforms out there, incorporating more than 1,000 variables and taking advantage of 10.5 million data points through its history of operation. Upstart doesn’t lend itself, of course—it partners with banks (and thus takes no lending risk) and connects with consumers via a cloud-based app that leads to higher and quicker (71% instantly approved with no document uploads or calls necessary) approval rates, while banks benefit from top-notch results, with a mostly digital process that can be customized while fraud rates remain nearly non-existent. Upstart has been growing quickly through these consumer-based loans (sales up 39% and 32% the past two quarters while earnings are in the black), but it’s now thinking bigger—the company purchased Prodigy, a leading sales software provider to auto dealerships, opening up the giant market of auto loans ($626 billion of loans a year, most of which are originated at dealerships!) for Upstart’s platform. (Analysts see earnings of nearly 50 cents per share this year and 83 cents next.) The stock came public in December and rose for a while, then dipped with growth stocks, but the Q4 results and purchase of Prodigy lit a fire under the name, leading to a massive move higher. UPST remains extended and is very volatile (it had a share offering this week), but we like this story a lot—some tightness would be tempting.

Your Best Opportunities Usually Come from Newer Names
During the past couple of years, the market has broken plenty of rules, which is why we haven’t been relying too much on precedents during that time—you simply don’t see many pandemics and ensuing economic recoveries throughout history, so drawing too close a relationship between today and X years ago doesn’t make much sense.

However, one thing that will always ring true is the fact that the market usually fools the majority, and one way it does that is by changing its tune, both in terms of its own action (sudden corrections or rallies out of nowhere) and in terms of individual stocks—oftentimes, leadership will shift after a correction, with older names that have already advanced a ton likely to lag newer, peppier growth titles.

During the past week, the Nasdaq and many growth stocks have perked up, which is great. But take a look at some of the “old” winners from last year (especially those that broke out soon after the March low) and they’re still looking iffy. Old favorite DocuSign (DOCU) is a good example. The stock has about as good a story (e-signatures and digital contract management) and growth numbers (50%-plus sales and triple-digit earnings growth) as you’ll find. But despite topping out seven months ago and wearing out some weak hands, the stock has yet to get off its knees and is still stuck below its 200-day line.

And it’s not just pandemic stocks, either. Coupa Software (COUP) is a title that’s been a long-time winner and should see growth pick up as more firms restart B2B purchases and look for a better way to do it. Yet the stock is also languishing below its 200-day line and the recent bounce looks lackluster.

Of course, any former leaders could pull it together if the underlying company cranks out solid growth for a while. But just remember the market doesn’t run on fundamentals—it runs on the perception of those fundamentals, and after giant runs for a year or two, odds are some of these stocks may have already hit their point of peak perception. Long story short, while some of the old favorites may return to glory, you’re more likely to land big winners by looking for new names—names that (ideally) are in the early stages of a major perception increase as big investors pick up shares.

Some of these could include recent IPOs (within the past year) that have set up in recent months. SelectQuote (SLQT) is obviously a favorite of ours, as we’re adding it to the Model Portfolio tonight (half-sized position). But there’s also a name like Inari Medical (NARI), which gapped up on earnings in the middle of the Nasdaq correction and, while backing off, remains in good shape. The firm’s products for venous blood clot removal are borderline revolutionary and are quickly gobbling up the market. Sales were up between 144% and 172% each of the past three quarters, and the firm is profitable, too.

It doesn’t have to be a recent IPO, either. Shake Shack (SHAK), for instance, has been around for years but has mostly been gyrating up and down. But it looks to have changed character after announcing a bold store opening plan (45% hike in the store count within two years). The recent three-month sideways pattern looks like a normal rest, too.

Exact names aside, our overall point is that most of the questions we get these days involve the names of former leaders that, at least to this point, still look weak. Remember that fresher names are likely to provide better opportunities as growth stocks truly come back into favor.

Sentiment: Short Term vs. Long Term
One of the flies in the market’s ointment when it comes to the here and now is sentiment— while the super-frothy action from January and February (Reddit traders and the like) has definitely dissipated, we’re disappointed to see many measures tell us the average Joe is still pretty hot and heavy for stocks despite the eight-week rough patch in growth stocks.

Our Real Money Index, for instance, recently hit a multi-year high before backing off. To be fair, money flows have been horrifically negative for years—in the two years ending November, a whopping $500 billion flowed out of equity funds and ETFs, so the latest push higher (about $100 billion in the past five months) isn’t obscene. But on a short-term basis, there’s little question that money flows point to little fear or worry among investors.

That message is confirmed by many other measures, too. Take a look at the AAII survey; below is a multi-year chart of the survey, with the eight-week moving average of bearish responses in blue. You can see the line has dipped toward its lowest level in years (very few people are bearish)—and most of those resulted in some tough sledding for the market in the months after.

Is this a reason to bet against the rally? No—we always go with the primary evidence first. But combined with the divergences out there among the major indexes and the relatively few breakouts (so far), we do think it’s a reason to go slow and make the bulls prove themselves going forward.

Cabot Market Timing Indicators
The evidence has definitely improved during the past couple of weeks, with the Nasdaq perking up and some growth stocks doing the same. With the trends up, we’re putting some money to work, but given the lack of power and elevated sentiment, we think it’s’ best to go slow and let the market prove itself going forward.

Cabot Trend Lines: Bullish
Our Cabot Trend Lines have cooled off in general during the past two months, but at no point has this reliable, big-picture indicator come close to shouting caution. At the end of last week, both the S&P 500 and Nasdaq were about 10% (give or take) above their respective 35-week lines, which is a strong showing given the action since late January. All told, the longer-term trend remains firmly up.

Cabot Tides: Bullish
The Cabot Tides have remained positive throughout the past few weeks as most of the indexes we track have stayed above their lower (50-day lines). And now the one holdout may be rejoining the party—the Nasdaq Composite (daily chart shown here) has lifted back above its own 50-day line for the first time in about a month and has held those gains. It doesn’t affect the bullish signal, but it’s a feather in the cap for growth stocks.

Cabot Real Money Index: Negative
As we wrote above, sentiment remains a fly in the ointment when it comes to the overall evidence, with many signs of complacency out there—our Real Money Index recently hit its highest level in years, with money continuing to pour into equity ETFs as most of the news out there (vaccines, economy) is good. It’s not the be-all, end-all, but it’s a headwind for the market.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on April 22, 2021.

Cabot Wealth Network
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Chairman & Chief Investment Strategist: Timothy Lutts
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