Cabot Growth Investor 1478

The chop factor remains in force in the market, with yet another round of rotation this week out of growth and into the broad market. Even so, we see more good than bad out there, with an increasing number of growth stocks having popped out of multi-month ranges and recent dips mostly looking manageable. We added another new name last week, and we could add more depending on how this rotation plays out, but tonight we’ll stand pat with our stocks and 30% in cash.

In tonight’s issue, we write about one sector that’s showing some signs of perking up, some encouraging sentiment readings and go over all of our stocks and many others we’re keeping a close eye on.

Cabot Growth Investor 1478

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More Good than Bad
In our last issue, we asked the question on this page whether growth stocks could break free from what had been weeks (months?) of choppy conditions—could we see a persistent buying spree among big investors that drives a slew of stocks higher? In our view, that would certainly catch most off guard, as investors have been conditioned to look for pullbacks and expect selling to come after strength.

So far, though, it hasn’t happened—growth stocks had a couple of productive weeks, but recent days have brought yet another rotation out of growth and back into the broad market, with metals and financial stocks pushing ahead while cloud, technology and similar sectors are reeled in. In fact, for the first time in a while, we’ve seen a couple of supposed growth leaders crack key support, while some extended high-fliers (vaccine stocks) flash a bit of abnormal action.

Still, while the rotations are frustrating and that iffy action needs to be watched, we’re seeing more good than bad out there: More growth stocks have emerged from long consolidations (often on earnings), non-tech growth stocks look pretty good (some have actually picked up steam this week) and our Cabot Tides have nosed back into positive territory. It’s not 2020 out there by any stretch, but it’s also not hard to fill up a watch list with well-acting growth stocks that also have great stories and numbers.

Thus, the game plan remains mostly the same—we’re more constructive on things than we were a month ago, which is why we’ve gradually come off a huge cash position, taking stakes in what we think could be a collection of fresh leaders. That said, if you’re a position trader like us (attempting to hold for months or hopefully longer if all works out), it’s still important to go slow and pick your spots; plowing all-in or all-out in this environment will likely have you chasing your tail.

As for the immediate future, how growth stocks handle the current rotation will determine our next move—if the selling begins to get out of hand, we’ll certainly throw up some safety nets (though we may possibly look to add one more cyclical name), but we’re more interested to see if some liquid leader-types bounce strongly off support; today could be the start of that, but we’ll have to see more.

What To Do Now
For the here and now, though, we like where the Model Portfolio is at—with 30% cash, but also holding an array of growth titles in different sectors, most of which are still acting well. Last week, we added a new full position in Dynatrace (DT), but tonight we have no new changes.

Model Portfolio Update
Growth still can’t escape the chop, with a new round of rotation out of our favored type of names earlier this week, leading to some renewed damage and even a breakdown among some familiar names. It’s certainly a reason why we continue to favor going slow and picking your spots, as days or weeks of gains can be given back in a hurry.

All that said, we like how the portfolio is generally acting—the volatility and two-steps-forward, one-and-a-half-steps-back action is definitely frustrating, but we’ve seen more of our names begin to stretch higher, partly because we’re not solely focused on the glamour cloud and e-commerce areas of the market.

Moving ahead, we’d love to put some of our 30% cash position to work, and if growth stocks find support soon and rebound, that may be our play. But for the moment, we’re comfortable with our stance, with some top-acting stocks along with a good amount of buying power if fresh opportunities (mostly on pullbacks into support) emerge.

Current Recommendations

Asana (ASAN)—ASAN still has earnings coming out in about three weeks (Wednesday, September 1), but given the ups and downs in the market, we think the stock acts great—the stock pushed to new highs early this month before being chopped down some, but today it came right back toward virgin turf. The firm’s been all quiet on the news front (the latest release was about its latest app for Zoom, which allows teams to get more information about meeting topics and prerequisite tasks), but the action of the stock and the fundamental numbers suggest it has something special with its work management software platform. As always, if the stock bites the dust, we’ll cut bait, but we still think ASAN looks like a fresh leader. We’ll stick with our Buy a Half rating, preferring new buyers enter on dips of a couple of points. BUY A HALF

Cloudflare (NET)—NET has been up and down during the past few sessions (a $1.1 billion convertible note offering, which is dilutive, didn’t help the cause yesterday). But the trend is still up and, fundamentally, the Q2 report was about as pristine as could be, as more customers (up 32% from a year ago) and big customers (number of $100k customers is now 1,088, up 71% from a year ago) came on board, including the Department of Homeland Security (looking for cybersecurity protection). And those that are already clients bought more (same-customer revenue growth of 24%), driving revenues up 53% (a slight acceleration) and remaining performance obligations up 77% (and that didn’t even include the impact from some recent new signings). To be fair, the big convertible offering could cap the stock for a bit after its recent run, but (a) NET is still up on the week thus far, and (b) it’s still more than 15 points above its 50-day line. We’d like to fill out our stake, but we’ll wait a bit longer to see how the stock (and growth stocks as a whole) react to this week’s wobbles. If you don’t own any we’re OK starting a position here or (ideally) on dips of two or three points. BUY A HALF

DocuSign (DOCU)—For the first time since the May low, DOCU has shown a small change in character—instead of shooting to new highs after a pullback, it found sellers and dipped a touch below its 25-day line before today’s bounce. Admittedly, a lot will come down to the growth stock environment (is this rotation going to go on for weeks or be over in a couple of days?) and, later on, DocuSign’s own quarterly report (likely out in early September)—a decisive break of the 50-day line (now nearing 280) would obviously be a yellow flag. But right here, we don’t think the action is abnormal in any sense: Compared to the big-volume buying that came after earnings in June, the recent retreat hasn’t shown much teeth, and the first test of the 10-week (or 50-day) line usually offers a decent entry point. Plus, of course, every sign continues to point to massive growth ahead for its e-signature and agreement cloud solutions. We’re not complacent, but right here we think DOCU is at a nice entry point if you’re not yet in. BUY

Devon Energy (DVN)—DVN got hit before and right after its Q2 report, but a bounce in oil prices, a rotation back into some cyclical stocks and a realization of the gigantic cash flow potential has brought in some buyers. In fact, we think it’s less about the possible upside (which is gigantic if oil prices ramp) and more about the still-solid figures when stress-testing a decline in energy prices. For instance, even with realized oil prices of just $50 and natural gas prices of $2.20 in Q2 (both including huge hedging losses), the firm cranked out around 87 cents per share of free cash flow (12% annual free cash flow yield!). Thus, as hedges roll off, the firm should see a similar level of cash flow even if prices decline back down to that level, which is 25% below the current price of oil and 45% for gas! Now, with that said, shares aren’t out of the woods (testing the 50-day line from below), though they have lifted decently off support. We’re encouraged and optimistic that the correction is over, but we need to see more before going back to Buy. HOLD

Dynatrace (DT)—There’s no question that complicated fundamental stories can work, but we prefer those that make common sense—if you understand what’s going on, you’re more apt to hold on through the inevitable sharp (but normal) shakeouts that come along. Dynatrace fits the bill, as its platform is perfectly suited for giant companies that are transitioning massive amounts of apps and infrastructure across different business divisions to the cloud (especially to multi-cloud environments, where the company sees even less competition now than a couple of years ago). Management regularly talks about 30%-ish growth for many years to come as more firms sign up (135 new logos in Q2 alone; more than 3,000 total) and current clients expand their usage of the platform (many quarters of 20%-plus same-customer revenue growth). It’s not likely to be the fastest horse, but we think DT looks like an emerging blue chip that should see steadily rising demand as the inevitable digital wave continues. The stock has pulled back of late with all growth stocks, but only to its 25-day line—we think it’s buyable here. BUY

Five Below (FIVE)—One of the big challenges the market presents is that it’s very streaky—indexes, sectors and stocks will spend months bobbing and weaving before finally making a move. Five Below looks to be the classic case, with its six-and-a-half-month range of 15% finally giving way to a strong breakout and solid follow-through since. Of course, in this choppy environment, there’s still a chance that FIVE will embark on another tedious pullback, but there’s no question that the move is a bullish change of character, and we like the fact that some other retailers are beginning to perk up, too. If you own some, just keep holding on, and for new buyers we’re going to restore our Buy rating, but as has been the case with most stocks, we advise buying dips of a few points if you’re not yet in. BUY

Floor & Décor (FND)—FND has taken a couple of lumps since the last issue, but there’s little doubt the big-picture growth story remains as strong as ever. The quarterly report was fantastic and easily beat expectations, with sales up 86% from the pandemic-affected Q2 of last year (led by same-store sales growth north of 60%), but also up 65% from the Q2 2019 figure. As you’d expect, growth rates will slow as comparisons become more difficult, but there’s little evidence of any business hiccup—indeed, same-store sales for July were up about 11% from a year ago, a time when the company’s results were very strong. It wasn’t all good news (supply chain issues will hike costs and cut margins a bit for the next two or three quarters), but there’s every reason to expect sales and earnings to continue to head higher as the store count (up 20% this year) does. As mentioned above, shares have come down on the good-not-unbelievable numbers, but they’re still holding above even their 25-day line (now just above 116). A bit more retrenchment wouldn’t shock us, but until proven otherwise, we think the path of least resistance is up. BUY

ProShares Ultra S&P 500 Fund (SSO)—We could pretty much copy what we’ve been writing about SSO for the past couple of months and paste it here—the trend remains up (that’s good), and we’re pleased to see some measures of sentiment begin to show uneasiness among investors (another good sign). But there’s no question the advance is on the mature side (no sustained breaks of the 50-day line since last November!) and the repeated crosscurrents and divergences (NYSE advance-decline line, junk bonds, etc.) aren’t ideal. Still, we’ve been sticking with the trend for months, so that’s what we’ll continue to do, staying on Buy—but keeping an eye out for any major change in character that may come. BUY

Watch List

• Alnylam Pharmaceuticals (ALNY 201): If biotech stocks kick into gear, ALNY certainly looks like a big leader as its short- and long-term growth potential is as good as any. See more below.
• Bill.com (BILL 204): BILL has begun to calm down and it’s handled this week’s shake nicely. Earnings are out August 26.
• Carvana (CVNA 358): CVNA has been all over the place the last few days, but business has accelerated in an almost hard-to-believe way since the pandemic began. See more below.
• Dexcom (DXCM 493): DXCM has busted to new highs, has a new product coming later this year and earnings are set to surge in 2022. See more later in this issue.
• ZoomInfo (ZI 62): ZI is trying to get going, but two good-sized share offerings (all closely-held shares, no dilution) and the growth stock weakness have caused a lot of volatility. We like the story but want to see ZI settle down a bit.

Other Stocks of Interest
Carvana (CVNA 358)—Whereas many online auto sellers are really just referral networks for already-existing dealerships, Carvana has always tried to upend the $700 billion-plus used car industry by using a combination of technology and logistics to deliver a superior experience for buyers and sellers—with a huge inventory, excellent visuals, a seven-day test drive period, overnight shipping in most big markets and guarantees none of their autos have ever been in a reported accident, the concept has taken off in every market Carvana has expanded to. And it’s also become one of the largest buyers of used cars (I sold mine to them three years back), offering competitive prices to build its inventory. Of course, the company’s expansion efforts continue to suck up a ton of capital (it’s now in 301 U.S. markets that cover 80% of the population), but this always seemed like a business that was going to take major share in the industry—and then the pandemic arrived and accelerated a move that was likely to take many years. Business here has mushroomed in recent quarters at an almost hard-to-believe pace: In the year before the pandemic, units sold lifted at a solid 25% pace, but in the year since, they’ve basically doubled, with 107,815 units sold in Q2 alone, while revenues have basically tripled during that time! (Carvana even cranked out its first-ever profit in Q2, though that isn’t expected to last.) And, while the growth is huge and the firm is no longer just an upstart (north of $3 billion in revenue in Q2 alone), the company is actually capacity constrained and is still just scratching the surface, with around 40 million used cars sold in the U.S. annually, compared to ~450,000 run rate for Carvana (just over 1% of the market). CVNA had a massive run through last year before beginning to chop around and correct. Like many growth stocks, the action since May has been excellent, with a persistent advance as the stock has moved to new highs. CVNA is high on our watch list.

Nucor (NUE 125)—Commodity stocks are always a tough play as they can come in and out of favor very quickly, and it’s not like our recent foray into Devon has paid off (yet). But (a) we still think most cyclical names are early-stage, having just gotten going from multi-year dead periods last November, and (b) now many are getting going up after two-plus months of consolidating. The driver: While prices won’t stay up forever, of course, there are some longer-term things going on—from the boom in renewable energy to heavier investment in U.S. manufacturing (more control of supply chains; market share for steel imports is now at the lowest level since 2003) to more warehouses for e-commerce—that bode well. All of this has us taking a look at Nucor, which is one of the big boys in the steel industry (#1 North American player in structural, merchant bar and cold finish steel, #2 in rebar, plate and SBQ bar steel). Not surprisingly, earnings are going through the roof (it earned $5 per share in Q2, more than in any full year before save 2018), but what has the stock resuming its advance is the fact that earnings are likely to remain elevated for longer than many believed a few months ago—90 days ago, analysts saw earnings of $9.30 per share this year and $4.21 next, but each of those figures has more than doubled (now $19.08 and $9.65!), with Nucor’s top brass expecting Q3 to be even better than Q2 and stating that “order backlogs at most of our businesses suggest strength well into 2022; further supporting our optimistic outlook, inventories throughout the supply chain remain lean.” Throw in a decent dividend (1.3% yield) and an active share buyback program (3% reduction in the share count in the first six months of the year) and there’s plenty of reason to think the stock can enjoy another run. Indeed, NUE’s 22% dip in June and July was very modest compared to the prior advance, and now the stock has come under accumulation again, shooting to new highs. Near-term dips should be buyable.

Snowflake (SNOW 286)—We wrote about Snowflake two months ago, talking mostly about a unique chart action (three straight big-volume weeks right off the bottom for a recent IPO) and how it’s been seen in many prior big winners. And so far that’s worked pretty decently, with SNOW making some upside progress (with plenty of chop, of course). But we never become interested in a stock just because of a chart—Snowflake has one of the most impressive sets of growth numbers we’ve seen in a very long time, and with earnings coming up (August 25), a gap could be buyable. The big idea here is that Snowflake looks like the next big thing in data management and sharing: Dubbed the Data Cloud, there are no limitations on computing power, everything is in one programming language (a big plus for programming simplicity among clients) and, importantly, it allows secure sharing of data inside and even outside organizations (between departments, partners, customers, suppliers, etc.). Basically, Snowflake allows companies that are collecting massive amounts of data to house it in a single platform and let the right people around the globe make the most of it, which sounds logical but has been a logistical nightmare to this point. Revenues have been growing at triple-digit rates, and just as impressive have been two sub-metrics: Same-customer revenue growth chimed in at 68% in Q1 (due in part to the firm’s consumption-based model—the more clients use the platform, the more Snowflake makes), while remaining performance obligations (all money under contract due to Snowflake) leapt 206%. The valuation is definitely up there ($82 billion!), which could keep the stock under wraps, but we’ll be watching the quarterly report to see how it affects investor perception.

Sentiment Continues to Slowly Improve
Whether you’re talking about a modest downturn, a correction or a full-fledged bear market, market retreats tend to primarily come in one of two flavors—they either scare investors out through vicious, quick losses that raise the fear level, or they tend to wear investors out through time more than price, with lots of ups and downs, bad news and tedious action. Of course, many downturns have a mix of both, but tend to either quickly spike the fear level or grind sentiment lower over many months of frustrating action.

The past few months have definitely been the latter—yes, there has been some ugly weeks, but when you look at growth stocks and, increasingly, the broad market, this has been less about nosediving action and more about endless chop and rotation that has gradually worn down many investors and damaged sentiment. It’s not panic by any means, but the number of people that are bulled up is way down of late.

Our Real Money Index is the first example—on a rolling five-week basis, money flows into equity funds and ETFs have actually turned negative. If February was euphoria, today looks like relative apathy.

Then there’s the equity put-call ratio, which gyrates on a daily basis depending on the market. But measured over a 21-day (full-month) period, recent readings eked above the May highs to the highest (most pessimistic) since early last October.

And finally there’s the AAII survey, which despite its small size, has a darn good contrary record. Again, there’s not a ton of bearishness, but the bulls are also on vacation, with the eight-week moving average dipping under 40% to the lowest level since mid-November.

As we always write, sentiment is a secondary measure, and besides, this isn’t a classic situation where everyone is panicking (usually a good thing down the road). But to us, the steady erosion in optimism should be viewed as a positive sign that many of the weak hands that were buying earlier this year have been worn out.

Can Medical Stocks Get in Gear?
While some Covid-related medical names (like those producing vaccines) have been hot, most have been lagging for months—indeed, the broad S&P Biotech Fund (XBI) is still sitting beneath its 200-day line, trading 27% below its February peak. But on an individual stock basis, we’re beginning to see some early signs things might change, which would be great; medical names have always been a good place to find leaders, as once they hit on something big, they tend to offer rapid and reliable growth for many years.

Old friend Dexcom (DXCM) is one we’re spying. What we like here is that there’s something new with the story—specifically, the firm’s next-generation G7 continuous glucose monitor is likely to be released later this year and power earnings ahead (up 40%, which we think will prove conservative) in 2022. The G7 will be 60% smaller than the current G6, has a quicker warm-up time, combines the sensor and transmitter into one device, is fully disposable and will have a longer wear time. DXCM has emerged from a 14-month period of no progress and has advanced 12 weeks in a row, a persistent buying spree that usually leads to higher prices.

We’re also watching some other old favorites, but one fresher name has caught our eye: Alnylam Pharmaceuticals (ALNY) has the first and only FDA-approved RNA interference (RNAi for short) drugs on the market; these drugs “turn off” specific genes that cause rare but debilitating diseases. It has three main, small drugs on the market now that brought in $161 million total in Q2 (double that of a year ago) despite having just a couple thousand patients, but it’s just scratching the surface, with a ton of products in the pipeline (including a couple in Phase III trials)—all in all, the top brass is targeting 40%-plus annual revenue growth through 2025 as hundreds of thousands of patients move onto the company’s current and future drugs. The stock has lifted out of a long up-and-down period on a few days of big volume.

We can’t say the sector as a whole is necessarily out of the woods, which is something to keep in mind, but DXCM and ALNY (and some others in the group) have the stories, numbers and charts to suggest they could help lead the growth stock advance. Both names are on our watch list.

Cabot Market Timing Indicators
The good news is that our Cabot Tides have returned to the bullish side of the fence, though at the moment we’re not reading a ton into that because (a) the environment clearly remains choppy and rotational and (b) most of that strength is due to cyclical areas perking up. Overall, we’re seeing more good than bad out there, but still favor going slow.

Cabot Trend Lines: Bullish
There’s no change with our Cabot Trend Lines, which remain in the bull camp as both the S&P 500 (by 9%) and Nasdaq (by 8%) are holding nicely above their 35-week moving averages. Throughout time, this indicator is on the right side of the major trend north of 80% of the time, so big picture, the odds still favor this bull market having room to run.

Cabot Tides: Bullish
Our Cabot Tides certainly aren’t running away on the upside, but we’ve seen enough to call the Tides positive once again—granted, broader indexes (like the S&P 400 MidCap, shown here) are still sideways, but three of the five indexes (S&P 500, Nasdaq, NYSE Composite) are at or near all-time highs. We’re mostly taking our cues from the action of individual growth stocks these days, but the Tides buy signal is certainly a positive sign.

Cabot Real Money Index: Neutral
The Real Money Index is one of many sentiment measures that we mentioned earlier that are definitely showing a big decrease in bullishness—over the past five weeks, no net money has moved into equity funds and ETFs, currently sitting at the fourth lowest reading since last November’s blastoff. It’s not at the level of a pound-the-table contrary signal, but it (and others) certainly tell us optimism is steadily waning.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on August 26, 2021.

Cabot Wealth Network
Publishing independent investment advice since 1970.

President & CEO: Ed Coburn
Chief Investment Strategist: Timothy Lutts
Cabot Heritage Corporation, doing business as Cabot Wealth Network
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