February 24, 2022

The market plunged today on news of the “official” Russian invasion, but the turnaround was even more impressive, with the buyers pouncing and driving the indexes to solid gains; combined with sour sentiment and an internal positive divergence on the Nasdaq (fewer new lows than at the January lows), and there are a few rays of light. Even so, we need to see more than just that to turn bullish--the main trends of growth stocks, the broad market and the major indexes are all down, so while today was a solid first step, we advise patience while we watch to see if the bulls can really step up.

Market Overview & Model Portfolio Update

Follow the Evidence
Most people (active investors or otherwise) woke up today with news breaking about Russia’s “official” invasion of Ukraine and the accompanying losses in stock markets around the world caused by a rash of uncertainties, including spiking energy prices, questions about Russia’s ultimate intentions (and responses by other countries) and how it all plays out with a Fed likely to raise rates ... before stocks turned tail and actually closed higher.

Even so, all of the uncertainties are a lot to take in, and it’s one reason why, in recent weeks, many have become cautious if not outright bearish. But if you simply followed along with the market’s evidence, you saw something bad coming (and happening) a couple of months ago, with the intermediate-term trend getting iffy in early December, tons of growth leaders decisively breaking down around the same time and even the market’s longer-term trend flashing red a couple of weeks ago. We predict nothing, and certainly haven’t handled things perfectly, but by following what’s been going on, we’ve held plenty of cash for many weeks.

So, what does the evidence say now? Well, frankly, not much has changed—our Cabot Tides, Growth Tides and Cabot Trend Lines are all still negative with most every index tagging new correction lows this morning before reversing. Moreover, in recent days, that move was again led by many of the leaders of the last advance, some of which have keeled over again even after briefly rallying after earnings.

That said, we do see a growing number of secondary measures that are getting interesting. The first, of course, involves today’s headline-grabbing decline and recovery, which certainly has the potential to cause a crystallization of bearish sentiment. Backing that up is the aforementioned drop in many (though not all—money flow indicators are still mid-range) sentiment measures, which is good from a contrary perspective.

Moreover, in terms of more direct evidence, we’re seeing the broad market show marked resilience—even as the Nasdaq clearly sunk to new lows this morning, the number of stocks hitting 52-week lows dried up nicely compared to the prior low. The NYSE wasn’t as positive, but new lows (just shy of 800) were about even with the late-January selloff, even as the Dow closed below that area despite today’s turnaround. Said another way, fewer stocks are participating in the plunge.

What to Do Now
Those are some positives, but we need to see more than a ray of light or two to believe the market is ready to get going—we don’t advise selling wholesale here, especially if you have plenty of cash, but for the most part patience remains key. In the Model Portfolio, we’re ready to change our stance if the evidence changes (today was obviously a great start), but tonight, we’ll again sit on our hands (68% cash) and wait for a bullish change in the market’s character.

Model Portfolio Update
There’s a saying among investors that “the market can be a bad teacher,” and that’s played out in recent months. For the past few years, declines had been limited to a couple of months, even when stocks were faced with truly unique circumstances (like a once-in-a-lifetime pandemic). Some truly big winners (like, say, a Shopify (SHOP)) even took poundings but came back, reinforcing the view (especially among new investors that came in during 2020) that all dips were buyable.

Eventually, of course, the music ends, and for most growth stocks, that’s what’s happened since the top, with most glamour names falling 50% or more in just three months. We certainly haven’t played things perfectly, but we’re glad that our system began flashing red way back in early December, and we listened, holding (on average) more than half of the portfolio in cash since then.

At this point, with so much cash, our main (not sole) focus is on what comes next: We’re keeping an eye on growth titles that are either (a) building “normal” launching pads, maybe falling a max of 20% to 25% from their highs, and/or (b) those that haven’t completely disintegrated and are well above their January lows (even as the major indexes aren’t).

Bottom line, right now is an emotional time and there’s no doubt a ton of stocks are done for. But we’ve been around a few decades and have seen much worse than this—when it ends, there will be big, big opportunities in some of the stocks holding up. It’s just a matter of being patient and staying safe until that time comes.

Current Recommendations

Arista Networks (ANET)—Arista has nosedived with the rest of the market in recent days, falling a quick 25 points or so from its post-earnings high to this morning’s panic low before staging a good-looking rebound. Frankly, we have a growing loss here and we don’t want to let the position get away from us much from here—but tonight, we’re holding on for a few reasons that we’ve gone over before. Fundamentally, Arista is a (very) rare growth bird these days, offering not just growth but dependability, with an order book that’s chock full for the next few quarters, mostly thanks to the hyperscale cloud players (the “Cloud Titans” in Arista’s language) that are just starting a huge expansion cycle, but also due to enterprise and campus demand, which are smaller pieces of the pie but growing rapidly. Analysts see earnings up 27% this year and mid-double-digits for a few years afterwards, and for 2022 anyways, those estimates include some baked-in supply chain headwinds and cost pressures. And technically, while it’s hard to say something that’s 20% off its high in just a few weeks looks amazing, there’s no doubt ANET’s pullback looks normal overall (you wouldn’t know growth stocks have crashed looking at this chart). Moreover, we do think today’s headline-driven selling and rebound has a shot at least at marking another workable low. Long story short, we’ve been aiming to give this stock every chance to hold up, as we think it has all the makings of a winner during the next sustained rally—so tonight, we’ll hold on, though if the selling from this morning returns, we could revisit that thought. HOLD

Devon Energy (DVN)—Commodity stocks remain generally strong, and of course, for energy names anyway, a lot of that has to do with global events: Even after giving up its gains today, oil prices are still hovering north of $90 as Russia’s invasion threatens to throw the global energy markets into at least temporary chaos. That’s obviously good news for DVN, which remains in a solid uptrend (still north of its 25-day line), though to be fair, we are seeing some “sell the news” selling pressure pop up of late. We can’t rule out further selling pressure if some investors game out a rotation of sorts; it’s possible we could take partial profits if we see any real change in character, especially given that DVN is a huge part of our overall portfolio. Still, at this point, we’re viewing these wiggles as short-term profit taking that’s based mostly on oil price movements and occasionally jerks around the group—but the evidence has been building in recent months that more and more big investors are looking at names like Devon from a cash flow perspective, and because of that, dips have generally been bought up. Some of that support could show up from Devon itself, which just reloaded its share buyback program, while the upcoming $1 per share dividend (for those that own the stock on March 11; payable March 30) could keep some income investors interested. At $85 oil (8% below current prices) and $4 natural gas (14% below current prices), Devon’s free cash flow would total something like $7.30 per share for 2022 as a whole, with around $4 paid out in dividends and a bunch more going to share buybacks. (So far this quarter, oil prices have averaged $86 and gas $4.25.) All in all, we’re sort of splitting our view into two camps: Bigger picture, we think the energy story can play out for a while longer as perception of the cash flow potential improves, though short term, we see risk being a bit elevated given all the good news (for energy firms) and the weak and whippy market. Hold on if you own some, but if you want to buy, we suggest aiming for dips of at least a couple of points. BUY

ProShares Ultra S&P 500 Fund (SSO)—We’ve written in recent weeks that holding a leveraged long fund with our market timing indicators negative isn’t part of the plan—but, with a workable low in place from early January, having already taken partial profits a few times and two-thirds of the portfolio in cash, we decided to see how things played out. Obviously, things have played out bearishly, with the S&P 500 and SSO sinking to new correction lows this morning ... before staging a rip-roaring rally into the close while some key measures (new lows on the Nasdaq) are intriguing. We don’t call lows—we’re trend followers after all—but we do think the market could be at or near another low point, given the emotional selling this morning and headline-grabbing news. Our leash is very tight at this point, and if you have a decent-sized position, we’d probably favor trimming just to respect what’s going on. But given what we’ve seen and because SSO is a small part of our portfolio (less than 5% of the account), we’re going to give SSO a few more days to see if today’s rebound sticks; if it doesn’t, we’ll likely be on the horn early next week, but right now, we think a bit more leeway makes sense. HOLD

Watch List

• Bill.com (BILL 227): BILL is still well off its highs, but it’s also miles above its lows following a hugely positive earnings reaction three weeks ago. It needs work, but the numbers are great (accelerating and triple-digit revenue growth) and a ton of funds are piling in (942 own shares, up from 560 six months ago, including many top-performing growth managers).
• BioHaven Pharma (BHVN 134): BHVN is a money-losing biotech, so you’d expect it to get trashed in an environment like this. But instead, it keeps forming higher lows and actually tested new highs last week before pulling in some. The firm’s migraine drug is the only one approved to both treat and prevent symptoms; analysts see sales doubling this year.
• Dutch Brothers (BROS 49): BROS has pulled back from the 60 area two weeks ago, but volume has been light and it remains above its January low near 40. We still enthuse about the story—though earnings, due out March 1, will be a big event. We don’t see any of the macro worries (interest rates, oil prices, Russia) harming business at all.
• Halliburton (HAL 31): Energy stocks in general have hesitated this week despite new highs in oil prices, with some selling on the news of the Russia move. Until proven otherwise, though, we think the group’s rally has legs, especially oil service stocks, which only got going at the start of the year and should have a ton of earnings power after the dry times of the past few years. Further pullbacks in HAL would be tempting.
• Planet Fitness (PLNT 89): PLNT just reported a solid fourth quarter this morning (sales up 37%, EBITDA up 23%, same-store sales up 12% and another 2.5% gain in membership in January alone). The stock took a hit with everything else early this morning but closed in the middle of its three-month range.
• Snowflake (SNOW 270): SNOW has sloughed off, though like many potential leaders we’re watching, the stock remains north of its January low. The true tale will likely be told on March 2, when the company reports Q4 earnings—a big positive reaction could help the stock round out what, so far, looks like a reasonable launching pad.

Other Stocks of Interest & Reopening 2.0

Pioneer Natural Resources (PXD 226)—We’re always on the lookout for liquid leaders, which are the names in a particular group or theme that most institutional investors gravitate toward for their unique, reliable growth outlooks and liquidity. Devon certainly looks like one, of course, but Pioneer is a name we wanted to highlight after its Q4 update—if these elevated oil prices last a while (which we think is possible, save for the occasional shakeout), Pioneer should deliver. The attractions here are many: First, like most of the top performers, the firm has honed in on the Midland basin, where its operations are super high-margin. However, part of the attraction here is how Pioneer ended up with its focus on the Midland, with a $3.25 billion sale of its Delaware basin assets (to Continental Resources) late last year that it used to slash its net debt to less than 0.5 times annual cash flow, and it expects to be net debt free by year’s end. And because of that, it really has nothing to do with its mountains of cash flow except return it to shareholders—and it’s set to do that on an impressive scale, paying out around 80% of its free cash flow in dividends, with the rest fortifying the balance sheet and being used to buy back shares. (It just authorized a whopping $4 billion buyback, though that’s likely to be done over many years.) Still, the dividends are the main focus, and the math looks so compelling (partly because the firm liquidated all of its hedges) that Pioneer is even attracting some income-oriented funds in the door—at just $50 oil this year, the firm anticipates $11 per share of dividends (nearly 5% yield at the current stock price), while at $70 that should be $17 per share (7.5% yield) and $90 oil would crank out something like $24 per share (north of 10%). Longer term, at current strip pricing, the firm sees free cash flow of $28 billion during the next five years ($115 per share, not counting any share buybacks) and, in total, they see the lifetime value of their wells “well over $200 billion.” As always, we take these longer-term forecasts with a grain of salt—in fact, near term, we’d guess oil is getting close to a pullback—but the bottom line here is that Pioneer has the steady, reliable cash flow outlook even if the industry hits a pothole for a while. As for the stock, it changed character at the start of the year, with PXD exploding higher on 11 straight days of above-average volume, and it’s held its 25-day line since. If you’re looking for more exposure to the oil patch, we think PXD is buyable on dips of a few points.

Datadog (DDOG 160)—We took a swing at DDOG at year end and it stuck its thumb in our eye right away, nosediving with the market and stopping us out of our half position in a couple of weeks. Still, given the firm’s great story and relatively early-stage chart (the big breakout came “only” in August of last year), we suspected the implosion was basically market related—and so far, that seems to be the case, as Datadog’s underlying growth story seems to have actually strengthened. To review, the company has the pole position in the broad Observability sector, with offerings that allow clients to monitor their varying cloud and Internet infrastructure and apps, making sure they’re up and running and performing together as they should. Plus, there are newer products focusing on security (including protecting sensitive information across teams and groups, which is big for regulated industries). All told, there are 13 product lines these days, all of which are vital for every mid- to large-sized firm that’s moving into the cloud and digital era, which is why so many are beating down Datadog’s door to get onboard. In Q4, revenue growth accelerated again (up 84%, vs. 75%, 67% and 51% the prior three quarters) while earnings more than tripled, but even more impressive to us were some of the sub-metrics: Total customers rose a very solid 32%, but Datadog’s biggest clients (those paying it seven figures a year) leapt 114%, which is a sure sign that IT departments at many blue-chip outfits are building around the firm’s solutions. (Amazingly, Datadog’s same-customer revenue growth came in north of 30% for the 18^th straight quarter!) Fundamentally, then, the future is bright (analysts see the top line up nearly 50% more this year, with another 37% gain in 2023), and the stock is hanging in there—yes, it divebombed to start the year, but it never dipped much below its 200-day line and then popped nicely on earnings. DDOG has pulled in with the market in recent days, but it remains miles above its January low and found excellent support today. The longer it can hold up, the better the chance the stock will enjoy a good run when the market finally gets its act together.

Transdigm Group (TDG 649)—Aerospace names aren’t truly growth stocks, but we’ve had some success with them in the past for two main reasons. First, the business cycles here last a long time, usually many years, so once it gets going it’s not hard to have confidence it’ll stick for a while. And second, the industry is very concentrated, with most big players owning their sub-sector of the industry. Those are big reasons why we think Transdigm could be setting up for a sustained move: The company produces highly engineered aircraft components and systems, and one of the big attractions here is that about 90% of its sales are generated from proprietary products, with more than 75% of sales coming from offerings where Transdigm is the sole-source provider! (Around three-quarters of cash flow is aftermarket business, too, which essentially means long-term recurring revenue; the EBITDA margin here is near 50%.) Business obviously took a hit with the Boeing and Covid headwinds, but now it looks like a new industry uptrend is getting underway, with one analyst seeing double-digit annual gains in aircraft deliveries for the next three years—and that should basically guarantee a big upturn in business and earnings. In Q4, total revenues rose 8% from a year ago, but there are plenty of breadcrumbs that hint at a pickup in growth, including a 20% sequential improvement in commercial OEM bookings in the quarter; it’s early, but analysts see the bottom line recovering 30%-plus both this year and next, and our guess is even that will prove too low. An added bonus is the firm’s cash position, which is approaching $5 billion; even if the company does some M&A (it has a long history of doing small buyouts), there should be plenty for either share buybacks or special dividends going forward. As for the chart, it’s been setting up a giant base since right before the pandemic crash in 2020, and shares are just 6% from their high. Granted, we’re not huge fans of $600 stocks, but we don’t think big investors mind—a strong leap above 685 or so would be bullish.

Reopening 2.0
When the vaccines were first announced back in November 2020, the broad market took off on the upside, led by the “reopening” stocks—growth stocks did well for a few more months, too, but there’s no question that economically sensitive names (many of which had been dead as a doornail for the prior few years) were getting in favor.

The only issue from our point of view was that the vast majority of these names were basically no-growth or highly cyclical names—there’s nothing wrong with that, per se, but as we’ve seen in recent months, those sorts of stocks usually (not always) can only trend for a few months before something gets in the way, be it lower prices for a certain commodity, macro-economic fears or something else.

Of course, that doesn’t mean we’ll never buy something of that ilk, but we prefer having a company (or industry) that also has at least some sort of growth or otherwise unique angle that could produce a longer-lasting uptrend. Oil stocks were a good example—the industry was changing stripes and morphing into a cash cow that would return huge sums of money to shareholders even at modest prices. Our choice was Devon (DVN), but many have performed well in recent months as the story played out and big investors bought into it.

What’s interesting is that, while everything rallied somewhat during that period, many names never really broke free, remaining in (or close to) multi-month consolidations. And that brings us to today, when we’re seeing something of a “reopening 2.0” phase. And while it’s obviously not being led by pure growth stocks, the issues in pole position of that move have businesses with years of expansion potential even after the “catch-up” phase post-pandemic.

Look at Marriott (MAR), for instance—despite omicron, Q4’s results (reported early last week) were fantastic, with sales more than doubling from a year ago and earnings up 10-fold and obliterating estimates as leisure travel remained strong. Just as impressive was the fact that average room rates have already recovered back to their pre-pandemic highs, while revenue per available room was up 143% in the U.S. and Canada.

Obviously, those growth rates will slow (Q4 2020 was awful for the sector), but despite having more rooms (Marriott grew its room count by 4% last year), revenues were still down 19% from Q4 2019—thus, there’s still a lot of catch-up potential here financially, and with more rooms and cost controls in place, any pickup from here should fall right to the bottom line. MAR made no net progress from February 2021 through this January but shares have since popped to new all-time highs.

MAR probably does well if the market can hold itself together, though again, we’re focused on a couple other plays in the group.

The first, which we’ve mentioned recently, is Planet Fitness (PLNT). The underlying cookie-cutter growth story here is real, and surprisingly, the firm actually expanded its fitness center count (by 6%) and membership base (by more than 12%) last year, even with on-again, off-again mask mandates and virus worries. And similar to Marriott, we see a lot of growth potential built in as the recovery progresses … not to mention after that as the cookie-cutter story continues: In Q4, revenue per location came in around $68,500, compared to $88,000 or so in Q4 of 2019, so just getting per-store revenue back to where it was would hike the top line by 28%, with plenty of mid-teens growth likely after that due to the underlying growth story. (This morning’s quarterly report looked rock solid to us, too, with January seeing another 400,000 new members come onboard despite omicron.) Chart-wise, we love this setup, which started back in 2019 and, during the past three months, has come under control. Earnings are due tonight.

Another name we’re watching closely is Expedia (EXPE), which isn’t revolutionary but has a solid, underlying growth story thanks to its stakes in not just its namesake property but also VRBO, Hotels.com, Hotwire, Orbitz and more. Business has been recovering the past few quarters, and Q4 was even better: While revenues were still 17% below Q4 of 2019, EBITDA came in higher than any fourth quarter in the company’s history. Analysts see the top line up nearly 38% this year, with similar gains in cash flow, and we think there’s a good chance that will prove conservative barring an economic implosion. The stock actually ran to new highs for a couple of weeks before and after earnings; today’s drop wasn’t pretty but “only” took the stock down to the top of its prior zone.

The bread and butter for the Model Portfolio will always be growth stocks—the vast majority of our big winners have something new and unique that produces a long-lasting growth phase. But given the huge launching pads out there and the upside prospects, we think PLNT, EXPE or some other reopening 2.0 stocks can do well once the market gets out of its own way.

Cabot Market Timing Indicators

There are some legitimate rays of light out there, including the positive divergence in the number of stocks hitting new lows (on the Nasdaq at least); the next few days should be very interesting. But, simply put, the primary evidence—the trends of the indexes and most stocks—continues to point down, so we advise playing defense and practicing patience.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines turned bearish a few weeks back (their first signal since June 2020) and they remain clearly negative today, with the S&P (about 5% below) and Nasdaq (nearly 10% below) both sitting solidly below their respective 35-week lines. While it doesn’t mean the market is necessarily doomed, there’s no doubt the bearish Cabot Trend Lines are another headwind for the overall market.

Cabot Tides: Bearish
Our Cabot Tides also remain negative, with every index (including the S&P 500, daily chart shown here) well below their moving averages, and actually tagging new correction lows earlier today. Short-term, it’s possible today will mark a near-term low given the emotional selling and bad news, but there’s no doubt the intermediate-term trend is down and we need some solid gains to change that.

Cabot Real Money Index: Neutral
Some sentiment measures (especially survey-related ones) are showing some deep apathy and pessimism toward stocks, but those based on money flows—like our Real Money Index, which sums the past five weeks of money going into or out of all equity mutual funds and ETFs—are sort of mid-range. As we’ve been writing, a week or two of panic-like outflows could clear the air, but we haven’t seen that yet.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on March 10, 2022.