March 24, 2022

The market’s evidence continues to improve, with more bullish breadcrumbs being dropped--last week, it came via a rare, blastoff-type indicator that triggered for just the fifth time since 1970. To be fair, our primary indicators are still iffy, so you shouldn’t throw caution to the wind, but we’re doing a bit more nibbling tonight, and aim to continue buying if the market can prove itself on the upside going forward.

Market Overview & Model Portfolio Update

More Bullish Breadcrumbs
In the last issue, we wrote about what increasingly looked like a solid bottoming process in the market, with the indexes hanging in there despite a spate of awful news and some positive breadth divergences, but we’d yet to see buyers show up. Nearly on cue, they did—last week, the major indexes finally showed some spark, not just rallying but doing so in an unusually strong way.

From Tuesday through Friday of last week, in fact, the S&P 500 rallied at least 1% every day—just the fifth time since at least 1970 that it pulled off four consecutive 1% gains. Called the Four Day Frenzy, it’s a blastoff-type indicator that has historically led to very positive gains for the overall market when looking out six to 12 months. (See more of the details later in this issue.)

We put a good amount of weight on these blastoff measures—to us, it’s another bullish breadcrumb suggesting the market’s correction (and the growth stock implosion) is at or near an end. Tonight, in fact, we’re putting a bit more money to work with that in mind.

However, nothing is as meaningful as the primary evidence, and to this point, we’re still not seeing quite enough positive vibes to really floor the accelerator. Our Cabot Tides and Growth Tides have improved, but both are still effectively on the fence, with no green light as of yet. Individual growth stocks we own or are watching are in the same boat, with many perking up, though most are still finding sellers when they approach resistance. (Fifty-nine percent of NYSE stocks and 78% of Nasdaq stocks are still below their 200-day lines!) And let’s not forget our bearish Cabot Trend Lines, which tell us that there are still longer-term headwinds to fight through.

All in all, from negative sentiment to resilience during bad news to positive breadth divergences to the Four Day Frenzy signal, we continue to see more signs that the sellers are losing control and the buyers are stepping up—and that’s why we started coming off our huge cash position last week and are following that up with a couple more nibbles tonight. Ideally, that will soon bleed into the Tides, Trend Lines and individual growth stocks, which will be the sign to buy more aggressively.

What to Do Now
But as always, we have to see it first to believe it. In the Model Portfolio, we are going to add back a 5% position to our ProShares Ultra S&P 500 position, as well as a half-sized stake in Pure Storage (PSTG). That will leave still leave us with 55% in cash, which we’ll hold as we wait to see whether a true uptrend emerges. Details below.

Model Portfolio Update
The Model Portfolio has been mostly dormant since early December, biding its time for when the bulls truly stepped up and created a sustainable rally; everything until that point was either going to be commodity-driven (we had nearly 20% of the portfolio in Devon, one of the leading commodity names for most of that stretch) or trying to play near-term moves, which isn’t our game.

But now we’re seeing some of the clouds part—following six-plus weeks of bottoming action amidst horrible sentiment, last week saw a big push higher in the major indexes and leading stocks, and it was so dramatic that it actually triggered the Four-Day Frenzy, a very rare blastoff-type indicator.

As we write later in this issue, the Four-Day Frenzy bodes very well for the market when looking six to 12 months out, and is a reason we’re putting a little more cash to work today—however, it’s not unusual to see one more bout of weakness within the first few weeks of a signal, possibly retesting the lows. Combine that with the fact that our Cabot and Growth Tides haven’t yet flipped (they’re close) and few individual stocks are really ripping higher, and you should go slow and let the bulls prove themselves.

We added two half-sized positions last week, and tonight we’re going to do a bit more nibbling: We’ll add a chunk back to our position in SSO, while starting a half-sized stake in Pure Storage (PSTG); we’re also going back to Buy on ANET for those that don’t have a position.

That will still leave us with around 55% in cash, so we’re hardly flooring the accelerator, and if our stocks (or the market rally as a whole) fizzle, we’ll cut losses and return to our bunker. But overall, we’re optimistic a turn has come (or is in the works), so it’s best to lean a bit more bullish and then see if the market can make further upside progress.

Current Recommendations

Arista Networks (ANET)—ANET has been quiet on the news front since its earnings report about five weeks ago, but all indications are that the massive spending spree from some of the Cloud Titans (like Meta Platforms) is full speed ahead despite the macroeconomic worries that have popped up of late. There’s no question that those clients will be the main driver in the quarters ahead, but it’s not like Arista is wholly dependent on them, either—Arista’s smaller, specialty cloud segment saw growth accelerate last year, while its small campus segment (just $200 million in revenue last year) should get much larger over time, starting with a doubling in business this year alone. (Impressively, half of purchases in that area came from entirely new customers to Arista, which bodes well down the road.) Combined with the stock’s normal correction and consolidation thus far (12 weeks long, 27% deep, held above the 40-week line the entire time), ANET would definitely be on our watch list if we didn’t already own it. Thus, if you have some, sit tight, but if not, we’re OK starting a position around here—we’re placing the stock on Buy. BUY

Devon Energy (DVN)—Oil stocks remain strong, albeit very choppy and news-driven, with overnight comings and goings on the global scene pushing oil prices and energy stocks up and down. Still, beyond the daily gyrations is the simple fact that energy prices are very elevated, and leading producers like Devon should see their payouts grow from the already-huge levels of Q3 and Q4. Indeed, so far in the first quarter, oil has averaged $93-ish compared to around $77 in Q4, and while natural gas prices have been down a bit from the prior quarter ($4.45 vs. $4.80), some back-of-the-envelope math certainly implies the next payout should be even higher than Q4’s $1 per share—and, of course, that says nothing about likely additional share buybacks and debt reduction on top of that. (At $95 oil and $4 gas, Devon should crank out around $2 of free cash flow per quarter.) Of course, all of that price information is well known; what will drive the stock is perception of the future, and if there are some steps toward peace in Europe, it’s likely that the entire energy complex will pull in. Put it all together and we continue to think that, over time, the energy bull market has longer to run—most leaders in the group like DVN are still trading at free cash flow yields of 11%-plus even assuming a $25 drop in oil prices—but near term, further wobbles are possible based on the news of the day. If we do see a calm, controlled pullback, we could restore our Buy rating, but while we’re comfortable having taken some lucrative partial profits two weeks ago and holding our remaining shares. Right now, we believe new buying is likely better focused elsewhere for now. HOLD

Dutch Bros (BROS)—We normally try not to traffic much in recent, volatile IPOs, which Dutch Bros. certainly is. But, simply put, we think the downside risk, if something with the company or the market goes amiss, is much smaller than the potential upside if all goes well: Dutch has one of the better cookie-cutter stories we’ve ever seen, right up there with Five Below back in the day, thanks to a simple concept (all sorts of hot and cold beverages that never go out of sytle), a loyal customer base, excellent store economics (80% payback in year one; 30% cash margins in year two!) and a buoyant current (23% store growth planned this year) and long-term (more than 4,000 locations targeted in 10 to 15 years) expansion plan. The one hitch here is that pre-opening expenses are likely to ramp this year, partly due to a change in lease strategy (more upfront costs, less lease costs down the road); earnings, while well into the black, are expected to rise just 7% in 2022. But overall it looks like big investors are focusing on the big picture—despite a horrid environment, BROS held support in the low 40s numerous times from early December to early March, and as soon as the pressure came off the market, it spiked back toward five-month highs near 60. Volatility is going to be extreme here, as we’ve already seen this week, with the stock getting hit on Tuesday; thus, we’re using a loose loss limit under 50 for our half-sized stake, but we’re obviously thinking the odds favor upside over time. BUY A HALF

Globalfoundries (GFS)—Chip stocks can come and go relatively quickly, as we saw with Ambarella late last year, but Globalfoundries has the makings of a winner. The firm is a chip foundry, which normally doesn’t excite us too much; these businesses are often down-the-food-chain stories, with demand drying up quickly if their clients cut back. But there are a few reasons why that won’t be the case here: First, of course, are industry conditions, with a worldwide chip shortage likely to persist for at least another few quarters. Second is the company itself, which has focused much of its efforts outside of commoditized areas and instead in growth-y segments like smartphones (it has a dominant share here), communications infrastructure, Internet of Things and auto applications (which should be huge over time). And third, because of the first two items, Globalfoundries is inking a bunch of long-term contracts with big players that often include pre-payments, allowing the company to expand capacity in a big way to meet demand that’s sure to come; it signed more than 30 long-term deals last year, including one with BMW and an expanded agreement with Advanced Micro Devices in Q4. Long story short, Globalfoundries likely has three to four years of solid sales and cash flow growth ahead, with more in store afterwards if management makes the right moves. As for the stock, it etched higher lows during the correction and then went vertical on big volume to new highs last week. Since then, it’s gyrated, which isn’t surprising in this environment, but looks fine overall. We started with a half-sized position with a loss limit in the low 60s. BUY A HALF

ProShares Ultra S&P 500 Fund (SSO)—It certainly wasn’t pre-planned, but we ended up holding a small-ish position (~5% of the account) of SSO (which moves twice the S&P 500 (up or down) through the correction, as the S&P 500 generally held its January lows and we were seeing positive breadth divergences under the surface. And since then we’ve seen the Four-Day Frenzy trigger last week, and historically it (and its cousin Three-Day Thrust—see more later in this issue for all the details) have led to fantastic gains for the S&P 500 when looking out six months or longer, which obviously bodes well for SSO. However, the first few weeks after a signal are more of a toss-up, with a decent chance of at least a partial retest of the lows. Still, all together, the evidence sets up a reasonable risk-reward situation: We’re going to add a fresh 5% position to SSO here (if you have a $50,000 account, you’d buy $2,500 more of SSO for example), thinking it will pay off handsomely in the months ahead … but we’ll also use a stop in the 56 area (near the recent lows) in case this signal fails. For now, though, we’re obviously thinking optimistically—add to SSO if you own some and, if you don’t, you can start a position here. BUY ANOTHER 5% STAKE

Pure Storage (PSTG)—Pure Storage came public back in 2015, and it’s always had a solid story, benefitting from the long-term shift of bulk memory to flash memory, which offers capable of much faster read/write speeds and less power usage than traditional hard disks. Moreover, Pure’s proprietary hardware and software offers even better performance, reliability, longer lifetimes and non-disruptive upgrades, too, which is why the firm has consistently taken share in the industry. That’s all to the good, but what we think is changing perception here is Pure’s introduction of some subscription offerings, essentially providing a cloud-like storage system for clients either on-premises or in the cloud itself, doing away with refresh cycles and the like. It’s been a hit, with annualized subscription recurring revenue making up about 30% of total revenue (on its way to 50% by 2025), up 31% in Q4 with a same-customer growth rate north of 20%. Moreover, remaining performance obligations (all money due to Pure under contract) was $1.4 billion, up 29%. All of that has produced great headline numbers and allowed margins to expand, and Pure sees more of where that came from—management expects overall revenues up 20% this year with operating income rising 27%, but both should prove conservative. Indeed, in Q4, results crushed estimates, which helped the stock start a strong comeback that’s brought PSTG to new highs. Like many potential leading names, shares are a bit extended here, so we’ll add a half-sized position (5% of the portfolio) and, as with our other recent additions, use a loose loss limit in the 29 to 30 area. BUY A HALF

Watch List

• Blackstone (BX 126): BX is a grandaddy of the Bull Market sector, and it could be getting back in gear after a sharp, but reasonable, correction. See more below.
• CarGurus (CARG 43): CARG been all over the place since its monstrous gap near the end of February, so we’d like for it to settle down a bit. But overall, shares are holding up just fine and we think the new CarOffers business can replace old school auctions for thousands of dealerships.
• Inspire Medical (INSP 246): INSP continues to hack around in a big consolidation; it’s effectively made no progress for more than a year. If shares can get going, that should be a good launching pad.
• Nutrien (NTR 107): NTR is the largest potash maker in the world and third-largest nitrogen fertilizer producer, so earnings should be out of this world for a long time to come. Near term, we think some steam could come out of the stock, but pullbacks should be buyable. See more below.
• Palo Alto Networks (PANW 622): PANW actually kissed new high ground yesterday, which is obviously a good thing. If we don’t pull the trigger on PANW soon, we may wait for a higher-odds entry point for CrowdStrike (CRWD—see more below) down the road.

Other Stocks of Interest

Nutrien (NTR 107)—Outside of energy stocks, many commodity stocks had good runs early in 2021 but then stalled out for a few months. The main reason? While business was good and prices were elevated, most investors thought things would slough off soon, which kept the stocks under wraps—but as expectations changed (that elevated prices would stick around for a while), the stocks did well, and of course the Russian invasion added gallons of fuel to the commodity fire. That leads us to Nutrien, which was created a few years ago when PotashCorp and Agrium merged; headquartered in Canada, it’s the world’s largest producer of potash and third-largest maker of nitrogen fertilizer. Belarus and Russia were the second and third largest producers of potash in the world, so with those two economics roped off, the situation is dire, with prices going vertical and Nutrien racing to boost production—from an already-large base, the firm is boosting output this year 7% over its recent plan (the total should be 20% over 2020 levels), and while that will entail some extra CapEx, there’s no doubt that the firm is going to rake in ridiculous amounts of money for a long time to come. Indeed, in its Q4 report (pre-invasion), the already-tight fertilizer market had Nutrien forecasting earnings of something like $11 per share this year, though Wall Street now sees that figure north of $12.50 and even that should prove conservative—possibly extremely conservative. And, of course, a chunk of that money is going to come back to shareholders, both in the form of a solid dividend (1.8% annual yield) and a share buyback program (up to 10% of the float during the next year!). However, even beyond the next two or three quarters is the potential for a sea change in the industry: It’s likely Russia and Belarus will remain on the naughty list for a long time to come, at least in part, which could keep supplies tight and prices elevated; even in 2023, analysts see earnings north of $8.50 per share here. The stock certainly sees amazing times ahead—following a base-on-base pattern the last few months of the year, NTR went vertical after the invasion, with a brief shakeout last week leading to a renewed buying surge. We think another wobble or shakeout is possible given the recent run, and odds favor it should be buyable.

Blackstone (BX 126)—If the bull market is back on, Bull Market stocks (those whose business is directly tied to rising asset values) should resume their advance. And there’s really no better play in that group than Blackstone, the blue chip alternative asset manager that ended last year with a whopping $881 billion of assets under management (up 42% from the year before), divvied up between real estate, private equity and credit/insurance (all making up around 30% of the total asset base), with hedge fund solutions accounting the rest. Besides a rising asset base, the big thing here has been (a) the firm’s move to a C-Corp a few years ago (read: qualified dividends, no K-1, etc.), but business-wise, (b) Blackstone has placed a huge emphasis on fee-based assets and earnings—the company’s results used to be very lumpy and dependent on realization events (like an owned firm going public or sale of a building, etc.), but now the results are much more foreseeable (and leading to solid dividends, too). In Q4, fee-earnings assets totaled $650 billion (74% of total assets), up 38% from the year before, including $313 billion of so-called perpetual capital (money that doesn’t have to be returned on any timetable, if at all!), which rose a whopping 132% year-on-year. (All of this led to a $1.45 per share dividend in Q4.) With the Fed hiking rates and (likely) shrinking its balance sheet, money is likely to be less-easily obtained this year—but again, if the stock market’s correction (and growth stock crash) is over, the value of its real estate and private stakes should only improve. BX had a smooth run for an entire year after the 2020 vaccine announcements, then corrected by about one-third into the January low. Encouragingly, though, BX held that low on the various retests that followed and has begun to perk up. BX is on our watch list, and some further strength from here would go a long way toward confirming the next upleg has begun.

CrowdStrike (CRWD 223)—We readily admit we have no crystal ball—in fact, we think our admission of that is one of our big advantages, allowing us to stay flexible and adjust to the market’s message. Still, when it comes to individual stocks, there are names that have reliable stories and consistent, top-notch growth numbers that almost always have us keeping an eye on them. In the tech world, CrowdStrike is one: We’ve always thought it’s had emerging blue chip written all over it, with the firm likely to grow many-fold in the years ahead. The company’s cybersecurity platform, dubbed Falcon, remains the best of breed as far as we can tell, especially for endpoint devices (basically any device that connects to a network or Internet), and the system grows smarter the more customers it has, with Falcon taking trillions of data points a week, learning from them and applying any new security guidelines to all devices on the network. Moreover, CrowdStrike has gradually broadened out its offerings to include security for cloud workloads, log protection and extended detection and response. Supposedly, the fear back in November/December was that endpoint security growth would slow, and the firm’s new offerings might not gain traction, but (a) we think what was really going on back then was simply the start of the growth stock crash, and (b) CrowdStrike’s latest results blew those worries out of the water. In the January quarter, basically every metric wowed, with sales (up 63%), recurring revenue (up 65%), recurring revenue for newer non-endpoint offerings (up more than 100%), earnings (up 131%), same-customer revenue growth (24%) and total customer retention (98%) impressing Wall Street. Even better, when peppered with questions about competition on the conference call, the CEO swatted them away, simply saying “we’ve never seen a better competitive environment for us.” The stock fell 50% from November to January, retested that low a couple of times and then saw massive buying after earnings (heaviest weekly volume in 18 months), with CRWD pushing higher since then. To be clear, the stock still has lots of work to do—it’s below longer-term moving averages, for one—but we’re keeping it on our “back burner” watch list. If the company keeps executing, we think it’s likely the stock’s deep correction will turn out to be a big “re-set” in the longer-term rally.

Four-Day Frenzy Buy Signal Now in Effect
When evaluating the health of the stock market, nothing is ever going to beat the primary evidence—the price, volume and trend action of the major indexes and leading stocks is your best “tell” about whether the buyers or sellers are in control. But one set of measures that we’ve grown increasingly fond of in recent years (and that has treated us well) is the study of so-called blastoff indicators, which speak up relatively rarely but highlight times when buying pressure overwhelms selling pressure to a historic degree.

The reason this is important market timing-wise is best summed up by something the famed (and fantastic) technician Walter Deemer wrote: “The market gets most overbought at the beginning of an advance.” Said another way, when the market gets hyper-overbought (our term), it tells you there’s been a sudden change in perception—a vacuum of selling pressure, if you will.

When such a move happens, the crowd usually sees this as too far, too fast, something that will morph into yet another failed rally attempt. As we’ll get into below, these types of moves are often followed by a little weakness, reinforcing the view (usually amidst another wave of bad news) that it’s just a bear market rally.

The upshot, though, is that these signals almost always occur near the start of a major, sustained bull move—the too-far-too-fast action is actually a sign of powerful momentum that kicks off a major rally.

The two indicators that best highlight this unique condition are the 2-to-1 Blastoff Indicator, where you see, on average, twice as many stocks advance as decline on the NYSE over a 10-day period; and the 90% Blastoff Indicator, where you see 90% of all NYSE stocks rise above their respective 50-day moving averages. (Both last flashed back in mid-2020, after the pandemic crash.) Each indicator tells you the market is hyper-overbought, but both have led to great gains when looking out six to 12 months—on average, the S&P 500’s maximum gain is in the 16% range six months later and low- to mid-20% range a year later after these signals.

But right behind the 2-to-1 and 90% measures are two “cousin” blastoff indictors: The Three-Day Thrust (three straight S&P 500 gains of 1.5% or more) and the Four-Day Frenzy (four straight S&P 500 gains of 1.0% or more), the latter of which flashed last week. And their track record is just as good—in fact, the Four-Day Frenzy has only flashed four other times since 1970, and the average max gain in the S&P a year later is north of 30%!

More important to us than the numbers is just common sense—shown below are a few charts of the market and where either the Three-Day Thrust or Four-Day Frenzy signal occurred. Exact return figures aside, it doesn’t take an expert market technician to see that these generally flashed when the market was ready to take off, or at least had hit a low.

On that last point, one thing to be aware of with either the Three-Day Thrust or Four-Day Frenzy is that about one-third of the time you will see another partial or full retest of the recent market lows; if it happens, it does so within a month or two. In this case, that would mean a 4% to 6% retreat in the S&P 500 is possible. (Historically, none of these signals led to a breaking of the correction low, so if that happens, it would be a sign that something is amiss.)

Moreover, just because we get a blastoff signal doesn’t mean we throw our other tools in the garbage; at this point, our Cabot Trend Lines are still bearish (longer-term trend is down, or at least not up), and both our Cabot Tides and Growth Tides are still iffy. Throw in the fact that relatively few growth stocks are truly set up to run here, and we don’t advise throwing caution to the wind.

However, there’s no question last week’s Four-Day Frenzy buy signal is important—there’s no such thing as a perfect set of indicators, but these rare blastoff measures come close, with unmatched track records over the past 50 years. To us, it’s a reason to turn slightly more bullish, while waiting for continued upside confirmation from individual growth stocks that the next upleg is definitively underway.

Cabot Market Timing Indicators

The market has made some solid strides since the last issue, including the Four Day Frenzy move last week as well as some improvement in our Cabot Tides (which are now on the fence). Combined with prior encouraging evidence (positive divergence in the number of stocks hitting new lows, etc.), it’s OK to do a little buying—but we need to see more before turning outright bullish.

Cabot Trend Lines: Bearish
Our Cabot Trend Lines are still clearly negative despite the market’s recent rally—right now, the S&P 500 is just 1% below its trend line, though the Nasdaq is still 5% below its own 35-week moving average. Remember, we need to see both indexes close two straight weeks above their respective 35-week lines for a fresh green light, so that’s still going to take some work from here.

Cabot Tides: On the fence
Our Cabot Tides have improved a lot in recent days, but at this point we can’t say the intermediate-term trend has turned up—all indexes (including the S&P 400 MidCap, shown here) have popped above their 25-day line, but those moving averages haven’t really turned up. Another push higher would do the trick, but at this point, the trend, while improving, is on the fence.

Cabot Real Money Index: Neutral
There’s no question that sentiment has come down markedly during the past few months—inflation, Fed rate hikes, horrid action from growth stocks and war will do that. However, individual investors, while not enthusiastic, haven’t really thrown in the towel, with our Real Money Index coming back into neutral territory. It’s not a negative, but we’d love to see one period of big withdrawals to decisively clear the air.

Charts courtesy of StockCharts.com

The next Cabot Growth Investor issue will be published on April 7, 2022.