WHAT TO DO NOW: Remain defensive. The market is retesting its January 20 lows this week, and some minor positive divergences could lead to another short-term bounce attempt. But the market’s major trends remain down, and our three key market-timing indicators are all bearish. Thus, you should remain mostly on the sideline as we patiently wait for a new bull move to develop. In the Model Portfolio, we sold Amazon (AMZN) on a special hotline Monday morning, leaving us with just two stocks and a cash position near 80%.
Current Market Environment
The market finished mixed today, with the Dow falling 100 points but the Nasdaq rising 15 points.
Looking at the big picture, all three of our market timing indicators remain bearish, so a defensive stance is still advised. Moreover, there’s no question that growth stocks have taken it on the chin during the past few days, with many stocks disintegrating 15% or 20% in just two or three days. Thus, a big cash position makes sense.
On the positive side, we are seeing a minor retest of the January 20 lows this week in most indexes, and that retest has brought a positive divergence from our Two-Second Indicator (483 new lows Tuesday versus 1,395 on January 20). (We say “minor” because bottoms aren’t usually formed in just three weeks.) Throw in some continued extreme breadth and sentiment readings, and a short-term lift wouldn’t be surprising.
But what if the market just keeps sinking? Well, with the Model Portfolio nearly 80% in cash, and with investor pessimism elevated, we’re not eager to raise more cash—that doesn’t mean we couldn’t trim some shares here or there, but we usually don’t go 100% in cash, partially because you end up chasing your tail when a multi-week rally unfolds. The downside, of course, is that you could lose more equity during a huge bear move, but with just 20% invested, the risk of major losses is fairly small.
If you personally want to be “all out” of the market, there’s nothing wrong with that, but you’ll likely have to sit through some major rallies while being totally on the sideline, which can be mentally tough to do.
The main point here is what you do with that last 15% or 20% of your portfolio is more of a personal, “how you run your ship” kind of decision. We prefer to have a toe or two in the water, especially at times like now, when so much selling has already been done. But there are no absolute rights or wrongs to this question.
On the flip side, if the market does get off its duff, we’ll be watching for a buy signal from our Cabot Tides. Some levels to watch: S&P 500 1,950, Nasdaq 4,650, S&P 400 (mid-caps) 1,325, and S&P 600 (small-caps) 630. If the indexes close above their respective levels starting early next week, it could be enough to flip our Cabot Tides to a buy signal.
Obviously, there’s a long way between here and there, and even if the Tides do turn green, we anticipate going very slowly—the destruction in most growth stocks has left us with fewer potential set-ups, and the longer-term trend would almost certainly still be down. But it’s good to be prepared for a change in direction; our updated watch list appears below.
Model Portfolio
Amazon (AMZN 490) has been one of many growth stocks to get taken out and shot in recent days—the sharp correction off its highs had looked reasonable, and even a poor reaction to its earnings report two weeks ago wasn’t a death knell. But then the stock imploded below its long-term 200-day moving average on huge volume before finding some support today. We sold one-third of our shares a few weeks back, and let go of our remaining shares on a special hotline Monday morning. Long-term, it’s always possible that AMZN builds a big, multi-month base and helps lead the next bull phase. But that process is likely to take a while after the damage the stock has suffered of late. SOLD.
Facebook (FB 101) isn’t exactly a picture of health, but the chart is far stronger than almost every other growth stock in the market—shares bottomed around 89 during the January 20 swoon, but after a powerful gap higher on earnings, FB could “only” pull back to 97 this week. That’s not great action, of course, but with most growth stocks hitting sharply lower lows, it’s a ray of light. Fundamentally, there’s always a chance advertising growth in general slows if the economy falls into a recession, but with such high returns, advertising on Facebook and Instagram should remain strong. Back to the stock, if FB really gives up the ghost, we’ll probably sell a few more shares (we’ve taken partial profits twice since buying the stock way back in July 2013), but right here, we’ll sit tight. HOLD.
Ulta Beauty (ULTA 154) has taken a big hit in recent days, falling back into support in the 150 area. If we didn’t have such a huge cash position, we’d probably favor selling some shares, and we could still do that should we get a bounce in ULTA and the market. We still believe business is fine and that the stock’s deterioration is mostly due to valuation—that’s not an excuse, but it does mean there’s a shot Ulta’s upcoming earnings report (early March) could lend support. Long story short, we’re OK holding on here, though we’d like to see the stock find some support soon. HOLD.
Watch List
Align Technologies (ALGN 60): It’s not a brand new story, but Align’s Invisalign (see-through) braces continue to take market share, and earnings are likely to ramp 25% annually for the next few years.
Five Below (FIVE 33):
We still think there’s a good chance FIVE’s combination of its defensive characteristics (all items priced $5 or below) and growth potential (20% sales and earnings growth likely through 2020) will attract big buyers when the market finds its footing.
Ligand Pharmaceuticals (LGND 88):
LGND is sitting within what is essentially a large consolidation phase that started last August. Economic slowdown or not, Ligand’s royalty revenues should kite higher this year and next, producing $3.50 or so of earnings this year and around $5 in 2017. Earnings are due out tonight.
Nvidia (NVDA 25): NVDA is testing its 200-day line—not great, but like FB, it’s far more resilient than many stocks. We’ll be interested in hearing updates about demand for the firm’s graphics chips in its quarterly report on February 17.
PayPal (PYPL 33): Shares reacted well to earnings last week, and while they’ve fallen off since, they remain in a big post-IPO base. Yes, there’s competition, but PYPL is a leader in digital payments and should produce steady growth for many years to come.
ProShares Ultra S&P 500 (SSO 52) or other leveraged long funds:
The time isn’t here yet, but once the market builds a sustainable bottom, we’re anticipating a very fruitful bull move, and a leveraged long index fund would be a great way to play that.
SolarEdge (SEDG 23):
Shares are getting hit, but SEDG reported a great quarter last week, is still in a broad bottoming formation and demand is expected to remain strong in the quarters ahead.
Universal Display (OLED 43): The use of organic light emitting diodes (OLEDs) is set to boom in the quarters and years ahead, and Universal Display is a major supplier. Earnings are out February 25.
Vulcan Materials (VMC 93):
We tried our hand with Martin Marietta Materials last year (with no success), but we still believe the long-term rebound in demand for construction aggregates is in place. VMC is a leader in the industry, and has held its own in recent weeks while the market’s plunged.
That’s it for now. Your next issue of Cabot Growth Investor will be sent to you next Wednesday, and, as always, we’ll send a Special Bulletin should we have any changes before then.
| Stock | Date Bought | Price Bought | Current Price | Profit | Rating | |||
| Amazon (AMZN) | 10/8/15 | 530 | 490 | — | Sold | |||
| Facebook (FB) | 8/1/13 | 38 | 101 | 169% | Hold | |||
| Ulta Beauty (ULTA) | 11/6/14 | 121 | 154 | 27% | Hold |