January 27, 2020

The Sellers Strike Back

Current Market Outlook

The rapid spread of China’s coronavirus provided the impetus for a selloff that began last Friday and exploded onto the scene today. Where does that leave us? First, the intermediate-term trend of the indexes is still positive but close to the fence; the big-cap indexes look OK, but the broader measures (small and mid caps) are right around their key 50-day lines. Beyond the charts, it’s likely that more time is needed for investors to trim/hedge after four months of straight-up action. As for leading stocks, we’re taking it on a case-by-case basis—some are looking ragged and ripe for a deeper correction, but most are pulling back normally. If you’re heavily invested, our advice is to follow the usual plan: Hold most of your shares in your strong, profitable stocks, while selling or keeping tight leashes on losers and laggards. We’re moving our Market Monitor down to a level 6.

On the buy side, newer names that are holding up well should be near the top of your shopping list. This week features plenty of those, with our Top Pick being Kansas City Southern (KSU), a reliable grower that just reacted well to earnings.

Agios Pharmaceuticals, Inc. (AGIO)

www.agios.com

Why the Strength

Agios Pharmaceuticals looks like it’s in the beginning stages of a very nice run. The company makes cancer- and disease-fighting drugs based on cellular metabolism, and the firm just received FDA Breakthrough Therapy status for its leukemia drug. Dubbed Tibsovo, the drug treats relapsed/refractory myelodysplastic syndrome (MDS) in adult patients with certain gene mutations. (MDS is a group of bone marrow disorders that can lead to acute myelogenous leukemia.) AGIO recently presented new findings from a study of Tibsovo, indicating the drug was well-tolerated and associated with durable remissions, and is a significant improvement over current available therapies. A second arm of the study was recently opened, doubling the number of patients (up to 25), and longer-term, Agios is aiming to expand the number of indications it can treat. All in, analysts are forecasting 2020 sales from Tibsovo of $110 million or so, an 80% increase. AGIO has also received Orphan Drug and Fast Track Designations for Mitapivat, a first-in-class small molecule activator of pyruvate kinase-R, which is an enzyme involved in the conversion of glucose into energy and is critical for the survival of red blood cells, meaning it has the potential to treat diseases such as sickle cell disease. The company is forecasting that it will have four marketed products across eight indications by 2025. It’s speculative, but the potential is real.

Technical Analysis

AGIO had a terrible 15 months from mid 2018 (up near 100!) to October of last year (down to 28). But since then its intermediate- to longer-term momentum has turned up—shares rallied back above their 40-week line in December on big volume, and after a brief early-year shakeout, it’s stretched to higher highs. If you’re game, you could start a position here or on further dips.

AGIO Weekly Chart

AGIO Daily Chart

Bristol-Myers (BMY)

www.bms.com

Why the Strength

Bristol-Myers Squibb is the epitome of a post-merger growth and value story. The company completed its giant purchase of Celgene in November 2019 (for a cool $74 billion) that will not only greatly expand the firm’s offerings but quicken growth as well, given that Celgene is still expanding at a solid pace. And the pipeline will be helped, too, all while Bristol continues to look for wins at the FDA—this month, that body granted priority review of Opdivo in combination with Yervoy for the treatment of metastatic non-small cell lung cancer. Just as important, Celgene’s recent sale of OTEZLA (a psoriasis treatment) for $13 billion should contribute nicely to Bristol-Myers’ financial priorities, which include share repurchases, debt repayment and annual dividend increases. All in, analysts expect the company to enjoy a step-function increase in the bottom line thanks to the acquisition and new approvals—earnings should be well over $6 this year, and when combined with a solid, safe dividend (2.8% yield), offers a package of reliable growth at a very reasonable price. We don’t see Bristol suddenly becoming a great growth stock, but there should continue to be upside as institutions look ahead to a great few quarters. The next quarterly report is due out February 6.

Technical Analysis

BMY had been out of favor for a while, but since the stock bottomed in early July, the uptrend has been both steep and persistent. The reversal last week and today’s dip looks like the second pullback to (or close to) the 10-week line since the stock got going—usually a buyable opportunity. Thus, we’re fine taking a swing at it here, but keep the position small ahead of earnings and use a tight leash.

BMY Weekly Chart

BMY Daily Chart

Datadog (DDOG)

datadoghq.com

Why the Strength

One new-ish theme we’re keeping an eye on involves application performance management (APM for short) and infrastructure monitoring, which have been spawned as firms of all sizes migrate to the cloud and use an increasing number of different software programs and (often customized) apps to do business. Datadog bills itself as the top monitoring and analytics platform for developers and IT operations teams, providing real-time measurement and observation of all of a firm’s technology assets—in essence, offering end-to-end monitoring and analytics, which in turn allows clients to provide improved customer service, faster fixes to problems that pop up and quicker innovation thanks to a better understanding of how all the systems are working together. It’s a giant market (management thinks it’s a $35 billion opportunity) and Datadog’s solution has been a hit--it now sports 9,500 customers (up 34% from a year ago), including 727 with an annual contract value of at least $100,000 (up 93%). And like all of the best software firms, Datadog’s same-customer revenue growth rate is out of this world, north of 30% for nine straight quarters because clients expand their usage of Datadog’s offerings (50% now use at least two products, up from 15% a year ago!). The bottom line is just barely in the red, but revenues are growing rapidly, and analysts see the top line lifting 43% this year (almost surely conservative). We think it’s a great growth story. Earnings are due out February 13.

Technical Analysis

DDOG came public last September, and it’s been typically crazy since then, with lots of ups and downs. But taking a step back, the stock has etched a base-on-base formation, with the first lasting into early November, and after a brief push to new highs at 44, the second has formed during the past nine weeks. The daily volatility is extreme, but if you’re game, you can start small here with a stop in the 37 area, and add more on a decisive breakout above 44.

DDOG Weekly Chart

DDOG Daily Chart

Kansas City Southern (KSU)

www.kcsouthern.com

Why the Strength

We recently wrote about Kansas City Southern’s endeavors in precision-scheduled railroading (PSR), and the firm’s fourth quarter numbers show that its technology innovations like PSR, as well as its focus on crew management and fuel efficiency, are paying off. In the quarter, earnings grew to $1.82, up 17% year-over-year and a couple of pennies above expectations, while revenues came in at $730 million, up 5.1%, mostly attributed to a 13% increase in its chemicals and petroleum business and an 11% improvement in its industrial and consumer products division. Non-recurring items included $38 million in restructuring costs that the company believes will result in continued increases to its bottom line. More importantly, management said on its conference call that customer feedback on its PSR initiatives is very positive, with service improvements opening the door for more business wins. And the cost savings by using PSR are mounting up—the top brass sees approximately $125 million in savings (about $1.25 per share) by 2021. Due to company-specific and industry factors, Southern expects 2020 to be even better than last year in terms of volume and revenue, and impressively, the company is looking for mid-teens growth in earnings annually for the next three years. For 2020, analysts see the bottom line up 16%, which is probably a bit low.

Technical Analysis

Transport stocks have been hit and miss, but KSU has been one of the real leaders of the group, breaking out to new highs on earnings in October and, after resting for a few weeks, lifting to higher highs this month. Pullbacks are possible, but the buyers are in control of KSU.

KSU Weekly Chart

KSU Daily Chart

Sea Limited (SE)

seagroup.com

Why the Strength

Chinese stocks have taken a beating as the coronavirus spreads, cities are quarantined and major events are cancelled. But Sea, which is the dominant e-commerce and digital entertainment platform in southeast Asia (Indonesia, Singapore, Thailand, Taiwan, Malaysia and the like) actually gained steam last week as more big investors think the firm could be an emerging blue chip-type of outfit. The driver of the pop last week came from an upgrade (to the “conviction buy list” at Goldman), which cited continued rapid growth in Sea’s Shopee e-commerce business in 2020 (revenues up 261% in Q3, driven by a doubling of orders and a big increase in how much money the company gets on each order), with a path to profitability likely shown by year-end. The other end of the business remains in good shape, too—the firm’s Free Fire mobile game is one of the world’s most popular battle royale games in the world, but without any major new releases it’s likely growth will moderate in the entertainment segment. Analysts see revenues up 36% this year and losses shrinking, but Sea has regularly trashed estimates, and with hopes of accelerating economic growth (post virus) in Asia this year, it’s likely that will prove conservative. Beyond this year, though, is the long-term potential—some see e-commerce in southeast Asia booming four-fold by 2025, and as the lead dog, Sea is sure to get its fair share of that. Obviously, the virus is a risk if it gets out of control, but odds favor big investors will continue to accumulate shares.

Technical Analysis

SE had a big run from its original breakout in February 2019 to its peak in July, but given that the run only lasted five months, it was likely the stock had another leg up in it. And now we’re starting to see that—the stock crawled higher following a solid Q3 earnings gap in November, but after nearly tagging its 10-week line, the stock surged to new highs last week on a pickup in volume. You can nibble here or (preferably) on dips.

SE Weekly Chart

SE Daily Chart

Snap Inc. (SNAP)

snap.com

Why the Strength

Snap is poised to become a new leader in the fast-moving social media landscape with a growing user base, increased monetization and a popular hardware product. The company is known for its multimedia messaging app, Snapchat, which can be downloaded on multiple platforms. Founded in 2011, Snapchat allows users to share images called “snaps” that vanish from the Internet as soon as they’re viewed; allows them to share “stories,” or collections of pictures and videos that play in the order they were taken; and Snapchat users can also apply a unique set of filters to their videos, giving them an animated appearance. The company’s nearest rival is photo sharing app, Instagram, and while Snapchat has a long way to go before reaching Instagram’s 500 million daily users, its daily active user base is expanding steadily after a few quarters of stagnant growth—all in, Snap had 210 million users as of Q3 2019, up 11% from a year ago. The company also has an HD video camera designed to be worn like sunglasses; the latest version of the product (called Spectacles 3) features 3D-capturing technology and records video for Snapchat’s service. As for the numbers, Snap’s performance has steadily improved thanks to improved monetization tools (though, even now, its revenue per user is far below big competitors like Facebook). In Q3, Snap’s revenues leapt 50%, the third straight quarter of accelerating growth, and while the bottom line is still in the red, analysts see a small profit arriving this year. Earnings are likely out in a week or two (no set date yet).

Technical Analysis

SNAP’s long-term chart suggests that a turnaround is underway given its huge rally from its lows of 5 in late 2018. The stock did peak in July of last year, but after repeated support near the 40-week line, it’s developed some solid upward momentum during the past few weeks, actually nosing to new price highs before some selling over the past couple of sessions. We’re OK nibbling here, but keep any new position small with earnings likely out soon.

SNAP Weekly Chart

SNAP Daily Chart

STMicroelectronics (STM)

www.st.com

Why the Strength

STMicroelectronics is one of the world’s largest semiconductor companies, delivering solutions that are key to the smartphone and automotive markets. Major customers include Apple and Tesla, though the firm (which is based in Switzerland) sports more than 100,000 customers around the globe. The big driver here is the overall business environment for the chip sector, which is clearly up, and ST is taking advantage of it. Last week, shares surged when the company reported fourth quarter revenue and gross margin near the high end of guidance in all product groups, in addition to manufacturing efficiencies; earnings per share of 43 cents trounced consensus estimates by six cents. Demand for their chips and sensors in next-generation products, including smartphones and watches, is offsetting slowing demand in older generation products, such as for certain cars. But the focus is on the strength in personal electronics, and management is optimistic about potential rising demand for auto and industrial products later in the year. All in, Wall Street is now expecting EPS increases of 26% and 22% in 2020 and 2021.

Technical Analysis

STM got going as soon as the market bottomed in early October and it’s definitely been a leader since, rising 15 of 17 weeks, including last week’s earnings-induced pop to new highs! Like all chip stocks, it did get knocked around today, and similar to the overall market, it probably needs more time to digest the prior upmove. That said, dips of another point or so would be tempting.

STM Weekly Chart

STM Daily Chart

Taiwan Semiconductor (TSM)

tsmc.com

Why the Strength

As we’ve written recently, the semiconductor market is heating up, due mostly to demand for 5G smartphones and Internet of Things devices, which should provide ample opportunity for the leading firms —including Taiwan Semiconductor. Bank of America projects that the 5G semiconductors market will soar from $593 million in 2018 to $19 billion by 2022, and McKinsey & Company says the number of IoT devices may rise to 43 billion by 2023, three times as many as in 2018. All this growth means more chips are needed and that is very, very good for giant Taiwan Semi. The company released its latest quarterly report last week—sales (up 15%) and earnings (up 19%) both topped estimates by a smidge, driven by the trends mentioned above. The company’s 7nm chip (the smallest in commercial use) is also contributing, with its push into high-performance computing (data centers) demand. The company is now working on 5nm chips—the next evolution in chip capabilities—which should be in commercial production in the second half of 2020. Margins continue to be huge (37% after tax!) and expand, the dividend is solid (2.8% yield) and analysts see the bottom line surging more than 30% this year as the 5G tidal wave rises.

Technical Analysis

TSM actually broke out a few days before the market bottom in October, which was a clue to its leadership status—indeed, shares motored smoothly higher from there before finally hitting a wall near 60. TSM has since backed up, and even dipped a bit below its 50-day line today, though the damage isn’t outrageous. We’re actually going to do the unusual here, putting our buy range above the current price, thinking a strong snapback could tell us this dip was just a shakeout.

TSM Weekly Chart

TSM Daily Chart

Wix.com (WIX)

wix.com

Why the Strength

If you’re a small business, there’s a good chance you’ve heard of Wix.com, an Israeli company that helps small- and mid-sized operations set up a good-looking website. In fact, the firm offers a lot of website building tools for free (these sites tend to have ads for Wix products on them—you get what you pay for), and that’s helped it attract a ton of users (160 million at the end of September, up 17%), but then a portion of those sign up for premium offerings that help with customer engagement, marketing, payments, website speeds, mobile site development, video enhancements and help in specific industry verticals (4.4 million paying subscribers at the end of Q3, up 15% from a year ago). It’s a relatively simple idea, but Wix has developed a good following, and its track record is excellent, with each cohort bringing in more money over time. And every year sees initial sign-ups bringing in more money than the year before—revenue per new user was $247 in the latest quarter, up a huge 39% from a year ago, thanks partially to its focus on marketing to professionals. Even better, Wix’s cash flow is much larger than net income, and the slight growth deceleration in recent quarters was partially due to currency movements, which have already reversed a bit. Long story short, Wix has a combination of rapid and reliable growth that should keep buyers interested. Earnings are likely out in mid to late February.

Technical Analysis

WIX had a big run in 2016 and early 2017, and it’s done well since then, albeit with three deep and prolonged corrections, the latest of which began in the middle of last year and took the stock down 28% over a few months. But after finding support in the 113 to 118 area three times in the fourth quarter of last year, WIX is trying to re-emerge—shares quickly zoomed to the mid 140s on good volume, and they’ve consolidated tightly since. We’re OK starting small here.

WIX Weekly Chart

WIX Daily Chart

Zillow (Z)

www.zillow.com

Why the Strength

Housing-related stocks have come to life thanks to a mix of surging economic reports (inventories are scraping the bottom; housing starts boomed at year-end), the perception that mortgage rates could fall further and the fact that the group is mostly insulated from overseas (virus) events. While homebuilders look great (we wrote about Toll Brothers in last week’s issue), probably the biggest growth story in the group comes from Zillow, the leading online destination for real estate listings. The firm’s core business (linking agents to potential buyers) is still doing well, with 2.1 billion site visits in Q3 of last year. But the upside potential is all about Zillow’s Offers segment, where it dishes out offers (at no cost to homeowners) to buy their home in 21 markets in the U.S. (soon to be 26); if accepted, Zillow then spruces the houses up and sells them within a few months. With scale, the company believes it can make a couple of percent on each home, which is a gigantic opportunity that will only grow should the housing market continue to rise. Already, the firm is expanding its Offers business like mad—in Q3, it extended more than 80,000 quotes, bought 2,291 homes, sold 1,211 and held 2,800 or so on its balance sheet at the end of September. Given the ramp, Zillow is still losing money on the concept, but gross margin has actually turned positive and lower rates (cheaper to borrow when buying the houses; boosts housing prices) can only help. There’s still some doubt whether the business will scale as hoped, but the early signs are positive.

Technical Analysis

Z has been all over the map during the past year and a half, and frankly, it still has some overhead to chew through. But after teasing the bulls in the middle of last year (before falling apart), the stock now looks to have changed character—the stock has lifted 12 of the past 15 weeks (including last week) in a persistent manner, with pullbacks during that time unable to even reach the 25-day line! If you want in, we suggest starting small here or on dips and look to buy more if the uptrend continues.

Z Weekly Chart

Z Daily Chart

Previously Recommended Stocks

Below you’ll find Cabot Top Ten Trader recommended stocks. Those rated HOLD are stocks that traded within our suggested buy range within two weeks of appearing in the Top Ten and still look good; hold if you own them. Stocks rated WAIT have yet to dip into our suggested buy range … but can be bought if they do so within the next week.

Those stocks rated SELL should be sold if you own them; they will no longer be listed here. Finally, Stocks in the DROPPED category are those that failed to trade within our buy range within two weeks of our recommendation; that’s not a bad thing, we just never got the price we wanted. Please use this list to keep up with our latest thinking, and don’t hesitate to call or email us with any questions you may have. New recommendations each week are in green.