Correction in Full Force
The coronavirus and its impact on the economy had been making a few headlines in recent weeks and impacting a handful of stocks, but this week, perception has changed in a big way, crushing the major indexes and most stocks. Let’s get right into our thoughts.
First of all, with our Cabot Tides clearly negative (they turned red on Monday), many stocks (leaders or not) cracking intermediate-term support and some secondary measures (our Aggression Index is close to turning down), it’s obvious that the long-awaited correction has arrived. Moreover, given that the market and so many stocks had such big, prolonged runs (nearly five months with hardly any selling), the odds favor these rough seas lasting for a while.
Why? Because it usually takes time for big investors to reposition their portfolios and for sentiment (which got very greedy during the past couple of weeks) to dampen, and given the fact that so many stocks are still miles above where they were five months ago, it’s likely the selling isn’t spent.
That said, while we respect what’s going on (the ferocity of the decline right off the top shouldn’t be waved off), we’re also not necessarily hiding in our bunkers, either. So far, our Cabot Trend Lines are still positive, and the longer-term trends of most leading stocks is still up—in fact, many leaders are still acting resiliently, holding north of their 50-day lines, unlike most areas.
A common question is whether this could be another Q4 of 2018, when the market fell 20% and many stocks got hurt much worse. Our answer: Anything is possible, but there are three key differences between the two scenarios. First is the aforementioned Trend Lines; back then, they turned bearish in the third week of October, which caused us to hold 50%-plus in cash for the final two months of the decline.
Second, the reason for this decline is very well known, both among investors and, now, the man on the street; usually (not always), such obvious reasons don’t cause prolonged meltdowns. And third, the market is in a bit “fresher” of a position now, “only” 14 months off its major low in December 2018; at the prior top, the market was two and a half years removed from the early-2016 low, which meant a lot more overplayed, over-owned stocks.
With all that said, we wouldn’t obsess much about the past and we certainly don’t advise forming hard-and-fast opinions—the key in this sort of news-driven, air pocket environment is to have a game plan, be flexible and adjust as needed, which is just what we’re doing with our stocks.
Raise some cash and cut back on new buying. We came into this week with 17% cash in the Model Portfolio, and since then we’ve quickly pared back, selling all of Inphi (IPHI) and portions of both Sea (SE) and Vertex (VRTX). That’s boosted our cash total to around 36%, while we have tight leashes on a couple other positions. Meanwhile, we’re aiming to given our strong, resilient stocks (Teladoc (TDOC) wowed on earnings today) a chance to hold up.
Model Portfolio Update
As mentioned above, we’ve been paring back during the market’s mini-crash this week, and this week’s various sales left us with more than one-third of the portfolio in cash. From here, we’re not opposed to getting more defensive, but we’re taking things more on a stock-by-stock basis—we have a few stocks acting well, though we could kick some others out to raise more cash if the selloff continues. As always, we’ll be on the horn with any changes going forward.
Dexcom (DXCM 281)—DXCM hit new highs as recently as last Thursday and was up solidly today, so it’s doing all it can to hold up in the face of the market’s implosion, which is obviously a plus. That said, it’s good to remember that, in a market correction, the sellers can often eventually come around for stocks that have “meat left on the bone,” and given that this stock has had a great run during the past few months and is well extended above its 50-day line (down around 241 and rising), our guess is that shares could easily take more of a hit as the market’s correction progresses. That’s not a reason to bail in our view (taking partial profits is a possibility—but we’re not going there yet), but if you don’t own any, you should aim for dips and keep it small. Beyond the short-term, we continue to think DXCM has the rapid, reliable and insulated growth story that should keep big investors interested, especially on dips. (Analysts see earnings up 21% this year and 39% next, and the firm historically has trashed estimates.) All told, we’ll stay on Buy given the stock’s resilience, but again, don’t swing for the fences in this environment. BUY.
DocuSign (DOCU 83)—DocuSign remains all quiet on the news front, though it did present at a conference on Monday, and while the top brass couldn’t share any secrets (the firm is in the so-called quiet period ahead of earnings, due out March 12), they did hint toward the increasing popularity of non-signature services. While e-signatures will drive growth for the next couple of years (management still thinks they can grow that core business in the 30% range), more customers are starting to inquire about things like document generation, action items related to contracts (payments, etc.) and contract management (routing them to the right place, search, etc.), which in total double the size of the firm’s addressable market. In other words, the potential here remains as big as ever, though, as always, a lot will come down to the quarterly report. As for the stock, it’s taken on water with everything else, but it found support near its 50-day line today and has given back about half of its late-January to mid-February run, which is very reasonable. We’ll stay on Buy, but keep new positions small given the environment and the upcoming earnings report. BUY.
Dynatrace (DT 32)—Our timing really couldn’t have been worse with Dynatrace, but interestingly, the stock is holding up pretty well—so far this week, the stock is down about half that of the major indexes, and even after today it’s not far below its 25-day line despite last week’s large share offering. That said, we do have a loss, so we’re not going to whistle past the graveyard; support near 30 (both from its prior low and via the 10-week moving average) would probably be our maximum uncle point; below there and we’ll cut bait. But the company is on the forefront of the application performance management “theme,” which is one of our favorites in the market, so we’re willing to give it a chance. Because of our loss, we’ll stay on Hold and keep an eye on our loss limit. HOLD A HALF.
Inphi (IPHI 73)—It’s definitely still possible that Inphi is near the start of a new growth wave as many big players upgrade their networks and firms look for faster, more reliable speed inside and between data centers, too. But the stock, which had been in a steady uptrend for the past few months, is telling a different story. First, IPHI churned on earnings, then stalled out around 85, and this week, decisively broke support. We could always revisit it if the stock sets up again, but we sold a chunk on Monday and the rest on Tuesday, booking our profit. SOLD.
ProShares Ultra S&P 500 Fund (SSO 127)—Well, there’s no sugarcoating SSO’s action this week, as it’s melted down with the S&P 500 during the past few sessions. We’re glad we at least sold some in late January, but of course the question is what to do from here. First, looking at the landscape, the longer-term evidence is still mostly positive; yes, that could change, but we like to play the odds, not go against them. Second, though, this correction isn’t likely to end overnight. It would have been nice to sell a week ago, but that’s not realistic; at this point, we think it’s best to hang on to our SSO, though we could trim a bit more going forward (even on a bounce) depending on how things progress. Hold for now. HOLD.
Qorvo (QRVO 95)—QRVO was the first of our stocks to act iffy, with a huge earnings reversal and break of its 50-day line back in January. That’s not always a sign of doom, but we ended up selling it early last week as shares tripped our mental stop (we got out just north of breakeven), and of course it’s slipped since then. We think there will better names to own during the market’s next uptrend. SOLD.
Redfin (RDFN 28)—Similar to Dynatrace, our timing with RDFN was poor, as the market’s implosion this week has caused our half-sized position to skid sharply. That said, the stock found support near its 25-day line today, and while we’re not top-down (sector first) analysts, we think housing has a good shot at continuing to rebound with mortgage rates plunging, and that Redfin’s brokerage services should continue to thrive. All in all, we’re holding on, but we will switch our rating to Hold here given our loss, while keeping shares on a tight leash. HOLD A HALF.
Sea Ltd. (SE 45)—SE has taken it on the chin this week, likely because (a) it just had a huge run and (b) it has exposure to the growing virus issue in Asia. However, the stock really isn’t in awful shape here—yes, it’s been hit very hard this week, but it found support at its 50-day line this morning, which is miles better than the major indexes and the vast majority of stocks out there. (Just 21% of NYSE stocks were above their 50-day lines, and that was before today!) On the other hand, SE has had an extended run from its original breakout a year ago, and it’s clearly exposed to a worsening Asian economy that could develop due to the virus. Moreover, it’s now suffered a few days of heavy selling during the past five sessions and has earnings due next week (March 3). Thus, we took partial profits earlier this week (on Tuesday’s special bulletin), selling one-third of our shares. We’ll hold the rest, albeit with a fairly tight leash a couple of points below here. HOLD.
Teladoc (TDOC 135)—TDOC is certainly one of the market’s best-looking growth stocks—it was holding its own during the first three days of the market’s selloff, and today it boomed after Q4 earnings and the firm’s 2020 outlook topped expectations. As for the numbers, sales (up 27%) topped expectations, with management forecasting the same growth rate for all of this year. While earnings are still in the red, EBITDA was positive, and probably more important were many sub-metrics (paid membership was up 61% from a year ago; fee-only membership grew 104%; visit fee revenue leapt 47% as engagement rose) and the fact that management revealed that 50% of new bookings were for more than one product (these bookings are generally 50% larger than single-product sales) and had positive words on the integration of InTouch Health. Beyond that, investors are thinking that the virus could help accelerate the move toward virtual care for those who can use it (i.e., boost engagement) and entice more firms and plans to offer it. Back to the stock, the move is great to see, but it’s also very extended, which in a tricky market can bring some selling. We’ll stay on Buy given the strength, but if you want in, aim for dips and be prepared for volatility. BUY.
Vertex Pharmaceuticals (VRTX 223)—Vertex has slipped below its 50-day line, and because of that (and the horrid environment) we decided to take a few chips off the table earlier this week, selling our usual one-third of a position. We won’t play favorites, of course, but we are content to give our remaining shares room to maneuver; this is an institutionally-owned name with very fast and foreseeable earnings growth coming up, and the stock just got going from a multi-year base back in October. Translation: We continue to think VRTX can see higher prices down the road, so we want to give our remaining, profitable position (cost around 199) room to breathe. HOLD.
- Floor & Décor (FND 53): We’ve been watching FND for months, and it may finally be kicking into gear after a few false starts. This cookie-cutter story remains enticing, with years of 20%-25% growth possible.
- Square (SQ 79): SQ was a huge leader in 2017-2018, but after 17 months of correcting and consolidating it may finally be getting back on track. Fundamentally, growth has remained rapid, and while it won’t be the young buck it was back then, there’s plenty of growth potential from its various payment and lending offerings.
- Tesla (TSLA 679): We’re still of the view that, if this is a bull market (the odds favor it), then TSLA’s first multi-week launching pad will lead to higher prices. It appears to be etching that here. More later in this issue.
Other Stocks of Interest
Seattle Genetics (SGEN 108)—Chart-wise, there are two factors that are playing into SGEN’s favor at this time. First, while it’s early, we like the resilience in the biotech sector, which we write about more later in this issue. Second, this market correction (the odds favor this being a correction, not a multi-month downturn) could offer up some “second stage” buying opportunities in names that emerged from giant launching pads last year but have recently chilled out for a couple of months and could be ready to take off when the market gets going again. Of course, we don’t buy on charts alone, and Seattle Genetics also has a solid story. The company appears to be on its way to becoming an oncology powerhouse, both from current products (Adcetris, a treatment for various lymphomas, with north of $1 billion in global revenue thanks to many label expansions, with more growth on the way), ones that have just hit the market (Padcev, just approved in December for treatment of advanced urothelial cancer) and those down the road (Tucatinib, likely to be approved for use in certain types of breast cancer this year). As with most biotechs, Seattle Genetics is losing money as it invests in product launches and trials, but revenues totaled $917 million last year (up 40%), and while top-line growth will likely be tame this year, big investors are expecting late 2020 and 2021 to be party times as new approvals occur. Back to the stock, it was one of the early leaders when the market got going in October, with SGEN coming out of a three-year snooze and soaring 11 of 12 weeks before finally taking a breather. That pause is now 13 weeks old, and notably, SGEN (like many biotech peers) is still above its January lows (very resilient compared to the market). The longer it can hold up, the better, and a powerful breakout down the road would be enticing.
Tesla (TSLA 679)—For most investors, Tesla is a love-it-or-hate-it stock and company, with some thinking the firm is going to change the world, and others viewing it as a fraud. We really try to stay out of those preconceived notions and just go with what we see, and right now, what we see early on in this market correction isn’t bad at all. You know the general story, so we won’t dive into that. Suffice it to say that, while demand has never been an issue, the firm has finally gotten its act together in terms of production (112,000 vehicle deliveries in Q4; Model 3 deliveries up 46% year-on-year) and early indications for some new vehicles (Model Y ramp started in January) have been positive. All of that has led to a step-function change in the bottom line—the firm was basically breakeven last year, but analysts see earnings of $8.61 this year and nearly $15 in 2021, along with buoyant sales growth, too. Yes, those are just estimates, but exact figures aside, the firm is going to making a ton of money going forward. Finally, there’s the chart, which exploded out of a multi-year base late last year and went vertical, nearly hitting the 1,000 level earlier this month. Interestingly, though, while TSLA took a sharp hit after that, it’s still hanging around that level today despite the market’s over-the-falls action. It’s always possible the sellers eventually crater the stock, of course, and it’s likely that TSLA (like the market as a whole) needs more time to rest and shake out some weak hands. But given the evidence (long-term breakout, extreme upside power, early resilience during the current correction, huge and rising earnings estimates), we doubt the stock is done with its overall advance. Keep an eye on it.
Bilibili (BILI 27)—One telling piece of evidence is that Chinese stocks, which took the blunt of the initial virus selloff in January, have been holding up fairly well, and many “newer” names, like Bilibili, are acting peppy, even as well-known names (like Alibaba) look just OK. This online platform caters to China’s generation Z (there are 328 million of them in China!) with tons of new and fresh content (1.1 million content creators in Q3, up 93% from a year ago), including mobile games, comics, vlogs (video blogs), live broadcasting, videos (one of the largest anime libraries in China, though it’s a top producer of many video types) and even audio dramas. Monthly active users (128 million in Q3, up 38%) and paying users (7.9 million, up 124%) are surging, which is helping live broadcasting and advertising revenue to boom (up 167% and 80%, respectively), while the firm’s mobile game business (up 25%) remains popular. The bottom line is still in the red, but revenues are and should continue to grow rapidly. Most impressively, the stock has been super-strong—it burst out of an 18-month post-IPO base near the end of last year, and after shaking out a bit in January, soared to new highs this month and held those gains this week. As with everything, the longer BILI can hold up, the greater the chance that it will enjoy a nice run once the market correction ends.
Biotechs Could be the Next to Stage Major Breakouts
From a student-of-the-market perspective, one of the biggest characteristics of the nearly five-month rally is the huge amount of “long-term breakouts” (decisive moves to new highs after a year or more of correcting and consolidating) we’ve seen among a variety of stocks and sectors, and even the market as a whole, as the S&P 500 came out of a 20-month rest period around Halloween.
What’s interesting, though, is that we’re still seeing some longer-term setups out there in growth-oriented areas that could come alive during the market’s next uptrend. One of the clearest we see right now involves biotech and the general medical sector—some leaders in that area have done well in recent weeks and months, but it’s possible the overall group could get even more of a tailwind going forward.
For instance, check out the weekly chart of the S&P Biotech Fund (XBI). (We like this better than some other biotech ETFs because it’s more diversified—XBI’s largest holding is around 2% of assets, unlike others that are super-weighted toward the mega-cap names, giving it better exposure to what’s happening.) Like so many names, it peaked in the summer of 2018, got destroyed later that year, and after an early-2019 rebound, spent the next six months skidding lower. The fourth quarter brought a solid run, but it’s been range bound since—all in all, a 20-month launching pad.
What’s interesting, too, is that while biotech names got hit hard on the initial virus fears, and have certainly come under pressure with everything else this week, they’re showing some relative strength—XBI tested and held late-January low today, even as every major index is miles below its own January nadir.
To be fair, we’re already fairly loaded up on medical-related names, with three in the Model Portfolio—all of which, to this point, are hanging in there pretty well. But it doesn’t hurt to have your eyes open, as it’s possible some growth-oriented biotech names (like Seattle Genetics (SGEN), written about earlier in this issue) that have been base-building could emerge during the next leg up in the bull market.
Success Comes from Consistently Playing the Odds
This past week I was able to get away with the family to the Bahamas (the Hyatt Baha Mar—highly recommended, though it can be a bit crowded despite its huge size) for some R&R. And wouldn’t you know it, the place also had a big casino; I didn’t do too much gambling (nobody else I was with was a gambler) but I made my usual minor donation to the blackjack gods.
Of course, in a casino, the odds favor the house—you try to place bets as close to even odds as you can and then wish for Lady Luck to arrive. In the market, though, it’s the opposite: If you’re using a time-tested methodology like the one we employ, the odds will be in your favor over time. In reality, success doesn’t come from being a savant or by successfully predicting every wiggle, but by consistently putting the odds in your favor.
That long preamble leads me to Qorvo (QRVO), which we sold last week, getting out around breakeven as the stock closed below our mental stop. Whenever we exit a trade that didn’t go great, we like to ask ourselves, “Would we take the trade again given the evidence that existed at the time?” In the case of QRVO, the answer is a definitive “yes.”
Back in November, not only had the market begun to get moving, but QRVO exploded out of a multi-year range on gigantic volume as excitement about the 5G smartphone boom picked up. More than that, peers in the sector (chips) and the 5G theme also got moving, and of course, Qorvo had just crushed earnings estimates, portending more beats going forward.
Normally, if those factors are in place (big breakout, earnings beat, early in a market run, sector participating, “new” theme, etc.), the odds of success are probably seven or eight out of 10—but there’s always a chance things change, and that’s exactly what happened this time as the coronavirus (at first) slowly dented investor perception of the company’s intermediate-term future. It was a similar story for many of its peers, too, all of which have fallen sharply, especially as the selling has been unleashed this week.
To be clear, there are plenty of times where we look back and find something we erred on, possibly downplaying what ended up being a key piece of evidence that ended up cracking the stock’s uptrend. And in those cases, we make some new rules and tools into our system. But with QRVO, there wasn’t any of that—it didn’t work out this time, but in the long run, taking these types of trades will benefit your bottom line.
Cabot Market Timing Indicators
The sellers have clearly taken control this week, turning our Cabot Tides negative on Monday and breaking many stocks. It’s definitely a time for caution, though we’ll be watching our Cabot Trend Lines closely—at this point, they remain positive, so the odds favor this being a (very sharp) correction within an overall bull trend.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines have crashed back down to earth this week, though even including today’s maelstrom, the indicator remains in positive territory—as of the close today, the S&P 500 was around 1.5% below its 35-week line, but the Nasdaq remained 2.5% above their own. Remember, for a sell signal, we need to see both indexes close below their 35-week lines for two straight weeks; that might seem “slow,” but it’s proven to keep us on the right side of the major trend, which today remains up.
Our Cabot Tides turned negative during Monday’s plunge and have only worsened since, with all five of the indexes we track (including the S&P 600 SmallCap, which is the worst performer) well below their lower (50-day) moving average. And given (a) the ferocity of the decline and (b) the prior, prolonged run, it’s likely this new intermediate-term downtrend will do more damage before all is said and done.
Our Real Money Index remains in neutral territory, but the next week or two will be interesting—given the whoosh this week and all the worrisome virus-related news, a gush of money out of equity funds could tell us that the man-on-the-street is panicking. But right now, it’s too soon to say given that the correction just began this week.
Charts courtesy of StockCharts.com
The next Cabot Growth Investor issue will be published on March 12, 2020.
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