The Music Changes
When I first arrived at Cabot, I spent a lot of time in the summer of 1999 reading through all (yes, all) of the old issues of the Growth Investor (or Cabot Market Letter for you long-time subscribers). One of my favorite stories that our founder Carlton Lutts used to write about referenced a speech he heard from one of the Fidelity founders, I believe, who said the market’s music is frequently changing—when you’re used to the salsa, all of a sudden the market’s tune changes to a foxtrot. And when you’re used to that, here comes the waltz.
As we wrote about in the last issue, the music was steady as she goes from the market bottom in late March right through early July, with growth stocks skyrocketing while the rest of the market did just OK. But this week, the sellers are finally putting up a fight, at least when it comes to leading growth stocks, most of which have taken some hits after big runs.
And, historically speaking, that makes sense—as we write later in this issue, initial bull rallies after sharp market breaks or prolonged bear phases often (not always) run into trouble after nearly four months, which fits with today’s timeframe. Beyond looking at precedents is just relying on common sense, as many of these leaders have had gigantic moves during the past few months, leaving them miles above any sort of support (i.e., ripe for profit taking).
That’s a big reason we went easy on the buy side during the past month, and earlier this week, not wanting to leave our brain at the door, we pared back a bit, lifting our cash position to around 20%. As always, we’re flexible, so should the growth stock selling continue, we’ll continue to pare back (taking further partial profits is most likely), and if earnings season delivers some duds, we’ll dump anything showing abnormal action. We’ve had a great first half of the year, easily outdoing the major indexes, but now it’s all about handling what comes next.
With all of that said, we don’t think running for your storm cellar is the best idea, either, as the evidence tells us clearly that this is still a bull market. Indeed, many longer-term signposts remain encouraging—our Cabot Trend Lines are firmly bullish, the blastoff indicators from late May/early June are still in effect and, examining the weekly charts of leading stocks, many appear to be early-stage, so barring a complete market meltdown, odds favor they haven’t hit major tops. Even our intermediate-term Cabot Tides, while testing us a few times, remain on the plus side of the fence.
What To Do Now
Overall, then, we think it’s reasonable to pare back, reduce risk and, as always, stay flexible for what the market throws at us. But we’re also willing to give some of our winners (especially those we’ve taken a couple rounds of partial profits in) some room to consolidate. In the Model Portfolio, we booked our profit in Vertex (VRTX) earlier this week and sold one-third of our position in Okta (OKTA), leaving us with 20% in cash.
Model Portfolio Update
The bifurcated environment has bitten back this week, with cyclical stocks picking up steam while leading growth stocks take some hits. To this point, most of the overall evidence—market timing indicators (still overall encouraging), trends of the leaders (still up)—remains positive, so we’re mostly bullish.
But we’re also not ignoring the recent selling and the prior prolonged, extended runs in so many stocks, either. We pared back a bit on Tuesday morning’s special bulletin by booking a couple of profits (partial on OKTA, all on VRTX) and holding the cash. If this shot across the bow was another brief pothole, we could add a new name or two soon, but if not, we’re willing to motor back closer to shore until the growth stock selling subsides.
|Stock||No. of Shares||Portfolio Weightings||Price Bought||Date Bought||Price on 7/16/20||Profit||Rating|
|ProShares Ultra S&P 500 (SSO)||1,306||10%||120||5/29/20||135||12%||Buy|
|Vertex Pharmaceuticals (VRTX)||—||—||—||—||—||—||Sold|
Chegg (CHGG 71)—Back in 2017 and 2018, CHGG had a big move, but it was also known for a lot of trickery, with lots of dead periods and sharp corrections along the way higher. (That’s not a bad thing per se, as some leaders have this personality; we remember Intuitive Surgical doing the same in 2004 on its way to big gains.) Given that, the swings we’ve seen in the stock up and down since our initial entry still look normal to us—in fact, we filled out our position last week (adding another 5% stake), and the stock’s huge blastoff on more than 10 times average volume in May should lead to good things down the road. That said, we’re not complacent: Our average cost on the two buys is just above 69, so a drop to the very low 60s (below the 50-day line) would be iffy. But right here, CHGG’s action looks reasonable, especially given that it comes after a quick 20-point advance from the June lows. We’re sticking with our Buy rating. Earnings are likely out in early August. BUY.
Cloudflare (NET 35)—Cloudflare is a volatile name and has certainly gotten hit hard this week, but while further wobbles are possible, we still see a lot of positives here—NET remains well above its recent breakout area (just above 30 in mid-June, which occurred on enormous volume), is hanging around its 25-day line and, of course, is a recent IPO (public last September), so there should be a lot more potential buyers than sellers. Throw in a story that is almost sure to produce steady, reliable and rapid growth as everything moves online and there are many reasons to think big investors will be picking up shares on dips. That said, we want to consider all angles, especially with earnings out in three weeks (August 6); we could take partial profits if growth stocks remain weak or if NET dips below its 50-day line (now nearing 32; our cost basis is just above 27). Right here, though, we’re staying on Buy—you can grab shares here if you don’t own any, though you may consider keeping new buys on the small side given the upcoming quarterly report. BUY.
Dexcom (DXCM 413)—Tops usually take time, especially in the market, but also for individual stocks, too. Right now, DXCM looks OK, but our antennae are up—shares hit a peak above 420 back in early May, and while they moved to new highs last week, volume was light and DXCM has quickly fallen back into its prior consolidation. That’s not a death knell, especially as the stock found support on Tuesday after briefly dipping below its 50-day line (the support came on heavier volume than Monday’s dip, a small positive clue). Given that the major trend is up and that we’ve already taken a couple of batches of partial profits, we’re still giving DXCM some rope, though earnings will be key—the company will report second-quarter results on July 28 after the market’s close, and the reaction will probably go a long way toward determining the stock’s next major move. Because of the overall chart action, we’ll move back to a Hold rating. HOLD.
DocuSign (DOCU 191)—DocuSign has finally started to deflate, and the only surprising thing is that it took this long—before this week, DOCU hadn’t closed below its 10-day moving average since early April!! As we wrote in our bulletin on Tuesday morning, we’re not completely against letting go the rest of our DOCU shares; it’s possible the stock has staged a climax run, which happens at the end of a stock’s intermediate- to longer-term run and brings with it a huge climactic move. Still, while we’re keeping that possibility in mind, we don’t see enough evidence to conclude the stock has seen its peak—indeed, most true market leaders advance for a lot longer than 10 months (DOCU originally took off in September 2019), and fundamentally, thanks to its e-signature/contract lifecycle management offerings, there might not be a company better suited to helping businesses get stuff done outside of the office. Long story endless, after taking repeated partial profits on the way up, we’re still willing to give DOCU some room to consolidate and see if/when the buyers show up. HOLD.
Okta (OKTA 202)—OKTA looks fine overall, with this week’s drop pulling the stock back toward its rising 50-day line (now near 192), but at this point it’s no higher now than early May and Monday’s drop looked a tad abnormal. Thus, we decided to shave off some shares on Tuesday’s bulletin, selling one-third of our position (profit was around 33% in two and a half months on that chunk), and from here, we’ll go with our usual m.o., allowing our remaining shares plenty of leeway to correct and consolidate, as we still think the firm’s Identity Cloud offerings have years of growth ahead. SOLD ONE-THIRD, HOLDING THE REST.
ProShares Ultra S&P 500 Fund (SSO 135)—We bought SSO after the 90% Blastoff Indicator flashed green in late May, and while it hasn’t necessarily been smooth or pretty, SSO is up in the low double digits since then, which isn’t bad for an index fund over less than two months’ time. Beyond the major trends (up) and the blastoff indicators, we like having something tied to the S&P 500 in the portfolio for a bit of diversification—we run a concentrated ship with a focus on growth, so having a broad-based index that can benefit from any rotation that takes place (into financials, energy, transports, you name it) is an added plus. With the odds still favoring higher prices over time, you can enter here or on any dips. BUY.
Teladoc (TDOC 219)—TDOC remains in good shape, with its sharp drop early this week failing to bring the stock down to its 25-day line (now at 203 and rising) before a good-looking bounce. It’s not a perfect picture (volume has been light, etc.), but there’s no question the trend is up. The company will report earnings on July 29 after the close, and the numbers should be great, with expectations that paid members rose 80%-ish percent from a year ago while the number of visits advanced more than 150%. That said, most of the focus will be on engagement trends in recent weeks and what that portends as the pandemic progresses. Big picture, though, more investors are seeing virtual health as an idea whose time has come, and with the most comprehensive platform by far in the space, there’s no reason Teladoc can’t hit its growth goal (25%-ish top line) for many years to come. We’ll stay on Buy, though dips toward the 25-day line would mark a better entry point. BUY.
Twilio (TWLO 223)—TWLO has been lagging this week, and while that’s never fun, we think the dip looks normal, both in price (down to the 25-day line after a big gap and run during the past couple of months) and volume (below-average trade on the dip this week). As we’ve written many times, Twilio has the story, numbers and chart of a liquid leader, though going forward, we’re willing to play it either way—if the market finds support and TWLO successfully tests support (maybe near the 200 level?), we could consider averaging up, but on the other end of the spectrum, if growth stocks tank and TWLO cracks support, we could take partial profits. Right here, just sit tight if you already own a full position, and if not, you can consider grabbing some shares here or on further dips. Just be aware earnings are likely out in about three weeks. BUY.
Vertex Pharmaceuticals (VRTX)—VRTX is far from the worst stock out there, as it’s in a general uptrend and has a solid story and growth outlook. However, we’re wondering if it’s a bit big and well-known to truly outperform in a strong market—the relative performance line (not shown here) started to stall out in March and has actually sagged during the past month, even as other growth titles went nuts. Again, that’s not terrible, and we’re not anticipating a major meltdown, but given the potholes in growth stocks and VRTX’s own so-so action, we booked our 44% profit on Tuesday’s bulletin and are holding the cash. SOLD.
Wingstop (WING 133)—WING had a good first few days after our purchase in mid/late June, but has nearly round-tripped that move both before and during the recent weakness in growth names. It’s always possible the stock falters; a drop below 125 or so could have us moving to Hold, while a dip below its June low of 115-ish (give or take) could have us pulling up our stakes and moving on. But as with so many stocks we own or watch, we think the current dip is normal thus far (light volume, support near the 50-day line) and the company’s growth story should succeed no matter what happens with the economic reopening, given its strength in both digital orders and in-store dining. If you don’t own any, we think you can grab some around here or on dips of a couple more points. BUY.
- Datadog (DDOG 83) and Peloton (PTON 62): These are two of our favorite “glamour” stocks in the market, but after such big runs, we’re more interested in buying after two to four weeks of consolidation.
- Inphi (IPHI 120): IPHI originally broke out a year ago, so the current double-top-ish pattern could lead to a deeper/longer consolidation. But we’d be surprised if the stock was near a major top given the accelerating business trends for its high-speed networking wares. Earnings are likely out in early August.
- Redfin (RDFN 37): Housing has been probably the most surprising economic story of the year thus far, and RDFN has a real growth story as it upends and undercuts traditional brokerage outlets. The current pullback looks good.
- Spotify (SPOT 270): SPOT finally backed off a bit, but the damage has been limited (still above the 25-day line, volume on Tuesday’s rebound was solid). We still think this is a fresh liquid leader and is a name we’re looking to enter at the right time.
Other Stocks of Interest
The stocks below may not be followed in Cabot Growth Investor on a regular basis. They’re intended to present you with ideas for additional investment beyond the Model Portfolio. For our current ratings on these stocks, see Updates on Other Stocks of Interest on the subscriber website or email email@example.com.
Alibaba (BABA 244)—We owned Alibaba back in 2017 and it looked ready for a sustained run as a liquid leader of that bull market. Then the trade war flared up, and that fire kept burning on-and-off for the next couple of years, which hurt perception of the stock; throw in heavy investments that crimped earnings growth, and BABA made no net progress for two full years. Still, the company never really had any issues—it currently serves a whopping 960 million customers per year both in China and overseas, with its retail marketplaces transacting $1 trillion annually (95% of which is in China). Plus, there’s a cloud computing operation that looks a lot like Amazon Web Services, and analysts are getting excited about the growth potential there as the virus drives everything online. Speaking of the virus, it hit China hard early on, but despite that, Alibaba posted solid March quarter results (core commerce revenue up 19%; cloud computing revenue up 58%), though earnings and EBITDA were flat-ish. Still, the future looks bright as more and more commerce goes online and as some of the company’s investments pay off; it doesn’t hurt that Alibaba’s fintech arm (dubbed Ant Group) is planning a massive IPO in Hong Kong (though we’ll see how that goes given the unrest there). All in, Alibaba is a blue-chip growth name and analysts see sales up 30% this year and 26% next, while earnings grow at slightly slower rates (though investment spending should tail off a bit next year). Thus, the story remains solid, the numbers are good, and now the chart is looking interesting; BABA blasted off as part of a group (Chinese stocks) last week, rallying to new price and relative performance highs on very heavy volume. Shares have backed off this week with everything growth-related, but if it holds up, we think there’s a good chance BABA has started its next advance.
GW Pharmaceuticals (GWPH 136)—GW Pharmaceuticals is one of a growing number of biotechs that after years of R&D have moved firmly into the commercial stage and, in this firm’s case, to the cusp of profitability. The big driver today is Epidiolex, which was approved back in June 2018 for a couple of rare but serious forms of child-onset epilepsy and associated seizures, and results (first in trials, where most patients had tried other seizure medicines with poor results, and now in reality) have been terrific. (The drug is the first prescription drug made from a highly purified substance derived from cannabis, though we wouldn’t say the stock is a marijuana stock in any real sense.) Not surprisingly, as Epidiolex has taken hold, GW’s top line has soared from basically zero in 2018 to $311 million last year to an estimated $518 million in 2020. But there’s more coming! First, Epidiolex was just approved in Europe in September of last year; it’s available in Germany and UK today with France, Spain and Italy launches coming up. Second, the drug could also get a label expansion soon, with a July 31 decision date from the FDA to allow Epidiolex to be used for seizures associated with tuberous sclerosis complex (could increase addressable market by 80%). And third, GW is starting Phase III trials for Nabiximols, which is used in 25 other countries to treat spasticity in MS patients (potential FDA submission early next year). All told, Wall Street expects revenues to leap 56% next year with earnings reaching the black, too. As for the stock, it was in a long-term downtrend for years, but now it looks totally different; after a strong, persistent rebound into late May, GWPH moved straight sideways for nearly two months and, after testing its 10-week line, has moved to new highs on good volume this week. It’s a bit thin ($50 million per day in volume), but it’s a small/mid cap name that could do well as the growth plan plays out.
Ollie’s Bargain Outlet (OLLI 96)—Ollie’s was a great cookie-cutter winner during the 2016-2018 time period, but it ran into some problems (including the unexpected death of the CEO last December) and then the pandemic hit—long story short, the stock basically round tripped its entire advance at the March nadir. But now the stock has completely changed character (11 weeks up in a row off the bottom and back to its 2018 highs) as business has turned a corner. As for the overall story, Ollie’s has a leading position in the non-apparel section of the closeout retail industry, selling books, flooring, furniture, food, pet supplies, sporting goods, housewares and much more; with the relatively poor economy, the firm is actually seeing more buying opportunities (getting more stuff, cheap), too. There’s plenty of long-term expansion opportunities (it has 360 stores in the U.S. but sees potential for more than 900), and now it appears that business is turning up in a hurry—Q1 results (quarter ending in April) were just OK (sales up 8%, earnings up 7%), but the bottom line crushed expectations (49 cents per share vs 34 expected) and, when the results were released in late May, the company implied that same-store sales growth (which are usually in the low single digits) were up 20% or more in recent weeks! That pace won’t last forever, but the point is the firm’s steady and reliable growth story is back on track and could be accelerating due to the environment. Back to the stock, following OLLI’s big recovery, it’s now a month and a half into a rest as the 10-week line has caught up—it’s not a bad risk/reward situation around here.
Precedent Analysis: A Market Pullback Here Would Make Lots of Sense…
As we’ve written a couple of times recently, we’re not leaning too much on precedent analysis in this environment because there just aren’t a lot of “pandemic playbooks” to go off of. Plus, while we don’t get too into the economic weeds, it’s a fact that the policy response (both via government spending/stimulus and from the Fed) is wholly unique. That’s why we think staying flexible is really the best thing you can do for your portfolio in 2020.
All that said, one thing we’ve been studying are the initial market rallies after harrowing declines, be them long bear phases or sharp crash-like meltdowns. The question we wanted to answer was how long these rallies lasted before the sellers finally put up a real fight. To make it straightforward, we looked at how long the rally went on—from the first week off the bottom to the last up week—before the market broke its 10-week line (even if it was for a brief time).
First we have 1987, which brought a crash somewhat similar to this year’s February-March debacle. After a retest in December, you can see the Nasdaq kited higher for 15 weeks before settling down in March 1988, which ended up being the start of a three-month rest.
Moving on to 2003, the S&P 500 rallied strongly from its March retest for 15 weeks before starting a sideways phase that briefly cracked the 10-week line.
And even in 2011, which had a summer meltdown and was trickier to interpret, the rally that began in December (once the bottom process was complete) lasted 15 weeks before a meaningful correction. Other examples not shown that fit this time frame is 2009 (14 weeks before a pullback) and 1991 (also 14 weeks from the January kickoff).
To be sure, not every initial rally followed this script—when the 1982 blastoff came, the market didn’t break the 10-week line for 10 full months! And even during the above examples, different indexes acted stronger or weaker; in 2003, for instance, the Nasdaq went about 19 weeks before a real downturn.
Nevertheless a few things stand out. First, these initial rallies tend to last 14 to 15 weeks, which is right about where we are now; the current advance went on for 16 weeks before the recent dip. Second, of course, the retreats afterward took the market below its 10-week line, which for the Nasdaq, is currently at 9,820 and rising.
Third, and most important, none of these rallies marked major tops—there was some pain (usually for three to eight weeks) for sure, but the bull moves picked up steam afterwards. These precedents are worth keeping in mind as the Nasdaq and growth stocks have finally hit some meaningful selling. We’ll see how it plays out.
… but Odds Still Favor Lots of Leaders are Early in Their Overall Advances
Playing off the last theme above, probably the most bullish thing we see out in the market from a big-picture perspective is that so many stocks either (a) are recent IPOs in the past year or two that staged their initial breakouts in April and May, or (b) are names that had good runs in 2018 and early 2019, but had enough down action (including before the crash) to generally “reset” their overall advance.
In other words, many names look to be early-stage, meaning in the first half of their overall advances. For example, look at Peloton (PTON), which came public last September and shaped a nice IPO base from December through April before breaking out and having a huge run. Spotify (SPOT), written about in the last issue (and still at the very top of our watch list) is another example, with a longer 20-month post-IPO base before blasting off in May and June.
Then there are names like PayPal (PYPL)—in this case, the stock had a solid advance for a couple of years, but then had two big corrections over a nine- to 10-month period, the first being tedious and the second knifing lower during the market crash … action that likely scared out the remaining weak hands.
Of course, there are never any sure things; maybe PYPL and PTON will get crushed on earnings this month and won’t be heard from again. But the market is an odds game, and given the positive longer-term vibes from our indicators (Trend Lines, 90% Blastoff Indicator, etc.) and the early-stage nature of many leaders, the odds favor any correction in these stocks should set up solid buying opportunities down the road.
Cabot Market Timing Indicators
After a powerful 16-week advance, the sellers are finally putting up a fight, with leading stocks meeting resistance and the major indexes gyrating as well. Still, to this point, abnormal action has been minimal and the market’s trends remain in good shape. We’re pruning and reducing risk a bit, but remain overall bullish.
Cabot Trend Lines: Bullish
Our Cabot Trend Lines remain clearly positive—at last week’s close, both the S&P 500 (by 4.9%) and the Nasdaq (by a whopping 18.5%!) were well above their respective 35-week lines; clearly, things may have gotten too stretched in the growth arena, which plays into this week’s dip. But longer-term, the bullish stance of our Trend Lines as well as other measures (blastoff indicators, etc.) tell us higher prices are likely in the months ahead.
Our Cabot Tides have been on the fence twice in the past three weeks due to sluggishness in the broader indexes we track, including the S&P 400 MidCap (shown here). But each time the buyers have shown up and supported the indexes at their lower (50-day) moving averages. We’re not completely out of the woods, but so far the market is acting normally, keeping the intermediate-term trend pointed up.
Our Real Money Index remains in neutral territory, as the five-week sum of money moving into equity funds and ETFs is in the middle of its multi-month range. What we’re really looking for is the next extreme—should investors rush into stocks (on further strength) or pile out of them (should we see a sharp correction), it will likely be telling.
Charts courtesy of StockCharts.com
The next Cabot Growth Investor issue will be published on July 30, 2020.
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