December 12, 2018

The major averages’ behavior this week, though positive, continues the backing and filling process that often occurs as a market attempts to find a bottom. Whether the averages set new lows in ensuing days or weeks is not known, nor is it necessary to know.

The coast will be clear for the momentum player on the long side when there is more basing among growth issues. Along with that goes successful post-breakout follow-through, as was discussed in Sunday’s report.

Breakouts that have not failed are Vocera Communications (VCRA), Workday (WDAY), Amedisys (AMED), Codexis (CDXS), Tableau Software (DATA), Codexis (CDXS), and Etsy (ETSY).

The post-breakout gains from pivot for these names have been 13%, 5%, 4%, 5%, 9%, 5%, and 8%, respectively. That assumes entry took place right at the pivot point. The fact that none has gotten close to the 20%-25% range that might define a successful breakout is the key point.

This is where the rubber meets the road.

Vanda Pharmaceuticals (VNDA) is an exception. It rose 42% from its 11/8 breakout to its 12/3 top. Since then, though, the gain has been whittled down to 13% as sellers pounced on its 26% up day.

Meanwhile, a subscriber had this question: “I've noticed that many stocks within the Communication Services Sector (UBNT, ATNI, TDS, USM, CIEN, SHEN) have been holding up very well in this correction. But I don't see any of these stocks in your Report. Are these stocks generally considered defensive stocks, not growth, thus you avoid them?

Yes, telecommunications stocks are considered defensive, along with utilities, consumer staples, and healthcare. The latter is a hybrid, with defensive segments such as the pharmaceuticals and growth segments such as the biotechs. Companies with robust revenue growth to go along with big earnings growth estimates are favored.

In fact, sometimes I will pass on a stock if the estimates are solid, say 30%, but recent revenue growth has been in the single digits. The most desirable names are those with big sales growth to go along with the big earnings estimates. Some are disruptors within their industry, and these are often the biggest winners of all. But, with the biotechs as an exception, single-digit sales growth is not found among disruptors.

Here is a quick rundown on the six names mentioned in the question:

UBNT: June ’20 estimate +13% (not enough to make this a sought-after commodity).

ATNI: ’19 estimate shows an earnings decline and recent quarters show negative sales growth.

TDS: ’19 estimate of +25% (good), but 4% revenue growth in the recent quarter.

USM: ’19 estimate of +4%.

CIEN: Oct ’19 estimate of +34%, but 3%-4% sales growth in three of last four quarters.

SHEN: ’19 estimate of +43%, but 5% sales growth in recent quarter.

While leadership is currently in the utilities, staples, and healthcare sectors, these differ from growth-stock leadership because the market usually places a premium on the expected earnings stream of growth issues. This premium refers to a higher price-earnings multiple, or p/e ratio. This tends to produce healthy stock price gains as each earnings report is magnified by the higher multiple.

Ironically, it is the stocks with the richest p/e multiples that tend to produce the biggest gains.

Among the names, Atlassian (TEAM) was noted in the Dec. 5 report (“This is one to watch for a pullback or handle to be formed. It has some of the best relative strength since the 11/20 market low”). The stock now has a five-day handle. Normally, it could be taken as a cheater entrance above the 89.82 handle high. However the suspicious treatment of recent breakouts + the averages’ downtrends augur for passing on TEAM at the moment.

Codexis (CDXS) is mentioned here because of a subscriber's email question. He was trying to get a handle on whether a stock that runs up the right side of its base can be bought on the base breakout. In such a case, a pause or pullback or handle formation is desirable because it lifts some of the attention from the stock.

In a market such as this one, where breakouts are not being rewarded, buying a breakout like CDXS, which did not pause at all on the right side of its base, is questionable from a risk standpoint. Following breakout, it can possibly be entered on a pullback, but only if the market is rewarding these types of plays.

There is nothing to be done with CDXS at present.

Okta (OKTA) is a security software developer that is expected to record a loss in the January ’20 fiscal year. But sales growth has been heavy and consistent, with rates of 59%, 60%, 57%, and 58% in recent quarters. Sales growth like this is hard enough to find, but to have it come in so consistently says something. A 98 RS stock.

The three-month chart pattern is not tight enough to warrant much attention, but OKTA deserves monitoring in coming weeks. The stock is up 40% since Nov. 20 vs. the 3% gain of the Nasdaq Composite.

Sunrun (RUN) was noted in Sunday’s report (“…respect should be accorded the general market by not taking the stock above the top of its three-day handle. Waiting instead for a formal takeout of the 16.45 pattern high would be a more deservedly prudent means of entry”).

What was a three-day handle Sunday is now a six-day handle. This can be taken above the 15.00 handle high. However, the view here is that nothing should be taken on the long side until the market shows that it wants to reward breakouts.

Ra Pharmaceuticals (RARX) is a development stage biotech outfit. This means a loss is expected in ’19 and there is no revenue, i.e. a higher-risk situation. Some speculators have sworn off biotechs, while others are comfortable “trading off the chart” alone, with no help from fundamentals. It is a matter of personal preference.

RARX is a 99 RS stock after more than quadrupling last spring and summer. It forms a two-month consolidation and needs a little more time after becoming volatile Monday due to a proposed primary offering.

Splunk (SPLK) was recently added to the watch list. This is an institutional-quality issue with a 38% ’19 estimate and 40% sales growth in the recent quarter. This is to be given some time to fill out its somewhat rough-looking base. It is nevertheless encouraging that some prior leading growth titles like SPLK have stopped going down and are partway up the right sides of their new patterns.

The Trade Desk (TTD) was discussed in Sunday’s report (“TTD has a very low level of earnings volatility historically, and is likely the reason why it is performing well relative to other growers. The stock is three days into a handle and is worth watching”). A 99 RS stock.

The stock is now six days into a handle. Similar to a few others in this report, this is a constructive pattern, a cup-with-handle, with a cheater entrance close by. However, the view here is that breakouts should not be taken for the moment until there is some evidence that the market wants them.

Twilio (TWLO) was addressed in Sunday’s report (“It is forming a four-week shelf with a 28% depth, excessive for such a short pattern. Due to this, the stock would seem to need more time to base before an attractive entrance appears”).

Wednesday, the stock came out of a five-week pattern, a pattern that has the depth issue as noted above, plus an overall level of volatility that is best avoided for now. The stock reversed after breakout and went out in the middle of the day’s range. Another example of a market that is not enamored with breakouts in growth stocks.

In sum, long-only subscribers should remain in a 100% cash position. While very aggressive players who like to flip breakouts for small gains might be enticed to take some of the names discussed above, this is a wait-and-see market for most.

Kevin Marder

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The views contained herein represent those of Marder Investment Advisors Corp. At the time of this writing, of the stocks mentioned in this report, Marder Investment Advisors Corp., Kevin Marder, or an affiliate thereof held no positions, though positions are subject to change at any time and without notice. Estimate data provided by Thomson Reuters.