The Gilmo Report

April 18, 2012

April 18, 2012

The major market indexes picked up another distribution day today, and their second of the week if we throw in Monday’s higher-volume sell-off. Monday’s sell-off took the NASDAQ Composite Index to a lower low, but it came on less selling volume than we saw last week, and so the NASDAQ responded yesterday by gapping up and rallying back above the 50-day moving average. Meanwhile the S&P 500 and the other major market indexes remain in the sixth day of a rally attempt since they did not undercut last week’s low. The NASDAQ’s undercut on Monday was no doubt the result of Apple (AAPL) breaking down to its 50-day moving average, much as I surmised it would in my report of this past weekend. AAPL found support at its 10-week moving average and bounced hard yesterday, helping to bring the NASDAQ up along with it. The NASDAQ was slighty down today on heavier volume, but overall the market seems to offer six of one and half a dozen of another as it continues to go through what appears so far to be a normal correction, and based on the action of the broader NYSE Composite Index, which is 7% off of its recent peak, we might consider this more of an intermediate correction even while the NASDAQ and S&P 500 Indexes remain a mere 3% off of their highs.

NASDAQ Gilmo Report Stock Chart

This week we’ve seen Google (GOOG) get smacked on earnings, but GOOG was never really a leader in the market rally that has characterized most of 2012. For a real leader, look at something like Intuitive Surgical (ISRG), which announced earnings yesterday after the close and launched higher, staging a buyable gap-up move today using the 569.60 intra-day low of today plus 2-3% on the downside as your selling guide. ISRG opened up right around the 570 level where it was imminently buyable, and the stock kept moving higher all day before tailing off just a bit into the close. This is essentially a buyable gap-up coming out of an ascending trend channel, and it is a pattern that reminds me of several other big-stock leaders from recent memory. ISRG beat earnings estimates and came in with 35% earnings growth on sales growth of 28% as it continues to churn out consistent growth and establishes itself as an institutional favorite as a result of its ability to generate steady growth.

Intuitive Surgical (ISRG) Gilmo Report Stock Chart


Tractor Supply (TSCO), which I don’t show here on a chart, also staged a similar buyable gap-up of its own last week as it also powered out of a steady uptrend channel in the same manner that ISRG did today. This sort of thing is reminiscent of many historical examples, and I can think of Apple (AAPL) in October of 2005 (not shown) or Chipotle Mexican Grill (CMG) just two years ago in 2010, as I show on a daily chart from that period below. The way these things work is that the stock is just chopping its way higher in a steady ascending trend channel that moves along the 10-day moving average or 50-day moving average. This slow, upside grinder tends to bore you to death if you own the stock, and we can see how this might be possible with CMG in 2010. Once the stock gaps up and out of the trend channel its move begins to accelerate as it morphs from dull to exciting very quickly. Not that ISRG and TSCO have to do that today, but their buyable gap-ups both today for ISRG and last week for TSCO could lead to sharper upside moves as long as they do not violate their stops at the intra-day low of the gap-up day at 569.60 for ISRG and 93.55 for ISRG.

Chipotle Mexican Grill (CMG) Gilmo Report Stock Chart

I wrote over the weekend that I had considered AAPL to be in violation of its 10-day moving average and primed for a test of its 50-day moving average, and on Monday we got exactly that as the stock got whacked on heavy volume. The downside move bottomed out on Tuesday as the stock came right down into its 10-week moving average on the weekly chart (not shown), which coincides with the stock coming down to a point just above the 50-day moving average on the daily chart, below. Priceline.com (PCLN), another big-stock NASDAQ leader got whacked along with AAPL on Monday, but it held up a little better. In any case, both stocks were up on strong price runs and are certainly entitled to a bit of correcting and base-building if that’s what they have in mind here. AAPL’s sell-off to the 50-day line came on much heavier volume than the bounce we’ve seen over the past two days, so I would expect it to at least back-and-fill here. I wouldn’t say that the stock has topped for good as a base-building process here would only result in a second-stage base. But with the crowd so bullish on AAPL, the stock was bound to temper expectations with a healthy pullback.

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While AAPL corrects, I’m more interested in seeing which stocks can continue to form bases or even break out as the market also continues to correct. In this camp, LinkedIn (LNKD) has continued to bide its time, even after last week’s pocket pivot buy point off the 10-day moving average, as we see on its daily chart below. LNKD came in hard the next day with the market on Monday of this week but held the 20-day moving average. Volume has since dried up sharply, and I particularly liked the way LNKD was pulling down into the 20-day line at around 101 with volume drying up to over 80% BELOW average daily volume on an intra-day basis. By the end of the day, volume picked up sharply from its very low early morning “voodoo” levels and the stock made a run for its recent highs later in the day. It still has some resistance in the 105-107 area, and it may be that next week’s earnings announcement is what will be necessary to propel the stock out to higher highs. LNKD tends to hold up around the 20-day moving average these days, so I view light-volume pullbacks to that line as potentially buyable, using last week’s lows at around 96 as my selling guide.

LinkedIn (LNKD) Gilmo Report Stock Chart

Holding up very tightly in the midst of this market correction is Red Hat (RHT), shown below on a daily chart. RHT recently staged a huge-volume buyable gap-up a couple of weeks ago, and I have to admit that at the time I saw the gap-up but 12% earnings growth in the most recent quarter was just not enough to get me excited about a buyable gap-up in RHT, or at least it wasn’t at the time. The proof in the pudding is always the price/volume action, and the way RHT is holding in very tight after streaking higher on the buyable gap-up puts it on my watch list for a possible pocket pivot buy point coming up and/or off of the 10-day moving average. The stock even looks potentially buyable right in this little flag formation using the 20-day moving average down at around 57.82 as a selling guide. That would also coincide with the lows of last week’s pullback. On a relative basis RHT is outperforming the general market during this pullback as it holds up very tight following its huge buyable gap-up of three weeks ago. If the market is able to settle down and stage a follow-through in the coming days, I would expect RHT to push into new-high price ground.

Red Hat (RHT) Gilmo Report Stock Chart

We’ve also seen some interesting breakouts during the market’s correction, which is one factor in leading me to believe that this is mostly a correction and not likely to be the start of a deeper downside move. But that is not conclusive, so in the meantime I prefer to treat the market as a market of stocks and focus on the better-acting situations. In my report of April 4th I discussed data storage player Western Digital (WDC), not shown, which has been fiddling around its recent breakout through the 41 price level. A close cousin to WDC in the data storage space is Seagate Technology (STX), shown below on a daily chart. STX is showing some big turnaround numbers with earnings up 300% and 956% and estimates of 851% earnings growth on $2.58 in earnings per share for the next quarter. STX gapped up on Monday on what appears to be a buyable gap-up that is also a breakout following a shakeout through the lows of the base two weeks ago, making for a nice “shakeout and breakout” situation. Along with WDC, STX provides evidence of a possible data storage group move. I would consider this buyable right here using a standard 6-7% stop.

Seagate Technology (STX) Gilmo Report Stock Chart

A few weeks ago someone asked me what I thought of commercial rental company United Rentals (URI). At the time the stock was in a decent uptrend, but somehow “rentals” just didn’t sound like an exciting concept for a leading stock. But just to prove that judging a book, or a stock for that matter, by its cover, can be the wrong way to go, URI exhibits impressive strength here with today’s buyable gap-up to new highs. You might also notice that URI’s pattern looks a bit similar to STX, above, with the
“shakeout and breakout” type action it exhibits in the daily chart below. This is potentially buyable both as a buyable gap-up using the intra-day low of today at 43.06 as your selling guide, or as a standard new-high base-breakout with the standard 6-7% downside stop that is standard policy whenever buying a base breakout pivot point.

United Rentals (URI) Gilmo Report Stock Chart

As you know, I have tested a few short positions during this correction, and the one that produced the biggest gain was shorting AAPL for a quick 25-30 point move on the downside once it breached its 10-day moving average. I suppose I can claim some glory by knowing I was short AAPL stock, from start to finish on Monday which was the largest point drop in the history of AAPL stock! I covered at the close on Monday, which worked out pretty well. As noted cartoon character and pork-rind investment expert Homer Simpson might say, “Woohoo!” That, however, was a tactical, short-term trade, and I would not be looking to short AAPL otherwise. I am, in fact, waiting to see if it builds another base or other constructive price formation from which it might issue a new buy signal coming out of what would be a second-stage base. The point of bringing this up is that my AAPL short is really the only short that has borne any fruit as there is little of a practical nature to short in this market. The set-ups just are not there, hence my conclusion is that this market correction will come to an end at some point soon, perhaps as soon as the crowd has concluded that everyone must “sell in May and go away.” And so I am more interested in buying new breakouts and new buy points in both existing and emerging leaders in this market currently, even in the face of a correction. My guess, however, is that the correction will not last too much longer, and this report reflects some of the ideas I’m looking at currently. Stay tuned.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC
Principal and Managing Director, MoKa Investors, LLC
Principal and Managing Director, Virtue of Selfish Investing, LLC

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