The Gilmo Report

April 20, 2014

April 18, 2014

The logical reaction rally that was triggered on Tuesday once the NASDAQ Composite Index undercut its early February lows and found support right at the 200-day moving average, as we can see on the daily chart below, continued right into the end of the holiday-shortened trading week. As I discussed in my Tuesday report, this is what I was expecting as the market had finally reached an oversold “point of no return” that also coincided with so many leading stocks getting decimated over the past six to seven weeks. As former leading stocks became more and more oversold, the market simply needed some sort of technical “trigger” to create some kind of reaction bounce and rally. Once the NASDAQ got down to its 200-day moving average, the trigger was set in place.

So far the rally looks like a typical oversold bounce with trading volume coming in well below average despite the slight increase on Thursday as a result of options expiration. As I wrote on Tuesday, the short-selling party might have run its course, at least for the short-term, and I was perfectly willing at that point to let the “grinder rally” take hold and push up into the end of the week, something I thought was quite logical given the confluence of technical events among leading stocks and the major indexes. Like the NASDAQ, the Russell 2000 Index also bounced off of its 200-day moving average on Tuesday as small-cap stocks finally found some relief, which could turn out to be temporary. For now all we know for certain is that the NASDAQ is in a three-day rally attempt off of the intraday lows of this past Tuesday, and is in fact in position for a follow-through day coming on Monday or later.




Meanwhile, the S&P 500 Index has engaged in a four-day rally attempt so far off the lows of two Fridays ago, as we can see on its daily chart below. The index has also regained its 50-day moving average, which can be seen as a healthy development, as it lies less than 2% below its recent March peak. The S&P 500 was in position for a possible fourth-day follow-through on Thursday, as I had pointed out in my Tuesday report, but with the expectation of a quiet trading day ahead of the three-day holiday weekend, I didn’t give this much of a chance of occurring. Despite higher options expiration volume on the NYSE on Thursday, the S&P 500 did not have anywhere near the required percentage move on the upside for a follow-through. So for now both the NASDAQ and the S&P 500 remain in positions where a follow-through could occur over the next several days. Whether a follow-through actually does occur is one question that remains to be answered. More importantly, given the weak technical positions of so many former leading stocks, would such a follow-through simply end up failing? I believe it again makes more sense to focus on individual stocks rather than fixating on what the indexes are doing in order to generate some sort of all-clear sign in the form of a follow-through that may not even hold up if it does occur.




Oil-related names have been quite strong both during the market’s correction throughout March and April, and this pattern has been accentuated over the past three days. In my Tuesday report I picked out what is my favorite oil name, Diamondback Energy (FANG), as being buyable right along its 10-day moving average as it has held the short flag breakout in late March that occurred in the midst of the market’s correction at that time, as we can see on the daily chart, below. FANG has moved higher over the past two days, making an all-time high on Thursday on volume that was higher than Wednesday’s volume but still below average. Unless the market rolls over again, FANG looks fine here but would only be buyable on any pullback towards the 70 price level.




With oil-related names doing so well both crude oil and natural gas commodities have been working on bases. I have been watching the United States Oil Fund (USO) ETN, not shown, and the United States Natural Gas Fund (UNG), shown below on a daily chart, and while the USO is coming up the right side of a base the UNG actually flashed a pocket pivot buy signal on Thursday, as is evident on the chart, below. The UNG was pretty volatile back in February as it streaked higher and then dropped just as fast, but since then it has settled down and tightened up a bit.

The idea here is that the pocket pivot on Thursday indicates that this is ready to move to higher highs, so if I were going to play this on the long side on the basis of the Thursday pocket pivot, then I would use the 50-day moving average at around 25 as a tight downside stop. While pocket pivots are not applicable to all ETFs and ETNs, experience has shown that they can be valid when dealing with single-commodity ETFs and ETNs like USO and UNG as well as precious metals ETFs like the SPDR Gold Shares (GLD) and the iShares Silver Trust (SLV). Pocket pivots are not effective signals when dealing with broader stock and commodity index ETFs that are made up of a number of stocks or commodities so trying to apply them to every single ETF and ETN is not likely to be rewarded.




Fiber-optic leader Finisar Corp. (FNSR), shown below on a daily chart, was another situation I picked out in my Tuesday report as likely to rally with the market given that it had held its prior trendline base breakout and the 50-day moving average as it pulled back in orderly fashion during the market correction. FNSR showed its strength in obvious fashion on Wednesday and Thursday as it continued to rebound sharply off of the 50-day moving average to close the week at a new 52-week high, as we can see on the daily chart below. FNSR is at the peak of this short four-week flag, so I might expect the stock to back and fill a bit here as it consolidates a strong move up and off of the 50-day moving average.




Twitter (TWTR) continues to act constructively following Tuesday’s bottom-fishing pocket pivot coming up through the 10-day moving average in what I would call a classic “deep doo-doo” position, as we can see on the daily chart, below. TWTR pulled back briefly on Wednesday, allowing for an opportune entry point for members willing to give the stock a shot here, using the 10-day moving average at 42.71 as a reasonable downside stop. TWTR got as low as 43.54 on Wednesday, and although I was on the golf course during the day as I had banked significant short-side profits over the prior several weeks and was looking to take some R&R time, I did come in and take some shares around the 44 price level on the pullback. TWTR is now holding tight here along the 20-day moving average, closing just below the line on Thursday but still holding well above its 10-day moving average.

Meanwhile, my indicator bars along the top of the chart are turning blue again following the appearance of three gray, vertical oversold bars. Earnings are expected to be announced on April 29th, so I’m looking for some sort of move to develop before earnings. If the stock has moved up 10% more by then, then one would be in a better position risk-wise to determine whether they would want to hold through earnings or not. There are a number of factors involved here, including what happens with the general market over the coming days, so TWTR remains fluid here as it makes an attempt at a turn off the lows of its pattern.




Every day a couple of hours after the close I download and update the data on my HGS Investor analytic software package and scan through several lists that the system generates automatically. I then view it in the “Warehouse” module which allows you to rank, sort, and view lists of stocks. One of my favorites is the “Stocks and Groups Moving to Upside” which I scan through every day. I show the list generated for Thursday’s close below, and, you might notice that Plug Power (PLUG) shows up at the top of the list with the highest ERG rating, which is simply the combined total of the EPS, RS and Group percentile rankings. It is a sort of “composite” rating that I find useful in identifying strongly-performing stocks.

Over the past few weeks, PLUG has consistently appeared at the top of the list, and this reminds me of last year at this time when Tesla Motors (TSLA) and SolarCity (SCTY) began showing up at the top of this list day in and day out back when TSLA was trading at around 44 and SCTY at around 19, despite the fact that neither stock met the required O’Neil characteristics typical of “winning” stocks. It has been my view for some time that the O’Neil strategy is less effective these days as a template for finding winning stocks, and the majority of big, winning stocks over the past year did not fit the classic O’Neil characteristics as they had no earnings, including notable and fantastic winners (in addition to TSLA and SCTY) like FireEye (FEYE), Yelp (YELP), Tableau Software (DATA), Workday (WDAY), and Splunk (SPLK), for example. However, all of these names consistently showed up on this list generated by my HGS Investor software BEFORE they began their big moves. These days I notice that PLUG is showing up on a regular basis, even on days when it isn’t doing all that much, such as on Thursday. Meanwhile, the stock garners high ratings as it sits quietly within a tight base.




On Thursday Plug Power (PLUG) plugged its way higher, as we can see on the daily chart below, allegedly on reports that they would be adding Ford (F) as a new customer. PLUG doesn’t announce earnings until the middle of May, but the stock is tightening up nicely along the 10-day moving average and looks to me like it has a reasonable chance of breaking out before then. Relative to other short-lived moves in “cousin” stocks like Fuelcell Energy (FCEL) and Ballard Power Systems (BLDP), PLUG has held up far better as it builds something of a “high and tight” flag formation here along the $7 price area. I consider the stock buyable with the idea that it will hold Wednesday’s low at 6.53.




How short-sale targets have played out gives us some insight into how the current market environment might play out going forward. If we look at a chart of the NASDAQ Composite Index from 2007-2008, below, we can see how a potential bear market starts out. While this may or may not be directly transferable to the current environment, it does give us some context within which to view the current action. If we pair this chart up with a chart of Crocs (CROX) from that period, lining them up one on top of the other, we can see how the head and shoulders top in CROX in late 2007 and early 2008 played out in synchrony with the NASDAQ at that time.  CROX topped with the market in late October, and the stock’s big-volume break off the peak at that time defined the right side of the “head” in what eventually developed into a complete head and shoulders formation.

Over the past several weeks we have seen a number of leading stocks with huge-volume breaks off of their recent peaks that serve to form the initial head in potential H&S formations that we can consider to be potentially “in progress.” Notice that once the NASDAQ hit its 40-week moving average on the weekly chart, corresponding to the 200-day moving average on the daily chart, it finally began to bounce. It then spent the next five weeks chopping its way higher where it found resistance at its 10-week moving average, corresponding to the 50-day moving average on the daily chart, before rolling over again and embarking on a new leg to the downside in early January. With the NASDAQ currently bouncing off of its 200-day moving average this past Tuesday, we might surmise that if the market is not able to regain its feet and start a new rally phase it may simply end up doing what it did in late 2007 by chopping sideways for a few weeks before rolling over again.


GR042014-NAZ 2008 Weekly

GR042014-CROX Weekly


Here is the current weekly chart of the NASDAQ Composite showing the initial bounce off the 40-week moving average, corresponding to the 200-day moving average on the daily chart that I showed at the outset of this report. After the first move down off the peak, it is now in a position to spend some time chopping around and perhaps drifting up towards the 10-week/50-day moving averages and then rolling over, assuming it doesn’t start a new rally phase instead.


GR042014-NAZ Weekly


Obviously this I just a theory, but one that has some justification in the current evidence. For example, if we look at the weekly chart of former big-stock NASDAQ leader Netflix (NFLX), below, we can see how it has completed what appears to be the “head” of a possible H&S formation that still needs to form a right shoulder. In the same manner that CROX in 2007 formed its right shoulder during a corresponding period of sideways chop and upside drift in the NASDAQ Composite Index, we could see NFLX do something similar as it builds a possible right shoulder at the same time that the NASDAQ chops and drifts its way higher over the next several weeks.




We can also see how similar action is playing out in Pandora Media (P), a stock I have discussed repeatedly as a primary short-sale target back when it was up around the 35 price area several weeks ago. With the stock undercutting the lows of the base it formed back in November and December of last year, it appears primed to try and rally from here as it forms a possible right shoulder in a potential H&S pattern that is still in the process of forming. In this manner we can derive some clues about where these short-sale targets and the general market might be headed over the next several weeks based on their current positions and the precedent of CROX and the NASDAQ in 2007-2008. This sort of analysis is why I tend to think the short side is played out for now, but it could come back into play in a big way if and as some of these stocks start to form right shoulders to complete their potential H&S patterns.




Something like FireEye (FEYE) provides a more extreme example given seven straight weeks of downside action in its weekly chart, shown below. FEYE’s demise has been so brutal that the stock has given up all of its gains since gapping up in early January right after I discussed the stock as a buy on a pullback to 42 or better in my December 31st report. Notice, however, that with the stock round-tripping back to the mid-40’s and the top of its prior base, weekly selling volume appears to have reached a short-term climax, setting up a potential bounce that could form the right shoulder of a big H&S formation. The one notable difference in FEYE is that its upside move was all of 10 weeks in duration coming out of a first-stage IPO base, and most leaders that form H&S tops do so after many, many weeks have been spent in a major upside trend. From here it looks like FEYE could have a normal reaction rally up to the 55 price level, possibly even higher, depending on the duration of any general market bounce from here. Whether something like this would be tradable on the upside depends on one’s psychology as well as trying to find reasonable upside price objectives and downside stop-out levels.


GR042014-FEYE Weekly


The daily chart of FEYE, like a number of other broken-down formerly “hot” leaders, is also showing vertical gray oversold bars over the past couple of weeks as the downside movement has started to slow. The past two days have seen light selling volume, but this can be explained by the approaching three-day holiday weekend. Nevertheless, we can see that a reaction rally from here might carry up towards the 20-day moving average which is around 55, while a rally beyond that would likely encounter some resistance along the 60 price level, as I’ve highlighted on the chart. The basic gist of what I’m trying to get across here is that we appear to have reached points on the charts of a broad number of former leading stocks where bounces and reaction rallies within the patterns would be logical, even normal, based on precedents like CROX in 2007-2008.


GR042014-FEYE Daily


I’ve also got my eye on the weekly charts of former big-stock leaders like Tesla Motors (TSLA) that have corrected with the market over the past six to seven weeks and which are well within the normal percentage range of corrections that can occur in leading stocks during periods of general market weakness as the stocks try to build new bases. If you look at the weekly volume bars in TSLA’s chart you can see quite clearly that selling volume has lacked the intensity seen in the smaller growth names throughout March and early April. TSLA has now corrected 25% from its late February peak and has pulled right back to the top of its prior base, as I’ve highlighted on the chart. Thus while TSLA has violated its 50-day moving average, it is still within range of trying to build a new base and should be monitored for any bottom-fishing pocket pivots that might occur along the way just in case the market is able to find its feet and enter a new rally phase.




Facebook (FB), another big-stock leader that has been correcting with the market since early March, as we can see on the weekly chart below, now lies 18% off of its all-time highs. If we look at this as a potential new base, the stock is now six weeks into building this new base. Now, if we take the bearish side of the argument and look at it as a possible H&S topping formation that is still in-process and has yet to form the right shoulder, one thing that stands out to me is that a rally from here would come from a position that is above the peak of the left shoulder, as I’ve highlighted on the chart.

You may recall that two weeks ago I discussed the idea that FB would complete its head in a possible H&S formation by trading down to the 200-day moving average, corresponding to the red 40-week moving average on the chart. So far it has remained well above the 200-day/40-week lines and in fact has held right at the 150-day moving average which I don’t show on the chart below. For all we know, FB is just building a new base. The fact that it is above the peak of the left shoulder makes me look at this as a less bearish pattern than something where the stock has moved well below the left shoulder, such as with NFLX or P, for example. Thus I think we can maintain an unbiased view and allow FB to play out, keeping a lookout for any potential bottom-fishing pocket pivot that might occur along the way.




Hopefully members are getting a sense of how I came to the conclusion on Tuesday that the market was ready for a bounce and “grinder rally” higher going into the three-day holiday weekend. It is based not only on the action of the general market, specifically the daily chart of the NASDAQ Composite, but also the action and current positions of short-sale target stocks and other former leaders that have broken down precipitously. Members should review my report of this past Tuesday for my review of current resistance levels in the short-sale targets I have discussed over the past several weeks as they try to rally with the market.

Currently I maintain a roughly neutral posture as I wait to see if the market stages some sort of meaningful follow-through that occurs in conjunction with some potential long buy set-ups that would make it actionable in terms of taking long positions, or whether the bounce and reaction rally fails and brings the short side back into play. In this market, as I have noted many times before in prior reports, the action of the stocks tells you what you want to know well before the indexes do, and so keying on individual stocks is the best way to approach any potential bounce. In fact, taking positions in FANG or FNSR, both of which were in buyable positions as they have held up well in contrast to the market’s correction over the past several weeks, would have yielded nice moves over the past two days even as the market’s bounce remains in a very nascent stage.

It is quite possible, as with the example of 2007-2008 I discussed earlier in this report, that we will spend the next several weeks bouncing and chopping around as the market sets up for another downside leg in a continuing market correction. Therefore it is important to simply watch the action unfold in real-time as you clear your mind of any bearish or bullish bias and allow the market and, more importantly, individual stocks, to reveal their respective messages. In the meantime, there is no reason to take an aggressive stance one way or another until further evidence presents itself in the coming days and weeks. Stay tuned.


Gil Morales

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

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, Virtue of Selfish Investing, LLC, and/or Gil Morales & Company, LLC had positions in PLUG and TWTR, though positions are subject to change at any time and without notice.

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