The Gilmo Report

April 22, 2012

April 22, 2012

 

If one wants to remain constructive on the general market, then one might consider that the NASDAQ Composite remains in position for a possible follow-through day, This is something I had considered as a possibility in my mid-week report of this past Wednesday, but the last two days of the trading week gave the market a heavier, sort of lumbering feel to it. The hard evidence for this “feel” are four distribution days along the 50-day moving average. Friday’s action saw the index stall above the 50-day line and then close below it, as we see on the daily chart below. This came on lighter volume than the previous day and therefore did not constitute distribution, but volume was still above average thanks to options expiration. Unless a follow-through day appears in the next few days, the NASDAQ’s daily chart has more the look of a consolidation of the prior move down from the peak. With no significant upside buying volume showing up as the index clings to its 50-day moving average, the probability of further downside grows.

NASDAQ Gilmo Report Stock Chart

The S&P 500 Index, shown on the daily chart below, is in a bit of a wedging rally off the lows of two Tuesdays ago as it too remains in position for a possible follow-through day. Still, it has not seen any significant buying volume show up as it drifts up along its still-rising 50-day moving average. Each upside day comes on declining volume while four distribution days are folded into the mix of daily price/volume action over the past two weeks. The S&P 500 closed below its 50-day moving average on Friday on increasing volume, ending the day right at the lows and giving the price bar a long upside “tail” that implies some stalling. As I discussed in my report of this past Wednesday, there have been a few new breakouts, but we’ve also seen some leaders come loose, and so without a follow-through day one cannot really think about getting too aggressive on the long side, as the action of the major market indexes remains unresolved, at best. The NASDAQ and S&P 500 are still only 4% and 3%, respectively, off of their recent highs, so even a normal intermediate correction could see another 3-5% on the downside if the indexes break down again from their current inverted consolidations.

S&P 500 Gilmo Report Stock Chart


Apple (AAPL) is credited with being responsible for most of the positive action in the NASDAQ Composite Index, as well as for tilting the average earnings of the S&P 500, so perhaps its action is a barometer for the market. No doubt, Tuesday’s AAPL earnings announcement will be the big news of the week, and it seems that AAPL shareholders are more interested in selling their shares as earnings approach. AAPL has tested its 50-day moving average once before, and on the daily chart below we can see that it is testing it once again as volume picks up sharply. The weekly chart of AAPL, not shown, shows the largest single-week selling volume in the pattern since the week of April 21, 2010, which is certainly well-reflected in the daily chart. This is the first pullback to the 10-week/50-day moving average for AAPL since breaking out in January, but in my view if this is buyable then we should see some strong buying volume support come in at or near the moving average. As of Thursday the pullback was looking normal with volume declining, but Friday’s action saw a huge increase in volume as the stock streaked to the downside.

Apple (AAPL) Gilmo Report Stock Chart

While AAPL’s earnings announcement may be pivotal for the stock and perhaps for the market, we can see that big-stock leader Chipotle Mexican Grill (CMG) has come under significant selling pressure after announcing earnings after the close on Thursday. As the big red volume bar on the daily chart below clearly illustrates, institutional investors were unloading shares on Friday. A test of the 50-day moving average appears to be in the cards for CMG, which otherwise has held in a very steady upside trend along its 10-day moving average since breaking out in January. CMG’s action becomes another chink in the market’s armor. If you look closely you will notice a continuation pocket pivot buy point off the 10-day moving average seven days ago, but that pocket pivot has now officially failed, and I believe that in this current market environment new pocket pivots and new breakout buy points are more susceptible to failure. In terms of the long side of this market, I would have to say that the odds are not with those who would seek to buy stocks right here and now.

Chipotle Mexican Grill (CMG) Gilmo Report Stock Chart

This does not necessarily mean, however, that the odds are with those who would sell stocks short, as I still do not see very many short-sale set-ups that I would be comfortable shorting, particularly if they have an earnings announcement coming up. Last week I considered F5 Networks (FFIV), not shown, as a late-stage failed-base/POD type of set-up that might come loose before its earnings announcement, but the stock held tight in the low 120’s and then gapped up on earnings. Among former big-stock leaders, Amazon.com (AMZN) remains in this big head and shoulders type of formation but still has managed to hold above its 50-day moving average. AMZN comes out with earnings this week, so while I would not be in the mood to short the stock going into earnings, I am very interested to see what it does after earnings. Many breakdowns from H&S top formations occur on an earnings announcement, and so for me a downside “breakout” through the rising lows trendline I’ve drawn on the AMZN daily chart below would be confirmation of a breakdown in the stock and therefore a short-sell signal on AMZN.

Amazon.com (AMZN) Gilmo Report Stock Chart

In my report of this past Wednesday I painted a cautiously optimistic picture, considering that perhaps we would see a follow-through day in the major market indexes. But the action over the past two days, as I discussed at the outset of this report, strikes me as uneven and somewhat dicey. I believe as well that investors should be aware that we are now into the third year of a bull market that started in March 2009, and one could certainly argue that this bull cycle is getting a bit long in the tooth. However, all that is necessary to understand is what the market is doing right now, and at best I find the market’s “breathing” to be somewhat labored here. This is in light of the fact that the indexes appear to be doing little more than consolidating the prior downside move off the peak. I do not like the look of this as it brings into play the distinct possibility of a break to lower lows in the coming days. Perhaps, with the “meat” of earnings season coming into focus this week with big-stock companies from AAPL to NFLX to AMZN to CAT reporting, the market will soon find its catalyst. The bottom line for me is that risk is likely increasing for the long side of this market, but the short side may yet require some time to develop, and so my current strategy centers on keeping my powder dry as I wait to see where the next big opportunity in the market emerges.

As far as the short side goes, recall that last year during the August to October market correction it was only necessary to play two short-sale set-ups in Netflix (NFLX) and Green Mountain Coffee Roasters (GMCR) to make big profits on the short side. Both stocks qualified as clear prior big-stock market leaders that had morphed into topping situations and by the time they blew apart their respective H&S formations were ripe to fail. NFLX’s weekly chart below provides us with a ready “model” of what one is looking for on the short side: a big-stock leader that begins to roll over, and once its topping formation has had time to fill out and “ripen” the stock blows to pieces. In my view, big success and big profits on the short side are achieved by being patient and waiting for the optimal “big-stock” short-sale set-ups to appear. I can see the H&S formation in AMZN discussed further above in this report as being one potential target in this regard, but most big leaders showing weakness currently are in the early stages of any potential breakdown.

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While NFLX had topped in early July, it took another two months for the pattern to “ripen” before the fruit began to fall off the tree. Currently, the weekly chart of former leader Tempur-Pedic (TPX), shown below, is a good example of what I am talking about, as the massive-volume gap-down and break off the stock’s recent price peak this past week is only the start of the topping process for TPX. In and of itself, such a sharp break is not a shortable event, as we would expect the stock to attempt a few “dead-cat” bounces as it forms some sort of identifiable topping formation. However, it is exactly this type of action that one wants to keep an eye out for as TPX should now be placed on your short-sale watch list. If and as more leading stocks show breakdowns like this, they too should be added to your short-sale watch list.

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If we continue to see leading stocks act like TPX, or even like AAPL, shown further above in this report, as it sees heavy volume on a retest of its 50-day moving average (whenI would prefer to see lighter volume on the retest), then it may turn out that the short-side begins to develop in a more pronounced way. At that time, we may likely begin to see the potential for significant short-sale profits. In the meantime, I think it is wise to be patient and let the situation develop. 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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