The Gilmo Report

April 23, 2017

April 23, 2017

The NASDAQ Composite Index, with the help of its NASDAQ 100 big-stock components, posted a new all-time closing high on Thursday, shaking off Wednesday’s bearish higher-volume churning action. The index looks strong as it pushes back up toward its highs, but the rally is being led mostly by the big-stock NASDAQ names.

 

GR042317-$COMPQ

 

The lack of breadth on this move back up to new closing highs is evident in the NASDAQ Advance-Decline chart, below. So, as the NASDAQ has consolidated over the past seven weeks, breadth has deteriorated. In an Ugly Duckling market, this may or may not be bearish.

 

GR042317-$NAAD

 

Tracking lower at an even steeper rate is the number of NASDAQ stocks currently trading above their 50-day moving averages. This also argues for the fact that as the NASDAQ has consolidated for seven weeks, the situation with respect to individual stocks has deteriorated on the basis of this chart.

 

GR042317-$NAA50R

 

In an Ugly Duckling market, however, you can’t just take the data at face value like you could in the “old days.” With an increasing number of stocks trading below their 50-day lines, is this a bearish clue? Or, if we wish to invoke the Spirit of the Ugly Duckling, does this mean that the market just has a boat load of stocks trading under their 50-day lines and therefore ready to pitch back above those very 50-day lines?

In this market you never quite know for sure. The action over this past week has certainly demonstrated enough turn-on-a-dime, about-face volatility to keep everyone, bull or bear, guessing.

While the number of NASDAQ stocks trading below their 50-day lines has been expanding, the S&P 500 Index (along with every other major market index) is itself trading below its 50-day moving average. Thursday’s attempt to break above the 50-day line fell a few cents shy. On Friday, the S&P 500 closed down on higher volume, logging another distribution day.

 

GR042317-$SPX

 

With the S&P 500 trading below its 50-day moving average and the declining tops trendline I’ve drawn on the chart, above, we can easily spin this as bearish chart action. On the other hand, the potential for the index to pull off a 50-day moving average and trendline breakout still exists in the here and now of this market.

When the market lives under the spell of the Ugly Duckling, trading underneath your 50-day moving average can be a virtue. And the reason for that is because it simply gives a stock the opportunity to post bottom-fishing and roundabout type of pocket pivot coming back up through the 50-day moving average.

Chinese internet leader/former leader Weibo (WB) demonstrates how this is done. On Thursday, it posted a nice pocket pivot off the 10-day moving average and coming up through the 50-day moving average. I’d say WB has become something of an authority on this type of pocket pivot, because it’s now done this twice since blowing apart after earnings in late February.

If you see this materializing in real-time during what was a big index rally on Thursday, you can act upon it at the “point of impact” along the 20-day exponential and 10-day simple moving averages. Now WB is slightly extended and right at potential resistance at the prior highs.

 

GR042317-WB

 

But the bottom line is that two days ago WB was a stock trading forlornly below its 50-day moving average, just another statistic in the calculation of just how many stocks are trading below their 50-day line. It has now pocket pivoted back above the line for the second time? Does this stick?

And, furthermore, are there any other stocks on our watch lists that might be in similar positions (think recently broken-down leaders) in their chart patterns? Any time a stock is removed from my buy watch list, it goes on another list I call my “Ugly Duckling” watch list. I constantly review this list for broken-down leaders that might be in position to surprise the bears.

I find that in an Ugly Duckling market, this is a useful process, and it is how I found names like WB (and MOMO and NTES) back in early January. So, with the indexes in position to break out or break down, we want to be prepared for anything, and that includes any potential visits from the Ugly Duckling.

Meanwhile, there are a decent handful or two of stocks that are still looking down upon their lowly 50-day moving averages. These include big-stock NASDAQ names like Apple (AAPL), Amazon.com (AMZN), Facebook (FB), Tesla (TSLA), Priceline Group (PCLN), Alphabet (GOOGL), and even Microsoft (MSFT)¸ which broke out on Friday.

 

GR042317-MSFT

 

All of these big-stocks will be announcing earnings this week and the following. So, big upside moves in any of these ahead of earnings are not likely, although not entirely improbable. Some of this might be dependent on the dynamism of the individual stock set-up in question and the company’s thematic characteristics.

As an example, I still like the look of Tesla (TSLA) as it coils along its 10-day moving average and the $300 Century Mark. On Thursday, the stock got hit with some selling after announcing a voluntary recall of Model S and X vehicles due to a parking brake issue. I tweeted and commented in the blog on Thursday that the news was a non-event.

As a result, TSLA pulled to within 23 cents of the $300 century mark on Thursday. I tweeted that the pullback was buyable as the news was not that big of deal. On Friday, the stock again pulled down to the Century Mark, getting within 42 cents of the 300 level before turning higher to close up on the day.

On a percentage basis, the move just looks like tight action along the 10-day line. Therefore, the stock is still actionable here with the idea of getting some sort of pop in the spirit of Jesse Livermore’s Century Mark Rule ahead of the expected May 3rd earnings report.

As of the last reported date, TSLA still has over 31 million shares sold short. This causes me to wonder whether the stock cycles through shorts and squeezes one group of shorts out while simultaneously bringing in fresh shorts. Otherwise, there are a lot of investors who are hellbent on tinkling into the wind if they’ve been continuously short the stock all year!

In any case, whether the shorts throw in the towel ahead of earnings or not might determine whether TSLA can pull off a more pronounced upside move as Livermore would expect when implementing his rule. I say the stock is swing-trader’s buy here using the 300 level as a tight selling guide.

 

GR042317-TSLA

 

Netflix (NFLX) is rallying back up into its 50-day moving average after busting the line on heavy volume after earnings earlier in the week. Volume is declining in a two-day wedging rally, and the stock fell just short of the 50-day line on Friday.

Technically, this is at a more optimal short-sale point at the 50-day line. The only caveat here is that the stock is more likely to break back to the downside if we see the general market get into trouble this coming week. Otherwise, there is always the possibility that NFLX could push back up through the 50-day line in classic Ugly Duckling fashion.

So far NFLX is a de facto undercut & rally move after undercutting two prior lows in the pattern from late March and mid-April. Whether it runs into resistance at the 50-day line or not remains to be seen, so I would be ready to run with this in either direction, depending on how it plays out here at the 50-day line.

 

GR042317-NFLX

 

Nvidia (NVDA) has trended higher all week after undercutting and retesting two prior lows in its pattern two Fridays ago. This past Friday the stock just barely cleared the 20-day exponential moving average, which theoretically puts it in a more optimal short-sale position.

However, there is always the chance that NVDA continues higher and meets up with its 50-day moving average where it could encounter resistance. That remains unclear to me, however, and I would remain open to any Ugly Duckling type of outcome here that sends the stock back up through the 50-day line instead.

Otherwise NVDA’s current head and shoulders formation (check the weekly chart to see this) implies that we should be looking to short the rally at some point. My guess is that NVDA will be something like NFLX in that it will have a better chance of failing IF we see the general market get into trouble over the next few days.

 

GR042317-NVDA

 

Other stocks holding up well above their 50-day moving averages (and their 10-day and 20-day lines as well) include the Chinese monster stocks, Alibaba (BABA). JD.com (JD), and Momo (MOMO). On Thursday BABA posted its second continuation pocket pivot along the 10-day line for the month of April.

With earnings approaching, however, it isn’t easy getting aggressive on the long side of BABA here with earnings expected on May 4th. However, if one owns it lower in the pattern back when it was bouncing along the 20-day exponential moving average in February and early March, the 20-dema remains your selling guide.

 

GR042317-BABA

 

Meanwhile, JD.com (JD), not shown, has gone short-term parabolic, spiking to a new high over the past three days. It is now quite extended at this point. Momo (MOMO), on the other hand looks like it wants to launch off its 10-day moving average. The stock is holding tight along its 10-day line with volume coming in very light here. Earnings are not expected until May 16th.

 

GR042317-MOMO

 

With Weibo (WB) trying to show signs of life, we can speculate whether Netease (NTES) will try to do the same. After failing on both its mid-February post-earnings buyable gap-up move and a subsequent $300 Century Mark breakout attempt, NTES has steadily trended lower since early March.

Once the stock filled the gap of its February BGU move on Wednesday of this past week it has been able to rally 2-3% and is now back above its 10-day line. I’m not interested in shorting the stock at this point, as a weak rally up into the 50-day moving average would probably be the most optimal place to look at shorting the stock, and we’re not quite there yet.

The other side of this is the potential for NTES to be working on a new base. In this position, it could round out the lows of such a new base, and we should also be attuned to any signs of that occurring. Last time around, when NTES rounded out a new base back in early January, the signs came in the form of bottom-fishing and roundabout pocket pivots.

With volume picking up on Friday as NTES cleared the 10-day line, the action is inconclusive. But I would watch this with an even-minded state of mind here and remain open to whatever evidence presents itself in real-time, whether bullish or bearish. The trick is not letting yourself get locked into a bearish frame of mind on the stock and thereby missing a good roundabout opportunity on the long side.

 

GR042317-NTES

 

Financials remain something of the weak underbelly of this current market environment, and it has been possible to stalk some of these big-stock financial names on the short side. Citigroup (C), which I blogged about as shortable at the 20-day exponential moving average on Wednesday morning, continues to find resistance along that moving average and the 10-day line.

The question is just how much further downside we will see in these names, at least in the immediate future. I would say that as long as the 20-dema continues to serve as solid upside resistance, C remains shortable on any rallies up into the line.

 

GR042317-C

 

Goldman Sachs (GS), not shown, also remains shortable on rallies up to the 219.89 intraday high of Tuesday’s shortable gap-down move after earnings. Short-term I would look for a test of the 200-day moving average down at 204.34 as a downside target.

J.P. Morgan (JPM), also not shown here on a chart, looks similar to C in that it continues to find resistance along its 10-day and 20-day moving averages, with the 20-day line serving as clear resistance over the past week.

The situation with financials appears to be signaling that the Fed won’t be raising rates as much as the Fed itself is letting on. The rallies in precious metals and bonds over the past several weeks add additional evidence to this idea of fewer (or even zero) interest rate increases going forward.

I do think that short-sellers of financials should remain nimble and alert since this is all dependent on news flow. If we see the Trump Administration suddenly start making material progress on the lip-service they’ve been paying to their pro-economy policy initiatives, then financials could turn on a dime.

So, I would be watching carefully for any undercut & rally moves that might develop in any of these names, C, GS, and JPM, as they move lower in their patterns and begin to test prior lows. In this market, when former leaders, which is how I would categorize the financials currently, start to become too obvious in their movements, that is when things can turn.

Applied Optoelectronics (AAOI) rallied into its 50-day moving average on Friday on news that it would be added to the S&P Small-Cap 600 Index, effective April 25th. The stock ran into resistance right at the 50-day line and reversed from there, but did close positive on the day to post a bottom-fishing pocket pivot off the 10-day moving average.

I would watch to see how this acts after April 25th, which is this Tuesday once the addition to the index is complete, as the stock could break down from there. However, if we take Friday’s action at face-value, then we should also remain aware of any potential roundabout type of move that would take the stock back above the 50-day moving average.

While the opticals group as a whole has been decimated, we have seen Arista Networks (ANET), as one bullish example, continue to act well. If AAOI’s fundamentals remain intact, I don’t see any reason why it couldn’t round out a new base here after getting a bit too obvious on the downside more recently.

In this market, when things get too obvious that is precisely when trends can change. We already saw AAOI fail after its breakout of late March. At that point the stock had already had a monstrous price run, and was probably due for a strong correction and base-building process.

For all these reasons, I would keep an open mind here and be ready to act based on the objective, real-time evidence rather than trying to force a rigidly bearish view on the stock. AAOI rapidly corrected 33% off its peak between late March and the second week of April, which would be sufficient for the start of a new base-building process, so this should be watched for in the spirit of the Ugly Duckling.

 

GR042317-AAOI

 

It’s very difficult these days to find anyone who is positive on Snap (SNAP). Everything I read about the stock seems to reflect a sense of certainty that their business model is failing and that the stock price is destined for single-digit status. That may or may not be true, but it didn’t prevent the stock from pulling off a short undercut & rally (U&R) move back up through the 20.03 low in the pattern over the past four days.

I’ve played SNAP both long and short over the past few days. On Friday, I came in long the stock but reversed into the opening rise and went short. The stock then breached the 20-day exponential moving average. As it came down to the 10-day line selling interest seemed to dry up, and by the close SNAP held support at the line on the lightest daily volume in its entire, short existence.

Essentially, what we have here in SNAP is an extreme “voodoo” volume dry-up at the 10-day line. Objectively, this must be considered buyable using the 10-day line as a tight selling guide. Short interest in the stock currently exceeds 36 million shares as of the last reported date at the end of March.

I wouldn’t be surprised if short interest has grown even more throughout April given how the pundits and naysayers have been egging shorts on. With earnings expected on May 10th and SNAP still holding above the $20 price level, will the shorts be forced to cover? I say just play it as it lies, which is buyable here at the 10-day line based on Friday’s voodoo pullback while using the line as a tight selling guide.

 

GR042317-SNAP

 

I’m watching these cloud names that I’ve discussed in recent reports trade over the past few days, and while I have been able to scalp some points on something like Splunk (SPLK), not shown, the stock hasn’t really broken down. In fact, SPLK has continued to rally back above its 50-day moving average, and can be watched for any reversal back down through the line, which would trigger it as a short-sale at that point.

The flip side of this is that the stock could also try and set up along the 50-day moving average as a long instead, so I would keep an open mind here. A low-volume pullback into the 50-day line could make this buyable at that point!

Workday (WDAY), also not shown, has also cleared its 50-day moving average, and like SPLK could be setting up as a long instead of a short. A break below the 50-day line would trigger this as a short-sale, but on Friday the stock pulled back into its 50-day line on volume that was -30% below average. That could put it in a buyable position here if it holds the line.

We could see both SPLK and WDAY, both of which don’t report earnings until late May, react in sympathy to ServiceNow (NOW) when it reports earnings this week. The report is expected on Wednesday after the close.

What I find quite interesting about NOW is that even with earnings expected this week, it spent the past week posting two roundabout type pocket pivots (RAPPs) at the 20-day exponential and 50-day simple moving averages. On Friday, it tried to move higher earlier in the day, but pulled back into the 50-day line as volume declined to just below average.

 

GR042317-NOW

 

GrubHub (GRUB), not shown, is expected to report earnings this Thursday after the close. There is nothing to do here ahead of earnings either way, but we’ll see what opportunities, if any, arise after earnings.

For newer members: Please note that when I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple, 20-day exponential, 50-day simple and 200-day simple moving average.

Notes on long ideas discussed in recent reports that continue to act well are below:

Activision Blizzard (ATVI), along with the other video-gaming “lipstick stocks” has defied any breakdowns (and my lame short-sale theories) and instead has acted quite well over the past week. ATVI is holding tight just below the 50 price level with volume drying up to -58% on Friday, which may imply a breakout attempt is imminent. Earnings are expected on May 4th.

Arista Networks (ANET) just missed posting a continuation pocket pivot on Thursday as volume fell just 5,200 shares short. Earnings are expected on May 2nd, so I don’t see much to do here before then.

Bioverative (BIVV) posted a continuation pocket pivot off its 10-day moving average on Thursday, and reversed to close slightly down on Friday. Earnings are expected on May 3rd. I first discussed BIVV as being buyable along its 20-dema in the 51 price area back in late March. The stock has moved over 10% since then, so anyone who bought the stock at that time must decide whether that is enough of a profit cushion to hold through earnings.

Electronic Arts (EA) has broken out to new highs on light volume. Not a move I would be buying, but it is constructive and thoroughly quashes any short theories I might have had until further evidence to the contrary presents itself.

Square (SQ) pulled off a clean trendline breakout on Thursday, but gave up all of that move on Friday on selling volume that was higher than Thursday’s. This just seems to argue in favor of doing nothing with the stock ahead of earnings, expected to be reported on May 3rd.

Take-Two Interactive (TTWO) has moved higher all week, breaking out to all-time highs on Wednesday on average volume and continuing higher throughout the rest of the week. Earnings are expected on May 16th.

Veeva Systems (VEEV) posted a strong pocket pivot on Thursday, but reversed part of those gains on Friday as volume declined. VEEV doesn’t report earnings until late May, so for now I would only be willing to buy shares closer to its 10-day or 20-day moving averages.

As we move into the heart of earnings season, we can expect that opportunities can and will arise as a result of a stock’s specific reactions to its earnings report. And such opportunities can occur on the short side just as readily as they can on the long side. NFLX proved that this past week after it reported earnings on Monday.

Earnings reports can also produce buyable gap-ups, as was the case with big-stock railroad CSX Corporation (CSX). The stock posted a big BGU on Thursday after beating handily on earnings. The intraday low on the BGU is 49.36, and CSX briefly tested that on Friday morning before turning back to the upside and closing near the peak of its daily range.

This remains within buyable range of the BGU. CSX is also showing an acceleration in earnings growth over the past four quarters, going from -16% to -8% to +21% and then +38% in the most recent quarter. Sales growth has followed a similar route.

 

GR042317-CSX

 

I find that focusing on individual stock set-ups keeps me on the right side of the market on a short-term basis, but the short side has remained more of a scalping expedition rather than a way to make big profits. This is no surprise given that the NASDAQ is testing its prior highs within a seven-week consolidation while the S&P 500 remains mostly in a choppy, sideways consolidation and in a position where it could break out above its 50-day moving average and declining tops trendline as discussed at the outset of this report.

If we’re looking for clues at the scene of the crime, we might consider what it is that the crowd knows currently. In my perusal of all the investment news and commentary that is fit to print on the internet, I would say that the consensus view is that the Trump Rally is losing steam here and the market is dangerously overvalued, hence vulnerable to a major correction.

One thing I know from spending 26 years as a trader and investor is that the market almost never plays out the way the crowd expects it to play out. Given how entrenched the crowd’s low expectations for the market have become, it might be surprising to see that the major market indexes haven’t given up more than 2-3% on the downside since peaking seven weeks ago.

Investors’ result with individual stocks, however, can vary. For that reason, our rallying (or correcting, as the case may be) cry is simply, “Watch the stocks!” Go with the set-ups you see in real-time, long or short, and be cognizant of the potential for the Ugly Duckling to show up when least expected while assuming nothing. That is all.

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 held no positions, though positions are subject to change at any time and without notice.

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.