The Gilmo Report

April 27, 2017

April 27, 2017

Last week the crowd thought this market was all about the inability of the Trump Administration to push through its legislative agenda. What the crowd perhaps wasn’t expecting was that it might be all about the French elections held on Sunday. As it turned out, a French round one election outcome that was considered benign sparked a massive futures gap-up move on Monday.

This sent the major market indexes off on big gaps through their descending tops trendlines, as in the case of the S&P 5000 Index, or to new highs, as in the case of the NASDAQ Composite Index. The action so far this week seems somewhat ironic in view of my observation over the weekend that the market was perhaps setting up for a classic Ugly Duckling move to the upside.

With breadth looking weak, and the percentage of stocks trading above their 50-day moving averages declining, a “traditional” interpretation might have caused one to draw bearish conclusions. But this is not a traditional market, and what the crowd knows is often wrong, even when it might seem obvious.

As I wrote over the weekend, “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?”

As it turned out, one of those stocks ready to pitch back above its 50-day moving average turned out to be Netflix (NFLX). I wrote over the weekend that you had to be ready to run in either direction with the stock depending on how it acted along the 50-day moving average. On Monday, NFLX opened above its 50-day line and held the line on light volume. It then gapped higher and broke out to all-time highs yesterday.

There were a couple of things at work here as I see it, and the first is that NFLX had already pulled an undercut & rally move after undercutting the late March low at 140 and rallying on Thursday of last week. When it cleared and held above the 50-day line on Monday, that also constituted a moving average undercut & rally move (MAU&R) using the 50-day line as a tight selling guide.

At that point the stock was a long in my view. I tweeted on Monday that I believed the company’s move to offer 1 billion Euros worth of debt to finance content acquisition and creation was very shrewd. Yesterday the NFLX announced a partnership with Baidu (BIDU) to bring its services to China. That sent both stocks moving sharply higher, with NFLX leading the way.

NFLX big-volume base breakout didn’t carry any further to the upside today, and it is now pulling down into the top of the base with volume declining. Technically, this is within buying range of the base breakout, using the 10-day line at 144.73 as a reasonably tight selling guide.

 

GR042617-NFLX

 

The NASDAQ Composite Index staged what might be called a breakaway gap on Monday on heavy buying volume. It then proceeded higher yesterday on expanding volume, but today ran into some profit-taking off the highs with volume coming in just slightly lower. Some of this was likely due to a “sell the news” mentality following the announcement and presentation of the Trump Administration’s tax proposal.

The rally up to the prior highs last week was mostly led by strong action in big-stock NASDAQ 100 Index types of names. One notable difference this week is that smaller stocks joined the party, which is either a bullish sign or an indication that the market is blowing its wad near-term and getting somewhat extended very quickly. We shall see.

 

GR042617-$COMPQ

 

The small-cap Russell 2000 Index provides visual evidence of the support from smaller stocks, as we can see on the daily chart of its close proxy, the iShares Russell 2000 ETF (IWM), below. Yesterday the index rallied right up to its prior March highs and today broke out to all-time highs.

Volume on the IWM ETF was very high today, and showed a bit of stalling as the late-day sell-off took away a little less than half of its intraday gains. Nevertheless, the only way this can be interpreted bearishly is if the breakout failed, and that didn’t happen today.

 

GR042617-IWM

 

The rally so far this week has produced a sharp rise in the percentage of stocks currently trading above their 50-day moving averages. We can see this on the chart below, and it is clear just when and where the Ugly Duckling was given his cue to come onstage – when things started looking the ugliest.

 

GR042617-$NAA50R

 

Over the weekend I noted that, “…the potential for the [S&P 500] index to pull off a 50-day moving average and trendline breakout still exists in the here and now of this market.” I must admit I didn’t realize how quickly this thesis would play out. But it does prove how one must always keep the Ugly Duckling in the back of their mind, because he tends to show up when he is least expected.

With the help of the Ugly Duckling, the S&P 500 Index trading under its 50-day moving average last week did indeed prove to be a virtue! The index blasted through its declining tops trendline on Monday and has since traded back up to its prior March highs.

 

However, the bull party ended abruptly right at the March highs as the index reversed to close down on higher volume. This would count as another distribution day in my view based on the upside “tail” rather than simply looking at the -0.5% decline as being “too small” for a distribution day. Distribution can also occur on churning, and the S&P did decline about half a percent from its intraday highs.

 

GR042617-$SPX

 

So, while the NASDAQ and the Russell blast to new highs, the S&P 500 lagged as it was turned away from a new high today, along with the Dow Jones Industrials and broad NYSE Composite Index, both not shown.

Is this bullish or bearish index action? I would say it strikes me as mostly mixed. For that reason, it all comes down to what individual stocks are doing. If you were alert to what was going on in NFLX on Monday when it regained and held the 50-day line, you got a nice trade out it yesterday. But the flip side is that yesterday’s breakout didn’t lead to any big upside streak from there.

The real question to answer is exactly where one is going to find fresh, new situations that have big upside potential. NFLX might be one of them, if this pullback to the top of its current base breakout holds.

As smaller names have surge to the forefront over the past few days, the big-stock NASDAQ names have certainly not gone away, as NFLX illustrated. With Amazon.com (AMZN) and Alphabet (GOOGL) expected to report earnings tomorrow after the close, there is certainly nothing to be done with either of those stocks at this time. Both continue to act well, however heading into earnings.

We also see Apple (AAPL), Facebook (FB), Tesla (TSLA), and Microsoft (MSFT)¸ all act well as they head into their earnings reports this week and next. MSFT is, like AMZN and GOOGL, expected to report tomorrow after the close, while AAPL, FB, and TSLA all report next week.

While I’m not inclined to do anything more than trade any of these names ahead of their soon-approaching earnings reports, it’s possible that Priceline Group (PCLN) could move higher before its expected May 9th earnings report. On Monday, the stock broke out of a short flag-like formation on heavy buying volume.

Over the past two days it has held those gains tightly with volume declining. Technically this is within buying range of the breakout, using the top of the base at 1800 as a very tight selling guide for anyone desiring to trade this for a possible pre-earnings move.

 

GR042617-PCLN

 

Over the weekend I called Tesla (TSLA) a buy on a trading basis ahead of next week’s expected earnings report. For the most part, the stock has been quite tradeable each time it has pulled back to test the $300 Century Mark. So far, it has been able to rally back up a few points following such pullbacks.

However, TSLA so far has not lived up to the expectations of Jesse Livermore’s Century Mark Rule, where Livermore would look for the stock to have a move of 10-15% or more “in a jiffy.” Since first clearing the 300 price level the stock has mostly chopped around on either side of its 10-day moving average.

Yesterday TSLA showed some spunk by posting a pocket pivot off its 10-day moving average. My preference, of course, would be to have bought the stock as close to the 10-day line as possible before the pocket pivot.

 

GR042617-TSLA

 

Another stock (in addition to NFLX) that has helped to improve the percentage of stocks trading above their 50-day moving averages so far this week is Nvidia (NVDA). As I indicated over the weekend, “…there is always the chance that NVDA continues higher and meets up with its 50-day moving average where it could encounter resistance.”

Notice how I put the world “could” in italics, emphasizing the possibility that it may not run into resistance at the 50-day line. And that is what happened as NVDA pushed above the 50-day line yesterday on light volume. Note, however, that the action both yesterday and on Monday would qualify as a pair of five-day pocket pivots.

If the general market doesn’t start pulling back here, today’s slight pullback by NVDA back towards its 50-day line on very light volume that was -50% below average might make the stock buyable here. In this case, we’d be looking for a move higher before earnings, which are expected to be reported on May 9th, while using the 50-day line as a tight selling guide.

A volume breach of the 50-day line, however, would bring NVDA back into play as a short-sale target. Again, one would take the trade with the idea of playing a move before earnings, assuming there is one.

 

GR042617-NVDA

 

Within the realm of the “China Five” stocks, Weibo (WB), not shown, has continued to move higher after last week’s bottom-fishing pocket pivot and is currently extended. Also extended are Alibaba (BABA) and JD.com (JD), not shown. BABA is expected to report earnings next week on March 4th.

Momo (MOMO) got tagged with some selling today on rumors of an investigation, the details of which were vague. That sent the stock down below its 20-day exponential moving average and the 36.26 prior low of last week.

MOMO then found support just below the 20-dema and rallied to close back above its 20-dema and the 36.26 prior low in the pattern. For those experienced in the “ways of the Gilmo,” the intraday move back up through 36.26 trigger an undercut & rally buy signal at that point, using the 36.26 low as your selling guide.

That U&R trade bore fruit by the close as MOMO closed up near the highs of the daily trading range on increased, above-average volume. That’s a nice trade if you’re alert to it, but it’s not clear how much upside progress will occur from here. Earnings are not expected until May 16th, so if one is going long the stock here than one is looking for some upside movement ahead of earnings.

 

GR042617-MOMO

 

Netease (NTES) demonstrates why one keeping a close eye on your short-sale watch list is important, even during a strong general market rally. NTES was pushing higher towards its 50-day moving average yesterday, but today ran into trouble along the prior lows of the consolidation that was formed between late February and late March, following the post-earnings buyable gap-up move.

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.

For those paying attention, NTES got hit with a 620 intraday chart sell signal right at the opening bell, and never looked back. It is now heading for a rendezvous with its prior lows of last week.

 

GR042617-NTES

 

The action in financials from here may provide a significant clue as to where this market is headed. Financials have gapped up and rallied with the market over the past few days this week, which is no surprise. But whether the “fundamental” driver of higher interest rates remains intact is another issue for this group.

As I wrote over the weekend, you must be nimble with these stocks since their movement is so news-oriented. Citigroup (C) jacked up through its 20-dema and then its 50-dma on Monday and Tuesday before running into resistance at its prior failed breakout points from early March.

If we see C breach the 50-day moving average in the coming days, then I would view that a short-sale trigger point. Otherwise, this needs to be watched closely as it could also set up along the 50-day line and attempt to re-breakout. Such is the nature of the Ugly Duckling market – you absolutely must be ready for anything, and able to recognize and act on the real-time information as it comes at you.

 

GR042617-C

 

Goldman Sachs (GS), not shown, should also be watched as it rallies just above its 20-dema. The stock held above the 20-dema today, but a breach of the line would trigger this as a short-sale at that point as well. Note that GS has not been able to rally up as far as its 50-day line.

Another big-stock financial that is having trouble moving above its 50-day moving average is J.P. Morgan (JPM). It is also rallying up to a prior failed breakout point right around the 88 price level, which happens to coincide with the 50-day moving average.

JPM has run into resistance right at the line over the past two days in a row, so in my view is shortable here using the 50-day line as a guide for a tight upside stop.

 

GR042617-JPM

 

I discussed Applied Optoelectronics (AAOI) as showing a bottom-fishing pocket pivot (BFPP) on Friday, and once it regained the 50-day line it made for a decent trade on the upside. The move was predicated on the fact that the stock was being added to the S&P Small-Cap 600 Index, effective April 25th, which was yesterday.

Once small-cap index funds got their fill of the stock, it promptly reversed today on above-average selling volume. This was almost a no-brainer swing-trade long and then short. Once April 25th had passed, the stock could have been shorted this morning for a nice move back below the 50-day line.

In this position AAOI can be considered to be shortable here using the 50-day line as a very tight upside stop. Otherwise, if it can regain the 50-day line, it could continue setting up as a “roundabout” situation with the stock attempting to form a new base. This is another one of those cases where you must be ready to run with the stock either way, depending on how things play out from here.

 

GR042617-AAOI

 

Over the weekend I considered Snap (SNAP) to be buyable along the 10-day moving average based on the voodoo action at the time. So far this week it has managed to regain its 20-day exponential moving average. Yesterday and today the stock posted a pair of five-day pocket pivots along the 20-dema, which is constructive. Today’s action was likely helped along by a strong earnings report and price gap-up by fellow social-networker Twitter (TWTR).

This remains in a buyable position here using the 20-dema as a tight selling guide. Earnings are expected on May 10th, so I’d like to see the stock put some upside cushion on with a move higher before earnings.

 

GR042617-SNAP

 

This afternoon as I write following the closing bell, ServiceNow (NOW) is gapping up in after-hours trade as a result of a favorable earnings report. As I noted over the weekend, fellow “cloudies” Splunk (SPLK) and Workday (WDAY), had both cleared their 50-day moving averages and did not appear shortable ahead of NOW’s earnings report.

ServiceNow (NOW) is currently trading at around 95 and change, as I write after the close. This would put it in the area of the chart that I have highlighted below, which looks like a breakout from its current base three-month base formation. I would watch this tomorrow for a possible buyable gap-up move.

Cloud names have been dormant for many weeks now, and some I have even been able to scalp on the short side from time to time, like SPLK. But if this recent breakout by the indexes is the start of a new market up leg, then look for new areas of the market to participate. The clouds could be one such area.

Assuming NOW holds this after-hours gap-up, it becomes the first cloud name to have cleared the hurdle of its earnings report. At the same time, it could be set to post a long set-up tomorrow at the open in the form of a buyable gap-up, so keep a close eye on the stock at the open.

 

GR042617-NOW

 

Among names I have discussed as shorts in previous reports, GrubHub (GRUB), not shown, posted a pocket pivot today along its 50-day moving average. Earnings are expected to be reported tomorrow after the close, thus this is not an actionable pocket pivot. We’ll see whether it is a clue with respect to how the stock will react once earnings are out, tomorrow, however.

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:

Activision Blizzard (ATVI) continues to hold up near its highs but is extended ahead of earnings, which are expected next week on May 4th.

Arista Networks (ANET) remains near its highs and in an extended position with earnings expected next Tuesday, March 2nd.

Bioverative (BIVV) continues to hold tight along its 10-day moving average and above its early April breakout point. Earnings are expected next Thursday, May 3rd, so there is nothing to do before then.

Electronic Arts (EA) posted a new closing high today, and remains extended ahead of earnings, which are expected on May 9th. Expect the stock to move in sympathy to ATVI’s earnings report on May 4th, however.

Square (SQ) broke out to new highs yesterday on a pocket pivot volume signature that was slightly above-average. The action is bullish, but with earnings expected next week on May 3rd, I see nothing to do with the stock before then.

Take-Two Interactive (TTWO) acts like ATVI and EA as it sits near its highs and in an extended position. Expect it to move in sympathy to ATVI’s earnings report next week on May 4th. TTWO is itself expected to report earnings on May 16th.

Veeva Systems (VEEV) is extended from last Thursday’s continuation pocket pivot, and would only be willing to take shares on a constructive pullback to the 10-day line. Earnings aren’t expected until late May.

When it comes to the long side, my preference is to focus on names that have already reported earnings or which aren’t expected to report earnings for at least 2-3 weeks. Set-ups can easily develop after earnings, so one does not have to resort to playing “earnings roulette.” Generally, buyable gap-ups are the most common post-earnings set-ups you will see.

The other type is where a stock sells off after earnings but sets up in typical Ugly Duckling style, such as NFLX, for example. One must therefore be resourceful and creative when figuring out when the Ugly Duckling is set to pay a visit.

As I pointed out over the weekend, one thing I’ve learned from my 26 years as a market participant is that what the crowd expects is almost never what actually happens. The crowd obviously wasn’t looking for a big upside gap over the weekend following the French election, which wasn’t even conclusive given that it was only a preliminary round, and a run-off is yet to be held to determine the final winner.

Meanwhile, the crowd expected that the announcement of a Trump Administration tax plan would be wildly bullish for the market. But in fact, after today’s announcement a “sell the news” mentality took over and sent all the major indexes except the Russell 2000 back into the red.

With the indexes extended in the near-term, a pullback would not be surprising. The bottom line, however, remains what set-ups can be found in real-time, long or short. So, it all boils down to watching the stocks. Carry on.

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 a position in NFLX, 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.