The Gilmo Report

April 3, 2011

April 3, 2011

The NASDAQ Composite Index has now come straight up off the lows since finding a bottom around the 2600 level, as we see in the daily chart of the index, below. While we have seen a few more breakouts in individual stocks, we also some saw carnage in “cloud” networking-related stocks on Friday, so it is still a matter of taking a slow, steady, and selective approach if one is building positions and moving into this market on the long side. Studying the chart below, we can see that over the past four days volume has steadily increased as the index has moved back near its February highs. Friday saw a little bit of churning as the index closed mid-range on the heaviest volume in the rally over the past two weeks. Friday’s jobs number came in strong enough to send the market higher at the outset but progress was somewhat muted by the close as there was a little bit of a “sell the news” feel to the action. The market is entitled to some profit-taking as it has rallied sharply off the mid-March lows without taking much time to digest gains. Hence one should keep this in mind before getting uber-aggressive on the long side as the potential for a pullback increases. In most cases, leading stocks have moved up sharply and are entitled to some pullbacks as they digest their gains, and such pullbacks would provide opportunities to add to or initiate positions in nascent leaders.

NASDAQ Composite Index Gilmo Report Chart

One of the problems with Friday’s rally was the underlying action in certain leading stocks. Fortinet, Inc. (FTNT), a name I have favored primarily because of how well it acted during the market’s recent correction, came unglued on Friday on no discernible news. I did note, however, that a downgrade of F5 Networks (FFIV), a stock that had already been displaying extreme weakness, appeared to affect several “cloud” networkers such as Acme Packet (APKT) and Riverbed Technologies (RVBD), both strong leaders in the market rally phase that began in early September. As we see in the daily chart below, FTNT was hit on heavy volume Friday but managed to hold, more or less, at its 50-day moving average, which is about the only thing constructive in its action on Friday. As well, this is a big outside reversal day to the downside and if I were long FTNT I would back away on the basis of this unusual weakness, as I operate on the principle that there are only two types of investors in the market: the quick, and the dead, and I know which one I don’t want to be!

Fortinet, Inc. (FTNT), Gilmo Report Chart

From examining the available evidence, the culprit in sending some of these cloud network-related stocks down on Friday was F5 Networks (FFIV), shown below on a daily chart. FFIV was downgraded on Friday by research firm William Blair & Company which projected that FFIV would miss revenue projections by $5 to $10 million in the next quarter based on so-called channel checks. This is all no surprise to us as we have been following FFIV for some time as a perfect real-time model of a Head & Shoulders topping formation in a big, former leader. After initially breaking its neckline two weeks ago FFIV was able to fake out shorts by rallying back up to its 20-day moving average, which also coincides with the yellow highlighted area of resistance in the 103-105 price area, and has now busted its neckline again on very heavy volume. It may be that FFIV is quite shortable here on any bounce as this second breach of the neckline may be the one that carries the stock significantly lower. If it were not for the fact that the market is in a confirmed uptrend, for now, I would likely be all over this one on the short side.

F5 Networks (FFIV) Gilmo Report Chart

The action seen in FFIV and other stocks on Friday may argue for an approach where we again revert to looking at the market not as a stock market but as a market of stocks, evaluating situations on a stock-by-stock basis. Mining equipment maker Joy Global, Inc. (JOYG), looked good on the long side Friday as it broke out of a short five-week base and remains within range of the breakout, as we see on the daily chart below. Note that Thursday the stock flashed a pocket pivot buy point before the new-high breakout, which was also likely helped along by a positive article in Investor’s Business Daily. I like the technical action here but would prefer to see more robust sales growth given that while sales growth is turning back to the upside, it remains below my preferred level of 20-25%. As well, forward estimates, while positive, are not huge. A 17% earnings growth estimate for the next quarter is not the type of stuff that gets me salivating very much, and when I am looking at a stock as a turnaround type of play I want to see much stronger earnings growth, say 50-100% or more, on the turn such as turnarounds I discussed in late 2010, like CLF and WLT.

Joy Global, Inc. (JOYG) Gilmo Report Chart

In contrast to JOYG is Deere & Company (DE), which broke out on Thursday with strong buying volume coming into the stock, as we see on the daily chart below. While it also has somewhat tepid forward estimates, similar to JOYG, it differs in that the past two quarters have seen a strong turnaround in earnings and sales, with quarterly earnings growth of 365.2% and 110.5% and sales growth of 38.9% and 30.1%, respectively. This has a little bit more fundamental “juice” behind it, while JOYG seems to benefit from the mining theme, perhaps as it relates to precious metals, rare earth metals, and other mined products, all of which represent hard assets that benefit from a continued declining dollar. As well, a declining dollar also benefits companies that do business in countries other than the U.S. such that when foreign revenues are translated back into declining dollars, their earnings and sales numbers get a nice currency-related boost. This is why Caterpillar, Inc. (CAT) has been doing so well, and to a lesser extent it helps companies like JOYG and DE. DE looks potentially buyable on a pullback towards the 96 price level.

Deere & Company (DE) Gilmo Report Chart

To me, strength in mining or farming machinery stocks comes back to the theme of rising commodities prices in the face of a long-term dollar downtrend. As I wrote last weekend, a lack of political will to both end and reverse insane budget deficits, such as a $1.65 trillion deficit in 2011, will force the U.S. to decide between two basic choices: default or devalue. When the Democrats and Republicans fight over their respective proposals of $10 billion or $61 billion in cuts to the gargantuan $3.5 trillion 2011 budget, it is, as I heard someone say, much like arguing whether to use a teaspoon or tablespoon to throw water onto a burning building in order to put out the fire. Hence, the dollar will likely continue to devalue, and commodities, especially precious metals, will continue to go higher. Some of you may have caught me mixing it up with Stuart Varney of Fox Business News on Friday morning as I named my initial upside price target of $50.50 for silver, even as many pundits are “nervous” about how “high” silver is. If we look at the iShares Silver Trust (SLV) daily chart, this thing looks to me like it wants to go higher. The 1980 spot price of silver, depending on what source you look at, was $50.50, but when adjusted for inflation equates to well over $130-an-ounce. Thus, while most pundits may see $50 as a “stretch,” I think it is quite attainable, and is why I continue to hold both physical silver and silver ETFs like the 2-times leveraged AGQ.

iShares Silver Trust (SLV) Gilmo Report Chart

Silver remains one of the cleanest-trending positions I have currently, and while sharp pullbacks are part and parcel of owning silver, given that it is 2-3 times more volatile than gold, as long as the dollar continues to look like its proxy, the PowerShares DB US Dollar Index ETF (UUP) that I show below on a daily chart, the trend for silver remains up. On Friday the dollar tried to rally but reversed course and closed below the highlighted resistance area on the chart. Default or devalue, those are the choices the U.S. faces, in my view, and in this regard what kind of story is the dollar telling you? Oil continues higher, silver continues higher, and gold is on the verge of moving to a new high, as I see it, which is why I also like the GLD or the 2-times leveraged gold ETF, the DGP, here as well, although I don’t show charts of these here. The GLD remains potentially buyable as long as it continues to hold its 50-day moving average at around 136-137, which I would use as a downside guide for a stop. Otherwise, one can simply wait for a decisive breakout through the $140 price level on the GLD, which has served as near-term resistance over the past five weeks.

PowerShares DB US Dollar Index ETF (UUP) Gilmo Report Chart

Under Armour, Inc. (UA) broke out on Friday from a base-on-base type of formation, as we see on its daily chart below, and this breakout was accompanied by a large volume increase. I last discussed UA in my report of March 13th, when it flashed a pocket pivot buy point as I show on the chart. Back then I wrote that the pocket pivot would be buyable with the idea that the stock can hold the 20-day moving average. Notice that five days later the stock broke down hard on heavy volume below the 20-day line, but this never developed into a full-blown violation since it is not the first close below the moving average that constitutes the violation since you would need to see the stock move below the intra-day low of that first closing day below the 20-day. It never did that, but given the huge volume on that gap-down move below the 20-day moving average, more practical concerns might have caused one to exit the stock pronto, which I probably would have done myself. Nevertheless, UA found support at its 50-day moving average and broke out Friday. The stock, which I see as a cousin to LULU, remains within buyable range of Friday’s $70 breakout point.

Under Armour, Inc. (UA) Gilmo Report Chart

I went on CBS Radio affiliate WBBM in Chicago a couple of weeks ago and stated that I considered Apple, Inc. (AAPL) to be a sell on any rally into the 140 level or higher. Well, AAPL challenged me by doing so immediately, even getting back above its 50-day moving average on weak volume as we see in the daily chart below. I still believe that AAPL’s best days, as a stock at least, are behind it, and at best during a market rally phase I believe the stock is “dead money.” At worst, however, it could be in the process of making a more significant top, although that is still too early to call. Nevertheless, to me it is starting to look less and less like a long, and more and more like a short. Given that AAPL is the consumer-tech juggernaut of the 2000’s, I have to ask myself why the market only values its forward earnings stream at 15 times. The simplistic answer is to view AAPL as a “value” stock, but the reality is that it is a growth play by nature, and I am troubled that the market puts such a “non-premium” on its forward earnings growth. Something doesn’t smell right here, and if I only had two trades to make in this market, long or short AAPL, I would be short AAPL here!

Apple, Inc. (AAPL) Gilmo Report Chart

Perhaps it is time for AAPL to pass the baton off to another big-stock NASDAQ tech leader as AAPL itself recedes and fades off into the sunset. And perhaps a likely candidate is Oracle Corp. (ORCL), the “granddaddy of cloud-computing” as I have termed it in previous reports (see the September 19, 2010 report). ORCL represents a unique combination of a “shakeout & breakout” and a “fadeout and breakout” mixed in with a pocket pivot buy point over the past three weeks, as we can see in its daily chart below. The stock first shook down to the 30 price level right when the market itself was making lower lows in mid-March, but then turned back up with the market and broke out after announcing earnings. This breakout reversed from new-high price ground up around 34 to close back in the base, but above the 50-day moving average. Despite closing at the low of the day and faking out the buyers of the breakout, this was technically a pocket pivot buy point. ORCL then held the 50-day moving average and on Friday staged a “re-breakout” to new highs on very strong volume. This is buyable with the idea that it should hold the breakout at the 33 price level.

Oracle Corp. (ORCL) Gilmo Report Chart

Members should review my reports of the past two weeks for additional buy ideas as all of my discussions for these stocks still stand, such as NFLX and BIDU, for example, so I see no need to blather endlessly about them in each report. However, members may notice that my work over this weekend is showing some interesting divergences “under the hood” so to speak with some former leaders (FFIV, APKT, RVBD, AAPL) getting hit while other former leaders break out (LULU, CMG, ORCL, UA). I’m not sure exactly whether this equates to a troublesome narrowing of leadership or simply the normal process of seeing old leaders fall as new leaders rise up to replace them. In my last report I discussed Salesforce.com (CRM) as a possible “three wave” exhaustion of selling that might lead to a rally, but I must admit I was disappointed with the stock’s performance on Friday as it lacked any real thrust. This may need more time to develop, or it may morph into some other type of topping formation, and so I wanted members to be alerted to this. Otherwise, I advocate a selective approach here, particularly with the idea of gravitating towards newer names that have recently broken out and which I have discussed in recent reports, such as ENDP, just to name one such idea. If the market does pull back here, it may provide an opportunity to enter stocks that have broken out but which are now slightly extended, but I would still maintain a measured approach on the long side without taking on too much additional risk too soon.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, and/or Gil Morales & Company, LLC held positions in AGQ and 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, 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. ©2011 Gil Morales & Company, LLC. All rights reserved.

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. ©2008-2018 Gil Morales & Company, LLC. All rights reserved.