The Gilmo Report

April 3, 2013

April 3, 2013

A noticeable divergence began to creep into the market earlier this week, and its effects became more pronounced today. Yesterday, the Dow and the S&P 500 indexes moved higher on increased volume, as we see below in the daily chart of the S&P 500. This was followed by today’s break down on heavier volume.




The NASDAQ Composite Index, shown below on a daily chart, diverged yesterday by stalling out on a slight increase in volume as the NYSE-based indexes moved higher. Today it rolled over and broke down on a sharp increase in trading volume.




Meanwhile the Russell 2000 Index, which had been leading the market earlier in the year, began to diverge on Monday as it started a three-day roll-over maneuver on heavy trading volume. This is illustrated by the daily chart of its proxy, the iShares Russell 2000 ETF (IWM), below, which broke down through its 50-day moving average.




The Dow Jones Transportation Index, shown below on a daily chart, joined the Russell 2000 in failing to confirm the NYSE-based indexes new all-time highs and staging its own three-day roll-over maneuver as volume picked up each day. It also closed below its 50-day moving average.




While divergence was seen at the beginning of the week between all of these indexes, today they all rolled over together. But as I wrote over the weekend, with the crowd hailing last Thursday’s S&P 500 all-time high close as a “return to normal,” the question still remained as to whether the market was poised to break out of the 13-year “secular bear” range or whether this was just another test of the highs of this range. The jury is still out to some extent, although today’s action, when combined with the divergences seen at the outset of the week, does not bode well for the market. As well, perhaps the biggest issue that I have with the current market action is the way leading stocks have been getting hit left and right throughout the week.


Financials, which have been a leading sector of the market, got whacked very nicely today as Goldman Sachs (GS) and J.P. Morgan (JPM) both violated their 50-day moving averages.






Another area of strength in this market, the homebuilders, all have gotten hit over the past few days, with Lennar Corp. (LEN), tossing its cookies today after a very short-lived breakout two weeks ago.




Another formerly strong homebuilder, D.R. Horton (DHI), which had also moved to a new high two weeks ago, added to the homebuilder’s horror show by blowing chunks and breaking down below its 50-day moving average as well. Not pretty, but pretty much illustrative of what was going on with homebuilders at large in today’s trade.




LinkedIn (LNKD), which had been moving higher on lighter and lighter weekly volume, as I discussed in my report of this past weekend, March 31st, also took a long walk off a short pier, setting up a potential move down to its 50-day moving average as it sold off on above-average volume.




Netflix (NFLX), which had allegedly been forming a “high, tight flag,” saw its flag turn a bit on the loose side as it began flapping wildly in the wind of selling pressure, breaking down through its 50-day moving average. A close below today’s intra-day low would constitute a 50-day moving average violation, hence a sell-signal, so watch out for this.




Commvault Systems (CVLT), which was holding along its 10-day moving average when I discussed it in this past weekend’s report, also broke down on a sharp downside price move that sent the stock below its 50-day moving average by today’s close. A move below the intra-day low of today’s range is a final sell signal for the stock, although today’s action would have been enough for me.




TripAdvisor (TRIP), which I also discussed in my weekend report, decided to break out of its “three-weeks-tight” flag formation. The only problem was it broke out to the downside. So much for the 3WT!




Anything and everything I’ve been talking about on the long side of this market over recent weeks has come undone over the past three days. This is logical, as it is the leadership that has been coming off, and it is the leadership that we usually target. Either way, this is not a good sign for the market. Even with QE manipulations sending the indexes all over the place going into the close today, QE may not be able to keep this rally alive, which is why I view cash as a viable alternative to trying to stay long this market in the face of current evidence, period.


Fortunately I did have the sense to provide you with a textbook short-sale set-up in Northstar Mortgage Holdings (NSM), shown below on a daily chart. As I discussed in my weekend report of March 31st, NSM had rallied right up into its 50-day moving average following the base-failure of a little over two weeks ago. The stock has broken hard to the downside over the past three days and looks poised to undercut the 31.89 intra-day low of eight trading days ago on the chart, which would likely coincide with a test of the 200-day moving average, currently at around 30.72. That sets up a nice profit objective of just over 15%, which I would be more than happy to take. On the weekly chart, not shown, NSM is forming a tight little head and shoulders-like formation with its neckline just above the 200-day line. This means this current breakdown may be only the beginning of a concerted downside move for NSM over time.




I last discussed Facebook (FB) in my report of March 20th, where I was looking for the stock to bounce off of the 200-day moving average as a potential shortable rally. FB did a little better than that as it undercut the 200-day line as well as its late-December low before turning and rallying back to the upside, as we see on its daily chart, below. This was pretty much a textbook area for the stock to rally from, and the current bounce is one I am monitoring closely as it may produce another short-sale point as it moves up into potential resistance. The rally is being aided and abetted by reports of a Facebook phone (dubbed “First”) being announced at a media event the company has scheduled for tomorrow. This will likely create further upside “buzz” for the stock, but the stock has resistance at around the 27 price area up to the 50-day moving average at 27.93. The question is how far and how hard it rallies following tomorrow’s media event, if at all. And so some judgment has to be exercised in determining how and whether the stock should be shorted into such a rally. Optimally, a move into the 50-day line would be the best short-sale point.




Michael Kors Holdings (KORS) was last discussed as a short-sale idea in my March 20th report as it was nudging up into its 50-day moving average, about two points higher than where it closed today. KORS found resistance at the 50-day moving average on Monday, but today picked up some volume as it counter-trended the market, thanks to some analyst upgrades of a number of retail stocks. Retail stocks have been beaten-down as of late, so the selling today was focused mostly on the leaders while the “weak sisters” like FB and KORS were left alone and allowed to rally. KORS is in a logical position to rally given that it is undercutting the prior lows just under the 55 price level. But I would watch for this current rally to perhaps give out below the 22-day exponential moving average at 56.53, thus setting up a potential short-sale point there. The 50-day line, currently at 57.71, remains ultimate resistance on the upside as well as an upside guide for a stop.




Also keep an eye on Lululemon Athletica (LULU), shown on a daily chart below. LULU is a stock I’ve discussed in prior reports following its late-stage base-failure in early January, and the stock recently gapped down prior to announcing earnings in mid-March, as we see on its daily chart, below. Like KORS, LULU also rallied today, probably as a result of the same analyst upgrades of other retailers. LULU, however, is now trapped below a strong area of resistance in the low 65 price range, which becomes a short-sale target zone on any rallies like we saw today. After-hours, LULU confirmed their prior earnings guidance, which I’m assuming wasn’t all that special since it did not lead to any recovery in the stock the first time. Thus I would be on the lookout for any possible bounce to the upside in LULU tomorrow at the open. Otherwise I view the stock as potentially shortable here using the 65.50 price level as your upside stop.




In my view the current market environment does not make the long side very tenable, although it is unclear whether one can begin shorting this market willy-nilly. If one is going to short stocks here, it is advisable to wait and look for optimal set-ups as stocks rally into logical areas of resistance, such as the way NSM set up for us on Monday as a textbook short following its bounce up into the 50-day moving average. One also has to wonder whether more QE manipulation will drive the indexes higher, making life difficult for shorts. The bottom line is that if the market is getting into any trouble here then further evidence will have to be forthcoming as all of the major market indexes are down 1% off of their recent price peaks, save for the Russell 2000 which is down 2% off of its recent peak. Thus, if there is going to be a short-side game to play then we’ve barely started the first inning, to use a tired baseball analogy. I’m content, then, to let this develop and pick my spots carefully, assuming that short-sale candidates begin to pop up on my screens in earnest. Meanwhile, I don’t see any reason to sit here on the long side waiting for the market to clobber you further as most leaders are showing such negative price/volume action that buying into this pullback looks dicey, at best, and so any prior long ideas are now off the table. Therefore I convert my longs to cash and comfortably wait for any opportunities that might arise on the short side. Stay tuned.


Gil Morales

CEO, Gil Morales & Company, LLC
Managing Director & Principal, MoKa Investors, LLC
Managing Director & 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.

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