The Gilmo Report

August 21, 2011

August 21, 2011

The NASDAQ Composite and S&P 500 Indexes made new closing lows on Friday in what is now a four-week correction that has carried them both down 18% off the peak. Friday’s volume, while lighter than the sharp selling we saw on Thursday, was still above average, and appeared to be more symptomatic of the market’s inability to find any upside traction. It could not sustain an early-morning reversal into positive territory that proved to be brief and ephemeral, at best. Support at the top of last summer’s “congestion” range at around 2310 is now coming into play, as we see on the weekly chart of the NASDAQ Composite Index, below. The S&P 500 is also coming down to a similar support area at around the 1100 price level. As we undercut the lows of nine trading days ago we may be setting up for a period of sideways movement as the indexes may begin consolidating this first downside move off the peak by bouncing along these support levels at 2300 and 1100 for a bit. Once these support levels are breached, whether that occurs in a matter of days or weeks. then you are looking at the lows of last summer at around 2061 on the NASDAQ and 1010 on the S&P 500 as the next logical area of support. My view is that we are just about to complete the first leg down in a bear market that will eventually see a test and maybe even a move below the lows of last summer.

NASDAQ Composite Gilmo Report Chart

What I find most fascinating about the current correction, a steep one by any standard, is that sentiment does not appear to be budging here. Bulls remain steadfast as the bears simply go into hibernation. The Investors Intelligence Advisor Sentiment poll, shown on a chart from www.Decisionpoint.com (©2011 used by permission) shows that 46.2% of investment advisers have remained bullish while bears sit pat at 23.7%. Even the American Association of Individual Investors sentiment poll shows that over the past three weeks the percentage of individual investors who are bullish has actually increased while bearish investors have declined. With individual investors tending to be the most skittish I would expect the AAII poll to show more bearish sentiment. It almost appears as if investors are by now so conditioned to believe that the markets will come back again as they have throughout the “QE-fed” rally off the March 2009 lows that they have become almost outlandishly complacent. Meanwhile, in July, investors withdrew a record $129.5 billion from conventional mutual funds, $29.9 billion of which came out of U.S. domestic equity funds. So perhaps it is less a matter of what investors say and more of what they actually do.

Investors Intelligence Advisor Sentiment Gilmo Report Chart

And while money keeps coming out of stocks, it appears to be pouring into gold. This flow of money into the yellow metal has now spilled into the white metal as silver has broken out of a cup-with-hande formation through the $42.06 level on the nearest futures contract. Many are now saying that gold is doing what silver was doing in late April as it went into a wild climactic top and a “bubble” is forming, but as I see it gold is likely just beginning a longer up leg here. What is interesting is that while the stock market sell-offs of late 2008 and summer 2010 eventually caused precious metals to sell off themselves, this time around the metals are instead streaking higher. This tells you something, and forces me to modify my view on the precious metals as I had previously expected them to stage some sort of pullback. Meanwhile, I note that gold has only moved 18.4% from its breakout point corresponding to the 151.86 price level on the SPDR Gold Shares (GLD), shown below on a daily chart, and the 1559-per-ounce level on the gold futures. While a test of the 10-day moving average could occur at any time, my current Point & Figure target for gold is $2090-per-ounce and 202 on the GLD.

SPDR Gold Shares (GLD) Gilmo Report Chart

I don’t tend to think that the GLD is going into a climactic move since it has only recently broken out of what I see as an 8-month base-on-base type of formation. Compare this to the climactic run in the iShares Silver Trust (SLV) after it broke out through the $30 price level in February of 2011. The SLV had previously broken out through the $20 level in September of 2010 before staging a short six-week consolidation that it broke out of in February. Thus by the time silver was going into a climactic top in late April of this year, it was already up about 150% from its September 2010 breakout point and 61% above its February 2011 breakout point. Therefore, it was well-extended in its run, in contrast to the move we are just starting to see in gold. Meanwhile, the SLV, as we see on its daily chart below, has broken out of a cup-with-hande type of formation. This shows a classic “shakeout & breakout” maneuver over the past three weeks as the SLV first broke down hard from the low 40 level, found support along the 50-day moving average, and has now turned and picked up above-average volume on what I see as a buyable breakout through the prior 41.19 peak on the SLV. The idea here is that it should hold the 20-day moving average at 38.83 on any pullback.

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I wrote in my report of this past Wednesday that given where the indexes were on the reaction rally and bounce off the lows of nine trading days ago one had to take shots on the short side right there. The ideas I put out in my report of exactly one week ago have worked out well so far. By Thursday morning, however, the big gap-down move made it tough to try and get short, although it was possible. In my Wednesday report I emphasized that Sina Corp. (SINA) was looking shortable on any earnings-related rally we might see on Thursday. In fact, SINA did rally up into the high 90’s as I discussed it might after announcing earnings after-hours on Wednesday, providing a prime shorting opportunity as analysts rushed to raise the stock to “buy” and “outperform.” Get real! SINA is showing negative -52% and -26% earnings growth over the past two quarters and is selling at 83 times forward earnings. In this environment, this sort of P/E expansion is more likely to turn into a P/E contraction, hence I consider SINA to still be shortable here. With the stock closing at 90.05, well under its 200-day line at 94.20, that line becomes your initial stop here and a possible trailing stop if you shorted into the Thursday and Friday rallies.

Sina Corp. (SINA) Gilmo Report Chart

The biggest of the big Chinese internets, Baidu, Inc. (BIDU), has roughly followed the scenario I outlined in my August 7th report when I discussed looking for a possible rally into the 147-150 area around the 20-day moving average as a potentially shortable move. Going into Wednesday of this past week BIDU was sitting right at the 20-day line, so it was there to be shorted before Thursday’s gap-down break. Now we see on the weekly chart below that BIDU has bee-lined straight down to and just below its 40-week (200-day) moving average on very heavy weekly volume. I see BIDU’s here as something of a “mini-POD” – a smaller Punchbowl of Death thing that forms at the tail end of a long upside price run as BIDU has had. A bounce from here up towards the 50-day moving average would offer a low-risk short-sale entry point, but one could short it here using a short-fuse 3-5% stop in case it simply busts the 200-day line on the daily chart. The evidence here is a split-decision to some extent, since having undercut last week’s low and holding the 200-day line on the daily chart, the stock is in position for an “undercut & rally” bounce. But the massive selling volume and close below the 40-week line on the weekly chart tells you that the primary trend here is that of a “body in motion” to the downside.

Baidu, Inc. (BIDU) Gilmo Report Chart

Sohu.com (SOHU) is shown on a weekly chart, below, and one can easily discern the head & shoulders formation that the stock is in the midst of forming currently. On Wednesday I indicated that I would like to see a bounce back up into the 50-day moving average as a nice rally to short into, but instead the stock gapped down below its 50-day line on Thursday and moved lower again on Friday. It is heading for its 67.10 low of last week, so from here it might undercut that level. There is potential for the stock to rally up into the 50-day/10-week moving averages from here, in the 76-77 price area, which is what I would consider to be the lowest-risk entry point for a SOHU short-sale. Eventually it is likely headed for its neckline at around around 55-60. The critical factor in ALL of these short-sale set-ups we are looking at in this report, as well as those I’ve discussed in previous reports and which have come down sharply, such as Under Armour (UA), for example (not shown), is going to be the general market. As the market comes down to support around 2300 on the NASDAQ, any bounce or sideways chopping could coincide with bounces and the further “forming-out” of these patterns. This is something short-sellers should keep in mind here, and members should refer to my last report for downside targets on short-sale target stocks previously discussed.

Sohu.com (SOHU) Gilmo Report Chart

In this vein of thinking about where we are with respect to the general market’s position in this current sell-off, consider the biggest of the big-stock NASDAQ stocks, Apple, Inc. (AAPL), shown below on a daily chart. AAPL is similar to BIDU (not shown) on the daily chart in that both it and BIDU were breaking out to all-time highs in late July before turning tail. BIDU then broke down below its 50-day moving average before rallying up to its 20-day moving average, while AAPL bounced off of its 50-day moving average but also only rallied back up to its 20-day moving average before breaking down through the 50-day moving average on Friday. Selling volume in AAPL is extremely heavy here, but you are on top of a big support area stemming from the five-month base it broke out of in July. I tend to think there are better stocks to pick on when it comes to the short side, but keep a close eye on AAPL as a barometer for the general market. I believe a clear late-stage failed-base with AAPL violating its 50-day moving average (which it hasn’t yet) on huge volume would confirm that we are moving into a longer-term bear phase, and not just working our way through a correction like we saw in summer of 2010.

Apple, Inc. (AAPL) Gilmo Report Chart

Other big-stock NASDAQ leaders confirm the weakness in the general market as AAPL and BIDU do, and of course among these is Priceline.com (PCLN), a stock I’ve been continuously discussing as a late-stage failed-base short-sale set-up that was shortable along the 50-day moving average and the 510 price level. PCLN split wide open on Thursday, breaking down through its 200-day moving average and then staging a clear 200-day moving average violation by trying to rally back up into the line intra-day on Friday before completely reversing and closing at a new low. Friday’s intra-day rally was a very brief “undercut & rally” that occurred once PCLN had undercut its June lows at 451.75 on Thursday, and it then failed incredibly quickly. If you’re already short PCLN from up around the 50-day line then the 200-day line becomes a potential trailing stop. PCLN could also spend some time consolidating here if the general market is able to find support along the 2300 level on the NASDAQ.

Priceline.com (PCLN) Gilmo Report Chart

Along with PCLN, fellow big-stock NASDAQ e-commerce player Amazon.com (AMZN) staged a similar move on Thursday and Friday as it now sits at lower lows beneath its 40-week/200-day moving average, as we see on AMZN’s weekly chart below. AMZN started out as a late-stage failed-base formation, but its rapid three-week break off the peak on massive downside voluime here is starting to look like a possible head & shoulders formation with the left shoulder and head already forming. AMZN’s move this past week took it down to a potential neckline area, so a bounce from here up into the 40-week/200-day moving average might finish out a right shoulder to complete the H&S pattern. AMZN’s earnings are quickly decelerating and going negative here, with a weak +13%, +7%, -33%, and -9% sequential earnings growth over the past four quarters. The stock is selling at 89 times forward estimates so it is ripe for a P/E contraction. If you are already short the stock along the 50-day moving average, as I discussed in my report of last weekend, August 14th, the 40-week/200-day line is a potential trailing stop. Longer-term watch for AMZN to try and build a right shoulder here.

Amazon.com (AMZN) Gilmo Report Chart

As I discussed earlier in this report, I see the market as likely forming the first leg down in a continuing bear phase. In order to understand the short side it is also necessary to understand that a bear market occurs in stages, with each new leg down taking the indexes to fresh lows. Each leg down is then usually followed by a period where the market moves sideways or stages a reaction rally and bounce. This action is also seen in individual stocks that begin to form topping formations, and it also provides a period where late-stage failed-base (LSFB) short-sale set-ups evolve into head and shoulders short-sale set-ups as they chop sideways or rally slightly to form what become right shoulders. AMZN, above, is one such example, as is Sodastream International (SODA), shown below on a weekly chart. The action of the past three weeks has taken the markets down 18%, nearing potential support around 2300 on the NASDAQ and 1100 on the S&P 500, while taking stocks like AMZN and SODA (among many, many others) down sharply off their peaks so that they have now formed the right side of the “head” in potential H&S patterns. This is something for short-sellers to be aware of here. Thus watch SODA for any “right shoulder rallies” up towards the 50 price level.

Sodastream International (SODA) Gilmo Report Chart

In Chapter 6 of “Trade Like an O’Neil Disciple,” which I co-authored with my colleague and former O’Neil portfolio manager Dr. Chris Kacher, we discuss this concept. In a recent article we wrote for Technical Analysis of Stocks & Commodities magazine on “Market Contex” (see: http://www.traders.com/Documentation/FEEDbk_docs/2011/05/Morales.html if you are already a subscriber to that publication) as well as Chapter 10 of the latest, hot-off-the-presses “Wiley Trading Guide Volume II” (see: http://www.wiley.com/WileyCDA/WileyTitle/productCd-0730376877,descCd-description.html) we also discussed this concept as it relates to various sides of the market, including the short side. Understanding where you are in a potential bear phase and how this impacts the evolving action of individual short-sale target stocks as they complete and “form out” their short-sale set-up patterns is useful in guiding one’s trading strategy on the short side.

As we come down into this area of congestion from summer of 2010, there is potential for the market to bounce off the 2300 and 1100 price levels on the NASDAQ and S&P 500, respectively, with an outside chance of further downside carrying to 2061 and 1010 on each. This week I might look for the market to move lower before finding a short-term bottom that lasts more than one week as this last bounce did. This would make sense given the position of a lot of these short-sale target stocks we’ve been tracking, including some of the newcomers I mentioned in my Wednesday report of this past week, like Wynn Resorts (WYNN) and Carbo Ceramics (CRR). Thus pay attention to potential downside price targets that I’ve discussed in recent reports (especially the August 17th report) as stocks come down and undercut prior lows or meet up with a major moving average, such as the 200-day moving averages in most cases given the extent of the market’s free-fall over the past three weeks.

Meanwhile silver is breaking out, hence is potentially buyable here, while gold remains in its uptrend as it heads for $2,000. I would still recognize the potential for a protracted stock sell-off to weigh on the precious metals, but their strength so far argues for something else at work here. Thus maintain your trailing stops on the GLD while using the current breakout level at 41.19 down to the 20-day moving average at 38.83 as your downside guides for a stop on the SLV – that is the simplest way to approach it. Since its pocket pivot buy point on July 13th, the SLV has not violated its 50-day moving average, so using strict selling guides rather than trying to predict that stocks will eventually drag precious metals down with them is already proven, in this environment, to be the more intelligent approach.

I will be appearing on Fox Business News’ Bulls & Bears segment Monday at or after the close. Currently I’m not sure of the actual “hit” time, but it will be sometime at or after the close, probably between 1 p.m. and 2 p.m. Pacific, or 4 p.m. and 5 p.m. Eastern. This past Thursday afternoon Stuart Varney called me in for duty on short notice to appear on his Fox Busines News show Friday morning right at the open. It was a lively discussion, and Gilmo members can view it via the FBN videolink to the video at: http://video.foxbusiness.com/?playlist_id=87060#/v/1118336292001/how-long-will-selling-continue/?playlist_id=87060.

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, SLV, and SINA, 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. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.