Market Comment

Be Careful What You Wish For

May 9, 2011

“A speculator is one who runs risks of which he is aware and an investor is one who runs risks of which he is unaware.”

                    — John Maynard Keynes
                    

Shares, in light of all the head-shaking and “wows” elicited by the collapse of one of the most one-sided trades in recent memory, hold up well.

The Naz has only shown one distribution day in three weeks.

The SPX, weighted more in materials, energy, and industrials, put in three major distribution days last week. Still, similar to the Naz, it was off just 3% from its peak, barely qualifying as a reaction, let alone a correction.

At the margin, silver was done in by four margin increases in the last two weeks. This, along with word that Soros and others were selling, applied the coup de grâce, handing “poor man’s gold” its worst four-day drop in over 30 years.

Silver,
which put in the first witches’ hat peak of any sector/group since perhaps the bios in late-’99, is unlikely to make an assault on its recent high for months. This according to historical precedent: Markets that show this amount of pronounced accumulation followed by sharp liquidation do not repair themselves in weeks, but usually months, if not a year or more.

On 4/25, there were two clues that the character of silver’s advance had changed: The intraday range and volume were both the largest since the move had begun. At the time, we thought that either 1) price was beginning the topping process, or 2) price was ready to embark on a final climactic run. On that day, neither was knowable with certainty. In retrospect, the top occurred in a more compact manner than we had anticipated.

The moral of the story is that when you have a market that seemingly defies gravity, rather than get caught up in the hype and excitement, we prefer to study each day’s volume and range (among other things). As the above chart shows, volume on 4/25 was about double any previous day on the run-up. This was objective evidence that the character of the move had changed. And range obviously changed that day, as well. It may well have factored into the regulator’s decision to increase margin for holding silver.

The dollar, meanwhile, firmed, responding to hesitation by Trichet on a near-term rate hike, talk that a flawed Grecian formula may send that nation out of the euro zone, weakness in commodities, and a prior area of technical support.

Copper, with China comprising about 39% of its demand, and bond yields both peaked within days of each other in February. At the same time, defensive stocks began to outperform. All of these foreshadowed a recent set of softer US economic data.

However, the previous paragraph notwithstanding, the retailers are telling you that the exit of government stimulus is not expected to plunge the economy into a double-dip scenario.

Among the names, you are now looking for those that bounce back the quickest to new-high ground ahead of the averages.

Amazon.com (AMZN). This institutional favorite lagged during December-March, as the stock faced some headwinds from unexpected expense growth. Up to that point, we had looked for the stock to be a leader among technology bellwethers, due to its presence in the cloud space and primarily its then-beefy earnings estimates for ’11/’12. The estimates are currently -2%/+55% for ’11/’12, and the market tipped its hat when the company released Q1 earnings, as the below chart shows. It is currently one of the strongest-acting glamours. This despite decelerating earnings growth over the past few quarters of 41%/13%/7%/-33%, to which we pay little attention. Monday (9) printed the fourth major accumulation day in nine outings. AMZN is a bit too far away from nearby support to consider this any sort of high-probability entry. The stock could easily come back to the 190 area on any market weakness. At this level, then, we would hold off on a fresh-money buy.

Polycom (PLCM). We are watching this one due to its estimates of 45%/27% in ’11/’12, extreme accumulation highlighted by its 12.6% jump of Apr 25 on volume of 487% greater than its average, its five quarters of earnings growth acceleration, and the relative strength shown in today’s soggy tape. The potential entry above the 4/28 high of 61.70 is not low-risk, but it is a better actor and deserves our attention. It is to be noted that any entry from a two- to four-week ledge is in most cases a higher-risk proposition than buying from a six-week-or-greater base.

Medical research service provider Illumina
(ILMN) shows earnings growth estimates of 42%/29% for ’11/’12, steadily increasing institutional sponsorship in recent quarters, solid intermediate-term accumulation, membership in a good group in the strong healthcare sector, and a constructive three-month base, with potential entry being a traditional clearing of the base-top high of 74.12 set on 2/15. One of the most constructive bases in the current market.

Ariba (ARBA). We owned ARBA at the end of the Bubble Era. The stock came public in ’99 and proceeded to go up 11 times in the next nine months, peaking at $1,099 a share. Then, within 18 months it had dropped to $8. This was typical for many late-Era leaders. The Street is a master at supplying a need. No one does it better. The need then was for Internet/telecom stock. With a smile wink, the Street complied, and brought many stocks public in ’99 that had no earnings. But they were Internet/telecom – and that is all that mattered to the market. The Street, though, did such a bang-up job of scratching the itch, that by early in the new millennium there became too much supply of the stuff. Too many Internet stocks. And this is how the Bubble Era ended. Not by portfolio managers one day waking up and realizing they no longer wanted to own CSCO because it was selling for 160 times earnings.

ARBA, with its estimates of 8%/31% for the Sep ’11/’12 fiscal years, high relative strength, strong group, rising institutional sponsorship in the last few quarters, and decent six-week base, has just enough going for it for us to monitor it. A potential buy point exists at the top of its current pattern at 35.63.

Netsuite (N) is one of a number of leaders that recently broke out, and are now pulling back toward the top of their prior base. Earnings growth is expected to pick up from 8% in ’11 to 107% in ’12, according to Thomson Reuters; the group is strong; mutual fund sponsorship has gradually risen over the past year; and the breakout occurred on its Q1 earnings report, with price moving up 15% on volume nearly 500% above its average. Average daily dollar volume, at about $11.4MM, is to be noted, as this is not an especially liquid title. Similar to Ariba, N is worth watching for a possible entry above its recent high of 34.99.

Qlik Technologies (QLIK), mentioned in our last report of April 26 as having “the potential for a big move on its earnings report,” did clear its 4/21 high of 30.20, which we suggested might be a potential entry. With its ’11/’12 estimates of 57%/58%, its briskly rising sponsorship by large investors, its recent new-issue status, its strong group, its solid accumulation, and its status as a leader by virtue of its tripling in the 10 months since its IPO, this is worth watching for those not in it.

Acme Packet (APKT) is a stock mentioned in these reports beginning in September, though has not set up technically for our liking. Things are a bit different currently, as price recently broke out of a base just before the 4/26 earnings release and an aggressive entry is possible above the 84.50 high of 4/29. We like the ’11/’12 estimates of 45%/30%, the higher estimate revisions, the strong group, the bulky increase in fund sponsors over the past three quarters (from 353 to 408 to 498 to 561), and the stock’s high relative strength over the past 15 months.

Polypore International (PPO). In our April 11 report, we mentioned a possible pivot being the 4/5 high of 60.50. The stock was able to clear this, before failing and then re-emerging. The last two sessions showed price going out near the top of the range, a plus. Of note was Thursday’s (5) gap which led to a 19% move on volume 442% greater than average. Fundamentally, we like the recent revised earnings estimates, now showing 34%/30% growth in ’11/’12. We would also note the increasing sponsorship in recent quarters, the respect for the 50-day going back almost 18 months, PPO’s RS being top in its group – a segment that is in the top 2% of all industry groups – and good liquidity at $60MM in average daily dollar volume. Potential entry may not be ideal, however by leaning on the 5/5 gap day’s beefy move on the greatest volume in 2.5 years, the aggressive participant could consider a junior position using a pivot of the 5/5 high of 68.55.

Accretive Health (AH) releases its earnings report before the open on Wed May 11. Given the rich P/E multiple, the average daily dollar volume of about $13MM, the high ’11/’12 estimates of
88%/58%, its status as a recent new issue, and its very high RS, it is likely the stock will make a gap move following the earnings announcement. Thus, the 5/2 high of 30.65 may be used as a reference point, but putting a position on prior to the earnings report is not a risk that would interest us. Worth watching.

ARM Holdings (ARMH) represents one of the best actors in the improving semiconductor segment, with estimates of 23%/26%, rising estimate revisions, a decent-looking base, and weighty increases in fund sponsorship over the past few quarters. The base-top signified by the gray horizontal line in the below chart could be used as a potential entry.

In addition to ARMH, Atmel (ATML) is the other semi which has our attention. The stock has the highest RS in its group, has ’11/’12 estimates of 28%/22%, and has nice increases in mutual fund sponsorship over the last few quarters. Although we are generally not attracted to teenaged stocks like this one, we would note that average daily dollar volume is a liquid $144MM.

In summation, in classic, be-careful-what-you-wish-for fashion, the intermediate-term speculator would have been better served by an 8%-12% market correction, rather than the 3% reaction seen thus far in the averages. The result is precious few six-week-plus bases being formed among the glamours. What is left are a number of growth titles with two- to four-week ledges. This normally does not represent a high-probability play unless the underlying market is one of volatility and volume. We have, in most cases, attempted to mitigate this potential risk by highlighting those ledged setups showing at least one recent session of blatant institutional demand, e.g. PPO, PLCM, N, etc. Even so, junior-sized entries are advised in light of the higher risk associated with these patterns.

Kevin Marder

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.