The Gilmo Report

December 18, 2011

December 18, 2011

The NASDAQ Composite Index remains below its 50-day moving average despite a two-day attempt to bounce off the lows of Wednesday’s gap-down day, as we see in the daily chart of the index below. Three of the past four trading days have seen the index attempt to rally early in the day before reversing and closing weakly, either reversing entirely in an ugly outside reversal day that carried the index below the 50-day line as it did on Tuesday, or simply giving up its gains from gap-up opens on Thursday and Friday before closing near the lows of the daily trading range. On the chart this has the look of four tiny downward-pointing arrows, and when combined with the action in the NASDAQ’s advance-decline line, which is not shown on this chart but which is leading the NASDAQ to lower lows, the chart looks like it wants to head lower. I don’t consider it meaningful whether the NASDAQ A/D line is making new highs or new lows since the NASDAQ advance-decline has never made a new high due to the quirk of its abundant, inconstant, smaller-cap, and more entrepreneurially oriented index components. I do consider it meaningful to see how breadth moves with any given move in the index. Currently I see the weakening breadth as the undertow that drags the index back towards the unchanged line by the closing bell on days like Thursday and Friday.

NASDAQ Composite Index Gilmo Report Chart

In my mid-week report of this past Wednesday, December 14th, I called the end of the gold trade, at least for now, given its breach of the 200-day moving average, something it has not done since August of 2008. On the daily line chart below, I show the price of the SPDR Gold Shares (GLD), the red/black line, and compare it to the NASDAQ Composite Index, the dark gray line. Back in August of 2008 the breakdown in gold was an early clue that a liquidity crunch was coming, and in fact just such a crunch that led to massive forced selling in stocks came within a month later, resulting in the brutal downleg in stocks that we saw in the final quarter of 2008. Remember that nothing settles in gold, only in currencies, so when a liquidity crunch comes and institutions must sell assets to raise liquidity, gold goes along with everything else. Thus we must ask what is the current breakdown in gold through its 200-day moving average, something it has not done since August of 2008, telling us about the state of liquidity in the system currently and the need for more forced selling in stocks? In short, is gold providing a clue that a major wave of forced-selling is about to take stocks to new lows? In the Age of QE, gold has become a reasonable barometer of the QE-induced trade, and so I view its current action as potentially ominous for stocks. This is not a time to be long stocks.

SPDR Gold Shares (GLD) Gilmo Report Chart

I do think that there is a good chance that a very profitable downleg in the market could be coming soon, perhaps after the holidays. I remain focused on my small handful of short-sale targets, as these are all former big leaders in patterns that are highly suspect currently, such as Apple, Inc. (AAPL), shown below on a daily chart. As I discussed this past Wednesday, AAPL violated its 50-day moving average on Tuesday, and this violation comes two months after the “two-down-and-one-up” sell signal it generated in late September/early October. AAPL tried to push higher with the market on Thursday and Friday, but like the market it ended up right around the lows of the day each time as it forms what looks to me like an inverted or “reverse” flag formation. It looks to be preparing to move lower. The view here is that this can still be shorted using the 50-day moving average as your guide for an upside stop at 391.52. The key here with AAPL is that the 2-down-2-up sell signal provides the macro-basis for the short trade here: I expect price to test the 200-day MA soon enough.

Apple, Inc. (AAPL) Gilmo Report Chart (AMZN) also flashed its own “two-down-and-two-up” sell signal at the same time as AAPL did in late September/early October, and this provides us with the macro-basis for a short-sale trade in AMZN, as I’ve discussed many times in previous reports. Last weekend, in my report of October 11th, I pointed out the short head and shoulders formation in AMZN’s weekly chart, and in the daily chart below we can see how after undercutting and rallying from the mid-August low (see my discussion in this past Wednesday’s report) the stock has rallied right back up into the neckline of the H&S formation, where it becomes imminently shortable. AMZM has been benefitting from news that it is selling over a million Kindle Fires a week, but note how the news-induced rally has come on very weak volume and simply becomes another of these news-induced rallies that we know tend to be shortable in stocks that are simply rallying within a severely weak pattern such as AMZN’s. Kindle Fire sales that are on fire are nice, but they aren’t that profitable for AMZN, and I think the chart of AMZN was already telling us this, hence this is potentially shortable here using the 185 level around the highs of Thursday/Friday as an upside stop. (AMZN) Gilmo Report Chart

In spite of the market gapping up on Thursday and Friday at the open, Baidu, Inc. (BIDU) never rallied past the 120 level as it simply moved lower on Thursday and then held even on Friday. I was looking for a rally up above 120, maybe even up to 125, to short into, but that did not materialize going into the end of this week. However, this would tend to argue for the fact that BIDU is actually quite weak here, hence I think the 120 level is now likely to serve as upside resistance. The weekly chart of BIDU distills the action down a bit, but remember that last weekend I noted that the stock was hovering around its 10-week (50-day) moving average as volume was drying up, hence it would be important to see on which side volume came in once trade picked up. We can see on the chart that selling volume came into the stock this week and carried it to a lower low. If BIDU cannot rally above 120, then my best guess is that, with corresponding continued weakness in the general market, it is primed to test the neckline of its big H&S pattern down below the $100 price level, as I’ve drawn it on the chart below. BIDU is a potential short here, using 120 as your quick upside stop.

Baidu, Inc. (BIDU) Gilmo Report Chart (CRM) also responded quite weakly to Thursday’s and Friday’s gap-up openings as it found ready resistance at and around the $110 price level. The weekly chart of CRM, below, distills the situation down to where we can see that four weeks ago the stock undercut the $110 price lows in the right shoulders of its current H&S pattern and then staged a very logical “undercut & rally” that carried the stock up into its 10-week (50-day) moving average where it stalled and churned on heavy volume, as I’ve annotated on the chart. This “undercut & rally” came on news of other CRM competitors being bought out by the likes of SAP, IBM, and ORCL, but with nobody interested in buying CRM the stock has now broken down below the $110 level and may be ready to “break out” to lower lows as it tests the low of four weeks ago. Selling volume picked up, and my view is that if the general market remains weak here, CRM will soon be testing the mid-90’s on the downside. If you short here, Friday’s high at 112.16, less than 5% from Friday’s close, is my guide for an upside stop. (CRM) Gilmo Report Chart

I’m adding one name back to my short list of short-sale target stocks, and that is one I’ve discussed before, Fossil, Inc. (FOSL), which I show below on a weekly chart. A number of other higher-end retailers have been acting weak, most notably Tiffany & Co. (TIF) and Coach, Inc. (COH), for example, but FOSL is a much weaker pattern than these are, although I would admit all of them look pretty soft here. Sometimes these patterns take longer to form out than you think at first, and FOSL is a good example of this. We were initially looking at FOSL as a possible H&S set-up, but the fact is that this has developed into an improper double-bottom where the second bottom is higher than the first, thus it is an improper, late-stage base. FOSL tried to break out eight weeks ago, but has since failed, so now I see this as a late-stage failed-base (LSFB) short-sale set-up. Note the weak upside weekly volume three weeks ago as the stock rallied into the 10-week (50-day) moving average. Now this looks ready to “break out” to the downside, so I would be willing to short this here with the idea that it should not get above this past week’s high at 84.38.

Fossil, Inc. (FOSL) Gilmo Report Chart

The major driving theme in the market’s current weak phase appears to be “Where’s the QE?” The action in gold appears to be a harbinger of a liquidity crunch in the making, similar to late 2008, and right now that is what I am looking for to develop here. It may not, and we may get some announcement from the European Central Bank or the Fed at any point regarding another wave of QE. But more QE simply continues to kick the can down the road, and it appears that the only country that recognizes this is Germany. This is of course understandable given that Germany is only too intimately acquainted with the “fruits” of fiat money-printing. The Germans experienced hyper-inflation during the Weimar Republic, a time that gave rise to the stereotypical hyper-inflation image of the consumer rolling a wheelbarrow full of paper money to the store to go buy groceries.

The other major question becomes just what is the “elasticity” of QE; in other words, are the effects of any given blast of QE the same, round after round, or do they weaken over time? Is the financial system today more or less sensitive to infusions of QE than it was, say, in 2009? Obviously, all of these are questions one can intellectualize over and ponder for days, but the bottom line is “What is the market telliing us, if anything, right now?” The breakdown in gold may be telling in this regard, and in a market with few clues and a lot of “chop and slop,” this may be something to key on here. For a new downleg in a continuing and developng bear market, if it were similar to that seen in late 2008, would be very profitable indeed. This is probably the best potential “window of opportunity” that I can conjur up, as the long side of this market remains severely compromised with more and more leaders continuing to break down. I think your best chances here lie on the short side, and for now that is where I am probing and playing, pending further market evidence.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC
Principal and Managing Director, MoKa Investors, LLC
Principal and Managing Director, 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 AAPL and AMZN, though positions are subject to change at any time and without notice.

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