Market Comment


April 11, 2011

“Trends always go further than rational people expect, or even imagine. In a very uncertain world, perhaps nothing makes more sense than simply following trends.”

–John Henry

Shares have stalled within spitting distance of the February highs as concerns over rich oil prices begin to bite. Based upon the tepid demand for stock shown in the below chart (four of the five accumulation days are minor accumulation days)

and the fact that the averages came straight up off the Mar 16 lows with nary a pullback, it is logical that the market would take a rest here. The August-February move, historic in its one-way, all-risk-all-the-time demeanor, may have unfairly raised expectations of another smooth-with-light-bumps ride higher.

Markets generally do not act like the August-February move. Thus it is logical to expect the next leg up to encounter more volatility.

The backdrop is a bit murkier than we have seen in some time, with one central issue being the bond market, and what happens to yields in H2 as QE2 expires in June. With China reducing its uptake of Treasurys, and Japan’s hands being tied, the risk is that yields have nowhere to go but up during Q2. As it is, 10s have gone from 3.14% to 3.57% in the past month.

Most bear markets are caused by one of two things: inflation or recession. Both are usually preceded by a revolt in the bond market, which sends yields high enough to wear down stocks. Thus, the typical pattern is for a top to occur in bonds, followed by one in shares, followed by one in commodities, in that order. Looking at commodities in isolation, then, does not tell us much about when the ultimate bull market top in shares may occur.

Emerging markets, however, have tended to lead the US share market, and this is what we are on the lookout for.

It is to be noted that the current scenario – whereby shares have been rising due to the US economic recovery further taking hold, while oil richens on EM growth and question marks in the Mideast and North Africa (MENA) – is not something that can continue ad infinitum. At this pace, higher oil prices would damage consumer spending which would likely cheapen share prices.

At the crux of the issue are bonds and oil. Either independently or in concert, they are viewed as the limiting factor in this bull market.

We are not fans of long-term predictions, as every cycle is different from the last. With that said, the first one to two years of a bull are considered the “easy money” phase, when many are skeptical of its credentials. During this phase, volatility diminishes from the high levels of the previous bear. It is often the third year of a bull in which volatility and choppy action transpire to slow the upward progress of an advance. (This is a generalization: Every cycle is different. The ’98-’00 cycle, for example, showed some of the biggest gains in the bull’s final six weeks.)

The point here is not to be surprised or discouraged if things become less cut-and-dried vs. what we have seen over the first two years of this bull. Nimbleness may be more important for the intermediate-term speculator than in the recent past.

Among the names, in our Oct 17, 2010 report, retrievable via the “View Past Reports” button at lower right of this viewer, we provided background info on rare earths minerals, highlighting Molycorp (MCP) as a name that “may continue to be a burner.” We spoke of the aggressive participant using an unorthodox entry to squeeze into a junior position in the stock. Due to the less-than-perfect entry and MCP’s higher volatility, a junior position with a wide, 10% stops made sense, as we noted. All that was important was getting on board, if possible, and, of course, only if one’s risk tolerance accommodated this. Had the stock been entered using the suggested entry (above a three-bar high) and wide stop of 10%, the position would not have been stopped out on the Nov. 19 low, and then moved up as high as 116% in about three months.

The point: If you have conviction that a stock could be a burner, yet the setup is either high-risk or nonexistent, consider taking a junior position with a wide stop (e.g. 10%). If your stops normally approximate 5%, using a junior position with a 10% stop = a 5% risk on the trade, the same as if you had taken a normal sized position with your normal stop-loss of 5%. This can be effective at just getting you in the door of the thing, which is all you are trying to do in the first place. The add-on(s) can then be tacked on should the position move in your favor.

We like to manage each entry separately instead of using one average price for, say, the entry and two add-ons, which would allow us to track the profit/loss of the entire position but not the profit/loss of each individual entry. This is just the way we do it, and is not to suggest that this is the optimal way.

Since that Oct 17 report, we have discussed MCP in four other reports, the most recent of which was our last report (Mar 27), where we noted that two days of major volume indicated “the stock may be preparing to launch”, adding that the “aggressive speculator might consider a junior position above the 3/24 high of 56.78.”

At this stage, the stock is extended and does not offer attractive entry. Holders of MCP would be advised to allow it plenty of leeway, as this one can whip 10% in either direction on a moment’s notice. A logical support area might be the 60-62 area, and we would give it at least this much room to pull back, as a big leader is, from time to time, wont to do.

Polypore International (PPO) is in a top-decile group, specialty chemicals, which has late-cycle tendencies, has estimates of 32%/29% for ’11/’12, has shown eps growth deceleration over the past few quarters (yet the stock has moved up better than fourfold since the start of ’10), and is building a constructive six-week flat base, with a possible pivot above the 4/5 high of 60.50.

Netsuite (N) is a fast-growing developer of CRM (customer relationship management) software, is in a top-decile group, computer software – enterprise, has estimates of 38%/78% for ’11/’12, is forming a sound eight-week base, and, while not a favored title, is nevertheless worth watching in a market that is not loaded with setups. The standard breakout pivot would be above the 2/14 high of 31.32, while Friday’s (8) high of 30.91 might serve as a starter entry for a junior position.

Nxp Semiconductors (NXPI), a recent new issue that is up 161% in the last five months,
is in a top-quartile group, fabless semiconductors, is showing good accumulation, estimates of 108%/29% in ’11/’12, and last Wednesday (6) broke out on volume of 143% above average from a miniature cup-with-handle of 28% depth over five weeks’ duration. This base was likely too deep for its duration, so NXPI might have to put in more time consolidating. Worth watching.

Over the past five weeks, the It stock’s (AAPL) acc/dis score is 2-11, and it is no coincidence that it has shown fewer institutional sponsors sequentially for the past few quarters. AAPL broke its 50-day once and subsequently rallied back to its ascending neckline at “A” in the below chart – and then broke down anew over the past fortnight.

The big reason why AAPL may be done: In five months’ time, the ’11 fiscal year will be over, and along with it the company’s heady growth rate, estimated at 52% by the Street. Institutions are believed to be discounting the much-slower growth rate of the Sept ’12 fiscal year, estimated by the Street at 16%. AAPL is not expected to regain its leadership role anytime soon. From a product standpoint, still the unquestioned technology leader. Apple TV?

Globe Specialty Metals (GSM), a specialty metals producer that went public in July ’09, is showing 82% estimated growth for the June ’12 fiscal year, is under extreme accumulation over the intermediate term, has shown increased institutional sponsorship in recent quarters,     moved up 138% from the late-August market lows, has respected its 50-day three times recently, and is worth watching as a cyclical leader. Its recent breakout attempt came on respectable volume and we will see how it acts should it begin to move up the right side of its six-week base.

We are watching software specialist Verisign (VRSN), an old friend from ’99 and early-’00. Though not the most exciting candidate from an RS standpoint over the past year, the ’11/’12 estimates are 42%/28% and were recently revised upward, the base is tight, the 50-day has been respected, and, relative to other names on our list, its price is close to its prior high. The tight base and proximity to its prior high are what have our attention.

Chipotle Mexican Grill (CMG), in the ninth week of a constructive, 14.7% deep base, shows ’11/’12 Street estimates of 20%/23%, rising institutional sponsorship in recent quarters, strong accumulation, and a potential entry above the 4/6 high of 282.

United Rentals (URI) and Brigham Exploration (BEXP), both mentioned in our last report with potential entry points, did cross those entry points, but on weak volume, nullifying the entry.

Rackspace Hosting (RAX), also mentioned in our last report, did cross its suggested add-on, or second tier, entry point on strong volume, and would still be a hold.

Names that have held up well, and therefore represent some of the top leadership, if extended, include Shutterfly (SFLY), (PCLN), Ulta Salon (ULTA), Fossil (FOSL), Rightnow Technologies (RNOW), Valeant Pharmaceuticals (VRX), Mercadolibre (MELI), Jazz Pharmaceuticals (JAZZ), Calix (CALX), Under Armour (UA), Opentable (OPEN), and Accretive Health (AH). We would not chase any of these until attractive entry presents itself.

The coals, like Peabody (BTU), Walter Energy (WLT), and Arch Coal (ACI), broke down last week, as did the oil & gas explorers, including Georesources (GEOI), and Approach Resources (AREX).

Other breakout failures included Stratasys (SSYS), Polycom (PLCM), and Three D Systems (TDSC).

In summation, a market that had gone straight up since the Mar 16 lows, with 12 up days in the last 15, is taking a deserved breather at a logical point coinciding with the February peaks, the last notable highs of the averages. The speculative growth stock glamours act well, generally, and it is this behavior that heartens. Too, the rich relative strength of the retailers over the past month shows no signs of abating, suggesting that recent sogginess in the oil patch is not indicative of a referendum on the expansion in toto. There are some, but not many, pattern setups in the glamours.

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