The Gilmo Report

February 1, 2016

January 31, 2016

Later in the day on Thursday later in the day I put out a blog post discussing the fact that I was seeing action that appeared to be setting up a “Wyckoffian” low in the major market indexes based on the successful pullback and retest of the January 20th. The January 20th low also has the bullish characteristic of closing well up and off of its intraday lows and near the peak of the intraday price range on very heavy volume.

The Wyckoffian low was then confirmed the very next day on Friday when the indexes jacked to the upside in a big “follow-through” day. In my view it was enough to identify the Wyckoffian low on Thursday, but I suppose the follow-through day on Friday just serves to put the icing on the cake of my Thursday call. On the other hand, given the track record of follow-through days in this market, let us hope that it doesn’t “jinx” it! ;-p Nevertheless, Friday’s action was quite impressive as the major market indexes across the board launched on huge upside moves. Leading the pack was the “risk-on” small-cap Russell 2000 Index, not shown, which posted a very sharp 3.2% upside move in, not shown.

The NASDAQ Composite Index popped 2.38% on higher volume, producing the textbook follow-through day exactly one day after the Wyckoffian low and on the eighth day of the rally attempt. I count the close near the upper part of the daily trading range on January 20th as the first day of the rally attempt, making Friday’s action an eighth-day follow-through. One could also see it as a seventh-day follow-through, but it makes little difference.

 

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If we take all the evidence in summation and at face value, the only conclusion that can be reached is that the market is indeed in rally mode. That said, the main task at hand is in finding the right stocks to play if the rally has legs. For now there is no reason to assume that it does not until evidence to the contrary is forthcoming. This report will focus on the stocks that may serve as potential upside vehicles in any sustained rally from here.

At the very least I would not be looking to stand in the way of the rally by shorting stocks willy-nilly in aggressive fashion. We would need to see the rally fail in order to bring the short side back into play. As well, most of our short-sale target stocks are so far down in their patterns that they have plenty of room to move higher before running into any areas of real resistance.

We can let that play out while, and see if, when, and where any of these stocks rally and then fail at some point. I might also add that in some cases and especially if one is highly enterprising and nimble as a trader, one can try and play these logical reflex rallies in short-sale target stocks on the long side for as long as they can carry higher.

The S&P 500 Index’s follow-through can be seen in its daily chart, below, but we might also notice that it has the look of a “deep doo-doo” type of bottom-fishing pocket pivot. The index popped up and off of its magenta 10-day moving average on volume that was higher than any down-volume in the pattern over the prior ten trading days. Perhaps this is yet another piece of evidence helping to confirm that we may have an at least playable rally on our hands.

 

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Looking back over the entirety of what was a very interesting week for the market, we can see that the turn in the market was perhaps first hinted at by a follow-through in the Dow Jones Industrials on Tuesday. But as I wrote in my Wednesday mid-week report the fact that it occurred in the narrowest of the major market indexes made it suspect and perhaps more indicative of a move by institutions to a more defensive posture.

Wednesday’s action appeared to confirm that suspicion, but the Wyckoffian low on Thursday combined with Friday’s broad follow-through action in (including a “DDD BFPP” in the S&P 500!) every other index was far more meaningful. Given that the strong action was seen across the board, and especially in the small-cap Russell 2000 Index, speaks well of the breadth behind this current attempt at a market turn.

On top of all this, there is also the unusual wrinkle that in the very same week we saw an initial follow-through fail the very next day we also saw a second, much broader follow-through that appears more legitimate.Are we at the cusp of a bold new bull phase where stocks will trend steadily higher, enabling traders and investors to make big money?

The only realistic answer is that we cannot know for sure, all we know for sure is what we see in real-time. And that includes not just the action of the general market indexes, but, more importantly, what is going on with individual stocks.

There are hardly any “quality stocks” breaking out of “sound bases” coinciding with Friday’s bit follow-through, and most stocks are coming up from positions within potential new bases. Facebook (FB) can be seen as an exception since it has broken out to all-time highs. The stock gapped up to its prior highs on Thursday after an impressive earnings report on Wednesday.

At first, as the stock appeared to find resistance along the prior highs as I’ve highlighted on the daily chart, below, I thought the gap-up might turn out to be shortable. But, as is often the case, the persistent bid underneath the stock as it pulled back early in the morning started to take control, and in my view that was not very difficult to feel, much less see.

 

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By Friday, FB cleared the highs of its prior base on heavy volume, and it remains within buying range of the breakout. The only issue is that it is coming straight up from the bottom of its base, and would seem to me to be in need of a pullback and retest of the breakout. If I’m looking to buy the stock, that might be something to look for, although technically the stock is within buying range of the breakout through the prior 110.65 high.

Microsoft (MSFT) is perhaps more representative of what we’re seeing in individual stocks. The stock gapped up strongly following its after-hours earnings report on Thursday, opening up on Friday just above the 50-day moving average. This can be treated as a buyable gap-up using Friday’s intraday low at 54 as a selling guide.

The 50-day moving average is also nearby at 53.98, so risk can be controlled quite well. I note that a number of top-rated funds have taken big positions in MSFT over the past couple of quarters, and one could argue that money flowing out of Apple (AAPL) could be finding its way into MSFT and FB.

 

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Speaking of Apple (AAPL), the stock came within 39 cents, or a little over 1/8th of a point, as we used to say in the old days, of its 92 low of August 24th and the now infamous Capitulation Monday event. This also represented an undercut of the low of eight trading days ago on the chart, triggering a logical undercut & rally move that occurs in synchrony with the general market. Pundits and some analysts are still trying to find a way to stay positive on this greatest of all “must-own sure-thing” stocks by now referring to it as a “dividend growth” play.

Okay, the dividend part I understand, but I don’t see the growth side of that equation when AAPL is expected to post 3% earnings growth in 2016, and 10% in 2017. But who knows for sure. The huge selling volume on the gap-down move on Wednesday following earnings the day before might represent a short-term washout for the stock, triggering a normal reaction rally on strong volume within what is still an overall bearish formation.

Translation: I think I’m done shorting the stock for now, and it’s now a matter of watching to see how the stock rallies from here and whether a new short-sale re-entry point emerges in the process.

 

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Amazon.com (AMZN) has had a clear pattern of gapping up following earnings over the past year, something I’ve noted in previous reports during 2015. The stock finally broke that pattern on Friday by gapping down hard following its Thursday after-hours earnings report. During the regular trading session on Thursday the stock was rocketing higher in a big pocket pivot type of move as it approached its 50-day moving average. But the stock blew its wad and gave it all back on Friday, although it did manage to end the week relatively unchanged.

We can also see that the stock closed near the peak of its intraday gap-down price range on volume that was even heavier than the huge volume seen on Thursday.  So while the stock did gap down on heavy selling volume, it was finding support off the lows of the day as buyers stepped up to meet sellers at that point. It’s difficult to say what one should do with the stock either way, and my preference would be to wait and watch to see how things develop from here.

If the general market continues to rally, AMZN could recover, and it is a matter of watching for the precise price/volume clues that might indicate such a recovery is at hand.

 

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Alphabet (GOOGL) is the next big-stock NASDAQ name that is on deck for its own earnings report which is expected Monday after the close. Like AMZN did on Thursday before its earnings report sent it gapping to the downside, GOOGL rallied strongly on Friday, one trading day before its expected Monday report. That rally was strong enough to propel the stock back above its 50-day moving average on heavy buying volume. GOOGL’s action on Thursday and Friday qualified as a pair of five-day pocket pivots.

As long-time members know, I generally consider clusters of five-day pocket pivots to be positive clues. But it is important that these five-day pockets come in clusters to have any validity in comparison to a standard ten-day pocket pivot which only needs to show up on a single day to be considered valid. Obviously, I’m not going to try buying this and playing “earnings roulette” on Monday, but it might be watched for a buyable gap-up similar to what it had the last time it announced earnings back in October 2015.

 

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In the “old days” when we would see a big follow-through day like we did this past Friday, there would usually be a reasonable number of stocks breaking out of bases. That doesn’t happen so much anymore, as the distorted QE market functions somewhat differently in this regard. One has to be quite creative to find viable long trades, but they are there if one has the technical tools and methods to find them.

In a Friday blog post I discussed the concept of using Wyckoffian retests as ways of buying Ugly Duckling situations, and I mentioned a number of names that were in such positions. Some were uglier than others, but most have some element of ugliness to them. Given the way so many stocks have been beaten down, my usual Ugly Duckling techniques, which include things like bottom-fishing or roundabout pocket pivots deep within bases and voodoo pullbacks, were not sufficient. It is at this point that my studies of the works of Richard D. Wyckoff come into play and I am forced to additionally engage the creative use of the Wyckoffian retest/low.

First Solar (FSLR) perhaps combines all of my Ugly Duckling methods, as it was first buyable along the 50-day moving average over a week ago, as I first discussed in my January 20th report. At that time FSLR was retesting its 50-day moving average and finding support along the line, which in my view brought it into a lower-risk buy position. That was followed by a move back above the 20-day moving average and subsequent low-volume retests of the 20-day line provided additional, but higher, entry points.

I mentioned FSLR as a buyable situation on Thursday as it was sitting along the 20-day line, and by the close it showed decent supporting action off the line. On Friday it moved to higher-highs as it moves into the gap-up “rising window” it had in early January. Earnings are expected towards the end of February.

 

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SolarEdge (SEDG) has continued to hold up well along its 200-day moving average, even in the midst of sharp sell-offs that hit the market several times this past week. On Thursday SEDG posted a pocket pivot at the 200-day line after finding support just below the line and then rallying with the market.

By the close on Thursday the stock was back up in the upper half of its daily trading range. SEDG had previously showed strong supporting action on the pullback to the 50-day moving average earlier in January, as I discussed in my January 20th report. To its credit, the stock has managed to rally throughout the second half of the month even as the general market was making lower lows.

 

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Earnings are expected to be announced on Wednesday of this coming week, so it may not do anything until then. It does bear watching for any buyable gap-up that might develop. SEDG is still deep down in its pattern and well off of its 43 price high of last June. The longer-term daily chart below gives us a better picture of where the stock lies within its macro-pattern, and we can see a clear recovery and attempt to come back up the right side of what could develop into a big cup formation.

Even if this were to develop as some sort of Punchbowl of Death or POD formation, it would still imply that a move back up to the highs at 43 is quite possible. That will likely depend on how much of a rally the general market is able to muster following Thursday’s Wyckoffian low.

 

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With FSLR and SEDG acting well, I keep an eye on the other names in the group for clues of a turnaround as well. Sunpower (SPWR) is in a less orthodox position in its pattern, but we can see how the action over this past week was also a type of Wyckoffian low similar to what the general market put in. In this case you have the stock undercutting a December low eight days ago in conjunction with the general market low on January 20th.

The action over the prior five days before this past Friday was essentially a short consolidation as the stock retested its 10-day moving average on Thursday on light volume. I actually bought the stock on Thursday at the line, looking to trade it up to the 50-day line. It cooperated reasonably enough, moving right up to the line by the close on increased but just about average volume.

 

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Among the solars I still tend to think that FSLR and SEDG are the best situations in the group, and so far their action proves that out. That doesn’t mean however, that some opportunistic short-term trades on the long side won’t develop in other names in the group. I would also note that Solar City (SCTY), not shown, looks similar to SPWR, while another rooftop solar installer, Sunrun (RUN) has moved back above its 50-day moving average.

Both SCTY and RUN are trying to recover after coming under severe pressure after the State of Nevada Public Utilities Commission moved to raise rates for customers with rooftop solar systems. This past week the Nevada PUC voted to extend those rate increase over the next 20 years, which took some of the pressure off, and now it is a matter of seeing how these stocks are able to develop from here with earnings expected for each over the next couple of weeks.

 

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The solar camp is more or less divided between large-scale solars like FSLR and SPWR, while the residential/rooftop installer side of the market is being buffeted about by an alternating, positive and then negative news flow. Initially, we saw all the solars gap-up sharply on news that House Republicans had come to an agreement on extending solar tax credits out to 2019, but only the residential/rooftop installers have been hurt by the news coming out of the Nevada PUC.

This makes for some interesting dynamics among all the different names, while SEDG seems to side-step much of this as a solar-converter/storage play. I say keep a close eye on this group, as it shows some promise among certain names, while others can be watched for possible recoveries, particularly as they begin to report earnings.

 

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CyberArk Software (CYBR) is an example of creative trading. In this case we see a stock that initially gapped up on talk of the company being bought out by Check Point Software (CHKP), but has since slid back below its 50-day moving average on low volume. Looking at this Thursday after the close, I noted that the stock had just filled its prior gap-up rising window, which could serve as potential support. As well, the stock looked to be engaging in a retest of its early January low on volume that remained quite low all the way down.

I also noted that fellow cyber-security stock Fortinet (FTNT), a brutally beaten-down name if there ever was one in this market, was gapping up after announcing earnings after the close on Thursday. On Friday morning CYBR held steady for a short while before taking off on the upside and clearing its 50-day moving average on a five-day pocket pivot move. To me this was a nice day-trade, and yielded a 9.33% upside move by the close.

If this thing can hold the 50-day line from here, it might be viable as a comeback cyber-security name. Earnings are due out on February 11th, so until then it may have some further upside from here.

 

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So when there isn’t much in the way of breakouts following a turn in the general market, one resorts to more creative and cutting-edge methods rather than rely on standard-issue base breakouts to provide the all-too obvious buy points. Given the dearth of roundabout and bottom-fishing pocket pivot types of set-ups, these odd Wyckoffian low/retest set-ups are mostly what I’m seeing here and which I am willing to play, even if only for some decent short-term long trades.

GoDaddy (GDDY) is another Wyckoffian low/retest after bottoming out right at its newly-appeared 200-day moving average and was mentioned in my blog post of Friday morning. A low-volume pullback on Wednesday that saw the stock gingerly retest its 10-day moving average was constructive and served as the proper Wyckoffian retest. By Friday GDDY was moving higher on strong, above-average volume, and just missed qualifying as a valid 10-day pocket pivot move through the 20-day line by one day.

So again we have a situation where a low is made, this time at a logical area of support at the 20-day line, and the ensuing bounce results in a barely perceptible pullback and retest along the 10-day line that leads to higher highs. While it’s not clear to me that I’d want to be buying the stock after Friday’s strong move, it is a nice case study of a typical Wyckoffian retest/low type of set-up.

 

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After looking like a flake out on Wednesday, Starbucks (SBUX) fooled me quite nicely by bouncing right back to the upside over the next two days to retake its 50-day moving average. What made this subject to some solid misinterpretation on my part was the fact that following the pocket pivot of six days ago on the chart the stock pulled back on above-average selling volume. Normally, what I want to see is volume drying up in voodoo-style as the stock constructively consolidates following the pocket pivot.

Thus the price/volume action ends up fooling me while offering proof that no method or technique is absolutely 100% fool-proof! In any case, what we now have in SBUX is a trendline breakout on above-average volume, which can be considered buyable using the 50-day line at 59.92 as a guide for a tight downside stop.

 

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Carnival Cruise Lines (CCL) and Royal Caribbean Cruises (RCL) turned out to be two of the last playable short-sale set-ups that I’ve discussed in recent reports. Of course, with the general market and most stocks deep down in their patterns, there was very little in the way of fresh short-sale set-ups. Both worked out well and in textbook fashion as both reversed at their 200-day moving averages and headed lower over the past several days.

Both stocks then, and in tandem, undercut their respective lows from the week before, hitting my short-term downside price targets for each. It was a fairly simple matter to take profits in either or both, and then stand aside. From here perhaps rallies back up into the 200-day line might present new short-sale re-entry points. But whether they would work on the short side would depend on whether such rallies fail in conjunction with a general market rally failure.

 

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Netflix (NFLX) may be reaching a point from which a possible reflex rally becomes a reasonable probability. We can see on this longer daily view below that it is currently undercutting its September lows while remaining above the 85.50 low of August 24th. The stock could not muster even a small rally on Friday as the general market rocketed higher, which obviously doesn’t speak well for the stock.

On the other hand, NFLX is some 35-40% below its early December peak at 133.27, and is getting a bit long in the tooth on the downside. Therefore I would not be surprised to see the stock spring back up towards the 200-day line in a continued general market rally.

 

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Southwest Airlines (LUV) gave us one last little burst to the downside as a short-sale play from the 200-day moving average last week, as I discussed in my reports at that time. Here we see the stock undercutting its September and October lows as it gets deep down within its pattern. In my view, this sets up an undercut & rally move, which is exactly what we saw on Friday as the stock rallied on strong, above-average buying volume.

I would also note that other, larger airlines that have been under pressure lately, such as Delta Airlines (DAL) and American Airlines (AAL) have undercut prior lows within their patterns, so the group movement appears to be in synchrony.

 

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With beaten-down airlines names attempting to pull undercut & rally moves this past week, I have to wonder whether a bounce in the group will bring some of the better names in the group back into the limelight.

Hawaiian Holdings (HA) had an amazing move after a breakout in early October of last year which I missed entirely. One reason for that was the negative sales growth, although the company has posted very strong double-digit earnings growth before upping the ante with a 113% growth number when it reported earnings this past Wednesday. That led to a buyable gap-up type of move that ran into some selling along with the general market on Thursday.

This then set up a successful test of the 20-day moving average on Friday as the stock found support at the line on above-average volume. This can probably be tested on the long side using the 34.19 intraday low of the BGU day on Wednesday as a guide for a reasonably tight stop. Otherwise one could give it more room to the 20-day line at 33.34.

 

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McDonald’s (MCD) continues to trudge higher after initially looking like a stalled/failed breakout attempt on Monday of this past week. As I wrote in my Wednesday report, the failure could lead to a short-sale possibility. As I wrote at the time, “If the general market pushes to lower lows, I would not be surprised to see MCD fail from this current chart position, so that is something to keep an eye out for.”

The key factor that did not play out was that the general market did not move to lower lows, and instead formed a Wyckoffian low on Thursday followed by a follow-through day on Friday. That would immediately take out any possibility of MCD failing on this recent breakout attempt. Instead, MCD jacked to fresh, all-time highs on strong, above-average volume.

 

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In some ways MCD is like MSFT – a big-cap name with slow earnings growth and negative sales growth, but one which continues to show technical strength. What we conclude is that institutions are drawn to these names as stable, established big-cap situations with perhaps attractive, forward-looking stories that override some fairly putrid current earnings and sales growth numbers. In the end, price/volume action rules over fundamentals, and at this point I can’t argue with the technical action in both.

My view towards short-selling currently is probably best expressed in what I wrote in my Wednesday mid-week report: “With so many broken-down leaders deep down in their patterns one has to be fairly selective in what they try to short as the market appears to weaken again. NFLX is one name that set up nicely this week as a decent short-sale opportunity over the past several days, as did LUV, CCL and RCL. But those are now looking played out, at least on a short-term basis.

Therefore, the short side of this market is entirely off the table as we watch to see how this current market rally progresses. I do not discount the possibility that the rally could fail at some point, at which point our prior short-sale target stocks may have rallied into much more favorable and lower-risk short-sale positions within their chart patterns. January 2016 has been a good month for the shorts, but February is looking like it may be better for the long side, at least at the present moment.

From a macro-perspective, the fact is that nearly all of our January 2016 short-sale targets had undercut major lows over the past week-and-a-half. So from the standpoint of what individual short-sale target stocks were doing, they were all in position to rally as early as the prior week. And I did begin to sniff some of this out as early as two Wednesdays ago as I first discussed in my report of January 20th. Taken in total, the action on January 20th represented a bullish hint at a bottom as I discussed at the outset of this report, and the ensuing Wyckoffian low and follow-through on Thursday and Friday serves to confirm at least a short-term low.

This rally could certainly fail at some point, but we don’t know that for sure. As well, it is often the turns in the market that you have a hard time believing that end up working the best. So the key is to keep an open mind and look for long set-ups to emerge in real-time. Given that we aren’t seeing a broad swath of base breakouts or even well-formed roundabout and bottom-fishing pocket pivots upon which we act, all we can do is take what the market is giving us right now.

If the rally is able to sustain and evolve then more set-ups will become apparent, and I will be discussing anything new that I’m seeing in real-time, in-between regularly scheduled reports, on the Gilmo live blog. So for now, until further evidence to the contrary presents itself, the rally is on, so we play it that way.

 

Gil Morales

CEO and Principal, Gil Morales & Company, LLC
Managing Director and Principal, MoKa Investors, LLC
Managing Director and Principal, Virtue of Selfish Investing, LLC

 

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