The Gilmo Report

February 1, 2017

February 1, 2017

The week got off to an interesting start with futures selling off overnight on Sunday, leading to a sharp downside break on Monday. In the process the Dow Jones Industrials Index dropped just over 200 points on an intraday basis Monday, but rallied into the close to end the day down 122 points.

On Tuesday the selling continued, and a number of big-stock leaders re-tested support levels, at which point I felt the pullback could be bought into per my blog post early in the day yesterday. As I wrote at the time, my approach would be to go after big-stock leaders that had already announced earnings and which were pulling into areas of support at their 10-day or 20-day moving averages in most cases.

What I had noticed relatively early in the day Tuesday was that despite the scary-looking index action, breadth as measured by the NYSE and NASDAQ advance/decline liens was actually flat to slightly up. This divergence was a clue that the action was more typical of a “sit on it and rotate” type of day where sellers sit on the indexes but at the same there is rotation into other areas of the market.

Going after big-stock names is one way to help reduce risk in that these stocks will offer ample liquidity that assists in making a quick exit if things don’t work out. In addition, the market has been showing a predilection for big-stock names, particularly those of the NASDAQ variety.

After selling off 187 Dow points, the Dow ended the day on Tuesday down about 54 points. Meanwhile, the NASDAQ Composite and the small-cap Russell 2000 Indexes closed up on the day. This added to the overall divergent mood of the market yesterday. The net result for the day was that the Dow was now well back below 20,000 while the NASDAQ remained near its all-time highs.

As they say on those cable TV infomercials, “But wait! That’s not all!” The volatility was not over. With Apple (AAPL) gapping higher on earnings last night, the entire market was off to the races this morning on a big futures-led upside gap. The Dow rose 103 points not too long after the opening bell in what looked like a strong rally continuation in the making.

By the time the Fed came out with their first policy announcement of the New Year, however, the early-morning market rally had faded. One final upside spasm after the Fed did nothing, and even sounded like they might hold off on raising rates in March, at least as I read it, was short-lived before the indexes turned back to the downside.

By the close, the Dow managed to hold a 0.14% gain, entirely due to the price move in one of its largest components, AAPL. Meanwhile, breadth on the NYSE was negative, even as the Dow and the S&P 500 were up. This contrasted with yesterday’s action where the indexes were down but breadth was up. The net result was a big churning and stalling day along the 10-day and 20-day moving averages on higher trading volume. On its face, this looks a bit negative, especially when you figure in that the Dow has now failed on last week’s Dow 20,000 breakout.

 

GR020117-$INDU

 

The S&P 500 Index, not shown, looks similar to the Dow, but it is holding right at the top of its prior six-week price range. It does, however, sit at the precipice of a breakout failure.

The NASDAQ Composite Index held up and outperformed all day long, thanks to AAPL, but breadth ended the day barely positive. By the close, the index ended the day below where it began on much higher volume. On its face, this is churning and stalling action near the peak.

 

GR020117-$COMPQ

 

The Russell 2000 Index, which had diverged to the upside yesterday with the NASDAQ, diverged to the downside today. While the big boy indexes all closed up on the day, the Russell closed down on heavy volume in a reversal off of its early-morning highs.

 

GR020117-$RUT

 

In addition to the Fed policy announcement, the other big news of the day was Facebook’s (FB) after-hours earnings report. As I write this afternoon, the stock is up just over 1% and is trading around the 134 price level after gapping up to 137 or so earlier in after-hours trading. Obviously, this is a rather tepid move, and won’t qualify as a buyable gap-up (BGU) tomorrow morning if it opens at 134.

Keep in mind that a weak open in FB tomorrow could be a two-sided affair, since the company didn’t beat earnings by a huge margin. So while it could certainly turn out as an actionable BGU tomorrow, should it fail it could morph into something quite different. For now, it’s just a matter of seeing how it acts tomorrow, but so far the after-hour action looks quite weak.

 

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I pointed out Apple (AAPL) as a buyable gap-up this morning in my first blog post of the day as the stock was trading just above the 127.70 price level. At that point the stock had set a 127.01 intraday low, putting it in a lower-risk entry at that point. Had it broken below that 127.01 low, however, one would have been quickly stopped out, so it looked like a reasonable trade to me at the time. AAPL eventually cleared the 130 price level on an intraday basis, but backed down quickly near the close to end the day at 128.75.

That resulted in a mid-range close, but technically this remains in force as an actionable BGU using the 127.01 low as a tight selling guide. We’ll see if FB can match AAPL tomorrow. Meanwhile, AAPL is flirting with its all-time high of 134.54 achieved in April of 2015.

 

GR020117-AAPL

 

Netflix (NFLX) has moved to the top of its current price range that it has been working on since posting a buyable gap-up (BGU) after earnings two weeks ago. Yesterday the stock traded volume that was -39% below average as it held tight just above its 10-day line. That made it a prime candidate on the long side after successfully testing its 10-day line the day before.

NFLX moved higher today but stalled a bit off its highs on higher volume. So it could be viewed as either stalling action off the highs, or supporting action off of the 10-day line. For now, we’ll view this positively, but a breach of the 10-day line at 139.82 might bring the 2-day line at 135.98 into play.

Technically, NFLX remains within buying range of its January 19th BGU of two weeks ago using the 138.25 intraday low of that day as your selling guide. So far the stock hasn’t made any real progress since the BGU, which could make this vulnerable to a pullback, so stay alert with this one.

 

GR020117-NFLX

 

These are my notes on the other big-stock NASDAQ leaders I’ve discussed in recent reports and which continue to lead this market:

Alphabet (GOOGL) has broken down all the way back to its 50-day moving average following last Friday’s earnings report. This breakdown has occurred on four straight days of downside volume, and now I’m looking at GOOGL as a possible short on rallies up into the 20-day line at 828.52. A broken big-stock NASDAQ leader that could be sounding an early warning here.

Amazon.com (AMZN) is expected to announce earnings tomorrow after the close so there is nothing to do here. Note that the stock has been holding pullbacks to the 10-day line so far this week.

Microsoft (MSFT) is another faltering big-stock NASDAQ leader after failing to hold its prior buyable gap-up (BGU) move. The stock has pulled right into its 20-day moving average, and a breach of the line at 63.48 could morph this into a later-stage failure type of short-sale set-up. Another warning shot across the market’s bow?

Priceline Group (PCLN) has pulled into its 10-day moving average after getting hit with some selling volume on Monday and Tuesday. Today it held the 10-day line as volume dried up, but the action was volatile as the stock swung around in a wide range. This needs to hold the 10-day line here and find support after failing on a new-high breakout attempt from Friday. Earnings are expected in mid-February.

Tesla Motors (TSLA) is consolidating after a torrid upside run in January. Earnings are expected next week, so nothing may happen before then. The stock closed below its 10-day moving average today for the first time since it began its strong upside move with a bottom-fishing pocket pivot at around the 193 price level in mid-December of last year.

Steel names look like their respective geese have been cooked currently, and both Steel Dynamics (STLD) and U.S. Steel (X) failed at their 50-day moving averages this week. I show X below which became a short-sale target this morning on the reversal off the 50-day line.

If one was alert to that, an easy entry near the 50-day line was possible after the stock rallied briefly this morning after announcing earnings last night after the close. By today’s close, X pulled a big outside reversal to the downside on heavy volume. This looks like a short to me, using any rallies back up toward the 10-day line at 32.91 as lower-risk short entries.

 

GR020117-X

 

Allegheny Technologies (ATI), not shown, remains one of the last steel names left standing, but I would be wary of getting long the stock here since a) the weak action in the group could drag it down and, b) it is way too extended from the 19.10 intraday low of last week’s buyable gap-up (BGU) move.

Caterpillar (CAT), not shown, has failed to hold its breakout of last week, which is no surprise since buying breakouts still doesn’t seem to be all that effective in this market.

In CAT’s case, the breakout attempt of last week failed on Monday as the stock slid back below the breakout point on above-average selling volume. The stock has now pulled down to its 50-day moving average, and stalled today on light volume. A breach of the 50-day line brings this into play as a short-sale target, using the 50-day line as a guide for a tight upside stop.

 

GR020117-CAT

 

If you need more examples of why I shun base breakouts in this market cycle you can take a look at optical leader Oclaro (OCLR). The company announced earnings yesterday after the close, which didn’t strike me as all that critical given that they had already given guidance in mid-January. That led to a buyable gap-up move followed by a base breakout that didn’t hold up.

This morning OCLR spun out to the downside, hitting a very brief low at 8.80 before rallying to close well up and off of the intraday lows but below the 10-day moving average on heavy selling volume. This is just sloppy action, and illustrates why I prefer in the current market to sell into a breakout after buying lower in the base. It saves one from having to endure this kind of junky action.

 

GR020117-OCLR

 

Applied Optoelectronics (AAOI), not shown, on a chart, tested its 20-day exponential moving average on Monday, and is now back above its 10-day line. I think that when it comes to this stock one has to be opportunistic, looking for pullbacks into the short moving averages as potentially lower-risk entry opportunities.

In this case, given that the stock remains well-extended from the 26.11 intraday low of its January 12th buyable gap-up move, pullbacks to the 20-day line would represent the most opportunistic entries and be less risky than trying to jump on the stock after it has had a 20%-plus move in January.

Ciena (CIEN) is yet another failed breakout and it is now right back in the thick of its prior base. Today it reversed at its 10-day and 20-day moving averages to close down and below the two moving averages on light volume. This is starting to look like a short, using the 20-day line at 24.29 as a guide for an upside stop.

 

GR020117-CIEN

 

You might also look at Finisar (FNSR), not shown here on a chart, as a possible short-sale target here as it is now living well below its 50-day moving average and has recently dipped below its lower 10-day and 20-day moving averages. If the group starts to fail, this one may do so as well.

CIEN’s and FNSR’s cousin, Juniper Networks (JNPR), also looks like it might be in play as a short-sale following last week’s shortable gap-down move following earnings. In this case this is a simple trade.  Short the stock here and use the 27.04 intraday high of last Friday’s gap-down price range as your tight upside stop.

 

GR020117-JNPR

 

If you’d like to see more failed new-high breakouts, look no further than Martin Marietta Materials (MLM), which had posted a strong-volume new-high base breakout last week. That breakout, however, has failed rather quickly, and the stock is now sitting down at its 20-day moving average.

This is either a lower-risk entry point after the failed breakout or MLM is on the verge of a late-stage base failure, which would of course morph it into a late-stage failed-base (LSFB) short-sale set-up. This could go either way, I suppose, but it does help to illustrate the difficulty investors find in buying breakouts to nowhere. This seems to be plaguing many stocks that act well one day and then fizzle out the next, and you’ve already seen some examples already in this report.

 

GR020117-MLM

 

MLM’s materials cousin Eagle Materials (EXP) has also slumped back into its 20-day moving average. In this case, however, it has not yet failed on last week’s buyable gap-up type of breakout. In fact, it has been able to hold above the 102.98 intraday low of the BGU day and the 20-day line.

This of course puts it in a do or die position, as a failure below the 20-day line would bring this into play as an LSFT short-sale set-up. These materials stocks appear to be beholden to news regarding the Trump Administration’s infrastructure policies, which may or may not be passed in their entirety.

Thus the idea of making any meaningful upside progress in these names is dependent on the news flow regarding future infrastructure projects, if any, that may result from increased government spending in this area. So MLM and EXP can be played as two-sided situations here. One could go long looking for a recovery off the 20-day line back to the upside.

Conversely, if these stocks fail to hold their 20-day moving averages, they could then be flipped to short-sale targets. This is the essence of maintaining a bifurcated approach in a market that is starting to show me some potential short-sale set-ups.

 

GR020117-EXP

 

Barracuda Networks (CUDA) illustrates that the Ugly Duckling is alive and well in this current market environment. Over the weekend I considered the stock to be looking somewhat junky and that turned out to be an apt assessment by Monday morning. CUDA blew to the downside right off the open, found support right at its 40-week moving average on the weekly chart, and then rallied sharply to close near the peak of its intraday trading range.

Yesterday the stock posted its second five-day pocket pivot in the pattern as it regained its 50-day moving average, as well as the shorter 10-day and 20-day moving averages. This action does little more than create a crazy, incoherent situation that is difficult to play. However, had one been alert yesterday one could have come into the stock as it rolled up through the 22.66 low in the pattern.

After posting a five-day pocket pivot yesterday, CUDA is now in a lower-risk buy position, technically speaking, as it sits above its 10-day, 20-day, and 50-day moving averages. Of course, the issue at this point becomes one of trust. After one watches a stock pull big, wide somersaults like this, it’s difficult to have any confidence in any long position one might decide to take in the stock. For all you know, it will quickly flip back below the moving averages, but for those willing to take the risk, the 50-day line would serve as a relatively tight selling guide.

 

GR020117-CUDA

 

It was quite interesting to see Palo Alto Networks (PANW) and CyberArk Software (CYBR), post roundabout pocket pivots yesterday at their 10-day moving averages. PANW, not shown, didn’t hold up, however, and pulled back into its 10-day moving average today on lighter volume. Technically this would put the stock in a lower-risk buy position using the 10-day line at 144.42 as a tight selling guide.

CYBR, on the other hand, was able to hold yesterday’s pocket pivot move as volume declined sharply. However, I would not chase this move. It would have been preferable to buy the stock at the 10-day line on Monday or yesterday early in the day after I discussed it in this past weekend’s report. With earnings coming up and expected on February 9th, I only see this as something I would try and trade on pullbacks to the 10-day line. This also holds true for PANW.

 

GR020117-CYBR

 

Notes on other long situations discussed in recent reports:

Alibaba (BABA) continues to hold above the 99.94 intraday low of last week’s buyable gap-up move. While the stock remains within buying range of this BGU low, pullbacks to the 99.94 level remain your lowest-risk entry opportunities.

Checkpoint Software (CHKP) remains the de facto cyber-security leader, but remains extended at this point. My preference here would be to simply lay back and see if we get some sort of opportunistic pullback down toward the BGU intraday low at 94.50 or the rapidly rising 20-day moving average at 94.13.

Clovis Oncology (CLVS) keeps moving higher and remains well-extended. So far it has held its 10-day line quite well, so I would use that as a tight trailing stop ahead of earnings, which are expected on February 23rd.

Incyte Pharmaceuticals (INCY) pushed out to a new high today on slightly above-average volume. This has been buyable on pullbacks to the 10-day moving average and is now a tad extended. Keep in mind that earnings are expected out on February 14th.

JD.com (JD) closed below its 10-day moving average for the first time in the New Year. Pullbacks to the 20-day line at 27.59 would offer lower-risk entry opportunities.

Glaukos (GKOS) posted a big-volume pocket pivot off of the 10-day moving average yesterday and held tight today as volume declined sharply. This is obviously well-extended, and it was necessary to come into the stock on the long side on Monday’s pullback into the 20-day moving average per my comments over the weekend where I said, “…I’d look for pullbacks to the 20-day moving average at 37.31 as lower-risk entries if I got them.” GKOS is expected to report earnings on March 1st.

GrubHub (GRUB) is moving tight sideways over the past five trading days and today ran into its 10-day moving average where it found minor support. This puts the stock in a lower-risk entry position here using the 10-day line at 40.92 as a tight selling guide.

Mobileye (MBLY) got hit with a downgrade today and traded down to its 20-day moving average at 42.02 where it found support and closed down a single penny on above-average volume. Pullbacks to the 20-day line remain your references for lower-risk entry opportunities. Today was one of those, so you either took shares at the 20-day line or not!

Momo (MOMO) is tracking along its 10-day and 20-day moving averages as it goes nowhere following last week’s pocket pivot off of the 10-day moving average. Pullbacks to the 20-day line at 22.,02 would offer the lowest-risk entry opportunities from here.

Netease (NTES) continues to hold along its 10-day moving average. Pullbacks to the line at 249.90 remain your references for lower-risk entries.

Nvidia (NVDA) was buyable yesterday at the 10-day line as volume dried up sharply. The stock pushed higher today to close at 113.95 as it approaches its prior highs near the 120 price level. This is now short-term extended.

ServiceNow (NOW) is holding in a four-day flag formation following last Thursday’s buyable gap-up move. It remains within buying range of this BGU using the 89.41 BGU intraday low as a tight selling guide. NOW did reverse today on about two times average volume, which is not what I would call constructive action, so take note of this.

Square (SQ) closed a dime above its 10-week moving average, which has turned down and is now at 14.26. It’s 50-day moving average lies at 13.96, so while this current pullback does bring it into lower-risk buy range, one has to decide whether to use the 10-week line or the 50-day line as their selling guide. Speaking for myself, I would opt for the tighter selling guide at 14.25, but members should make their own risk-management decision based on their own preferences.

Veeva Systems (VEEV) continues to drift along the lows of its current base and has spent the past few days below its 50-day moving average. The stock actually flashed a pocket pivot volume signature today, but remains below its 10-day and 20-day moving averages in addition to the 50-day line, so today’s action cannot be considered a roundabout or bottom-fishing pocket pivot.

Weibo (WB) acts similar to MOMO as it also tracks along its 10-day and 20-day moving averages. I would look at pullbacks to the 20-day line at 46.78 or the 50-day line at 45.98 as reference points for lower-risk entries.

In all of these stocks noted above, proper, lower-risk entries should be maintained. Do not chase strength! If the market gets into any kind of trouble and things start breaking down, buying on weakness into pullbacks to logical areas of support is the best way to minimize risk. At the same time, I have no issues taking a bifurcated approach by coming after stocks on the short side if they begin to falter. That has certainly been the case with the steels such as X, for example. Notice how this is starting to apply to certain oil names I’ve discussed in recent reports.

For example, here we can see that Diamondback Energy (FANG) has posted a couple of pocket pivots along its 50-day moving average over the past two days. This might be considered actionable on the long side on the basis of these two pocket pivots, using the 50-day line at 103.16 as a tight selling guide.

 

GR020117-FANG

 

Now let’s look at Parsley Energy (PE), which is an entirely different animal. Here we see the stock decisively cracking below its 50-day moving average on Monday as selling volume comes in at above average. At that point the stock morphs into a short-sale target as a late-stage failed-base (LSFB) set-up. Today PE rallied back up into the 50-day line and reversed on slightly above-average volume. My view is that PE is now a short-sale target, and I would look to use any rallies back up to the 50-day line at 36.09 as a lower-risk short-sale entry opportunity.

 

GR020117-PE

 

Rowan Companies (RDC) is a similar situation to PE. It also busted its 50-day moving average on Monday on strong, above-average selling volume. Not good. That was followed by what I would call a typical dead cat bounce as volume declined to below average today. This now puts RDC into play as a late-stage, failed-base, short-sale set-up. From here any kind of further, weak rally back up nearer to the 50-day moving average at 18.86 would present a lower-risk short-sale entry opportunity.

 

GR020117-RDC

 

What you can see in a number of examples that I’ve discussed in this report is that more than a few of these names are beginning to act more like short-sale candidates than long candidates. When I start to see this occur among individual stocks, I consider it an initial warning shot across the market’s bow.

It doesn’t necessarily mean that all hell is about to break loose, but it does raise my awareness with respect to potentially increasing risk on the long side of this market. For that reason, I reiterate that you want to avoid chasing strength, and instead keep your entries as tight as possible on pullbacks to logical areas of support.

At the same time, make sure you know where your out points are if a trade doesn’t work out. While it is not entirely clear to me at the present time, I am open to the possibility of a market correction, if in fact that’s what the market wants to do.  I believe that currently I have reason to be at least somewhat cautious.

Recall also that over the weekend I pointed out that the spread between the number of names on my long watch list and the number on my short watch list was getting rather high. I also pointed out that while this isn’t necessarily an outright bearish development, it can point to the fact that things are perhaps starting to look too good and hence too obvious. It is at that point that this market has shown a tendency to pull back.

For this reason, combined with my observations of the price/volume action of individual stocks, my approach is shifting here to a more bifurcated approach. Thus I begin to look at short-sale set-ups that show up in real-time as being actionable as I simply go with the set-ups.” Obviously, if they don’t work, I will be stopped out. But as I’ve discussed in previous reports, taking this approach will often naturally have me moving to the short side of the market at the right time.

However, this does not preclude taking long positions on pullbacks when the stocks come into areas where risk can be kept to a minimum. This is the essence of a bifurcated approach. But if these pullbacks don’t hold, and I am quickly stopped out of any long positions taken on this basis, then the market’s cautionary message becomes even more clear.

So pay close attention to your stocks, and consider what message they may be giving you. Is upside progress easy or difficult? Are strong upside moves or breakouts holding up, or are they fizzling? By putting the puzzle pieces together, I think it is possible to stay on the right side of this market as it has become somewhat more volatile so far this week. Take it from there.

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

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 positions in JNPR and X, though positions are subject to change at any time and without notice.

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