The Gilmo Report

February 18, 2018

February 17, 2018

After six straight up days coming right up from the lows of two Fridays ago, the NASDAQ Composite Index finally backed down on light volume Friday. At this stage we now want to see if and how it consolidates the prior reaction rally. This could occur on a pullback to and test of the 50-dma, or the index could simply hold tight sideways as the 50-dma catches up.

Other alternatives, all of which are plausible, would be a nasty reversal back below the 50-dma, or a continued melt-up back to the prior highs. But no matter how you slice it, the sharp move off the absolute lows has been quite surprising as it has been accompanied by a number of busted leaders moving right back to the upside. It’s as if the sharp break off the peak merely pulled on a rubber band attached to their backsides, and once it had stretched far enough it was released, sending stocks snapping right back to the upside.

 

GR021818-$COMPQ

 

The S&P 500 Index cleared its 50-dma on Thursday, one day after the NASDAQ’s fourth-day follow-through, but stalled and reversed on Friday on higher volume. However, it held above the 50-dma, so remains in a constructive position. As with the NASDAQ, we want to see the index hold the 50-dma and perhaps move tight sideways along the line.

 

GR021818-$SPX

 

Gold is currently a mirror-image of the dollar, as the yellow metal bumps up against its recent highs and the dollar bumps up against its recent lows. As interest rates rise, and those who worry about such things are forecasting four Fed interest rate increases in 2018, it’s clear that the market is looking for rising inflation. Otherwise, higher interest rates would drive the dollar higher, as I see it.

The SPDR Gold Shares (GLD) is still trying to break out in decisive fashion, and sits in what appears on the chart as the handle of a cup-with-handle formation extending back to early September. As I wrote back in late December, I was looking for gold to shine in 2018, but I must admit for all the wrong reasons. At that time, I felt that continued low interest rates and a still-necessarily accommodative Fed (after all, you can’t taper a Ponzi Scheme) would result in continued devaluation of the dollar and hence higher gold prices.

What has happened is that we are now looking at de facto higher interest rates that are being raised by the bond markets, not the Fed, in anticipation of rising inflation. Since gold is typically seen as a hedge against inflation, it is rising as well. But, as I like to say, a rally is a rally, and if the technicals line up well enough to play it, then the underlying reasons for a rally are less important. Play it as it lies!

 

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The story of this current market rally is told by the chart of Apple (AAPL), which typifies the action seen in the majority of stocks. Big v-shaped rallies right off the lows of two Fridays ago are now a staple chart pattern, and the velocity of these rallies mimics the action of the indexes. In the case of a big index stock like AAPL, it creates the action of the indexes, along with all its cohorts that are rallying in the exact same manner.

I’ve been asked by many what causes this. Was the sell-off deliberately orchestrated (read: manipulated) to shake everyone out, take their stock, and send the market back to the highs? I tend to think that this is the Age of the Machine, and algo-driven computer trading is behind much of the pile in, pile out, and then pile back in action that we see.

Once these machines get moving in one direction, it seems that they develop a certain level of momentum that sustains itself until the machines’ programming begins to look at an oversold condition as a reason to buy. This is, of course, just a theory, since we can never know for sure, but it is a phenomenon that has given rise to my Ugly Duckling Principle. The best buy signal is usually the ugliest-looking sell-off you could care to see.

In the “old days,” such action meant that the market’s foundation was crumbling, and that more deleterious action was in store. Today, it’s as if the market was suffering from a bout of binge drinking, which it cures by throwing up all over the place. Once it’s done, it’s ready to start drinking again! And so, it just heads back to the upside. That, my friends, is probably the best analogy for this market, based on what we’ve seen over the past 2-3 weeks.

 

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This tendency to suddenly throw up is also embodied in the idea I like to talk about all the time regarding this market’s tendency to suddenly pull the rug out on investors. It does so swiftly, and can often catch slower-moving investors by surprise.

Twitter (TWTR) is consolidating its prior move back up to the current range highs and the highs of its buyable gap-up day that occurred seven trading days ago. The 10-dma is starting to catch up to the stock and is now at 30.38, so that would be my reference for a pullback that might provide a more opportunistic entry. If the stock decides to act more orderly (and this might depend on what the general market does from here), then look for support along the 32 price level.

 

GR021818-TWTR

 

Snap (SNAP) somewhat resembles TWTR in that it is also moving back up to the range highs defined by the peak of its own buyable gap-up day of two Wednesdays ago following earnings. The 10-dma is moving up rapidly and is now at 18.38, so that would provide a reference for any opportunistic entry on a pullback to the line as it rises to meet up with the stock.

 

GR021818-SNAP

 

I view both TWTR and SNAP as potential big-stock leaders IF we see this market do the improbable. And that would be a continued market rally following last week’s brutal correction in so many leading names. Both stocks were counter-trending the market correction as they broke out to higher highs, with TWTR posting new two-year highs.

In addition, both stocks represent resurgent names in an area of the economy, social-networking, that remains at the cutting edge of many areas as it expands into new methods of distributing news and information, entertainment, and other content.

Facebook (FB), which is now the surprising laggard in the social-networking space, admittedly looks like it could be a short here as it tries to hold above four primary lows in the pattern. On Friday it dipped below the most current low at 177.74, but that low may not be as relevant as the mid-January low at 175.80. Undercut & rally moves generally work best when they undercut a more established low where the stock has held for a few days as opposed to just one day, which is what the early February low at 177.74 was.

Meanwhile, the initial U&R move at the first low and the 200-dma is still in force. I would watch for a decisive move above the 50-dma as a clear sign of potential recovery, although the stock remains in a buyable position using the 175.80 price level as a selling guide. Of course, I would not fixate so much on FB since the clear social-networking leaders right now are TWTR and SNAP, but FB might also join the party since it has been basing for over three months.

I have thought that one of the things working against FB is the fact that it is so widely owned, but a three-month-plus base could help to shake out old money and help bring in new money, setting up a better upside move from here.

 

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The three strongest-acting big-stock NASDAQ names, in my view, are Netflix (NFLX), Nvidia (NVDA), and Amazon.com (AMZN). All three stocks have held up and recovered better than their cohorts, including names like Microsoft (MSFT) and Google (GOOG). The latter, in fact, looks like a short at its 50-dma, but I’ll let readers investigate that chart on their own. You’ll also notice that NFLX, NVDA, and AMZN all look the same on their charts.

Netflix (NFLX) has recovered back to its highs after posting an undercut & rally maneuver at the prior late January buyable gap-up (BGU) lows and the prior low at the 20-dema in early February. It held tight near the highs on Friday as volume receded, and looks like it might want to form a mini-cup-with-handle here. I’d look for pullbacks to the 10-dma as more opportunistic entries. What I might look for is some sort of pullback in the NASDAQ Composite in the coming days that would help create that sort of pullback.

 

GR021818-NFLX

 

Nvidia (NVDA) is also back near its prior highs, although the pattern doesn’t seem as well-rounded as NFLX’s. But the concept remains the same, as I would look for a pullback to the 10-dma or the 20-dema, which is tracking just above the 10-dma, as references for buyable pullbacks. NVDA posted a strong earnings report along with increased guidance last week, and as long as it doesn’t pull some sort of double-top here it looks like it could set up and go higher. And that of course depends on how it sets up from here.

As Bill O’Neil used to tell me, every cup-with-handle starts out looking like a “double top.”

 

GR021818-NVDA

 

Amazon.com (AMZN) completes a wolfpack of strong-acting big-stock NASDAQ names as it consolidates near its prior highs. As I’ve pointed out in previous reports, the big-volume support at the 50-dma is constructive, and the stock moved higher from there over the next four days as volume remained above average. That’s what a leader does, in my view. As with NFLX and NVDA, look for pullbacks to the 10-dma as potentially lower-risk entry opportunities.

 

GR021818-AMZN

 

I don’t know, and frankly I don’t care if this correction is over, because if it isn’t, we’ll see all these v-shaped rallies and recoveries in individual stocks roll over, and if we use the 20-dema or 50-dmas as selling guides, we shouldn’t get into serious trouble.

In addition, the objective, concrete action of two Fridays ago represented a big undercut & rally move that was playable on the long side for nimble traders. And members were advised of this possibility in my blog post of Thursday evening the day before it occurred!

Now, with the NASDAQ having posted a follow-through, which in my view tends to come late in the bounce, we are looking around to see where the next big upside legs will come in individual stocks. And for that, my tendency is to go with the strongest leaders that held up the best during the correction, or which are recovering strongly and may begin to set up again.

I don’t have to be in a big rush trying to buy every v-shaped rally off the lows. One or two, even three, can provide some nice swing trades off the lows, at which point one can back off a bit and see how the dust settles and where the new set-ups emerge.

Weight Watchers (WTW) looks like it wants to blast to higher highs as it consolidates tightly near its prior highs, just before it backed down to the 10-dma during the sharp market correction. The stock actually posted a new closing high on Friday, but volume was light. It may track sideways for a bit longer as the 10-dma catches up, so for now I’d be looking for any kind of pullback to the 10-dma as a potential lower-risk entry from here.

 

GR021818-WTW

 

Since we did not see the NASDAQ sell-off until Friday, Tesla (TSLA) never became shortable as it just kept moving higher with the market. On Friday, however, it got as high as its 200-dma, clearing the line early in the day before reversing to close below the line on about average volume. The reversal coincided with the NASDAQ losing momentum after six-straight up days.

This can be viewed as a short here using the 200-dma or Friday’s high at 343.12 as your stop, but I’d want to see conformation of weakness in the form of a break below the 50-dma, where TSLA found support on Friday. This remains one of my go-to shorts just in case this market rally fails.

GR021818-TSLA

 

After working well as a short during the market correction, Square (SQ) has since worked as a recovery long, even if surprisingly so. But in my last two reports I have discussed the possibility of playing this as a two-side swing-trading situation. The first occurred as the stock posted a U&R but failed to clear the 50-dma. However, once it cleared the 50-dma we shift our view from short to long and go with the moving-average undercut & rally (MAU&R) as it unfolds in real-time.

On Wednesday, I wrote that one could first play it as a possible short at the 20-dema after it rallied up to the line, but that, “If the stock can clear the 20-dema, then it may make a run for the late January highs ahead of its expected earnings report on February 27th.” And that’s what it did on Thursday as it posted a pocket pivot at the 10-dma and 20-dema. On Friday, the stock held right as it runs into some resistance along the prior highs.

 

GR021818-SQ

 

On the weekly chart, we can see that SQ is forming a cup-with-handle with a two-week handle that is quite jagged, or what might be termed “wide and loose.” However, this is mostly a function of the steep and sharp market correction, and reminds me of the cup-with-handle that stocks like America Online (AOL) and Schwab & Company (SCHW) formed in October of 1998 when we saw a very sharp and steep market correction. So, while this might look a bit volatile and improper, there is a good reason for it, and that would be simple market context.

Also, recall that a couple of weeks ago I compared SQ to SunPower (SPWR) in 2007. I still think that analogy could hold up, but we must remember again that market context will play a big role. In late 2007, the market was topping for good ahead of the great financial crisis and bear market break of 2008, and so SPWR came apart during that bear market.

If the general market continues to move higher in 2018, SQ could easily avoid a major breakdown and simply continue higher as it maintains its leadership status. One can always investigate possible precedents, but I find that this is less effective than simply interpreting the real-time price/volume action and going from there rather than blindly assuming something will follow this or that example from the past.

 

GR021818-SQ Weekly

 

Alibaba (BABA) has pulled into its 50-dma following a prior MAU&R move up through the line. This would bring it into a lower-risk entry position using the 50-dma as a tight selling guide.

SolarEdge Technologies (SEDG) had been removed from my long watch list several weeks ago, and it steadily declined after that. More recently, the stock undercut a primary low in its base at the time that the general market was bottoming out two Fridays ago. That turned into a U&R move, but with earnings coming up this past Thursday, it wasn’t all that appetizing to play. After earnings, however, SEDG, posted a massive-volume buyable gap-up (BGU) move to all-time highs. I don’t know if any members saw that buyable gap-up, as it was actionable Thursday morning.

Those armed with a knowledge of BGUs and how to implement them might have been able to act on this, and the stock developed some nice momentum throughout the day, closing near the peak of its range.SEDG stalled out a little on Friday, and from here I’d be interested to see how it retests the BGU low, way down at 41.50. A 50% retracement down to 43 or so might provide a lower-risk entry. What impressed me most about SEDG’s earnings report was the three-quarter acceleration in earnings and sales growth.

Over the past three quarters, earnings growth has gone from 25% to 43% to 166% while sales growth has from 9% to 30% to 70% in the most recent quarter after the company had previously posted negative earnings and sales growth.

 

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The recovery in SEDG leads me to wonder whether we’ll see anything similar from beaten-down former solar leader First Solar (FSLR) when it is expected to report earnings on February 22nd. The stock was looking great in early January as it broke out from a short base, but that breakout failed after the Trump Administration announced new solar tariffs. The stock then became a short at the 50-dma and 20-dema, per my discussions in my reports at that time.

Last Friday, FSLR found support along the top of a prior base structure, and has since rallied six days in a row off those lows as it has edged up to the 20-dema on light volume. I would keep FSLR on your radar, perhaps watching for a U&R move back up through the prior 62.20 base low as a trigger for a long swing-trade ahead of earnings. I’ve noticed recently that other U.S. based solars like SunPower (SPWR) and Sunrun (SUN) have been rallying off their lows.

 

GR021818-FSLR

 

MuleSoft (MULE) also posted a big-volume buyable gap-up after earnings Thursday after the close, rocketing higher on Friday and closing near the peak of its daily price range. The intraday low was set at 28.51, and the stock closed 8% above that at 30.81. Watch for any pullbacks closer to the 28.51 level as lower-risk entry opportunities. Notice also that the left-side peak on its big, nine-month long base is at 29 even, which might also represent a support level.

What is interesting to me here is the fact that this breakout occurred on massive volume, the largest one-day volume in the stock’s history by a wide margin, as it comes out of a long base. Remember, the longer the base, the more developed the “launch pad.” And this BGU occurring early in this relatively recent IPO’s lifespan, so it has a good chance at developing into something substantial. Of course, that doesn’t guarantee it will, but I find that the best BGUs tend to occur when a recent IPO breaks out of a long base formation.

 

GR021818-MULE

 

Lumentum Holdings (LITE) has finally retaken its 200-day and 40-week moving averages after reporting earnings two weeks ago. Previously, the 200-dma had represented stiff resistance for the stock, but it recently cleared the line on a bottom-fishing pocket pivot move.

I’ve previously discussed LITE as a strong thematic play in the 3D-sensing space, which is projected to be a huge market going forward, and the company confirmed this in its recent earnings report when it reported big, turnaround earnings growth of 193% on sales growth of 53% vs. prior negative earnings and sales growth numbers.

Nimble traders could have picked this thing up off the lows as it came up through the 50-dma over a week ago, yet the market was in the throes of a big correction at that point. But notice that LITE has put in three waves to the downside in a three-month base, with big weekly volume support off the lows of the last two waves. For this reason, I am far more comfortable with the stock as it clears 20-dma and 40-wma on its daily and weekly charts.

Back when I was at O’Neil advising institutional investors, we had a rule whereby a big weekly-volume move back up through the 40-week line was a strong turnaround buy signal. So, I view this as buyable here using the 40-week line at 56.21 as a tight selling guide. Pullbacks to the line, or the 200-dma at 56.07 would offer lower-risk entries.

My view is that if the 3D sensing theme is for real, the stock will eventually break out and begin a significant new up leg, and I am willing to be patient and let that set up. Thus, the first reliable, longer-term entry strikes me as being right here along the 200-dma and 40-wma.

 

GR021818-LITE

 

For newer members: Please note that when I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple (the magenta line), 20-day exponential (the green line), 50-day simple (the blue line) and 200-day simple moving average (the red line). On rare occasions, I will also employ a 65-day exponential moving average (thin black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

Is the current move off the lows of two Fridays ago just a reaction rally, or another big shakeout that will be followed by a move to new highs, something that has been a trademark of this QE market for some time now? Frankly, I have no idea. But what I’m looking for are those stocks that might become big leaders IF we see a breakout to new market highs that results in another significant upside leg. If not, then we will see things break down as the indexes drop back below their 50-dmas, and all we need to do is remain mindful of our selling guides to stay out of trouble.

Meanwhile, I do note that many of the patterns on the weekly charts show one big week down followed by one big week up, sometimes to new highs, and that can be a cautionary sign. But I think the prospects for a more sustained market rally from here will depend on how things set up over the next few days, maybe a little longer. Meanwhile, I am interested in those leaders showing the best action lately, as I believe leading names that shake out weak hands likely have the best chance of moving higher from here.

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 no positions, though positions are subject to change at any time and without notice.

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