Editor’s note: For the first time in 319 Gilmo Reports, Gil Morales is unable to prepare today’s report due to a travel commitment. Kevin Marder has written the following report.
Today gave us five distribution days in the last 10. At best, this is a cautionary sign. At worst, when combined with the broad breakdown across the leadership, this is a red flag, a time to be in a 100% cash position. Gil Morales moved to a 100% cash position yesterday (Tues Feb 22).
The below chart of the Nasdaq Composite shows volatility and volume increasing this week. Once a pullback turns into a bonafide correction, we prefer to see higher volume kick in, as most durable bottoms are formed by an abundance of sellers getting cleaned out, a selling climax.
A lot of leadership has gotten clocked. In many cases, the selling volume was much heavier than after the Egyptian crisis. In some of these, such as Cummins Engine (CMI), we saw huge selling volume as it breached the 50-day moving average, which was our stop.
A few relationships have broken down. For example, the dollar is not serving as a safe haven as it normally would in such circumstances.
Also, stocks like Walter Energy (WLT) are lagging when one might expect coals to act well in the face of rising oil prices.
Given the high number of distribution days in the past 10 sessions, as well as the broad selling seen in numerous leaders, we would not be buying on pullbacks. Instead, we would be noting which stocks are holding up better than others, and wait until the averages begin to show better tone.
For example, Lululemon Athletica (LULU) is expected to show 24% earnings growth this year, and is growing revenue at a 50%+ pace currently. Technically, the stock is behaving in a normal manner following its recent breakout, as it finds buyers at an area that is the confluence of two logical support zones: its 50-day moving average and the top of its prior base. But due to the high number of recent distribution days in the Nasdaq plus the overall liquidation seen in the market’s leadership, we would not enter a position in LULU on this pullback.
Rackspace Hosting (RAX) is a favorite growth stock of ours. The company is a card-carrying member of the cloud computing space. Earnings are expected by Wall Street to grow at 57%/49% in ’11/’12. Companies that are forecast to grow at 40% or more in each of the current and next fiscal years always get our attention. RAX has pulled back over the past two weeks and has shown less selling pressure on this reaction than other glamours.
We would not purchase it here, but would monitor it as it continues to build its base.
Chipotle Mexican Grill (CMG), with EPS estimates of 19%/23% for ’11/’12, bounced today off the confluence of its 50-day average and the high of the bottom of its recent base. Similar to RAX above, the stock is two weeks into a base-building phase, and we would watch it with a view toward possibly entering on a breakout some weeks from now.
Baidu (BIDU), much like RAX and CMG, is two weeks into a basing process. The stock today found buyers at the confluence of the low of its recent gap day (Feb 1) and the top of its November-January base. EPS growth is eyed by the Street at 58%/46% for ’11/’12.
If we did not own it, we would not purchase it here, but would monitor it as it continues to build its base.
Cloud stock Riverbed Technology (RVBD) has shown little selling pressure on its current pullback. RVBD remains under moderate accumulation on an intermediate-term basis. The Street looks for ’11/’12 EPS growth of 44%/34%. Like the other names listed here, we think the higher-probability play is to wait to buy on strength, e.g. a breakout of its current base, rather than enter on the current pullback.
Opentable (OPEN) has seen more distribution over the past few sessions than some other leaders, it being viewed as more speculative by the market. With expected EPS growth of 33%/52% in ’11/’12, and having almost tripled in price over the past year, we are monitoring it as a potential buy once the selling pressure overhanging the market clears.
Netflix (NFLX) saw heavy liquidation for two straight days, putting it about 14% off its recent high. Major leaders in a bull market are going to experience 15%-20% corrections en route to their big gain. This does not mean that you must necessarily hold through such pullbacks. Whether or not you do depends upon risk tolerance, temperament, and everything else that goes into making you a unique trader. If you bought NFLX on the gap day of 1/27, you should be about even or showing a slight profit on your position. If you bought it at the last logical entry point (above the 1/28 high of 218), your loss is about 3% currently. The 50-day average and the $200 handle are two perceived support levels somewhat lower.
For those who do not hold the stock, we would again classify NFLX, as all other leaders in this market, as a watch-and-wait case. Therefore, if we did not own it, we would prefer to wait for it to reset technically and enter on strength, as opposed to buying on this pullback.
Broadsoft (BSFT) has been one of the real burners of the current market advance, quadrupling in about 3 ½ months. It has not been immune to the recent distribution, sitting 15% off its recent high. We like the 81% EPS estimate for ’11, the strong sequential revenue growth over the past two quarters, and its top-rated group, telecom infrastructure.
We are watching BSFT, in the event of a quick market turn, as having the potential to be one of the first out of the chute.
After a fierce run-up last year, Las Vegas Sands (LVS) has been building a three-month base. The base has clear signs of distribution in it, however we like the 77%/25% EPS estimates for ’11/’12 and the strength of its prior run-up enough to monitor it for signs of nascent institutional interest and a possible breakout above its descending trendline below. General market conditions would have to improve from their current distributive mode for this to become attractive.
Away from the growth sector, the fertilizers and coals are not providing anything in the way of setups, though we will be watching these segments in the sessions ahead.
It is to be noted that leadership is most likely to change during a bear market or significant correction. We have recently seen prior leaders such as Vmware (VMW), Netapp (NTAP), Sina (SINA), Rovi (ROVI), and Travelzoo (TZOO) lose their leadership status. This is one reason why we believe the higher-probability play is to wait for the market to reset and allow leaders to build new bases.
The term “leader” does not always mean a stock is going to assume the role of market forecaster, i.e. topping in advance of the averages’ peak. Sometimes they do and sometimes they are among the last to top. Every market cycle is different. However, in this case, with some exceptions, the leadership did top ahead of the averages, suggestive of a certain fatigue that may not have much to do with the threat to Saudi oil.
This fatigue, or quickness on the part of institutions to pull the trigger, is one reason why we do not expect the correction to end right away. Other reasons include the magnitude of the liquidation seen up and down the growth corridor and the inability of the dollar to attract much of a bid, the latter a sign of complacency, perhaps.
One thing to keep in mind is that turning points in the market, especially when related to geopolitical situations, can happen rather quickly. The onset of the last two Persian Gulf wars saw the averages roar higher once the market discounted (priced in) a positive outcome for the US. Not believing the market’s message back then cost a trader an early jump on what became two profitable advances, in 1991 and 2003.
Therefore, be careful about placing more emphasis on the news events than on what the market is actually doing. Above all else, watch your stocks.
In general, a follow-through day carries more weight with this corner when it occurs amid a correction of at least 8%. Looking for an FTD after the averages are down 4% or 5% is not something in which we have found much value.
In summation, an advance that had reached historic proportions in terms of a paucity of pullback is now ensconced in one. The lack of recent set-ups and extended posture of nearly every individual market leader was an objective sign to go slow, leading us to title our report of exactly two weeks ago, “A Go-Slow Market.” When most everything is extended in the midst of a historic, one-way tape, any market pullback will likely result in quick, 10%-12% downward revaluation in many of the leaders, which is what we are now seeing. This occurs because there is no perceived support in the form of a base.
Cash is king. Rather than buy leading titles as they pull back to logical areas of perceived support such as the top of a prior base or the 50-day, the higher-probability play here is to allow a historically overheated market to relax and reset some of the leaders’ bases. The exception would be if you bought some of the leaders at much lower prices and are playing them out for a larger gain.
Market lows are often put in amid a climate of fear. Some of the better actors may actually break out before any “tell” given by the averages. The key: Keep an open mind as to what could possibly happen.
At the time of this writing, of the stocks mentioned in this report, Marder Investment Advisors Corp. and/or Gil Morales & Company, LLC held positions in BIDU and NFLX, though positions are subject to change at any time and without notice.