The Gilmo Report

February 27, 2011

February 27, 2011

Exactly one week ago I noted the little “doji” formation on the NASDAQ Composite Index, a daily chart of which is shown below, which had formed on higher volume compared to the prior day, and wondered whether this could be construed as churning. In the context of Tuesday’s somewhat surprising gap-down, allegedly on news of a fresh crisis in Libya, this now has the look of an evening star formation. On that basis alone I felt it was prudent to raise cash, and by Wednesday’s close the NASDAQ was resting at its 50-day moving average, which set up a logical rally on Thursday and Friday. As I’ve noted many times before, markets don’t top in one day, or even in one week, and when I consider the two-wave sell-off off the peak that the market had in January and combine it with this past week’s action, the case for the market building a top here starts to look plausible. A lot of this is going to depend on what the market and leading stocks do in the coming days, but in my view having cash in your pocket makes it a lot easier to assess the situation objectively. The past two days’ rally has also come on declining volume, so it is showing wedging action as the NASDAQ and the other major market indexes try to bounce off of their 50-day moving averages. Hence I remain cautious, at best, currently.

NASDAQ Composite Index Gilmo Report Chart

In my report of February 9th I noted the extremely high levels being reached by the NYSE Bullish Percent Index, shown below, which shows the percentage of industry sectors flashing buy signals on Point & Figure charts. Usually when this reaches an extreme over 80%, more or less, for a period of time, one can begin to get a sense that the market rally is getting a bit long in the tooth. However, this is not a tool for predicting tops, but it does give a sense of how stretched the rally may be. Also, given that the sell-offs in February have been “news-related,” keep in mind that when institutional investors begin to distribute stock, the process can take days and weeks, and institutions will also seek to “alibi” their selling with news. In other words, the first sell-off that occurred as a result of the “crisis” in Egypt saw the market quickly recover. Institutions sell on that news, but then stop, as their selling is provided with a ready “alibi” in the fact that the news turns out to be nothing special, and so investors come piling back in and drive the market back up. Another bit of “crisis news” out of Libya brings on another wave of selling, and of course this time investors are ready to “buy the dip,” providing institutions with a ready bid since investors have been conditioned to do so after the market recovered so quickly after the Egyptian “crisis.”

NYSE Bullish Percent Index Gilmo Report Chart

At some point in the next few days we will find out whether all this selling from these so-called crises in Egypt and Libya is real, or whether all the distribution days in the charts are telling us that a correction, at least, is in the offing here. For my money, I prefer to watch my stocks, and I did not care much for the way Baidu, Inc. (BIDU) broke down hard on volume, even undercutting on Wednesday the intra-day low of the buyable gap-up day at the end of January, as we see on BIDU’s daily chart below. As well, the past two days’ rally in the stock has not really drawn in any serious buying interest as volume has been quite tepid at best. When a stock breaks out on such a powerful gap-up as BIDU did at the end of January and then retests its breakout point or its 50-day moving average, you want to see some strong volume come in and push the stock up off of the 50-day line. As well, given the powerful gap-up move, BIDU, in my view, should have continued rallying up through the 130 level and beyond. This doesn’t mean the stock is “done,” but it does take a lot of the steam out of the stock as it is not likely it will instantly turn around and recover to new highs.

Baidu, Inc. (BIDU) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investor (www.highgrowthstock.com), ©2011, used by permission.

Two Fridays ago Netflix, Inc. (NFLX) was acting very well as it pulled back into its 10-day moving average, the magenta moving average on the daily chart below, with volume drying up. This was looking quite constructive until Tuesday of this past week when the stock gapped down and then tested the intra-day low of its own gap-up day of late January, similar to BIDU, above. If anything, NFLX seems to act a little bit better here as Friday’s pullback occurred on low volume and the stock has held the intra-day low of January 27th, 21 trading days ago. This may be a constructive retest of that low, and could become buyable on the pullback here as long as we don’t see downside volume pick up as the stock potentially heads further to the downside and its 50-day moving average, currently running through the $200 price level, more or less. This of course will depend on the action of the general market in the coming days. As well, NFLX has again been bombarded with news that AMZN and GOOG are set to offer streaming movies, but I would prefer to simply focus on NFLX’s price/volume action. Obviously, a breach of the 50-day line on heavy volume would not be a positive sign, so be careful of that.

Netflix, Inc. (NFLX) Gilmo Report Chart

In the midst of last week’s selling in the stock market, precious metals performed rather well, and silver the best of all. As we can see on the ProShares Ultra Silver ETF (AQG), my preferred vehicle for playing silver right now as a 2-times leveraged silver ETF, the move in precious metals was simply carrying over from the prior week. As I discussed in my report of two Wednesdays ago on February 16th, silver looked primed to break out to new highs, and so it did, resulting in a very sharp upside move. This of course led to a sharp pullback on Thursday, which is quite normal given the inherent volatility of precious metals. For now I remain quite bullish on silver, as I believe it not only trades as a precious metal or as an industrial commodity, but also as “money.” Consider that for thousands of years Chinese culture has readily accepted silver as a form of money, and in 2010 the Chinese imported 3,500 tons of silver, four times what they imported in 2009. I expect that trend to continue in a world that remains awash in fiat paper currencies. As well, Point & Figure chart analysis generates a $50.50 per ounce price target for silver, and as long as the metal holds its recent breakout through the $30-31 price level, the trend remains strong to the upside as I see it, until further notice.

ProShares Ultra Silver ETF (AQG) Gilmo Report Chart

After two days of selling started off the week, not all stocks acted feebly as they attempted to rally on Thursday and Friday. Acme Packet (APKT), not shown, was able to push to all-time highs by Friday, and “big stock
semiconductor and “hardware” cloud play Altera Corp. (ALTR) also pushed to new highs, as we see on its daily chart below. This is NOT a breakout from a three-weeks-tight formation, as one financial publication has written, since the stock was moving up in the prior three weeks, which is also evident on the daily chart as I’ve annotated it. A 3WT should have the stock moving tight sideways to drifting slightly downward, not edging up each week. In any case, ALTR broke down on Tuesday and Wednesday, and then rallied from there, putting in a continuation pocket pivot buy point on Friday. The one problem here, however, is that this pocket pivot occurs from a v-shaped formation, which lessens its probability of success. At this point I would consider ALTR to be somewhat extended from this v-shaped move and would not be looking to buy this pocket pivot.

Altera Corp. (ALTR) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investor (www.highgrowthstock.com), ©2011, used by permission.

Questionable action was seen in Deckers Outdoor Corporation (DECK) after it announced earnings on Thursday after the close, gapped up on Friday’s open, and then promptly sold off on huge volume to close down on the day, as we see in the daily chart below. This may or may not be a problem, and I would wait to see if the stock breaks down through the prior breakout point at around 87-88 and the 50-day moving average at around 81-82 before I would call this a late-stage failed-base type of situation. However, this sort of high-volume reversal shows that institutional investors clearly used the big earnings-related gap-up to sell into, and when the market is up as it was on Friday, one would have expected DECK to act positively as well. Is DECK in a late-stage base? My general view on late-stage bases is that trying to “count” them is pointless and not rooted in statistical fact. Stocks can form 5, 6, 7 bases or more in a big price run, or they can form two before they blow up – what I would rely on is the current price/volume action of the stock. You will know that DECK has formed a late-stage base if and when it actually fails from such a breakout attempt.

Deckers Outdoor Corporation (DECK) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investor (www.highgrowthstock.com), ©2011, used by permission.

Salesforce.com (CRM), one of the “big stock” cloud-computing leaders also ran into some trouble following its earnings announcement on Thursday after the close. After gapping up after-hours on Thursday to 148 or so, the stock opened up the next day and promptly sold off, closing near the lows of its daily trading range on Friday, as we see on the daily chart below. What struck me as bizarre is that CRM announced 3% earnings growth on Friday, but the stock was gapping up based on an earnings “surprise.” Surprise or not, their earnings growth rates stink, as far as I can see, so the reversal on Friday was quite deserved, in my view. CRM has got to hold the 50-day moving average at 133.66, more or less – otherwise you are looking at a potential late-stage failed-base (LSFB) type of short-sale set-up here. If this were to happen, I could see the stock testing the late-January low at around 122 which could provide a nice tactical short-sale opportunity.

Salesforce.com (CRM) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investor (www.highgrowthstock.com), ©2011, used by permission.

And since stocks tend to move in packs, I look at the other two “big stock” cloud-computing plays for clues as to whether CRM will break down and fail on this latest breakout attempt. When I look at VMware, Inc. (VMW), for example, I see a stock that has come under waves of selling since October of last year up into January of this year as it has overall made little progress during the market rally phase that began on September 1, 2010. As I see on VMW’s daily chart below, the stock attempted to breakout in early January, ran up just a bit, and then failed on the breakout attempt. The stock then gapped down through the 50-day moving average on heavy volume and since then rallied up into the 50-day lne for about four weeks before rolling over again on Tuesday of this past week. The stock staged a little “undercut & rally” and over the past two days has staged a low-volume, wedging rally back up into its 65-day exponential moving average, which I don’t actually show on this chart. To me this looks vulnerable to further downside at least to the 200-day moving average at around 80.

VMware, Inc. (VMW) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investor (www.highgrowthstock.com), ©2011, used by permission.

If I combine the weakness in CRM with that of VMW and then roll it altogether with weakness in yet another “big stock” cloud-computing leader, F5 Networks (FFIV), I see even more trouble for the group. Of the three, FFIV looks the ugliest, and while I only show a daily chart here, you can see on your own how bad the formation also looks on a weekly chart. The high-volume break in mid-January defines the right side of the “head” in a possible head and shoulders formation, and the action in February so far looks to be forming a right shoulder. FFIV also rallied on weak volume this past Thursday and Friday, but stopped right at its 65-day exponential moving average, the black moving average which I DO show on this chart. FFIV looks to me as if it could easily head for the neckline in this formation which roughly coincides with the 200-day moving average down in the 104 price “zone.” As well, the weakness evident in all three of the former “big stock” cloud-computing leaders leads me to think that these would make strong short-sale candidates in the event of a continued market correction or, especially, a bear market.

F5 Networks (FFIV) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investor (www.highgrowthstock.com), ©2011, used by permission

Stocks tend to move in packs, and of course the cloud-computing leaders like CRM, FFIV, and VMW have all done well since the market lows of March 2009. Now that they are all breaking down, they become some of the first stocks to begin hitting my short-sale target screens. With CRM I am looking for the stock to provide objective evidence of a late-stage failed-base set-up, while VMW has already failed and could be shortable using the 65-day e.m.a. as a guide for an upside stop. FFIV appears to be in the throes of a reasonably well-developed head and shoulders type of formation as it rolls over the right side of a right shoulder here with resistance at the 65-day e.m.a. For now, if I decide that the short-selling game is about to come into play here, these would be my primary targets as they were also some of the biggest leaders on the upside during the bull market that has just about reached a full two years in duration.

As I’ve written in prior reports, QE1 and QE2 have made this market something of a “weeble market” where the “weebles wobble but don’t fall down.” Will we see QE2 rear its persistent head again and drive the market indexes to higher highs yet again? As always, I think the soundest approach is to back away from the action of the indexes per se and instead treat the market, as I like to say, as a “market of stocks” rather than a stock market. Thus if I begin to see what I believe are reasonable short-sale set-ups, and if further evidence shows that we are entering a corrective or even a bear phase in the general market, I might be quite willing to engage in short-sale activities. For now, I mostly hold cash, but that could change in an instant. Stay tuned.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, and/or Gil Morales & Company, LLC held positions in AGQ, though positions are subject to change at any time and without notice. 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, 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. ©2011 Gil Morales & Company, LLC. All rights reserved.

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.