The Gilmo Report

February 3, 2016

February 3, 2016

Yesterday’s market action shows why any time we want to think about testing the waters on the long side of this market we need to have a strong edge. Just chasing follow-through days in indexes and momentary strength in individual stocks can easily get you into trouble in this market. Over the past four days, the best entry, from a general market standpoint, came on Thursday when I called a Wyckoffian Low for the indexes. As I wrote at the time, this was at least a short-term low, and the question then became just how short it might turn out to be.

The need for such an edge was emphasized yesterday when a big wave of selling hit the market, sending the S&P 500 Index down 1.87% while the NASDAQ Composite Index gave up 2.24%.

This of course puts the so-called “confirmed uptrend” back to “uptrend under pressure,” but to me it’s more a matter of understanding what the market is doing in real-time and reacting appropriately at the right time. What had the look of a powerful follow-through day that was led by the supposedly “risk-on” small-cap Russell 2000 Index on Friday quickly got into trouble, as I blogged right after the open yesterday.

The NASDAQ Composite, shown below, illustrates the give-up as it pushed down to the intraday lows of last Friday before finding support today as it undercut last week’s lows and then pushing back to the upside. By the close the NASDAQ recovered a good chunk of its intraday losses to close in the upper half of its trading range on heavier volume.

 

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The NASDAQ Composite and the NASDAQ 100 Index took the brunt of the selling today, as the NASDAQ logged another distribution day. However, as the NASDAQ lagged, the small-cap Russell 2000 Index, not shown, held up well to close up slightly on the day. The NYSE-based indexes like the Dow Jones Industrials, the broad NYSE Composite Index, both not shown, and the S&P 500 Index, shown below, also closed in positive territory on higher volume. This has the look of a nice reversal day to the upside after finding support along last week’s lows.

 

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It is perhaps a testament to the craziness of this market that such a “convincing” follow-through that came one day after the preferred Wyckoffian low ran into serious trouble so quickly. In my experience, rally failures, whether occurring after a powerful follow-through or not, tend to occur abruptly, and those who hesitate in the face of such a failure can run into trouble very quickly. This is why in this distorted money-printing environment I keep things on a hair trigger.

But by the time all the dust settled today, the index action had the look of supporting action off the lows following an undercut/test of last week’s lows. For this reason we might expect a move back up towards the highs of the range, but some of this is tantamount to throwing darts or flipping coins.

In the end it all boils down to simply finding tradable set-ups as they occur in real-time. In service of this objective, taking a bifurcated approach has helped at least make some sense of this market, as well as some profits. But I cannot say it is easy or, as I blogged on Monday, “a walk in the park.”

As I wrote over the weekend, despite the powerful look to Friday’s action, we were still faced with the problem of exactly what was out there to buy. There were practically zero breakouts in quality stocks occurring. Add to this the fact that the only way to buy anything on the long side required using what I might call more radical Ugly Duckling methods, namely buying Wyckoffian type lows in individual stocks, even some that we had previously been working on the short side.

In addition, I would note that during most market turns off the lows I will see at least a handful of bottom-fishing or roundabout types of pocket pivots, known by the acronyms BFPP and RAPP. This time I see none, which further complicates matters.

Once I could see that the market was in trouble on Tuesday, emphatically blogging right after the open, “Abort! Abort!” I quickly unloaded whatever long positions I had and immediately moved to the short side. In my blog posts that morning I discussed some targets to hit, and they did work out rather well on a short-term basis.

What makes this market so treacherous and difficult to play on either side is the fact that it can be subject to forced selling or liquidation at a moment’s notice, and that’s what I thought yesterday’s action looked like, After six years of QE from the Fed, free money has been floating around out there for a while. In the process, governments and a lot of businesses have levered up, such as the oil industry.

This is one reason why the falling price of oil has been correlated to stock market sell-offs so far in 2016. With a lot of leverage in the system, and QE becoming less effective, catalysts for a potential liquidity crisis become somewhat plentiful.

The primary side effect of such potential is that waves of heavy selling can come out of nowhere, and then disappear just as fast. This results in some massive volatility, and we’ve seen a good deal of that over the past week and a half. In my January 24th report I discussed in very simple terms the mechanics of how forced selling and liquidation generally works and its effects on the market.

So whether you come in on the long or short side of this market at any particular point in time, you have to operate very carefully and be ready to turn on a dime if necessary.  As a practical matter, this naturally requires keeping things on the proverbial tight leash.

With so many former leaders literally beaten down to a pulp and deep near the lows of extended downtrends, it is a bit of a problem trying to figure out exactly what might be in position to short when the market suddenly comes under pressure. However, I like to think I was up to the task yesterday.

During earnings season, as I’ve discussed before, I prefer to look for short-sale set-ups in stocks that gap-up after earnings. That is actually one of my favorite “earnings roulette” season short set-ups.

Members may recall that last July we got the short side off to a great start hitting Skyworks Solutions (SWKS), shown below on a daily chart from last year, on a gap-up above the $100 Century Mark after earnings at that time. That post-earnings gap-up quickly fizzled and provide short-sellers a nice two-day profit of more than10%, depending on where one shorted the stock.

 

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SWKS back in July of 2015 was a late-stage failed-base set-up that quickly evolved into a head and shoulders top. The gap-up on July 23rd following the company’s after-hours earnings report the day before set up a very juicy short-sale opportunity. The stock quickly reversed back below the 50-day moving average and the $100 Century Mark price level on huge volume, and continued lower the next day.

That reversal also served to form the right shoulder in the completed head and shoulders formation. From a short-seller’s perspective, this is a very nice set-up to look for during earnings season.

With the SWKS example firmly in mind, we can see how Alphabet (GOOGL) offered a similar opportunity as it failed around the $800 price level on Tuesday following an allegedly favorable earnings report on Monday after the close. I blogged about the stock as a potential Livermore Century Mark Rule in Reverse short-sale set-up early in the day. GOOGL barely got a little more than 1% above the $800 level before reversing and heading lower from there.

This morning it sliced right through its 50-day and 10-week moving averages on its respective daily and weekly charts, eventually finding support along the 10-day and 20-day moving averages. This set up at least a short-term cover point from my perspective, if one had shorted the stock near $800 on Tuesday. From here we would be looking for any rally up to the 50-day line at 757.76 as a potential short-sale re-entry.

 

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GOOGL is an interesting stock from the standpoint of having two separate but valid charts showing different price levels. One can look at the chart of GOOGL, the Class A shares, or GOOG, the Class C shares. On the chart of GOOG, which has a lower absolute price than GOOGL, we can see that it in fact never made it up to the $800 price level. Instead, it fell short, reaching an intraday high of 789.87, a little over 1% away from the $800 Century Mark.

Here we can see that GOOG also found support along its 10-day and 20-day moving averages. Therefore from here we would look at rallies back up to the 50-day line at 740.29 as potentially shortable.

 

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LinkedIn (LNKD) was sticking up in positive territory yesterday even as the general market gapped down at the open. Given that it was right up against its 40-week moving average on the weekly chart, below, that looked like a reasonable short-sale point. It then promptly moved back down to the lows of the prior two weeks before finding its feet and rallying after undercutting last week’s low at 186.80.

As I saw it, this was a short-term cover point after shorting it near the 40-week line yesterday. LNKD is expected to announce earnings tomorrow after the close, so there is nothing to do with the stock until then. In the meantime, a nice short profit is banked.

 

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Netflix (NFLX) also opened up yesterday morning as the general market gapped down, but was nowhere near a key moving average on its weekly chart like LNKD. It was, however, right at its 10-day moving average, which was worth a shot on the short side as I saw it. NFLX has not rallied much with the market over the past several days and was actually down on Friday when the market was jacking sharply to the upside.

NFLX quickly reversed yesterday at the 10-day line and today came close to its 85.50 intraday low of August 24th. In my mind, the intraday lows of the big Capitulation Monday breakdown of August 24th are not all that reliable since some of them occurred only instantaneously. So whenever I have a short-sale target stock that is approaching an August 24th low, I am watching for either an undercut or some sort of holding action near that particular low. In this case, as NFLX got close, that was a reasonable cover point. Now we can just wait for the next potential short-sale re-entry point.

 

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Nike (NKE) also looked in an optimal short-sale point along its 50-day moving average, and the stock ended up breaking down from there with the market over the past two days. It then traded right down to the confluence of its 10-day and 20-day moving averages where it found support. Note that selling volume dried up sharply, so it does not appear that sellers were all that interested in losing the stock today.

 

GR020316-NKE

 

Amazon.com (AMZN) is now officially what we might call “burnt toast” as it closes below its 200-day moving average for the first time since early year. One approach on the short side with AMZN would have worked by using last Friday’s gap-down move as a shortable gap-down. This would put your stop at the intraday high at 593, just shy of its 595.36 intraday low of the late October BGU, way over on the left side of the chart.

That was a feasible short-sale strategy, and would have worked as the stock has simply dropped like a rock from there. With AMZN just undercutting the 200-day line, it’s now a matter of watching for any shortable rallies from here. Otherwise, if one is short from last week’s gap-down move this would be a short-term cover point in my view.

 

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As far as the rest of my short-sale target stocks go, I don’t really see anything that is in an optimal short-sale position at this time. I did a good job picking off GOOGL, LNKD, NFLX, and NKE yesterday and today, but these are likely played out in the short time. GOOGL was an excellent Livermore Century Rule in Reverse short-sale play that is now a confirmed late-stage failed-base short-sale set-up, while LNKD and NFLX provided reasonable 10% profits on the short side in only two days.

NKE was less successful, but still profitable if one covered at the 10-day line. In this market those types of rapid-fire short-sale trades are very helpful, and at least put me in a better position to investigate the long side if today’s bounce holds.

Facebook (FB) has been the only big-stock breakout that I would consider buying, but it got extended rather quickly. Today, however, it tested the 110 price level and the top of its prior base as volume remained high. This served to bring it to within a more reasonable buying range, but my guess is that it may need to rest a little while to give its 10-day and 20-day moving averages some time to catch up.

The 50-day moving average has also started to turn to the upside. What I would consider to be “deep doo-doo” support for the stock would be along the 10-day and 20-day lines, but they are down around 104-105, and I would like to see them catch up to the stock to perhaps set up a continuation pocket pivot type move later on. In the meantime, the 110 level was a reasonable entry, as I blogged earlier today.

 

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Microsoft (MSFT) has been less able to hold support as it has now failed on last week’s buyable gap-up move. I had a position in the stock coming into Tuesday’s open, but as soon as it flirted with the 54 intraday low of the BGU day I tossed it without hesitation. In this market, you are either the quick, or the dead, and I choose the former!

Proof of that principle is shown by the fact that MSFT simply continued to move lower before finding support along the pre-BGU lows of last week. It has now filled the gap, so one might consider this as a potential Ugly Duckling buy using today’s 51.26 intraday low as a tight stop.

 

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Hawaiian Holdings (HA) has weathered this week’s selling reasonably well, as I see it. It has drifted down into the confluence of its 10-day and 20-day moving averages as volume dries up to -27.4% below-average. While this is constructive, I would not consider it a “voodoo” day since I would prefer to see volume dry up to -35% below-average or much less to qualify as a true voodoo pullback. Nevertheless, it is pulling down into a more buyable position here where risk can be controlled very tightly.

 

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The quality solar names (read: not the solar installers!) like First Solar (FSLR) and Sunpower (SPWR) have held up well. Both found support today along last week’s lows as sellers never really came after the stocks early in the day when the indexes were selling off reasonably hard. Both are expected to announce earnings towards the end of February, so where they go from here may be entirely dependent on those earnings reports.

In the meantime, I’ve found that buying into weakness as way of getting a decent short-term long trade in these names has been an effective short-term strategy, and may continue to work as their respective earnings report dates approach.

 

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SolarEdge (SEDG) is another quality solar name that settled its earnings report issues today by beating estimates. SEDG came in with earnings of 44 cents a share, 8 cents better than the analysts were looking for. The company also raised guidance for the next quarter. Needless to say, SEDG is gapping up in after-hours trade and we will want to watch this tomorrow on the open for an actionable buyable gap-up. I have no problem buying such a BGU as it could lead to a strong price move from here, and with the added benefit of no longer requiring us to play earnings roulette!

 

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CyberArk Software (CYBR) is holding tightly along its 50-day moving average after regaining the line last week, as I discussed in my weekend report. The stock has now pulled into and held its 50-day line as volume reaches voodoo levels at 36.7% below-average. This looks like a lower-risk buy position using the 50-day line at 43.35 as a guide for a tight stop. If one wants to give this more room on the downside, then today’s intraday low at 42.26 serves as an alternate stop.

The cyber-security group has taken a beating over the past several months since the group topped back in the summer of last year, but in this market we often see beaten-down groups with a compelling business theme, in this case cyber-security, become turnaround types of situations. CYBR is expected to announce earnings next week.

 

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I mentioned LED chipmaker Cree (CREE) in a blog post on Monday, and I have to admit I like this set up based on the fact that is a beaten-down name with comeback potential. The stock blasted its way back above its 50-day and 200-day moving averages after announcing earnings in mid-January. It has since been able to consolidate this strong move along its 200-day moving average, where it found support last week. That led to a pocket pivot last Friday during the big general market rally, and the stock has held tight so far this week as the index have gyrated around.

I think looks like it is worth a shot using the 200-day line at 26.95 as a guide for a reasonably tight stop. The stock has been pinned up against resistance along the low 28 price level, as I’ve highlighted on the stock. While I think it is certainly buyable here, and preferably so as it remains quiet along the 28 price level, I would like to see a decisive breakout through resistance to get the ball rolling on this one.

This is most definitely not your standard O’Neil stock making new highs, but in this market something like this has the potential to work, as we’ve already seen with some of the solars.

 

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This morning I blogged that little telecom name 8×8 (EGHT) looked like it was acting in a constructive manner as it meets up with its 10-day moving average. This reasonably tight consolidation, at least for a little stock like EGHT, comes after a buyable gap-up move that occurred nine trading days ago on the chart.

That BGU came the day after the company announced earnings of 5 cents a share, beating estimates by 2 cents, while revenues came in at $53.2 million vs. estimates of $52.05 million. The stop on this would be the BGU low at 11.91, which is also precisely where the 20-day moving average is currently.

EGHT provides enterprise level VoIP phone service, and is the only such provider that includes both instant messaging and web conference with its service, a compelling enough theme. With the small-cap Russell 2000 Index closing up today vs. its larger-cap big brother, the NASDAQ 100, I might look for a shift into smaller names, and EGHT looks reasonable based on its tight technical action following a post-earnings BGU.

 

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Another small-cap name that looks decent here is Ikang Healthcare Group (KANG). KANG is a little Chinese healthcare company that was first mentioned by a Gilmo member on the Gilmo live blog on Monday. In my reply I noted that the stock looked good from a technical perspective as it holds tight along the 10-day and 20-day moving averages.

The only caveat, of course, is that it is a Chinese stock, which these days naturally has the tendency to make any investor a bit nervous.

Nevertheless, we might consider that the stock is acting constructively in a market that has been none too kind to Chinese stocks. That definitely speaks in its favor, along with the fact that it is also the largest provider of private preventative healthcare services. China has a huge population, and no doubt healthcare will be a big area for them going forward as that population continues to age.

Technically, we can see that KANG posted a pocket pivot today along the confluence of its 10-day and 20-day moving average, which is actionable given that a) the stock hasn’t move that far off of the moving averages and b) provides a tight stop at the 10-day/20-day moving average confluence or, for those who might want to give it more room, its 50-day moving average at 19.99. Another small-cap idea with the idea that we might see a rotation back in this direction.

 

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The action so far this week underscores how difficult this market is, even after a powerful-looking follow-through this past Friday. However, in the midst of what may seem like confusing and at times scary action, the best way to keep your head is to a) seek the lowest possible risk entry points, and b) focus on individual stock set-ups long or short in a bifurcated approach.

The value of my live blog was demonstrated yesterday when I discussed short-sale targets in GOOGL, LNKD, NFLX, and NKE early in the day, and all of these led to some nice profits over the past two days.

With the market attempting to put in another wild and crazy low today, those become bankable short trades. In addition, I note that at least with respect to my own psychology, acting quickly and profiting nicely as these names broke down with the market yesterday puts me in a fresh position, flush with some quick short-sale profits, to assess the action with an open mind from here.

With big-stock NASDAQ names getting pummeled, it is clear that money is coming out of these names. Meanwhile, the Russell 2000 is starting to perk up after correcting over 25% from its mid-2015 peak and moving into in what the pundits like to refer to as “bear market territory.” As I’ve pointed out in recent reports, by the time an index reaches so-called bear market territory, a good chunk of its correction might just be over and done with.

The bottom line here is simple. I’m looking for smaller names to take up some of the slack as money moves out of larger-cap leaders that have come apart in the New Year. As I’ve shown in this report, there are some interesting situations and set-ups arising out of all the muck and mud the market has spewed about so far this week. So I choose to go with the set-ups that I see, set my stops, and let the chips fall where they may.

In the meantime, members should remain closely tuned into the Gilmo live blog, as the situation is likely to remain fluid. This likely implies that opportunities may show up out of nowhere, as those on the short side of GOOGL, LNKD, NFLX, and NKE did yesterday. When this happens the blog is the first place you will hear about, so stay tuned.

 

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 a position in EGHT, 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, 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.