The Gilmo Report

February 7, 2016

February 7, 2016

Tech stocks took a beating on Friday as the NASDAQ Composite Index led a nasty sell-off on surging selling volume. This sent the index breaking down, at least on a closing basis, through the lows of the bear flag it has formed since mid-January. This has bearish implications, as I blogged on Friday morning, particularly given the fact that it is occurring at the same time as we are seeing serious breakdowns in some of the last remaining leaders.

 

GR020716-$COMPQ

 

The S&P 500 Index, which has far less of a tech component, fared better than the NASDAQ Composite as it dropped a “mere” 1.85% on the day compared to the 3.25% dive in the NASDAQ. Volume came in lighter than Thursday’s levels, but was still above average. The S&P 500 also held along the prior lows extending back to the latter part of January, and has not broken out to the downside as the NASDAQ did on Friday. But the S&P 500 is still mired in what I would call a bear flag, and a possible break to lower lows appears to be a reasonable possibility.

 

GR020716-$SPX

 

The alleged catalyst for Friday’s sell-off was the Bureau of Labor Statistics’ monthly jobs report, which apparently wasn’t up to snuff. As I’ve written and blogged many times before, the number is nothing more than a statistical mirage. As a prime example, and one I’ve previously noted, 96% of last month’s jobs growth was entirely due to a “seasonal adjustment” of 181,000 jobs.

So let’s use a little common sense here. If the unemployment rate was really at 4.9%, the economy would be booming. In any case, the market didn’t care much for the report, and it was cited as the primary reason for the market sell-off on Friday. And this despite the so-called “full employment” unemployment rate of 4.9%. In any case, bad jobs number or not, the general market remains in a clear correction, and individual stocks continue to get decimated.

The market’s brief flirtation with a rally as a result of the big follow-through day two Fridays ago can now be considered dead and buried. In addition, despite the fact that some of the long ideas I’ve discussed in recent reports have held up reasonably well given the general carnage, the long side is not the place to be. I made that adjustment and shift to the short side on Thursday, as noted in the Gilmo live blog at that time.

Thursday evening I sent out my current short-sale target list that included three names that have recently broken out: Facebook (FB), McDonald’s (MCD), and Panera Bread (PNRA). As I wrote in that post, “In some cases, as with names like FB, MCD, and PNRA, I’m watching for possible late-stage base-failures. If the market continues to weaken, we may see more of these stocks that have held up start to post similar failures.” And that was exactly what we saw on Friday as all three of these morphed into short-sale targets based on what appear to be initial late-stage base-failures.

When Facebook (FB) gapped up and broke out following earnings the previous week, my first instinct was to short the stock. But it kept pushing on the upside, eventually achieving what is now its all-time high of 117.59. My thinking at the time, of course, was that a) the general market is in bad shape, providing a negative context for any stock breakout, and b) FB has had a long run and therefore has late-stage vulnerabilities on a breakout that was straight up from the bottom of its base.

As it turned out, my instincts were correct, just a bit early. FB finally failed through the top of its prior base on Thursday, at which point I discussed in the live blog potential ways to play a failure at that point, using either the 110 level plus a couple of percent beyond that as a guide for a cover point if the trade didn’t work.

FB briefly flirted with the 110 level on Friday, getting as high as 106.58, before breaking hard and making a break for the 50-day moving average. By the close, it was able to hold the 50-day line, but closed just below its 20-day exponential moving average. While the stock was shortable near 110 on Friday, a clean break of the 50-day line would confirm the stock as an LSFB. For now, it has more or less given up on last week’s BGU by closing below the 104.81 intraday low of the gap-up day.

 

GR020716-FB

 

McDonald’s (MCD) finally gave up the ghost on its recent breakout, something I had been looking for last week. Again, my instincts on this were ultimately dead on, but it was a matter of waiting out the stock as money kept piling into it. MCD can perhaps be considered somewhat defensive, so once money had finished hiding in the stock it was vulnerable to a sell-off.

As we can see on the chart, the sell-off was fairly steep on Friday, taking MCD decisively through its 50-day moving average on heavy selling volume. The stock is now a confirmed late-stage failed-base short-sale set-up. From here I’d watch for any possible upside move back into the 50-day line at 117.63 as a possible short-sale entry or re-entry point.

 

GR020716-MCD

 

Panera Bread (PNRA) was the third breakout that failed, although perhaps somewhat less late-stage than FB or MCD simply because the stock really hasn’t had a big run for quite some time. On Thursday the stock appeared to break out from a cup-with-handle formation of sorts, and I tweeted at the time that I would be shorting the stock into the breakout. A bold move, perhaps, but on Friday that paid off as it fully retraced the Thursday breakout on lighter volume.

 

GR020716-PNRA

 

The weekly chart of PNRA shows the macro-picture that I was seeing on this latest breakout attempt. The stock has been building a big, ugly, wide, and loose double-bottom formation for the past six months or so. Thursday’s breakout took it right into the prior highs at the mid-point and the right side of the “W” of the double-bottom. This latest move might be considered a failed breakout attempt from a double-bottom-with-handle type of formation, but in the end it is just a label.

What is more important is the fact that it was rallying into a clear area of potential resistance, as I’ve highlighted on the chart. PNRA is expected to announce earnings this coming Tuesday.

 

GR020716-PNRA Weekly

 

Alphabet (GOOGL) is mired in a death drop as it appears set for a test of its 200-day moving average down at 663.76. Members will recall that on Tuesday I blogged that the Class A shares should be watched for a failure at the $800 price level. This would invoke Jesse Livermore’s Century Mark Rule in Reverse and turn it into a short-sale target.

The failure was set up first by a big gap-up in GOOGL shares on Tuesday morning after the company allegedly announced strong earnings on Monday after the close. Pundits and financial TV talking heads were making a lot of noise over the fact that GOOGL was now the world’s most valuable company, overtaking Apple (AAPL) which has since fallen from grace.

That ranking didn’t last long for GOOGL, however, as it lost 13% of its value by the end of the week, closing just above the $700 level. I had shorted the stock on Tuesday as it held along the confluence of its 10-day and 20-day moving average. I thought it had at least a reasonable chance of having one more little rally back up into the 50-day line, but that was not to be. On Wednesday it just sat there at the confluence of the two short moving averages, and one could have simply shorted the stock right there, using the 10-day or 20-day lines as guides for an upside stop.

 

GR020716-GOOGL

 

Often times I will work a stock on the short side this way, covering at areas where a bounce might be likely. However, if it fails to show any inclination to bounce the next day I simply re-short it right there, knowing that I already have a profit cushion from the prior day. If it flashes a 620 buy signal at any time once I re-short it, I may decide to cover and back away at that point.

While it is admittedly an active way of operating, it is usually my favored method of campaigning a stock on the short side, while avoiding holding a big position overnight. In this market, with so many bizarre gaps in either direction occurring overnight, I prefer to operate this way.

I blogged on Thursday that chipmaker Avago Technologies (AVGO), which is now known as Avago Broadcom following its acquisition of the old Broadcom (BRCM), looked shortable as it rallied back up into and just beyond its 50-day moving average. The stock had received an analyst’s buy recommendation and $175 price target, triggering the rally on that day.

But AVGO’s reality consists of the fact that it is a confirmed late-stage failed-base (LSFB) short-sale set-up. Back in early December the stock gapped up on a late-stage base breakout that could also have been interpreted as a buyable gap-up at the time. However, that BGU within a few weeks as the stock went nowhere.

Eventually, in early January, the breakout failure was confirmed when AVGO broke through the 50-day moving average on above-average selling volume. Notice, however, that the initial breakdown began with a breach of the 20-day line, which is generally the first clue that a prior breakout is on the verge of failing.

 

GR020716-AVGO

 

AVGO’s breakdown in early January found its feet and turned back to the upside as its buyout of BRCM was finalized, bringing it back into shortable range along the 50-day line. Notice the wide daily swings along the line, the type of volatility that is usually a sign of pending trouble for any stock exhibiting such price behavior. AVGO closed just below the 200-day line on Friday, and could be shortable here using the line at 129.32, about a point above where it closed on Friday, as a tight upside stop. The first downside target would be the mid-January low at 117.17.

Walmart (WMT) had a rough time throughout most of 2015 as it topped in January of last year and embarked on a steady downtrend that finally bottomed out in November. Since then, the stock has steadily rallied back up to its 200-day moving average and a prior peak in its pattern from October 2015. WMT is generally a big, lumbering, and mostly boring stock. After all, it wasn’t until May of 2012 that it finally broke out of a long 12-year base that it had formed throughout the New Millennium up to that point.

During that 12-year period, however, WMT’s earnings steadily trended higher, starting out at $1.25 in annual earnings and reaching a peak of $5.11 in 2014. In 2015 that trend began to reverse, and the company grew earnings at exactly 0% in 2015, posting a number of $5.06 a share for the year. If you plot the annual earnings numbers on a chart, you can see that over the past two years the line has turned to the downside and is now exhibiting a steady declination.

That trend is expected to continue as analysts are now looking for annual earnings of $4.53 and $4.17 in 2016 and 2017, respectively.

 

GR020716-WMT

 

Lately, given its sustained and fairly brutal sell-off throughout most of 2015, I tend to think WMT is finding some favor as a defensive type of name, but ultimately it’s just another big, slow, lumbering big-box retailer with contracting growth. Once money stops moving into it as a perceived value name at 14 times forward estimates, it may be set to fall again, not unlike MCD.

Now that it has had some time to draw in buyers on a slow rally back up to the 200-day line and the prior October 2015 high, it may be worth a short again on the short side. In this case, the 68 price level, plus another 2-3% if so desired, can be used as a reference for a tight upside stop.

I blogged about shorting LinkedIn (LNKD) on Tuesday of this past week as the stock reversed at around the 208 price level and its 20-day moving average. While I covered my short on Wednesday’s big downside break, preferring not to sit through earnings on Thursday after the close, I have to admit I regret not doing so. However, hindsight is always 20/20, and the stock did give nimble and bold short-sellers an opportunity to short as a shortable gap-down on Friday, using the 128.99 intraday high as a stop.

That would have worked out rather well, as the stock dropped another 20 points to close just above the 100 price level on astoundingly huge selling volume. After breaking about 100 points from where I first shorted the stock on Tuesday, I think this might be set for at least some sort of bounce from here, so we can see how that plays out in the coming days.

 

GR020716-LNKD

 

LNKD is one of those stocks that has always been priced for perfection, so to speak, given its perpetually high P/E ratio. But the breathtaking magnitude of Friday’s selling tells you that institutions are getting out of the pool on this one, and they are in a big hurry to do so. I tend to think this is also a function of the current market environment, where we are starting to see it become more contractionary with respect to tolerating high P/E ratios, much less P/E expansions.

You can also look at the massive breakdown in Tableau Software (DATA), not shown here on a chart, which closed Thursday at 81.75 before announcing earnings that afternoon following the close. On Friday, it opened up 44.04 and closed at 41.33, getting sliced nearly in half in a single day. Even at Friday’s close the stock is still selling at 67 times forward estimates, and could easily go lower. If we treat Friday’s move as a shortable gap-down, then we would like to see a quick bounce back up into Friday’s intraday high of 45.64.

DATA is also an example of the current environment’s intolerance for high P/E ratios. This is typical of bear market environments where P/E contractions become the norm, as opposed to the expanding P/E environment of a bull market.

 

GR020716-DATA

 

Netflix (NFLX) was last shortable at the 10-day line, as I blogged this past Tuesday right after the open. Prior to that the 200-day line provided a nice short-sale reference point back in mid-January, and we can see how the stock has consistently obeyed its 10-day moving average all the way down.

The stock is now firmly below its 85.50 low from late August of last year, and it would see that it is in a position where it should rally. I use that term lightly, however, as the stock has shown absolutely no inclination to do so. Barring any such rally, the next stop would be the top of big price structure it formed between mid-2014 and mid-2015 at around the 70 price level.

 

GR020716-NFLX

 

Nike (NKE) briefly bounced off of its 10-day moving average on Wednesday, but the next day on Thursday it resumed its downtrend. A small gap-down open on Thursday sent the stock down below both the 10-day and 20-day moving averages on about average volume. By Friday, sellers overwhelmed the stock and sent it crashing through its 200-day moving average on heavy volume.

It is now approaching the mid-January lows at 56.59, 58 cents below where it closed on Friday. Any quick blip back up into the 200-day line at 58.37 over the next couple of days that precedes an undercut of the mid-January lows might be shortable for a break down towards the 56 level.

This week’s failure at the 50-day moving average, which I first blogged about on Tuesday of this past week, has completed a right shoulder in a head and shoulders topping formation. This H&S pattern extends back to late September. The next major low after the mid-January lows would be the low of 47.25 that occurred on the now infamous “Capitulation Monday” of August 24th.

 

GR020716-NKE

 

The selling in big-cap NASDAQ names was also heavy in former big-stock leaders like Amazon.com (AMZN) and Microsoft (MSFT), not shown here on charts. AMZN busted through its 200-day moving average on heavy volume after lingering along the line on Thursday, while MSFT can now be considered a late-stage failed-base situation as well. MSFT failed on its buyable gap-up attempt of two Fridays ago when it breached the 50-day moving average on Tuesday.

It has bee-lined from there straight to the downside as it appears headed for a rendezvous with its 200-day moving average.

But the selling in big-stock NASDAQ names wasn’t limited to technology or internet names. Coffee retailer Starbucks (SBUX), another big-stock NASDAQ name, has completely come apart after attempting a trendline breakout two Fridays ago. That breakout attempt failed on Tuesday as the stock broke back below the 50-day moving average on reasonably heavy selling volume.

That selling volume accelerated sharply into this past Friday earlier in the week as sellers mercilessly smashed the stock through its 200-day moving average. This now makes any rally back up into the 200-day line at 56.82 a new short-sale entry point.

 

GR020716-SBUX

 

The magnitude of selling in SBUX on Friday, a non-tech name, speaks to another wave of forced selling and liquidation hitting the market. I discussed the concept of force selling at length in my report of January 24th. As I wrote at the time, the environment is such that the market is vulnerable to new waves of this type of selling as a new liquidity crisis appears on the horizon, combined with the proven ineffectiveness of endless money-printing.

European Central Bank head Mario Draghi admitted on Thursday that deflation remains a problem for the Eurozone. This is occurring despite the ECB’s pumping of billions of Euros worth of QE into the system as well as the implementation of negative interest rates. As I’ve also discussed in recent reports, the global financial system has simply become leveraged up again, as it did in 2008. This time, however, the bubble might be larger.

Not everything in this market has been with hasty and motivated selling, however. As we expected based on its after-hours action following earnings on Wednesday after the close, SolarEdge (SEDG) gapped up on Thursday right at the open. However, what was looking like a possible buyable gap-up move turned into nothing of the sort as the stock quickly filled its gap by retracing back down to its 200-day moving average.

On an intraday basis, this was looking like a breakout failure in process, but by the close the stock rallied and closed at a higher high on strong volume. Friday saw the stock pull in slightly, a worthy performance in the midst of a brutal general market sell-off, as sellers failed to materialize and volume came in at just below average.

The question, of course, is whether one would ever want to think about buying this in the face of a very weak general market. My view is that as long as the market continues to suffer from heavy selling interest, SEDG is not likely to go anywhere, at best. At worst, it could simply fail and head back to the downside. As long as it holds, however, I would keep it on my buy watch list as a stock that may be tradable on the long side during any sharp market reaction bounce.

 

GR020716-SEDG

 

While I have liked the quality big-stock solar names First Solar (FSLR) and Sunpower (SPWR) on the long side of any market bounce, I would note that these could become vulnerable to selling in any continued general market weakness. While I only show the daily chart of FSLR here, both stocks are tracking along their 10-day and/or 20-day moving averages after making short-term lows in mid-January.

However, SPWR has found resistance at its 50-day moving average, which might put it in an optimal short-sale position if the market tide begins to pull it down. FSLR is further up in its pattern, is also vulnerable to failure here if it cannot hold its 20-day moving average, something I blogged about on Friday morning.

 

GR020716-FSLR

 

I actually shorted the stock on Friday when it gapped down right at the open, and it continued a couple of points lower after breaking down through its 20-day moving average. Volume was slightly higher than Thursday, indicating that sellers weren’t barreling in to unload the stock. However, sellers could come after the stock this coming week if the general market continues to break down.

And there is a technical basis for such a possibility. If we look at the weekly chart of FSLR, below, we can clearly see a double Punchbowl of Death or Double POD, as I prefer to call it. The left POD starts in September 2014, and encompasses a total duration of 31 weeks with 17 weeks down the left side and 14 up the right side. The right POD begins in May of 2015. It forms a little bit differently as it descends for 13 weeks down the right side but then proceeds to spend nine weeks chopping back and forth as it retests the first low twice.

It then launches up the right side for 15 weeks before reversing on heavy weekly volume. This is generally a bearish indication when it occurs at the right side peak of a steep POD.

 

GR020716-FSLR Weekly

 

I have thought that FSLR could break out to higher highs IF the general market got into any kind of sustainable uptrend. In such an environment, the stock might make for a decent long trade. And, in fact it has been over the past three weeks as the general market has chopped around in a three-week bear flag. But I have still only considered it to be a short-term play as earnings approach in late February.

Now with the general market suffering from what I consider to be forced selling, FSLR is vulnerable to a breakdown. The double POD formation also provides a strong technical justification for such a breakdown, and the first clue of such a breakdown is a breach of the 20-day line. That occurred on Friday, albeit on below-average volume. However, if market weakness persists this coming week, FSLR becomes a short here using the 20-day line as a guide for an upside stop.

In this type of market, I maintain absolutely no axe to grind. I merely assess the price/volume and technical evidence on its face in real-time, and then attempt to draw what hopefully turns out to be the most profitable conclusion. In my view this is the only way to make progress in this market – you must stay completely objective and fully open to new evidence as it presents itself in real-time. A rigid approach is a recipe for an early financial death, especially in this environment.

While I don’t see the long side as the place to be currently, I did have some words to say about Cree (CREE). I last discussed the stock in my Wednesday mid-week report, as it was sitting along its 10-day moving average. The stock broke out the very next day on above-average volume, but the outgoing market tide dragged the stock back down towards its breakout point.

This might be one to keep on your buy watch list if it continues to hold along the 28 price level. A simple reaction bounce in the general market at any time could makes this good for a long trade, but it is not clear to me that I’d want to be stepping into this if the general market continues lower in the coming days.

 

GR020716-CREE

 

Below is my current short-sale target watch list in table form, showing current moving average levels for each:

GR020716-Moving Average Table

 

I tend to think that I’ve been perhaps overly generous with this market in thinking that it might have a more substantial reflex bounce and reaction rally following the lows of late January. The big follow-through day two Fridays ago was just a big bull trap, and things ended badly for it rather quickly. In this type of environment, things can change quickly.

Therefore I can safely say that I am quite glad to have at my real-time disposal the medium of my live blog to communicate such market changes and their associated shifts in strategy, at least from my perspective. Some timely blog posts regarding short-sale targets in GOOGL, LNKD, NFLX, and most recently AVGO, FB, PNRA, and MCD have hopefully provided some profitable utility to members over the past week.

While the general market could continue to chop around, I would not be surprised to see the S&P 500 follow the NASDAQ Composite in a bear flag breakout to the downside. In the meantime the short side of the market has proven to be the most profitable over the past week, and for now that is where we focus our attention. For those who choose not to engage the short side of the market, as well as for less-nimble investors and traders, cash remains king.

 

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 FB and WMT, 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. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.