Market Comment

Here Comes The Sun

September 23, 2010

“Don’t worry about what the markets are going to do, worry about what you are going to do in response to the markets.”

— Michael Carr

The takeaway of the past fortnight has been the accumulation seen in the liquid glamours, those must-own names that institutions have to traffic in – Apple (AAPL), Amazon.com (AMZN), et al – a sign that large players have returned to the table after taking most of the summer off.

Shares appear to be in a normal reaction following a gaping 12.7% advance in 3 ½ weeks. That they went as far as they have coming off the late-August lows without a pullback is a feather in their cap.

Strength begets strength.

The best intermediate-term advances emanate from an intermediate-term 8%-12% correction and an extreme in bearish sentiment brought on by negative fundamentals amid a sense that things will only get worse, an accommodative Fed, and positive seasonals.

At present, all of these exist. Shares went 85% of the distance to a bear market, sentiment was the most bearish since the March ’09 bottom, the data consisted of one negative report after another, Mr. B is making noises about another round of Treasury purchases, and we are in the key September-October time period, when more meaningful bottoms have transpired than any other period of the year, including those that ignited the last four bull markets.

Two negatives stand out. The brokers and banks are two favored leading indicators. For example, the brokers peaked
in June 2007, four months before the peak in the SPX. The group bottomed in November 2008, three-and-one-half months before the averages bottomed. Other examples exist going back decades.

Both groups, along with the broad financial sector, are not only lagging on this advance but their RS lines are moving to new cycle lows. This is suspicious.

The second negative is nothing new, but bears repeating: Chinese shares continue to lag the SPX. This is inconsistent for an economy growing as fast as China’s. It is

the unexpected that is worth noting and China fits the bill.

Fortunately, a few positives counterbalance the above two negatives. Over the past few weeks, technology has begun to outperform. The extreme angle of the Qs’ RS line, shown below, illustrates this.

Commodities in general are performing well. If China was in any kind of danger of a material slowdown, we would expect to see coal or steel prices deteriorate. In fact, China produces one-half of the world’s steel. Coal, which is used in the production of steel, has been outperforming since mid-May, as the below chart shows.

Perhaps more important, retailers are outperforming. This tells us the double-dip argument is on thin ice.

Among the glamours, showing good tone are Ancestry.com (ACOM), Aruba Networks (ARUN), Chipotle Mexican Grill (CMG), Citrix Systems (CTRX), F5 Networks (FFIV), Netapp (NTAP), Netflix (NFLX), Opentable (OPEN), Priceline (PCLN), Qlik Technologies (QLIK), Realpage (RP), Riverbed Technology (RVBD), Salesforce.com (CRM), Sina (SINA), and Vmware (VMW), to name 15, though these are mostly extended and do not offer attractive enty.

Baidu (BIDU). We have been watching the shares with curiosity ever since the 10:1 split of mid-May. Many times, a stock will top after a long run that culminates in a split of at least 3:1. But there are very few stocks with estimates of 124%/54%/41% that also have a $25B market capitalization like this one. The 11-week base of May-July (Base 1 in the below chart) was sloppy and did not break out with much power (11% above average volume on the breakout day), though the width of the pattern, at 19.9%, was not excessive considering the extent and duration of its previous advance.

Compare this to the most recent six-week base (Base 2 in the below chart), which is much shorter in duration (six weeks vs. 11 of Base 1) and extent (13.9% vs. 19.9% of Base 1), not to mention the smoother day-to-day pattern of the bars. Add the 40% increase in volume over its average on the breakout day (Monday, Sept 20) and the fact that the pattern is one of the most classic, textbook patterns seen in some time, and the current base appears to be the higher probability play. Today’s volume, at 59% above average, established BIDU as the “it stock” of the moment. This is a bonus, coming as it does on the third day following the breakout day. The stock is now 7.1% above the top of its base. If you missed buying it, but would still like to, one solution is to take a junior position (half of your normal position size) and use a wider stop of 10%-12%. If stopped out, this wider stop would only equate to a 5%-6% loss on a regular-sized position. This allows you to at least get into the stock should it continue to leave the station. An add-on entry to fill out your position could be added on a pullback to a logical area of support down the road. This position-sizing technique of a half-sized position and a double-sized stop can also be used when dealing with a stock perceived to be riskier, due, for example, to its higher volatility.

Rovi (ROVI). We like the failed breakout of its flat base (between the two parallel lines, see below)
which was followed by
a shakeout that stopped 17 cents above its base low of $41.00. The heavy volume on the next day which accompanied a gap

opening was telling. Then today’s advance on volume 42% above average on a down day in the averages was another plus. Aggressive participants could consider entry above the Sept 21 high of $48.72. Although this would be a level that is 5.4% above the top of the base, and therefore extended, a junior position with a wider stop could be considered. In general, we are not attracted to stocks with estimated growth of 19%/22% for ’11/’12, as we prefer faster-growing titles. However, the technical position of ROVI, as discussed, potentially overrides this.

Strength in technology bellwethers, some of which are mentioned above, including Apple Computer (AAPL), shown below, Oracle (ORCL), Cognizant (CTSH), and Amazon.com (AMZN) augurs well for further upward revaluation in the averages.

Amazon.com is a candidate for a nice run by virtue of its estimates of 26%/37%/32% for ’10/’11/’12, and its move to fresh turf this week. Given its extended nature, we would wait for it to pull back and either buy on the pullback or on the ensuing breakout.

Qlik Technologies (QLIK), an issue we mentioned last time as being extended, but worth watching given its high estimates, has become even more extended.

Makemytrip (MMYT) is another that was mentioned in the last report (the search function in the upper right corner of the report viewer allows the reader to search any back issue for a particular ticker symbol, word, or phrase). It remains extended. The thick earnings estimates suggest there is plenty of time ahead in which to make a big move.

Rackspace Hosting (RAX). Another worth watching, given estimates of 53%/47% for ’11/’12. This is a choppy actor, and acts very different from a BIDU or PCLN, for example. It would be more likely to pull back after breaking out of its current base, and therefore we would suggest taking a junior position on any entry and using a wider stop than normal, perhaps 10%-12%. This is a good example of a stock that represents higher risk than other fast-growing titles, and warrants a smaller size position to begin with so as to avoid getting whipsawed out of what might turn out to be a big winner. This is a name that we’d prefer to buy on a pullback, as it is not a smooth trender, perhaps on a bounce off the 10-day MA.

In summation, institutions have returned to the game after summer recess. More backing-and-filling is possible given the extent and duration of the recent advance. The backdrop is not close to optimal given the softness in banks and brokers. This is a playable rally. Very few glamours offer low-risk entry. In light of better-acting retail/consumer discretionary sectors, the more pressing risk has shifted from the consumer and Europe to just Europe.

Kevin Marder

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.