The Gilmo Report

January 15, 2012

January 15, 2012

The Standard & Poor’s debt rating downgrades of several European countries, including France which had its rating cut to AA+ from AAA, was one of the more telegraphed events of the week, and the market, as is evident on the daily chart of the NASDAQ Composite Index, below, took it all in stride. And while the argument that we could be looking at another 2008-like break to the downside is always there, I have to wonder whether we are looking at another 1994, such as we see in the daily chart of the NASDAQ from 1994-1995, shown below the current NASDAQ chart.

NASDAQ Composite Index Gilmo Report Chart

The period of 1991-1994 was a nice bull market cycle, and it was a good time to begin my career in this business as a broker with Merrill Lynch in Beverly Hills. In February 1994 the Fed began to raise rates and the market broke very sharply to the downside in what was an extremely ugly break similar to the one we saw in August of last year. After bouncing along its initial lows for a few weeks and then undercutting those lows in June of 1994, a technical event that got everyone to thinking that it was time to “run for the hills,” the market faked everyone out by staging a classic undercut & rally maneuver as it actually put in a low in June 1994 that it hasn’t seen since. From there, the market slowly worked its way toward the end of the year and into the eventual and pronounced technology-led bull market of 1995. The difference back then was that the Fed was raising rates, and a final rate increase in February of 1995 really got the bulls going as the market viewed the action de facto deflationary since higher interest rates would serve to prune inflationary forces in a nascently growing economy. And at the time, the market’s rally after the Fed raised interest rates fooled the crowd quite nicely in February of 1995.

Another catalyst in 1994 came in the November elections when the Republicans achieved a majority in both houses of Congress for the first time since 1952. In November of 2012 we may be looking at another potential and similar power shift, and to the extent that the market begins to discount a change in economic policies it could provide a constructive foundation for a future bull market sometime between now and the end of the year. Perhaps that is what we are seeing here – a market that muddles along in uncertain and choppy fashion for a period of time until a final shakeout like the one in early December 1994 occurs to finally wear and scare everyone out of the market. On December 15, 1994, as we see on the chart, the market had a big follow-through day that marked the start of what became the very profitable 1995 bull market. And despite 1994 being a choppy market environment, there were big winners to play, like Ascend Communications or Printronix, if one focused on the market not as a stock market, but as a market of stocks. I think in this environment, that is the relevant course to take as well.

Obviously, this is my optimistic scenario for 2012. I suppose the global financial system could still melt down into oblivion and stock prices go to zero, along with every other paper asset on the planet. But I have to wonder if there is more here than meets the eye when a major ratings downgrade of European countries takes place, seemingly a significant “step” in the onset of further symptoms of financial sclerosis in the Eurozone, and the market seems to just yawn. As we can see in the daily chart of the NASDAQ at the outset of this report, the market traded up off of its lows on Friday quite nicely as it anticipated the ratings downgrades. Hence, a choppy environment such as that seen in 1994 is one scenario to consider, with the idea that opportunities, and perhaps strong opportunities, may arise in 2012 for investors who are alert to them. At the very least, while the news may make you “feel” bearish, it may not pay to take a rigidly bearish view. Particularly when I am beginning to sense rumblings that may be speaking to an improving environment. One phenomenon I notice hitting my screens right now is a pretty decent number of so-called “bottom-fishing” pocket pivots that are occurring in formerly beaten-down leaders like Netflix (NFLX), shown below on a daily chart. Note the bottom-fish pocket pivot as the stock came up through its 50-day moving average last week followed by a constructive consolidation. While this is still risky to buy, I tend to look at this as more of an indication of the “tone” of this market.

Netflix (NFLX) Gilmo Report Chart

Here’s another formerly beaten-down leader, Sodastream International Ltd. (SODA), that has formed a bottom-fishing type of pocket pivot almost exactly like NFLX’s. The main difference here is that following the pocket pivot up through the 50-day moving average nine trading days ago, as we see on the daily chart below, SODA consolidated normally and then on this past Friday issued another pocket pivot buy point off of the 10-day moving average. This is occurring as we see the 10-day, 20-day, and 50-day moving averages all start to turn to the upside. Like NFLX, SODA is trying to come up off of a “rounded” bottom after spending some time “hammering out” its lows in the high-20 price area, and this is the type of position from which I like to see stocks flash bottom-fishing pocket pivot buy points. Some may ask if this buyable, and I would consider that technically it is potentially buyable, using the 10-day moving average as a tight stop. In NFLX’s case I might use the 90 lows as a quick stop if that can also be considered buyable here in the mid-90 price area. SODA’s pocket pivot on Friday makes it more compelling, but keep in mind that buying bottom-fishing pocket pivots carries more risk. At the very least, NFLX and SODA are not shorts here, that much I can tell you .

Sodastream International Ltd. (SODA) Gilmo Report Chart

Even lowly LinkedIn (LNKD) is trying to come up off of what I would call a “Wyckoffian Retest” sort of low, as we see in the daily chart below. In this situation, the stock puts in a low in late November and then in late December retests that low as it pulled back without ever getting to that first low. All the while as it is retesting the late November low, LNKD’s selling volume dries up as we moved into early January. Then on Friday the stock came up through its 50-day moving average for a bottom-fishing pocket pivot buy point. The 72 area, however, looks like it may present some overhead supply and resistance. The message here is that LNKD represents another beaten-down stock, albeit in this case not so much of a former leader, trying to show some constructive action as it stabilizes and comes up off of its recent lows. There are a number of other stocks trying to do this, including “stuff stocks” such as U.S. Steel (X) and Freeport-McMoran Copper & Gold (FCX), which I don’t show here on charts. Subtle clues that underneath the surface the market’s tone is certainly starting to bubble up and improve currently.

LinkedIn (LNKD) Gilmo Report Chart

Strength is also coming in the form of sharp upside price moves in a number of agricultural “stuff stocks,” such as the fertilizers. Among these, I consider CF Industries Holdings (CF) as the strongest-acting fertilizer given its strong move up through its 50-day and 200-day moving averages last week. Note that on Thursday CF pulled back sharply after streaking up off of its 130 lows, but this pullback carried right down to the 10-day moving average where buyers stepped in and created a type of “reversal” pocket pivot buy point that I considered buyable in real-time. Friday morning saw a slight pullback in the morning where the stock remained buyable, in my view, and by the close CF was streaking higher on strong, above-avearge volume, as we see on the daily chart below. You may recall that I had previously viewed CF as a short-sale target as it broke down through the 140 price level, but that was short-lived as the stock has recovered and shown impressive strength off of its lows. CF is too extended here to buy, but I would keep an eye on this one as it moves up towards resistance in the 175-180 price area.

CF Industries Holdings (CF) Gilmo Report Chart

Aside from all the bottom-fishing pocket pivots I am seeing in the market, those stocks I have discussed as long ideas in my reports since early December continue to act well. Among these, Viropharma (VPHM) flashed a pocket pivot buy point on Friday as it finally cleared to new highs coming out of this tight flag formation it has been in since streaking higher earlier in December. As we see in the daily chart below, VPHM just barely cleared the down-volume bar of six days ago on the chart but it was sufficient for a pocket pivot volume signature. Six and nine trading days ago VPHM reversed back to the downside when it tried to clear to new highs, but overall VPHM held the 28 price level pretty well following those reversals as it set up again and made good on its third attempt at new highs. The Rule of Three comes into play here, making this pocket pivot on Friday very buyable, in my opinion, using the intra-day low of Friday as your downside guide for a stop. This pocket pivot here reminds me a bit of Java Holding Co’s (JVA) pocket pivot in late June as I discussed in my video report over the weekend of July 3rd. Whether it turns out to be as powerful remains to be seen!

Viropharma (VPHM) Gilmo Report Chart

It wasn’t too hard to miss the pocket pivot in (STMP) this past Thursday, given its volume and magnitude. As we see on the daily chart below, STMP blasted up through its 50-day moving average on very heavy volume, at least for this thin stock. STMP does not make it onto my main radar screen primarily because it trades less than 500,000 shares a day, which is my minimum for thin stocks. However, if you have a small account where you are running smaller positions, say 500-1000 shares or less, it is possible to play thinner stocks. If you have to buy 20,000 shares to fill out a “normal” position, then STMP is not the stock for you. I do note, however, that this is constructive action in a strong, albeit thin, leader, and the way STMP held up very tightly despite Friday’s early-morning sell-off was somewhat impressive since thin stocks tend to get rocked when the market sells off. The stock is a bit extended from the 50-day moving average, but if you can stomach a pullback to the 50-day line it is potentially buyable, although I would prefer to see a low-volume pullback to buy if I were interested in this stock; I’m not only because it is thin. I think it adds another bit of constructive evidence to the underlying market tone, however. (STMP) Gilmo Report Chart

Beverage company Hansens Natural (HANS) recently changed its name and stock symbol to Monster Beverage Corp. (MNST). One must admit that “Monster Beverage” is a far “cooler” name that its previous Scandinavian-rooted moniker, and this name change reflects the fact that much of the former Hansen’s success these days is derived from its Monster energy-drink line. MNST has been a relatively volatile stock, which is evident on the daily chart below given all the dips below the 50-day moving average over the past five months or so. Each time MNST tried to clear to new highs in October, November, and December of last year it failed, but most likely because each of these moves came straight up off of prior lows below the 50-day moving average instead of giving the stock time to set up. Note that over the past 4-5 weeks MNST has tightened up along the 50-day moving average and on Friday issued a clear pocket pivot buy point as it came up through its 10-day moving average after bouncing off the 50-day line the day before. This tightening action is also evident on the weekly chart, not shown here, as the stock has held in a tight five-week flat base. If this pocket pivot is for real, I would expect the stock to hold the 50-day line.

Monster Beverage Corp. (MNST) Gilmo Report Chart

I let the market tell me where the real action is brewing, and while I was successful shorting the market when we had fat, juicy short-sale targets like NFLX and GMCR in the latter part of 2011, in the early part of 2012 I am seeing no progress on the short side. Fossil (FOSL) blew me right out of my short position on Thursday when it ran about 10% to the upside, stopping me out at the 20-day moving average as it moved up through the 82 price level. CRM and VMW are also not breaking down, so in my view these are out the window as short-sale targets. The bottom line is that I don’t see any short-sale set-ups in great positions or that are even working presently, and that may be telling me something about this market. I remember 1994 as being a period where short-sellers beat their brains into mush trying to short a market that, while certainly choppy and sloppy, just didn’t want to break down. Thus in January 2012, if shorts are not working for me but my long positions are, the market is telling me quite clearly which direction I should be leaning toward. As I already indicated, 1994 was a choppy and sloppy year, but there were leaders like Ascend and Printronix to play and one could have made a lot of money. In fact, an O’Neil internal portfolio manager (not me) in 1994 won the U.S. Investing Championship with a return in excess of 230% despite 1994 being considered a “bear market year.” This proves that getting bogged down in trying to label the market can make you blind to potentially significant opportunities, and in this market I think it is best to maintain an even psychology by taking the position of seeing the market as a market of stocks.

On the other hand, the idea that we will see a melt-down similar to late 2008 isn’t currently bolstered by the fact that we are not seeing many short-sale set-ups in the right positions here as we did in September 2008 when so many former leaders were in the final stages of right shoulder breakdowns. That doesn’t mean it can’t develop down the line here, but I do tend to think that it would take some sort of new catalyst, perhaps a sharp worsening of the situation in Europe that is beyond what the market has likely already discounted currently, to take the market down in a new bear leg. Obviously, we have to simply remain open to the market’s real-time evidence as it evolves.

The scent of game on the long side is certainly in the air, but how far off it is from turning into a big money oportunity remains another question. In the meantime I’ll take the evidence in the form of near-term pocket pivot and other buy signals as playable as we “proceed with caution.” For a complete “buy list” Gilmo members should review long ideas discussed in prior recent reports.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

Principal and Managing Director, Virtue of Selfish Investing, LLC

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