The Gilmo Report

July 2, 2017

July 1, 2017

The NASDAQ Composite Index’s attempt to hold a bounce off the 50-day moving average failed quickly on Thursday, even before the opening bell. The NASDA 100 futures were already down overnight, presaging another brutal sell-off in the big-stock NASDAQ and tech names.

The more important sign of the failure was the fact that a number of undercut & rally long set-ups that appeared on Wednesday failed rather quickly. Other stocks simply broke near-term support. Based on the action of individual stocks, having a healthy store of cash strikes me as the most prudent position to be in currently. The past four days have been a series of sell-offs followed by logical rallies based on the position of the index within its chart. We can see that Tuesday’s sell-off found near-term support at the 50-day line on Wednesday, leading to a logical bounce off the line.

On Thursday, the index rolled over again and broke below its 50-day moving average, but undercut two prior lows in the pattern from earlier in June. That was a logical undercut & rally move on a short-term basis. Friday the index held in a tight range and mostly in positive territory as it attempted to regain the 50-day moving average. Going into the close, however, sellers sent the index back into the red on light volume.

This is unresolved action, and I cannot rule out further downside from here. At the same time, I want to be alert to where stocks on my long watch list are trading, as there is always the possibility that the current position of the indexes might result in some sort of “Ugly Duckling” recovery that has become the market’s trademark.

 

GR070217-$COMPQ

 

I’ve often discussed my view that in a market sell-off that then bounces off support, your best weapon on the long side is the undercut & rally set-up. The reasons for that are clear. The first, of course, is that we’ve seen many of these work quite well since the market has had a habit of rebounding from even the ugliest of sell-offs. In the process, we’ve seen more than a few undercut & rally moves that produce substantial, instant profits.

One of the best examples of this is Alibaba (BABA) in mid-May. On May 17th, the market sold off sharply in what looked like the start of a sustained break to the downside. BABA reported earnings on May 18th before the open, and the stock initially moved sharply lower in anticipation of further general market carnage to the downside.

But that never materialized, as the market pulled another one of its by-now famous “one-off” sell-off days, bottomed on May 18th. This occurred as the S&P 500 Index found support at the top of its April price range while the NASDAQ Composite undercut a prior early May low and then turned back to the upside.

You can check the index action on May 17th and 18th on your own, but the main point is that this set the stage for an associated U&R move in BABA. If one was not in panic mode on the 18th, perhaps holding a lot of cash, and most definitely not allowing one’s mind to drift into a lockset bearish frame of reference, one could have been open to this trade.

BABA turned with the market after the U&R move and jacked to new highs near 126. Most recently it traded at an intraday high of 148.29. That U&R on May 18th was quite an opportunity, but might have been difficult to see if one was absorbed into the bearish air that permeated the market that May 18th morning.

 

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But while the U&R set-up can work quite well, as BABA and other stocks on our long watch list have shown frequently in 2017, one must understand that it is a trade set-up. It is NOT a guarantee of a profitable trade. What makes a U&R set-up so attractive, in my view, is the fact that it generally occurs in a contrarian environment (i.e., it is bullish but occurring when the market looks bearish), and that, more importantly, risk can be kept to an absolute minimum.

This is of course achieved by using the prior low in the pattern as your long trigger and your long stop or selling guide. But when we test a U&R set-up on the long side and are quickly stopped out, as was the case with my Netflix (NFLX) position earlier in the week, that is also useful market feedback that can help on the short side.

Sometimes I will quickly flip to the short side of a stock after selling my long position if I get the sense that it is about to break to the downside. With NFLX, the potential undercut & rally and “LUie” set-up turned into a shortable bear flag breakdown on Monday.

All that is to say that while we can make use of these Ugly Duckling types of long set-ups, we absolutely must recognize that they may not work this time around. And that is useful market feedback. Getting back to the action of the indexes, right now the bounces look more like logical reaction rallies off near-term support areas within a nascent downtrend.

The S&P 500 Index took some heat on Thursday as sellers knocked it all the way back to the 50-day moving average. But this only set up a logical reaction rally and bounce off the 50-day moving average. You might also notice that Thursday’s bounce also came after the index had undercut the prior lows in the pattern from the first half of January.

 

GR070217-$SPX

 

Financials all gapped up on Thursday after the results of the second part of the Fed’s bank stress-tests were released. The SPDR Sector Select Financial ETF (XLF) shows how the gap-up move was sold into on heavy volume. The XLF was turned back on a bid to clear the 25 price level, which correlates to similar stalling and reversing action in BAC, GS, MS, WFC, and scores of other financials.

Currently this is the market’s only significant area of leadership, but I think it needs to be watched closely. If we see financials start to break down or fail on recent breakouts, like the XLF’s, then it will probably be associated with further downside in the major market indexes and the progression of a deeper market correction.

 

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Big-stock NASDAQ names have been pummeled with selling volume this week. Netflix (NFLX) was one example of a big-stock NASDAQ name taking some heat. The stock has been unable to hold any undercut & rally moves after Tuesday’s big-volume failure at the 20-day exponential moving average.

The weekly chart below shows the initial test of the top of the prior base three weeks ago. The ensuing one-week bounce came on light volume, and weekly volume picked up this week as NFLX ran into resistance at the 10-week moving average. It is now rolling over in what is now a retest of the top of the prior base. Failure here would likely spell doom for NFLX.

 

GR070217-NFLX

 

Facebook (FB) has also endured some heavy selling but so far has been able to hold at its 50-day moving average. On Friday, the stock held up in a tight range as volume declined to just below average. This might look buyable, but note that on the weekly chart, not shown, FB is actually now sitting below its 10-week moving average.

Bearish or bullish? Depends on whether you look at the daily or weekly charts. So, if we see the stock breach the 50-day line on the daily chart, this would confirm the already existing breach of the 10-week line on the weekly chart.

 

GR070217-FB

 

Alphabet (GOOGL) is another failed undercut & rally attempt after gapping back below the 50-day moving average on heavy selling volume on Thursday. This came the day after the stock was showing strong-volume support at the 50-day line as it also undercut the prior two June lows in the pattern and rallied back above them.

But Wednesday’s “support” at the 50-day line looks rather weak in comparison to the much-higher selling volume seen on Thursday. On Friday GOOGL posted its lowest closing low since early May. This looks bearish, and could easily result in further downside. I’d even say that GOOGL looks shortable on any small, weak-volume rally back up into the 50-day line from here.

 

GR070217-GOOGL

 

Tesla (TSLA) also failed on an undercut & rally attempt that occurred on Wednesday. Thursday the stock rolled over and broke below its 20-day exponential moving average on above-average selling volume. On Friday, the stock traded in a tight range as it churned about the 20-dema on light volume. This looks bearish, and may portend a test of the 50-day moving average. CEO Elon Musk is set to announce news on the new Model 3 on Sunday, so this may figure into the short-term action of the stock. But right now, it looks to me like it is being drawn towards the 50-day line.

 

GR070217-TSLA

 

The situation doesn’t improve much when it comes to the other big-stock NASDAQ names we’ve been following in recent reports. My notes below on each:

Amazon.com (AMZN) is retesting its 50-day moving average and looks vulnerable to a breach of the line after initially bouncing off the line on Wednesday.

Apple (AAPL) is trapped in an “L” formation that looks more and more like a bear flag than a potential LUie. The stock is living well below its 50-day moving average and over the past two trading days has been finding resistance at the lows of its 10-day moving average. This may easily head lower from here.

Microsoft (MSFT) broke below its 50-day moving average after finding support at the line on Wednesday on an undercut & rally move that has now failed miserably. This looks like a short here using the 50-day line as a guide for a tight upside stop.

Nvidia (NVDA) is rolling below its 20-dema and looks poised for a test of the 50-day moving average.

All these big-stock NASDAQ names failed to follow through on what looked like constructive action on Wednesday. They all rolled lower on Thursday on higher selling volume in most cases. Based on the action of these stocks, further downside in the NASDAQ Composite seems likely from here.

Chinese names also aren’t doing much to inspire confidence. JD.com (JD) failed to hold support at the confluence of the 10-day and 20-day moving averages and has since moved lower. On Friday, it held at the 50-day moving average as selling volume came in just above average.

A breach of the 50-day line would be a bearish development. The flip side is that the stock will hold support at the 50-day line and push back to the upside. But then it did that once before in mid-June, so one has to wonder how many more times Cinderella will show up at the ball.

 

GR070217-JD

 

Netease (NTES) attests to the volatility in many leading stocks lately. In early June, it broke out to all-time highs, but that breakout failed quickly on heavy selling volume. A week later NTES defied what looked like a late-stage, failed-base short-sale set-up and simply turned right around to re-breakout to all-time highs again.

But even that breakout was short-lived. This past week NTES reversed course again, failing on a base breakout for the second time in June. On Friday, the stock sold off even more, pushing further below the 20-day exponential moving average. So, will Cinderella show up at the ball for the second time here, producing yet another re-breakout? Somehow, I am skeptical. Now this looks like a short using the 20-dema as a tight upside stop.

 

GR070217-NTES

 

Alibaba (BABA), not shown, is holding tight along its 10-day moving average as it continues to track tight sideways within a mini-cup-with-handle pattern. I suppose one could see this as buyable right here, but I should say I wouldn’t be surprised if the stock moves lower given that on Friday it reversed at and closed below its 10-day moving average.

Momo (MOMO) is in a somewhat compromised position here as it hesitates following an undercut & rally move on Wednesday. Over the past two trading days the stock has held tight in what looks like a short bear flag given that there was no follow-through to Wednesday’s U&R attempt.

MOMO closed Friday at 36.96, just four cents above the prior 36.91 low of June 22nd, but if it breaks below that all bets are off, and the stock could be headed for a test of the 200-day moving average. Depending on the market context, this could be morphing into a short-sale here using the 20-dema at 38.12 as your upside stop.

The flip side of this is that the Ugly Duckling shows up here and the stock goes flying back up through all three of the moving averages that lie just above Friday’s close. This likely resolves based on the context of the general market action. Indexes go lower, MOMO goes lower.

 

GR070217-MOMO

 

Weibo (WB), not shown, is now trading below its 50-day moving average, so can’t be considered buyable unless it regains the topside of the 50-day line.

Optical names all got slammed on Thursday, with Finisar (FNSR), not shown, failing to hold above its 20-dema. Meanwhile, Lumentum Holdings (LITE) posted a pocket pivot at the 10-day line two Fridays ago, but that was short-lived. Since then, the stock has spent the past five days bee-lining for its 50-day moving average.

On Friday, it looked like LITE might try and pull an undercut & rally move coming back up through the prior 57.50 low of early June. That did not hold, and the position I took in anticipation of this move was quickly blown out as the stock faltered going into the final ½ hour of trading that day. In my view, that is useful market feedback, indicating that the stock is likely to retest the 50-day line in the coming days.

 

GR070217-LITE

 

Applied Optoelectronics (AAOI) looks weak here after looking like it might push back above its 50-day moving average early on Friday. The stock ran into resistance around the 20-day exponential moving average and reversed to close back below the 50-day line as volume increased. This looks bearish, but the stock is still sitting right on top of its prior base, as I’ve highlighted on the chart. I would not be surprised to see it break lower, particularly if we see the market continue to weaken in the coming week.

 

GR070217-AAOI

 

Appian Corp. (AAPN) is continuing to act reasonably well following last week’s pocket pivot coming up through the 10-day and 20-day moving averages. It has spent the entire past week holding tight sideways along its 10-day and 20-day lines with volume drying up. On Thursday, the stock was up on the day, which was somewhat bullish in the face of the big tech sell-off on that day.

Here we see the stock holding tight at the confluence of the two short moving averages with volume drying up to extreme “voodoo” levels. My guess, however, is that this will only produce more upside from here IF the general market is able to find its feet and rebound back to the upside. So, keep it on your buy watch list.

 

GR070217-APPN

 

While APPN looks okay, at least for now, I’m not interested in its larger cloud cousins, Salesforce.com (CRM), Workday (WDAY) (not shown) and ServiceNow (NOW) (also not shown) as longs right here, given the uncertainty of the general market environment. As big-stock leaders, these would all be susceptible to further downside in a continuing market correction.

If we look at the daily chart of CRM, we can see that this is looking like a fractal head and shoulders short-sale set-up here. Thursday’s failure at the 50-day moving average on above-average volume brings this into play as a short, in my view, using the 50-day line as a guide for an upside stop.

The issue here is that in this market we’ve become accustomed to patterns like these resolving as “LUie” formations. I’ve considered that if and when we ever start seeing these L-formations fail like bear flags instead of recovering into U-formations, a deeper market correction is coming. I think we’re starting to see that in several names, and CRM is one example.

 

GR070217-CRM

 

Tableau Software (DATA) may also turn out to be a shortable pattern. On Wednesday, it was pulling into the 10-day moving average and the top of the prior flag breakout as volume was drying up to “voodoo” levels. This looked like a constructive pullback, but only led to a sharp breakdown through the 20-day exponential moving average.

That is not what you want to see on a “voodoo” pullback. The stock should hold at the moving average and move higher from there. Now DATA looks like a late-stage failed breakout situation that is shortable on any small, weak, rally back up into the 20-day exponential moving average.

 

GR070217-DATA

 

Palo Alto Networks (PANW) looked to be pulling back into a buyable position right at its 200-day moving average on Wednesday. That turned out to not be the case, as the stock flipped back underneath its 200-day line on Thursday. This needs to hold the 20-dema to remain viable, and could be considered buyable near the line if it continues to hold the line in constructive fashion.

 

GR070217-PANW

 

Snap (SNAP) is another name I’d keep on my buy watch list in case I need some names to go to in the event of a market recovery. The stock is back above the prior 17.59 low in the pattern, so currently it has posted another U&R buy trigger. Note that it is also holding tight at its 10-day moving average with volume drying up to extreme voodoo levels on Friday.

This action also shows up as three weeks of tight closes on the weekly chart, which indicates that there is support for the stock down here. So, SNAP could present a reasonable Ugly Duckling set-up in the event that the market finds its feet and rebounds.

 

GR070217-SNAP

 

Twitter (TWTR) continues to find support along the confluence of four major moving averages as it pulls back and consolidates the prior week’s pocket pivot move back up through all four of these moving averages. This puts it in a lower-risk entry position along the moving averages, and so is a name I would keep on my long watch list in case I need it.

 

GR070217-TWTR

 

Nutanix (NTNX) is holding its buyable gap-up (BGU) move of Wednesday, although it has dipped slightly below the 19.68 intraday low of that day on an intraday basis twice of the prior two trading days. On Friday, the stock found support near the 10-day moving average and rallied into positive territory by the close. This remains buyable on pullbacks closer to the 19.68 price level. NTNX is another name that remains on my buy watch list as a potential “go to” name if the general market can find its feet and rebound.

 

GR070217-NTNX

 

Canada Goose Holdings (GOOS) failed to hold above the 20.50 undercut & rally low after pushing above it on Wednesday, as I noted in my Wednesday mid-week report. It sold off on Thursday with the rest of the market as absorption issues are coming into play following the 12.5 million share secondary offering that was priced on Wednesday.

On Friday, I blogged that the stock was testing the 19.43 low of the early June gap-up move it had as it filled the gap. It then rallied off the lows of the day, but did not build up much in the way of upside momentum. This may remain viable if it can hold the 19.43 price level and/or the 50-day moving average. For this reason, it remains on my buy watch list.

 

GR070217-GOOS

 

My thinking with some of these Ugly Duckling type situations, such as SNAP, PANW, and NTNX, and new-merchandise situations like APPN or even GOOS, which is also a bit of an Ugly Duckling (or that an Ugly Goosling?) is that they may perform better in a market rebound. This is primarily because they haven’t already had big upside moves the way the big-stock NASDAQ and other tech leaders that are now coming under pressure have.

Add to this the idea that a continued market rally will be dependent on some sort of healthy rotation as money comes out of the old, obvious leaders and into areas that have been neglected for some time. Among these, many look to the financials for leadership, and so far, they have been holding up.

Another area of deep neglect has been the oil patch, which is probably the most beaten-down area of this market. On Wednesday I blogged about Keane Group (FRAC) as it was poking its head up above the 50-day moving average. That was a follow-through to an undercut & rally move that occurred on Monday as the stock pushed up through the 14.31 low of June 8th.

That triggered a U&R buy set-up at that point, and Wednesday’s push up and off the 50-day moving average served as a nice confirmation of the prior U&R move. FRAC has since continued higher. Now it is back up near the highs of the current six-week price range that makes up the left side of this current IPO base. Pullbacks closer to the 15 level would serve as lower-risk entries.

I should point out that FRAC isn’t really a fresh, new IPO since it is a re-incarnation of the old Keane Group, which if my memory serves me correctly, traded under the symbol KEA way back when. I can remember trading the stock back during the big move in oils in 1996-1997. Back then, FRAC (KEA) was an oil services company, but today it has been reincarnated as an oil services company focusing on fracking services.

So, there’s the “N for New” for you. While FRAC is currently posting losses, it is expected to turn a $1.07 profit in 2018, so it can be considered an odd sort of IPO turnaround play.

 

GR070217-FRAC

 

Jagged Peak Energy (JAG) would qualify as a fresher situation in the oil patch. The company came public back in late January at $15 a share and opened up for trading below its offering price. Other than one intraday move to a high of $15.08 on February 6th, the stock hasn’t seen the light of day since in terms of trading above its offering price.

From early February to early May, JAG remained in a downtrend, but in mid-May gapped up after reporting a 267% increase in earnings as it turned off the lows of what is now a five-month IPO base. The stock was looking like death a little over a week ago as it started to roll over again, but found its feet around the 12 price level in the middle of last week.

At that point it staged an undercut & rally move that was also a “roundabout” or “bottom-fishing” pocket pivot coming up through the 50-day moving average, closing two cents above the line on June 23rd. Like FRAC, JAG is now approaching the highs of a six-week price range that forms the right side of a potential IPO base.

Pullbacks to the 10-day line at 12.66 would offer the lowest-risk entries, although I would consider the stock to be in buyable range right here. JAG is currently moving into profitability, and is expected to post earnings of 40 cents in 2017, and 96 cents in 2018, which would indicate a large percentage increase on tap for the stock.

 

GR070217-JAG

 

In addition, it is useful to note that rig counts for the U.S oil industry are on the rise, with the biggest increases occurring in North Dakota. The U.S. rig count is currently at 186, but way, way below the 2008 peak of 1,606. That leaves a lot of room for improvement, IF we can see the group begin to show a more robust revival. So far, FRAC and JAG appear to making attempts at doing so, and they also represent new-merchandise within the group, which I tend to favor.

Other leaders continue to falter, and some of these are evident in my notes on names discussed in recent reports below:

Activision Blizzard (ATVI) – holding support at the 50-day moving average.

Arista Networks (ANET) – holding support at the 50-day moving average.

Edwards Lifesciences (EW) – still holding tight at the 10-day moving average. Stock remains viable as long as it continues to hold the 10-day and 20-dema lines.

Electronic Arts (EA) – dipped below its 50-day moving average on Friday after failing on an undercut & rally attempt on Thursday after breaking below the prior 107.32 low of June 15th.

First Solar (FSLR) – stock is extended but I still view it as a potential short since it and all the other solars all rallied hard over the past week solely on President Trump’s comment about putting solar panels on the proposed U.S.-Mexican border wall. Thus, this seems entirely news-driven, and only brought these stocks back to life as they were breaking down to lower lows two weeks ago.

iRobot (IRBT) – has busted its 50-day moving average and has moved further below the line over the past two trading days. Removed from my buy list.

SolarEdge Technologies (SEDG) – pulling into the 20-dema as volume dried up to -45% below average on Friday. A lower-risk entry, assuming the general market holds up.

Square (SQ) – closed below its 20-dema on Friday.

Sunpower (SPWR) – extended.

Take-Two Interactive (TTWO) – has worked on the upside after posting an undercut & rally move on Wednesday. However, it stalled Friday at the 20-dema which looks like a retest of the 50-day moving average is likely,

Universal Display (OLED) – has dipped below the 50-day line. Removed from my buy list.

Zillow (Z) – stock has held the pullback to the 10-day line, but is in an extended position, so at best may need more time to consolidate and set up again.

For newer members: Please note that when I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple (the magenta line), 20-day exponential (the green line), 50-day simple (the blue line) and 200-day simple moving average (the red line). On rare occasions, I will also employ a 65-day exponential moving average (thin black line).

The market remains no less tricky than it was when I wrote my last report, and might even be getting a bit messy. Most of the undercut & rally moves I saw on Wednesday and that were actionable on the long side at that time failed rather quickly on Thursday. That is, as I’ve already pointed out, useful market feedback.

On Friday, there was some potential for other similar types of long set-ups that were starting to unfold in real-time, as was the case with LITE, for example, but that failed to pan out. So far, when it comes to these Ugly Duckling set-ups, I’m not seeing anything that has demonstrated any sustainability just yet. Meanwhile, the index action looks questionable, and many leading stocks are showing deterioration in their patterns or attempting to make a final stand at their 50-day moving averages.

From a practical standpoint, I have operated on a bifurcated basis this past week, trading stocks long and short when I could discern strong potential for at least a short-term move in the desired direction. In the process, I had one of my best trading weeks of the year, believe it or not, despite things getting off to a slightly rocky start on Monday where I had some long positions gapping down slightly at the open.

This coming Monday is a short trading day ahead of the Independence Day Holiday, otherwise known as July 4th, on Tuesday. So, we may not see anything decisive until we clear the holiday, but that is not always the case. I can remember several short pre-holiday and post-holiday trading days where the market has had big moves, such as the big gap-down move on November 27, 2009, the day after Thanksgiving.

For now, we are on alert for two potential developments. The first is a resolution to the downside as the indexes sputter about after logical reaction bounces, and the second is a market stabilization and recovery that potentially sees rotation into other areas of the markets. I don’t know whether financials and oils, for example, can drive a big, bad bull market continuation, but I would not discount anything in this market.

I would also imagine that based on the action of many leading stocks, those using either the 10-day simple or 20-day exponential moving averages as selling guides have already been stopped out. Those giving positions a wider berth by setting their selling guides at the 50-day moving average may be starting to get stopped out, as would be the case in something like IRBT, for example.

Central banks are now starting to sound more aggressive in ending their QE programs, as they look to hand off the stimulus game to the fiscal policy creativity of the politicians. In this regard, there are some potential proposals by the President, including tax-reform and tax-cut legislation, that could have a positive impact for the market. But without significant progress on the fiscal front, the taking away of the easy money punchbowl could have a deleterious effect on the markets.

In the meantime, I choose to tread lightly here, keeping plenty of dry powder in my pockets. This will allow for the possibility of keeping an entirely open mind here as we see where this market goes from here.

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 no positions, 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.