The Gilmo Report

July 20, 2016

July 20, 2016

The indexes have remained relentless in their quest for higher highs. Both the Dow Jones Industrials and S&P 500 Indexes moved to fresh all-time highs today, albeit on volume that was roughly even. While the lower volume could indicate that the NYSE-based indexes are getting set for some sort of logical pullback, it remains a matter of watching the stocks first.

 

$GR072016-$SPX

 

Objectively, the market rally remains intact, and the action of the NASDAQ Composite Index helps to confirm this. The index moved to a higher high today as it gets ever closer to its all-time high of 5231.94 achieved exactly one year ago today. Volume was higher today, thanks to heavy trade in big-stock NASDAQ index names like Microsoft (MSFT) and Cisco Systems (CSCO).

Among individual stocks there have been some breakouts, but many have simply spent the last week or so moving around within reasonably well-defined price ranges. In most cases the sharpest moves occurred off of the Brexit sell-off lows.

 

$GR072016-$COMPQ

 

As the indexes move higher, I like to keep an eye on a couple of charts, the first being the NYSE Bullish Percent Index ($BPNYA). As we can see this is starting to reach the peak of last summer, just before the market split wide open in August of 2015. It remains below its highs of 2013 and 2014, however.

 

$GR072016-$BPNYA

 

Back when I was running money for Bill O’Neil and managing his institutional advisory services group, we used to keep a close eye on the percentage of stocks above their 150-day moving average on both the NYSE and NASDAQ Exchanges. When this got into the 65-70% range, we saw that as approaching cautionary levels. Below we can see the chart of the NYSE Percent of Stocks Above 150-Day Moving Average ($NAA150R), below. This is just starting to poke above the highs of last summer.

 

$GR072016-$NYA150R

 

Meanwhile the chart of the NASDAQ Percent of Stocks Above 150-Day Moving Average ($NAA150R), below. It has already well-exceeded its prior 2015 highs, and is approaching levels last seen in 2012. In general, you will find that extreme highs in all three of these charts tend to be associated with at least market pullbacks.

I use them as a measure of how prone the market might be to a natural pullback, if not something worse. Normally, however, I can get a sense of how extended things are getting on the upside just by the movement in my favorite long situations. No doubt, things have been very, very good for the long side of this market since the big undercut & rally move of late January.

 

$GR072016-$NAA150R

 

So while we could be getting a bit extended here, my approach simply focuses on looking to sell long positions into extended strength. I then look to buy back on constructive pullbacks. Most of the time I am able to do just that. Some are calling the current market rally the “Trump Rally” in anticipation of a more business-friendly administration potentially entering the White House in January. That may or may not be true, but it does appear that the market is trading higher on the idea that the economy is improving.

This in turn will keep the Fed on track to raise rates, perhaps when they meet next week. So the U.S. Dollar Index has made its highest high since March, which in turn has sent precious metals gapping lower. The SPDR Gold Shares ETF (GLD) gapped below its 20-day moving average today but remains just above its prior base breakout. As it comes in here, the 50-day moving average at 122.82 looms as potentially solid support.

If one is longer-term bullish on the metals and believes the Fed will stand pat next week when it meets, then looking to buy into this weakness is the preferred way to buy the GLD. While the top of the prior base could be seen as the first level of potential support, it could move lower to the 50-day moving average.

 

$GR072016-GLD

 

The iShares Silver Trust (SLV) gapped down to its 20-day moving average on above-average selling volume today, but remains well above its prior base breakout level. The top of the prior base more or less coincides with the 50-day moving average, now at 16.93. While the 20-day line could be seen as an initial lower-risk entry point for the long side of the SLV, a deeper pullback would present the most opportunistic entry point.

The metals tend to be quite volatile, and the action today simply continues an old pattern in this regard. That is why, and I’ll say it again, if one is bullish on the intermediate- to longer-term prospects for the metals, buying on weakness while looking to keep risk to a minimum is the preferred way to do it. If the Fed remains on hold next week, then we could very well see the metals snap out of this current pullback. In any case, both the SLV and GLD were somewhat extended from their prior base breakouts and primed for pullbacks.

 

$GR072016-SLV

 

The weakness in the metals sent precious metals stocks careening to the downside today as well. However, within the context of their prior upside moves, the pullbacks are coming off of recent peaks. If we look at the daily chart of Silver Wheaton (SLW), below, we can see that the stock is just barely peeling off of its recent 52-week highs. While selling volume was above average today, the stock is still well above its 20-day moving average. It is even further above its last trendline base breakout in early June.

Agnico Eagle Mines (AEM), not shown, has dropped below its 20-day moving average and looks primed for a teste of its 50-day moving average at 50.34. As with the metals, my view is that the best time to buy these is on weakness, assuming one is interested in doing so. That remains the case until we begin to see more definitive price breakdowns in these names.

 

$GR072016-SLW

 

Facebook (FB) proved me wrong by coming to life on Monday with a nice pocket pivot off of the 50-day moving average. I had assumed that the stock might simply remain dormant at best ahead of earnings next week, but that was not the case. FB followed up on Monday’s pocket pivot with another pocket pivot volume signature and then today cleared to all-time highs on a pocket pivot volume signature. However, it was enough to consider Monday’s move to be a trendline base breakout on a bona fide pocket pivot off the 50-day moving average.

The question now is how far the stock can go before earnings are expected to be announced late next week. Therefore, unless one is interested in playing earnings roulette with the stock, then one must answer the question with respect to whether they wish to treat the current action as a swing-trade ahead of earnings or not.

That would of course depend on how much profit cushion one has in any FB position going into the report. One could then decide whether to hold a full or partial position going into earnings. For now, however, the new-high breakout on a pocket pivot volume signature remains in force

 

$GR072016-FB

 

Not quite a month ago I told members to watch for the major market indexes to undercut their May lows following a post-Brexit selling washout and then attempt to rally from that point. At the same time, within this general market context, we also saw a large number of stocks do the exact same thing. They undercut prior lows in their patterns, shook out weak hands and then turned higher.

Now I’m starting to see the after-effects of showing people this type of set-up, because it now appears that some want to call each and every move by a stock below a prior low an “undercut & rally.” It doesn’t even seem to matter where the low is. Every undercut of a low is now automatically assumed to be a buy set-up. Unfortunately, that is not the case.

This is the phenomenon I refer to as “a little knowledge can become a dangerous thing.” It reminds me of when Bill O’Neil first discussed the ascending base in 1998. After that everyone was seeing ascending bases all over the place. As is typical with many investors, the tendency to start mindlessly applying something they think they’ve learned is strong but sets them down the wrong path.

What many have failed to understand about an ascending base is that context is everything. What makes an ascending base so powerful is that it occurs while the general market is in a correction or bear market. A strong stock actually wants to keep going higher even as the market goes lower. Once the weight of the market comes off, the stock then shoots higher.

The undercut & rally situation is also dependent on market context. As most of you know, I have used undercuts of prior lows in a pattern after a stock has come down for a period of time as points where I cover all or part of a short position. I then remain open to the possibility of shorting the stock again as it undercuts and rallies to the upside.

But this type of move is also often associated with the general market and therefore has a specific market context. Usually, a stock will post a U&R move at the same time that the general market is undercutting a major low or coming down to an area of potential support such as a key moving average.

This was the case as the market undercut its prior May lows in late June during the Brexit sell-off. And its ability to rally back up through that low in a big shakeout type of maneuver is also what provided the proper context for so many stocks to do the same. That is the essence of an undercut & rally set-up in most cases.

We can see how Tesla Motors (TSLA) set up as a U&R back in late June at the same time as the market was forming its Brexit sell-off lows. At the same time, TSLA was undercutting the 195 low of August 2015. It was also undercutting its prior May lows, but the August 2015 low is a much more significant low since it occurred during a severe market break at that time.

So we can see that there is a clear synchrony between what TSLA was doing in late June and what the market was doing. The market’s subsequent drive back up through the May lows is what gave TSLA and many other stocks in similar positions so much upside thrust, as is common with these types of moves.

That is why on the Monday after the Brexit vote I was blogging that members could try and play undercut & rally moves with smaller positions. One could take advantage of the strong upside thrust by taking a smaller position, allowing the equation Force = Mass x Acceleration (translated into Profit = Position Size X Price Movement) to work for them.

The reality is that I went into a deep discussion of this whole undercut & rally concept at that time, and I set it within the context of the Brexit sell-off. Now I see people trying to take this and use it lazily and in a sort of ad hoc manner without taking into consideration all of the contextual factors at play in a U&R move.

Successful investing is highly dependent on one’s ability to think critically, taking contextual factors into consideration, not relying on the simple-minded application of misperceived labels. So instead of just seeking knowledge, it is better to develop true understanding instead.

Getting back to TSLA, we can see that its late June undercut and rally move led to some nice upside gains, and the stock is still going. As I wrote over the weekend, “…if we simply focus on the price/volume action of the stock, this low-volume pullback into the 10-day line at 219.15 looks buyable.”

So far this week that has been the case, although we have yet to hear about CEO Elon Musk’s “master plan” for the company.  However, blocking out the news and simply operating on the basis of what the stock was doing as it pulled into the 20-day line on light volume would have yielded some upside results so far this week.

 

$GR072016-TSLA

 

Netflix (NFLX) announced earnings Monday after the close and surprised investors with extremely weak subscriber numbers. This sent the stock gapping down to its late June lows on huge selling volume. Initially, this has the look of a potential shortable gap-down (SGD). The slight wrinkle here is that it is also testing its prior late June low, and slightly undercut that 84.81 low yesterday. Therefore, this can serve as near-term/short-term support but I would not see this as an undercut & rally set-up as the basis for a sustained upside move.

If one is nimble and can employ the 620 intraday chart as a guide, it is possible to scalp a bounce in NFLX off of yesterday’s lows. However, given the magnitude of the downside break, this may only result in a shortable bounce. The undercut & rally concept originated from my work on the short side and is discussed in detail in the book, Short-Selling with the O’Neil Disciples. It has only been during the great bull market that I have found it useful as a long set-up under the right contextual conditions.

Most undercut & rally moves eventually end up being shortable again. So while an upside scalp in NFLX over the past day or two was certainly possible, it did not warrant a complacent long position on the basis of the U&R alone. The intraday high of yesterday’s SGD was 86.75 and the stock moved about a percent beyond that today. For a stock like NFLX, this would strike me as being well within the range of upside porosity through the 86.75 SGD high.

However, if one is looking to short this rally, watching your 620 chart for an intraday sell signal is the best way to try and enter on the short side during the trading day. If the stock doesn’t give way to the downside, one can then back away and wait for the next such opportunity.

 

$GR072016-NFLX

 

One major consideration with NFLX as a short-sale target is that we are in a market rally phase. Therefore, the short side will tend to be a lower-probability proposition in terms of success rates. But NFLX could have some downside from current levels during any general market pullback as the market gets extended to the upside. ServiceNow (NOW) is another example where one member tried to make the pullback down to the 20-day line on Monday into an undercut & rally long set-up. In this case, one is simply complicating matters when it is entirely unnecessary.

In this case the stock simply pulled down into the 20-day line yesterday on volume that was -36% below average. That qualifies as a voodoo pullback to the line. NOW then rallied back to the highs of its current seven-day range on above-average volume, a strong showing. Remember that what makes an undercut & rally work is the fact that the initial move below a prior low in the pattern is seen by the crowd as a breach of support. In this manner it washes out any final sellers, sucks in shorts, and then fakes out the crowd by turning back to the upside.

In NOW’s case the decline on Monday and Tuesday below the lows of last Thursday and Friday is not an undercut at all. There is no major low there that would represent a level that would be considered major support for the stock. In this case, just using a little common sense and having some understanding of what drives the dynamics of an undercut & rally is helpful. It’s not as if I haven’t talked about this whole concept enough in my reports.

 

$GR072016-NOW

 

As NOW and TSLA both demonstrate, most stocks are moving sideways within areas of consolidation. One then simply uses pullbacks to the lows of the range and a key moving average to buy the stocks on constructive weakness. In some cases, as with Mobileye (MBLY), the pullbacks don’t amount to much as the stock more or less moves tight sideways. MBLY has held very tight along its recent highs above the 49 price level over the past week or so as the 10-day moving average has finally caught up to the stock.

If one had sold into the extended upside movement as the stock formed a double-top just above the prior 49 price high of late June, then it would have been possible to re-enter on the pullbacks down into the 47 price level and below. Now the 10-day line at 47.24 serves as a near-term guide for support. Keep in mind that MBLY is expected to report earnings next Tuesday, so you have to decide whether having a nice profit in hand, assuming you bought it near or below the 40 level, is preferable to playing earnings roulette.

 

$GR072016-MBLY

 

Among the two solar names I discussed in this past weekend’s report, SolarCity (SCTY) and SolarEdge (SEDG), only SCTY is showing any upside spunk. But as I wrote, this one could be bought if one was feeling lucky enough and confident enough that the TSLA buyout of SCTY would proceed apace.

The stock has been helped along by a Wall Street Journal report alluding to comments by CEO Elon Musk that he expected the buyout to be approved by a majority of TSLA shareholders. This has sent SCTY further up into the proposed buyout range of 26.50 to 28.50 a share. If CEO Musk can articulate a strong vision for a TSLA acquiring SCTY, then it could bring the stock closer to the highs of the proposed buyout range at 28.50. So far the stock has moved to a high of 27.48 on an intraday basis, right at the mid-point of the proposed buyout range.

 

$GR072016-SCTY

 

Workday (WDAY) is another stock that had a sharp run-up from the late June Brexit sell-off lows and has spent the last week or so consolidating those gains. As I wrote over the weekend, I tend to view this as buyable on pullbacks down to the 78 price level. With the 10-day line now at 78.33 and the 20-day line now at 77.49, the stock has two reasonable reference points for downside support on any further pullbacks. Today WDAY rallied with the market back to the highs of its six-day price range on increased but below-average volume.

I would continue to consider the best opportunities to take shares in WDAY on pullbacks down to the 10-day or 20-day moving averages. Earnings are not expected to be released until late August.

 

$GR072016-WDAY

 

Splunk (SPLK) looks almost identical to WDAY, but with one major difference. The stock started out the day today perhaps not looking all that strong as it traded down to its 20-day moving average. However, as I wrote over the weekend, “SPLK remains buyable on pullbacks towards the 20-day moving average…”

Thus one had to be taking an opportunistic view of this morning’s pullback on the long side. By the end of the day, SPLK posted a clear pocket pivot move off of the 20-day line and back up through the 50-day moving average.  It is now back near the highs along the 60 price level that extend back to early June. Certainly, if one has no problem allowing the stock downside to the 20-day moving average, this pocket pivot could be considered actionable. However, pullbacks to the 10-day line at 57.90 might offer more opportunistic entries.

 

$GR072016-SPLK

 

Other cloud names I’ve been following have also been edging higher. Adobe Systems (ADBE) and Citrix Systems (CTXS), not shown here on charts, have been edging up but offer no concrete entry points. Meanwhile, Salesforce.com (CRM) did manage to flash a pocket pivot today off of its 10-day moving average.

That move stalled a bit as the stock closed roughly at the mid-point of its daily price range. I would prefer to buy the stock on any retest of its 10-day moving average at 81.27. At the same time, any pullback to the 20-day line at 80.83 would provide an even more opportunistic entry point, should that occur. As I wrote over the weekend, you want to remain alert and opportunistic, and so far this week there have been some opportunities to buy favored long names on pullbacks. You either make use of those or you don’t.

 

$GR072016-CRM

 

As both Barracuda Networks (CUDA) and CyberArk Software (CYBR) remain in extended positions on the upside and FireEye (FEYE) continues to go nowhere fast, Palo Alto Networks (PANW) can be considered the Ugly Duckling winner among the cyber-security stocks so far this week.

Over the weekend it was looking rather grim as it clung to the underside of its 10-day moving average. But by yesterday PANW was able to edge back above the line on a stalling move to the upside. This, too, didn’t look all that constructive, but note that Monday’s action showed some voodoo volume action right at the 10-day line.

This was also a Wyckoffian retest of the prior late June and early July lows on what was ostensibly a test for supply. The test was passed with flying colors and the stock dutifully turned back to the upside as volume picked up but remained below average.

PANW did find some intraday resistance today at the 50-day line, closing below the line and in the upper third of its daily trading range. From here I might look at pullbacks into the 10-day line at 125.71 as potential lower-risk entry opportunities. Ultimately, however, I’d like to see the stock post a big pocket pivot as it slashes back up through the 50-day line, so that is something to watch for.

 

$GR072016-PANW

 

I’m beginning to think that some of these stocks read my report. It seems that whenever I grow tired of a stock and give it very little credit, perhaps even calling it “dead in the water,” it does something to prove me wrong. FB has certainly been an example of that this week. Square (SQ) can be considered to be a second example as I didn’t think much of the stock in my weekend report. But it has also responded by proving me wrong and posting a nice bottom-fishing pocket pivot (BFPP) coming up through its 50-day moving average today.

It’s nice to see the stock finally get back above the 50-day moving average. But that was likely to happen eventually as the stock continued to track sideways while the 50-day line has been descending for the past couple of months. Nevertheless, this pocket pivot is a nice show of strength, and the stock would be buyable here or on any pullbacks to the 50-day line at 9.33 as a lower-risk entry option.

 

$GR072016-SQ

 

The pocket pivots start to pile up as we see Zayo Group Holdings (ZAYO) posting one of its 10-day moving average touches on very strong volume. As I wrote over the weekend, I “Still prefer to use pullbacks down towards the 10-day line at 28.30 as lower-risk entry opportunities.” That opportunity came today as the stock pulled into the 10-day line and then turned back to the upside. In the process, ZAYO posted its highest high since September of last year. In the meantime, pullbacks into the 10-day line at 28.62 remain your best lower-risk entry opportunities.

 

$GR072016-ZAYO

 

Gigamon (GIMO) pulled into its 10-day moving average last Friday, as I noted in my weekend report, putting it in a lower-risk buy position. That turned out to be the case as it immediately came through with a strong pocket pivot move off of the 10-day line and into new high price territory on Monday.

The stock is now extended, and with earnings expected late next week it may have put in all the upside it can ahead of that report. In the meantime, additional pullbacks into the 10-day line at 40.40 would present lower-risk entries from here, but with earnings looming next week it may not be worth averaging up at this point.

 

$GR072016-GIMO

 

Below are Notes from my Trading Journal regarding other long ideas discussed in recent reports:

Acacia Communications (ACIA) – this thing has gone nuts on the upside and is now way, way extended. The 10-day line at 52.34 would be your nearest reference point for a buyable pullback.

Activision Blizzard (ATVI) – volume is drying up as the stock pulls back but so far has failed to hold its 10-day moving average. The 20-day line down at 40.62 would be your next reference point for a possible lower-risk entry.

Alibaba (BABA) – stock pulled right into the 10-day line on Monday where it was buyable per my comments over the weekend. As I wrote, the 10-day line “…would represent your best reference point for a buyable pullback.” The stock has since pushed to its highest high since December of last year.

Amazon.com (AMZN) – found support at its 20-day moving average on Monday and has moved back above the 10-day line. Earnings are expected next week.

Ambarella (AMBA) – stock continues to move higher so far this week, and is only buyable on pullbacks to the 10-day line at 55.19 or the 20-day line at 53.44 if one wants to take a more opportunistic view.

Atlassian Corp. PLC (TEAM) –  stock moved to a higher high today on below-average volume. Pullbacks to the 10-day line at 27.27 or the 20-day line at 26.65 would present lower-risk entry opportunities.

Barracuda Networks (CUDA) – stock remains way extended following its bottom-fishing buyable gap-up of nearly two weeks ago. The 10-day line at 19.51 and the 20-day line at 18.12 would be your nearest reference points for any buyable pullbacks.

CyberArk Software – finally got a decent pullback in the stock today as it dipped just below the 10-day moving average on above-average selling volume. I prefer a more opportunistic view here, looking for the pullback to carry down to the 20-day moving average at 50.99.

Electronic Arts (EA) – has not been able to make any progress to the upside since last Thursday’s pocket pivot off of the 10-day line. In fact, the stock has moved lower and is now right at its 20-day moving average after reversing at the 10-day line. Volume has been above average for the past two days as the stock has closed at the lows of its price range both days.

Fabrinet (FN) – stock pulled into the 10-day moving average today as volume declined to -68.5% below average. This would bring it into a lower-risk entry point, using the 10-day line at 37.53 or the 20-day line at 37.08 as your tight selling guides.

Imperva (IMPV) – holding very tight along the 10-day line, which puts it in a lower-risk entry position using the 10-day line at 46.07 as your guide for a tight downside selling guide.

Nvidia (NVDA) –  made higher highs today. Remains quite extended with the 10-day line at 52.51 or the 20-day line at 50.44 as your nearest reference points for a buyable pullback.

Twilio (TWLO) – as I wrote over the weekend, “the 10-day line at 38.06 would be your reference point for support on any pullbacks.” TWLO tested the 10-day line over the past two days and held, rallying back up through the line today on increased buying volume. This is a volatile, tricky name in an extended position, so make sure you only look to buy this thing on constructive weakness, if and when you can find it. Not a stock for the sleepy, that’s for sure!

Twitter (TWTR) – stock continues to trend higher ahead of next week’s expected earnings report. Pullbacks to the 10-day line at 18.06 could be considered buyable but remember that earnings are just around the corner.

Weibo (WB) – gave buyers a chance to buy shares on Monday as it pulled into the 10-day line. Now it’s back to being extended, with the 10-day line at 32.28 being your nearest reference point for a possible lower-risk entry on a pullback. One could also take a more opportunistic view here and see if the stock doesn’t pull down to the 20-day moving average at 30.61 as an even lower-risk entry opportunity, should that occur.

Yirendai Ltd. (YRD) – made another all-time closing high today and is need of some consolidation. If one bought down near the 16 price level and the prior double-bottom breakout level, one can either hold and use the 10-day line at 18.31 as a guide for a trailing stop or take profits and look to buy back on a pullback to the 10-day line.

Zendesk (ZEN) – bounced off of its 10-day moving average today where it was buyable today. The pullback also took the stock down into the 28 price area and the top of its prior consolidation from early June to early July. Would continue to use pullbacks into this price level as lower-risk entry opportunities.

As I wrote over the weekend, “For now, there is no reason to assume that this rally will fail.” And I might add that it’s done one better than that by not even posting much in the way of any pullbacks so far this week.

While we may be getting short-term extended on the upside, it remains a matter of watching your stocks and looking to approach things in an opportunistic and patient manner without chasing upside strength. If one has abided by that approach, then one has probably been able to make some upside progress since the late June post-Brexit lows.

Most of the long ideas I’ve discussed in my reports since those lows have done quite well. You really can’t ask for much more than that, and we are now mostly in a position of seeing where the next buy points will emerge. Some emerged this past week in the form of buyable pullbacks in names like ZAYO, GIMO, FB, BABA, SPLK, TWLO, etc., and those remain the sorts of things we want to remain alert to.

While many stocks are acting well in this market, I believe that my selections have done as well as any and have provided suitable and effective vehicles for riding the current market uptrend. So, for now, we stay the course, and await the next set of entry opportunities as they show up in real-time. Certainly, a nice, normal, and logical market pullback from here would hopefully present just such an opportunity as things get extended on the upside. As always, remain alert and opportunistic, assuming you haven’t gotten the memo by now!

 

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 SCTY and SPLK, 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.