The Gilmo Report

July 22, 2012

July 22, 2012

The market remains in its state of summer slosh, sort of an investment water park that sprays and splashes in various directions, as we see in the NASDAQ Composite daily candlestick chart, below. The market indexes ran up for three days in a row before succumbing to a pullback on Friday, an options expiration day. While the major market indexes are continuing in their uptrend, there is still very little coming through my screens in terms of new, buyable ideas, and this may be what is wrong with this market. While the indexes have rallied off their lows of early June, most of it seems to be driven less by emerging leadership and more by formerly beaten-down leaders bouncing off of recent lows. This strikes me as a bit of stock market sleight-of-hand, and speaks to the fact that there is little that I find compelling in this market. As I wrote in my mid-week report of this past Wednesday, I’m more inclined to sell into a rally than to buy into one. Each of the three short-term peaks we’ve seen in the market since early June has resulted in churning action that shows up in the form of “spinning tops” on the candlestick chart below. Each time, the market has rolled over and declined over the next several days, so I would not be surprised to see the same thing occur again.

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With more big-stock former leaders getting shellacked this week and fewer new leaders moving to the forefront to take their place, the market strikes me as being susceptible to further downside. This past week we saw Chipotle Mexican Grill (CMG) and Intuitive Surgical (ISRG), neither of which I show here, get slaughtered after earnings. Apple (AAPL) continues to appear to hold up well along its 10-day moving average, and has formed what might otherwise be seen as a constructive cup-with-handle formation. One issue I have with the chart, however, is that the handle is not drifting downward but is instead moving straight sideways to slightly up, which doesn’t look right to me. AAPL announces earnings this Tuesday, and it remains to be seen whether this will be a catalyst for a breakout from this cup-with-handle base formation or a breakdown. I will stick my neck out here and say that the weekly chart might be providing a tiny clue as to the price/volume outcome that will emerge from AAPL’s earnings announcement on Tuesday, and it may not be a positive one. For now I see this as reason enough to sell AAPL shares and take profits made from the pocket pivot buy point of July 2nd, waiting instead to see what kind of resolution occurs once earnings are out on Tuesday.

Apple (<a href=AAPL) Gilmo Report Stock Chart" title="Apple (AAPL) \" />

This past Wednesday after the close, and as I was in the process of writing my mid-week report, I noted that Mellanox Technologies (MLNX), which had posted a huge upside earnings and revenue surprise that afternoon, was trading above the $100 price level. In my view, such a gap-up of over 50% is somewhat extended and so carries more risk. MLNX did, however, open at 92.71 the next day, a price level that was not as extreme as the 100-plus level reached after-hours on Wednesday. Does this therefore become more buyable here in the high-80’s/low-90’s than would otherwise be the case had the stock opened up in the 100’s? Fundamentally, this is a powerful and compelling story, but the stock has already had one big buyable gap-up in April after which it spent nearly two months in a tight sideways consolidation. Certainly, if one is willing to take the risk, MLNX perhaps can be bought here, either initially or as an addition to an existing position if one was fortunate enough to have a position on Wednesday going into earnings – as long as it holds the 89.02 intra-day low of Thursday’s gap-up day. On the other hand, the stock may simply continue to go sideways for a period of time much as it did the last time it staged a big-volume gap-up move. And that may be the likely case if the market remains in its sloshy state.

Mellanox Technologies (MLNX) Gilmo Report Stock Chart

Onyx Pharmaceuticals (ONXX) is another stock that has two buyable gap-ups in its pattern, the most recent of which occurred Friday just before the FDA announced its approval of the company’s Kyprolis drug for the treatment of multiple myelomas, otherwise known as cancers. ONXX had a buyable gap-up back on June 21st, and since then has trended higher in a sort of ascending flag formation. Friday saw the stock break out of this ascending flag on the buyable gap-up move. This was technically buyable early in the day using the 70.12 intra-day low as a downside stop, but after a couple of hours of trading the stock was halted and the FDA news released, sending the stock much higher before it closed at 76.38, a position that is fairly extended at this point. Buying into the stock here, particularly after the news of the expected FDA approval of Kyprolis is already out and the stock is extended from this most recent buyable gap-up and breakout, is likely too risky a proposition. I would only be willing to buy the stock if it pulled back closer to the 70 price level, keeping in mind that ONXX is going to see its annual earnings per share drop from positive 66 cents in 2011 to a loss of $2.75 in 2012 and a loss of $1.22 in 2013.

Onyx Pharmaceuticals (ONXX) Gilmo Report Stock Chart

While there has been a lot of action in the bio-tech sector, everything is not coming up all roses for the group. Vivus (VVUS) also received an FDA approval for their own obesity drug, Qnexa, something we jokingly refer to as “The South Park Drug” in reference to the crude name starting with the letters “F” and “A” that is derisively given to the character Eric Cartman by the other characters in this off-color animated series, and that’s as far as I’ll go there. Suffice it to say that after the FDA approval of Qnexa on Tuesday of this week VVUS gapped up to new highs and then blew to pieces, diving nearly 30% off of its Wednesday intra-day peak before closing down 22% from the peak after all the dust had settled by Friday. It was, as the daily candlestick chart below aptly illustrates, more than a tumultuous week for VVUS, it was insane. And if that’s what these bio-techs with no earnings but big promise have the potential to do, then one must recognize the risk inherent in these names, and that goes for any bio-techs I’ve discussed in recent reports that have no earnings. I’ve noticed that at the brokerages that I trade through, often these no-earnings bio-tech stocks are not marginable, perhaps reflecting the fact that their stock prices can be blown to particulate matter of less than 10 microns in diameter overnight on the basis of a bad product announcement. Be realistic and keep your risk tight on these if you choose to play.

Vivus (VVUS) Gilmo Report Stock Chart

If one wants to try and do some hunting on the short-side, I note one big former bio-tech that was looking pretty good just a month ago but which has since staged a massive-volume late-stage type of base-failure, Questcor Pharmaceuticals (QCOR), and it could be a decent target. As we see on the weekly chart, below, the stock has blown through its 10-week (50-day on the daily chart) moving average on the downside and violated both the 10-week/50-day line and its previous base-breakout buy point just above 45. QCOR announces this week, so I might be interested in trying to short any earnings-related rally. The tremendous selling volume off the peak is not a good sign for any leading stock that has had a reasonably long price run as QCOR has, and so this is a logical place for a top to occur. My strategy here would be to take the safe route and see if one gets a shortable bounce in the stock following earnings this week on Tuesday. On the other hand, brave souls might take a shot at shorting the stock or buying puts going into earnings if risk can be contained to their liking – e.g., their individual risk preference and tolerance. From my perspective, I never really want to try and short larger than a 10% position in a short-sale target stock going into earnings, seeking instead to use that initial position to perhaps add to a position on a playable downside gap move.

Questcor Pharmaceuticals (<a href=QCOR) Gilmo Report Stock Chart" title="Questcor Pharmaceuticals (QCOR) \" />

I discussed Fossil (FOSL) as a short-sale target a couple of weeks ago in my July 8th report since the stock first “broke out” to the downside from a big reverse flag formation it has been forming since it blew apart in early May, as we see on its weekly chart below. This past week saw the stock rally feebly into its 10-week/50-day moving average on light volume. FOSL comes out with earnings on August 7th, and the company’s exposure to economic weakness in Europe is expected to weigh on the stock, although it’s not clear just how much of this is priced in. FOSL sold off hard last July and August and made a strong showing as it rallied back up to its prior peak and into new high price ground eight months later. This time around, selling volume was much larger and the stock has remained in a relatively tight bear flag. The wrinkle with FOSL, as with QCOR, is that earnings are yet to be released, so shorting into earnings carries with it the same risk that buying into earnings does, thus risk must be measured properly with respect to position size. And as I mentioned with QCOR, there is also the possibility of using options for those who know how to implement a proper options strategy that keeps any potential losses well-contained if the stock moves the wrong way after earnings.

Fossil (<a href=FOSL) Gilmo Report Stock Chart" title="Fossil (FOSL) \" />

Speaking for myself, I remain back in cash over the weekend, and content to sit out the action until I see set-ups that I consider at least playable on a swing-trade basis, which is mostly what this market appears to be about. As trend-followers we know that this is not how the big money is made – we need a sustained, coherent trend with expanding leadership, and that is not what is going on in this market currently. There were some pocket pivots on Friday, such as in the builders D.R. Horton (DHI) and Toll Brothers (TOL), which are slated to announce earnings this week, but I’m not that interested in playing “earnings roulette.” Perhaps the market’s direction will gain some clarity from the action, or rather reaction, of AAPL’s share price to Tuesday’s after-hours earnings announcement given AAPL sustained role as a big-stock leader that has continued to hold up even as other former big-stock leaders have come unglued. Right now it is just a matter of laying back and remaining alert to the possibility of a new leg down in the major market indexes, which I believe may be the greater possibility here, but I will leave final judgment on that up to the market as we could also just remain in a chop ‘n’ slop environment. Stay tuned, most definitely.

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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