The Gilmo Report

July 29, 2012

July 29, 2012

The market started out the week on a downside “zig” as it approached its 200-day moving average, as we see on the daily chart of the NASDAQ Composite Index, below, but ended the week with a “zag” back to the upside, maintaining its character during this “Zig-Zag Summer” of 2012. In my Wednesday report I noted that maintaining fluidity aided by liquidity was the only way to be involved in this market if one was going to try and anticipate a breakdown through the 200-day moving average. This was due to its being in a position to rally off the lows of its curving trend channel as I’ve creatively drawn it on the chart. Certainly the negative technical evidence was building with breakdowns in Apple (AAPL) and Priceline.com (PCLN) earlier in the week, but this is a market that loves to fool the crowd, and it helped to prove that point with twin follow-through type days on Thursday and Friday that were powerful moves. Just like that, suddenly upside strength has come into this market in a very material way, as I see it. And while some might find this perplexing, I find it a simple matter to buy into a rally as there are some stocks in buyable positions. Comments from the head of the ECB, Mario Draghi were credited with getting the market to roar back to life on Thursday. While this is all well and good, I would not focus so much on the news “alibi” as a reason to be skeptical of the twin follow-throughs, preferring to let the price/volume action speak for itself.

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In my Wednesday report the only stock I was willing to consider as a short-sale was Apple (AAPL), shown below on a weekly chart. As I surmised five days ago in that report, AAPL was beginning to develop into a potential late-stage failed-base type of short-sale set-up with an upside stop at the 50-day moving average. AAPL quickly moved up through that level on Friday, taking it off the table as a short-sale target, end of story. I was in fact short a decent-sized position in AAPL and held it through Thursday’s rally since it still closed roughly flat on that day, but Friday I could feel that selling pressure was abating in the stock, so I flipped and went long the stock with the idea that it should hold the 50-day line. The interesting thing about AAPL, from a technical point of view, is that this gap-down pullback is occurring within a handle that is still only about 11-12% deep, and it may help to correct the upward-drifting, improper handle that I discussed in my report of one week ago, July 22nd. Volume was heavy on the break Wednesday, but AAPL closed the week above its 10-week moving average giving it the look of supporting action at the 10-week/50-day lines. AAPL may not be dead yet, and if it can hold the moving averages on this pullback it could set up in a proper handle from which it could break out through the 619.87 peak in the handle.

Apple (AAPL) Gilmo Report Stock Chart

Of course, AAPL could still come back into play on the short side if it breached the 50-day/10-week moving averages on huge volume, but it is not clear to me that institutions are ready to start dumping AAPL just yet – I need to see further evidence, and at this point I might lean towards being more bullish than bearish on AAPL right now. Helping that frame of mind is the action in Amazon.com (AMZN), which in fact broke out of a cup-with-handle formation that has all the constructive characteristics such as a couple of higher-volume supporting weeks within the pattern, the drying up of selling volume in the handle, and then of course the big-volume breakout on Friday. AMZN may be one of those rare exceptions, given that it just reported -98% earnings growth at a penny-a-share in earnings, which makes the shorts love to hate the stock. In fact, many pundits were deriding AMZN’s price/volume action on Friday as indicative of investors’ “naiveté” and “fantasy,” but as we know such arguments are merely ways to gain entrance to the poor farm in a hurry. AMZN is a forward-looking situation, and despite -98% earnings growth in the past quarter and 0% estimated for next quarter, over the following five quarters the company is expected to post consecutive earnings growth of 84%, 89%, 200%, 207%, and 84%. That’s what the “fantasy” is all about, and the pundits can say what they want – in my view, AMZN is a buy right here, using a maximum 6-7% downside stop.

Amazon.com (AMZN) Gilmo Report Stock Chart

Priceline.com (PCLN), which this past Wednesday was looking grim with a high-volume breakdown through the 50-day moving average that was influenced by TripAdvisor’s (TRIP) big earnings miss and gap-down, did a quick about-face on Friday when Expedia (EXPE) came out with a positive earnings announcement, as we see on PCLN’s daily chart, below. PCLN matched EXPE’s big gap-up move on Friday with a buyable gap-up/pocket pivot buy point combination that came on massive upside volume. While I don’t show a chart of EXPE here, that stock’s buyable gap-up is still well within buying range using the 53.66 intra-day low on Friday as a downside reference for a stop. Meanwhile, PCLN still has to announce earnings on August 7th, so I would like to see the stock move up from here in anticipation of earnings. PCLN is potentially buyable here on the basis of this pocket pivot, and with the massive upside volume in the stock I would look for it to continue higher over the next couple of weeks. Either way, I would be willing to hold a 10% position into earnings, knowing that a 10% drop in the stock will cause total damage of 1% to my overall portfolio value, as long as it can continue to hold above the 50-day moving average, and preferably much higher than that.

Priceline.com (PCLN) Gilmo Report Stock Chart

While I was able to pull off a nice trade on Facebook (FB) from the 26-27 price level up to the low-30’s a month ago, FB looks pretty well like little green fried tomatoes at this point and not worth touching with a 2-foot pole. Weak earnings earlier in the week from Zynga (ZNGA) dragged down FB, while FB’s earnings tried to drag down LinkedIn (LNKD), shown below on a daily chart, on Friday. Notice, however, that LNKD bucked the action in FB by undercutting its early July low for a shakeout before turning back to the upside and regaining the 50-day moving average on a reversal pocket pivot type of move. Volume was pretty impressive on Friday, and while volume on Thursday did see an increase, notice that the stock closed mid-range on the daily price bar, indicating some supporting action on that day. Friday’s action is a very constructive follow-up to this, and it sets up a possible shake-out and breakout situation here as the yank back and shakeout through the 50-day line helps to correct the low-volume wedging action in the pattern when the stock tried to reach the 110 price level. This is probably buyable in small-size, given that LNKD will announce earnings on Thursday of this coming week. Again, if you want to buy LNKD on the basis of Friday’s action going into earnings this week, I would suggest limiting the position to 10% of your portfolio value, with the idea that it should continue to hold the 50-day line going into Thursday.

LinkedIn (LNKD) Gilmo Report Stock Chart

Medical and Bio-tech have remained strong areas in this market, and on Friday we even saw Merck (MRK), not shown, flash a continuation pocket pivot buy point. Another stock in the medical device group that I’ve been watching for some time is Edwards Lifesciences (EW), a maker of products that address cardiovascular disorders. EW has been building a nice, tight four-week flag from which it broke out of this past week, and this constructive pattern has occurred following a breakout in mid-June from what was a 15-month long-term basing formation, making it a second-stage formation. EW flashed a pocket pivot buy point on Wednesday after announcing earnings, and the stock finished the week at its highs as it found support at its 10-week line on the weekly chart, which I do not show here. This should hold the $100 price level, as I see it, given Livermore’s “Century Mark Rule,” and perhaps on this basis the stock could build up a head of steam from here if the turn in the general market that we saw at the end of this past week turns out to be something sustainable.

Edwards Lifesciences (EW) Gilmo Report Stock Chart

Affymax (AFFY) is a no-earnings-yet bio-tech company with a new drug, Omontys, that competes with Amgen (AMGN) and its drug, Epogen, as a treatment for anemia in dialysis patients who have chronic kidney disease. It is claimed that Omontys will be cheaper to manufacture than Epogen and so AFFY could have an advantage. AFFY recently announced a deal with German-based Fresenius (FMS) whereby FMS will buy Omontys for more than 100 of its U.S. dialysis centers while it considers broadening its use of the drug. I suppose this is a compelling enough forward-looking story for a bio-tech company that is still losing money and projected to lose money for nearly the next two years. This is similar to money-losing bio-tech Onyx Pharmaceuticals (ONXX), which I discussed in my report of last weekend, July 22nd, but it is still acting well after a buyable gap-up move the week before last. Thus I prefer to let the price/volume action tell me what to do here, with the story providing some support on a forward-looking basis. As we see on the weekly chart, the stock is holding up in a short, tight flag formation after breaking out of an unusual cup-with-ladle type of base pattern three weeks ago. AFFY could be potentially buyable on a pocket pivot move up through the 10-day moving average on volume that is greater than 1,912,400, the highest down-volume in the pattern over the prior ten days.

Affymax (AFFY) Gilmo Report Stock Chart

The medical bio-tech area is as strong as I’ve ever seen it, and the list of bio-techs that made new closing highs on Friday includes: Alexion Pharmaceuticals (ALXN), Amgen (AMGN), Biogen-Idec (BIIB), Gilead Sciences (GILD), Seattle Genetics (SGEN), and Onyx Pharmaceuticals (ONXX). The first four make money, the last two, like AFFY, do not. If you prefer bio-techs that make money then I think it is worth taking a look at Regeneron Pharmaceutical (REGN), shown below on a daily chart. REGN flashed a pocket pivot buy point on Wednesday after announcing strong earnings growth of 264% on 90 cents a share, up from 37 cents a share last quarter. Next quarter REGN is looking for 240% earnings growth on 96 cents a share. REGN is a little bit extended from Wednesday’s pocket pivot, but having come up from the lower part of its base to challenge its all-time highs just above 140 the stock is entitled to a pullback here and I would look at any pullback to the 130 price area as potentially buyable.

Regeneron Pharmaceutical (REGN) Gilmo Report Stock Chart

Because the market’s sharp rally on Thursday and Friday was driven by more lip-service from the “big Eurocrat” himself, Mario Draghi, most investors are likely skeptical of the market’s bounce. For now I tend to see the market as just doing what it’s been doing all summer, which is bouncing along in zig-zag fashion.

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But as difficult as things may seem, note that the weekly chart of the NASDAQ Composite Index, above, reveals that compared to the big Summer Correction of 2010 and the big Fall Correction of 2011, all of which I’ve highlighted on the chart, the current correction is really not that volatile. The weekly ranges during the 2010 and 2011 market corrections were far wider and erratic, while in 2012 we can see that upside weekly volume tends to dominate the pattern, and in a sense the current market correction has been far more orderly, at least on a weekly basis. But markets are orderly until they aren’t any more, so in and of itself the market’s “orderliness” is not an “all-clear” sign.

But as I wrote on Wednesday, July 25th, fluidity is critical here as things can change very rapidly, and the action this week certainly made that point to investors who insist on adopting a rigid stance. On Wednesday my feeling was that if the market was going to blow apart, then one could simply be short AAPL as a possible late-stage base-failure, and AAPL’s serious trading liquidity was desirable for such a shorting adventure as it enables one to move quickly and in size. But as the week closes, it is not clear that either one of those premises is going to be proven any time soon. There is the possibility that the opposite will in fact prove to be the true outcome as we move into the final month of summer for the market and into the September/October time frame when significant turns in the market area often occur. So with twin follow-through days and some stocks in buyable positions as I’ve outlined in this report, I have no problem testing the market on the upside by taking a few long positions and keeping risk as low as possible given the potential for more whip-saw action in the general market indexes. Fear is not an investment strategy, so rather than fearing the whip-saw “bogeyman” I prefer to put the rally to the test. If one gets 40-50% invested and sets maximum downside stops of 6-7%, than your total portfolio risk is 3.5%. However, if one buys a breakout such as that seen in AMZN (closed the week at 237.32) very close to the breakout price point (the 230.50 high of the handle), then one can keep the stop to less than 6-7% by using the breakout point as a near reference for a stop. It’s certainly not rocket science, but in tricky environments one just operates according to discipline and maintains well-measured risk. Take it from there.

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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