The Gilmo Report

July 3rd, 2011

July 3, 2011

Testing short positions as target stocks rallied into their 50-day moving averages and other areas of resistance was quickly stopped out this week as the market’s upside strength was relentless. The daily chart of the NASDAQ Composite Index, below, shows that July 1 and June 1 form the peaks of a deep “V” formation that found support at the 200-day moving average. It appears that forced selling in the first half of June was due to institutions raising cash and balance sheet liquidity as they braced for a potential Big Fat Greek Meltdown. When that did not come to pass, the market simply “melted” back to the upside on light volume as all the necessary selling had subsided. In hindsight, however, one might conclude that the action on June 21st was in fact a fourth-day follow-through, although many have considered it to have occurred on only the second day of the rally attempt, making it invalid. With the NASDAQ Index trading well above its 50-day moving average on this rally, we can now see whether that provides support for a continued rally as it provides a simple downside reference. Being in cash, I have no bias one way or the other, and so I’m open to whatever trend eventually emerges from this big “chop and slop” sideways movement the market has been locked in since February.

NASDAQ Composite Index Gilmo Report Chart

An interesting chart that provided one of several clues I considered last weekend when I began to think that the short side of the market was for the most part played out at the time is the chart below of the National Association of Active Investment Managers (NAAIM) sentiment index. This NAAIM Sentiment Index comes from www.DecisionPoint.com (©2011, used by permission), and it is a relatively new sentiment survey that shows the percentage invested by 40 NAAIM member firms. In a nutshell, it shows whether these active managers are moving to cash or moving towards getting more invested. Note that coming into the middle of June it shows a 20-30% cash position on the part of these active investment managers. I haven’t had a lot of time to study this new sentiment index, but it does appear to provide a reasonable forecast of at least short-term lows, and we can see that a period where active managers remain at very high levels of cash, such as at and around the lows of October 2008 and March 2009, appears to mark a major bottom. The concept here is simple: if this group of 40 NAAIM member firms is representative of most money management firms out there, then the chart tells you when most of the money is “in” and when most of the money is “out.” Coming into the middle of June, most of the money was “out,” hence it set up the potential for an upside snapback, which is exactly what we’ve seen in this wild and crazy summer market so far in the month of June. If nothing else, we see again that the market does its best to fool most investors most of the time!

National Association of Active Investment Managers (NAAIM) Gilmo Report Chart

With June over and done with, theoretically by Friday, July 1st there was no QE2 to hold up the markets. This, however, was not evident from the way stocks traded on July 1st. However, the disappearance of QE2 was quite evident in the action of Treasury bonds, as indicated by the iShares Barclays 20+ Year Treasury ETF (TLT), shown below on a daily chart. Treasuries got a nice hole blown out of them this week as the TLT traded straight down through the 50-day moving average. So with Treasuries getting pounded and precious metals making lower lows confirming the lack of support from QE2, what, you may ask, is going on with stocks? While this is not so easy to think through, the market’s message may be that interest rates are about to head higher, something that is bad for bonds and commodities, and so we may be seeing a sharp asset shift away from bonds and commodities and into stocks. Over the long-term, stocks tend to provide a hedge against inflation, and that is what may be going on here. We should remain open to the fact that this shift could continue to drive stocks higher, albeit in choppy fashion, through the summer. For trend followers like us, it is not 100% clear to me that a window of opportunity is opening wide here, but there does appear to be more set-ups developing on the long side than the short side which may be your first clues.

iShares Barclays 20+ Year Treasury ETF (TLT) Gilmo Report Chart

While we will have to see whether the market is able to break out of this wide-ranging consolidation it’s been in since February, it appears likely that short-selling is out of the picture currently. With the major market indexes clambering back above their 50-day moving averages I am now more interested in seeing how the market handles any pullback towards the 50-day lines. As well, most short-sale target stocks that we’ve been watching in June had their brief window of opportunity in the first half of June before jamming right back to the upside, as we see in the example of Apple, Inc. (AAPL), shown on a daily chart below. Volume picked up to above average on Friday as the stock pushed back above its 50-day moving average, providing a quick and convenient stop-out if one was trying to short that rally at the moving average. The same goes for just about all of the other short-sale target stocks on our watchlist such as LVS, TZOO, ROK, NTAP, etc. Bearish sentiment still prevails on this current rally, and with active managers still only about 32% invested, according to the NAAIM Sentiment Survey discussed above, the impetus to play “catch up” may drive more money back into this market with the potential to drive it to higher highs. Thus I believe it is best to revert to playing the market as a market of stocks rather than a stock market, focusing on the action and opportunities that may present themselves in individual stocks.

Apple, Inc. (AAPL) Gilmo Report Chart

To be sure, even with the market correcting sharply in the first half of June, some leading stocks, such as Biogen Idec (BIIB), shown below on a daily chart, offered playable opportunities. BIIB, as I discussed in my report last week, flashed a pocket pivot off of its 50-day moving average 14 trading days ago right as the market was pushing up off the 200-day moving average on the general market indexes. BIIB is now up 12 out of 15 days in a row or better, as the small black triangular “ants” on the chart indicate, and we now see the stock pulling back over the past couple of days on lighter volume. The stock may need to back and fill for a few days here as it just begins to emerge into new-high price ground, but as far as I’m concerned this is a clean base breakout through the 106.99 intra-day high on the left side of the base. As well, the strength of BIIB as it has moved up 12 out of 15 days in a row or better over the past three weeks is likely a precursor to further upside. If you bought shares along the $100 price level on the basis of invoking the Livermore “Century Mark” rule then this is a good spot to add to that position. An initial position could also be taken here with the idea that the stock should hold the $100 price level.

Biogen Idec (BIIB) Gilmo Report Chart

Medical stocks have been among the top groups during the market’s v-shaped June madness, and a number of medical-related names have not formed v-shaped patterns of their own as they have held up much better relative to the market, a sign of contrarian strength. Thus I prefer to stick to potential leading stocks that have held up the tightest while shunning the risks inherent in buying something that has come straight up off the bottom in v-shaped fashion. Illumina, Inc. (ILMN), a maker of gene-sequencing systems that greatly enhance and speed up the process of sorting out DNA is one such name. Note how the stock held very tight along its 10-week (50-day) moving average with a series of tight closes just above the 70 price level, as we see on the weekly chart below. This week saw the stock begin to break out with weekly volume picking up, thus I view this as potentially buyable right here using the standard 7-8% stop. Medical stocks like ILMN tend to be insulated from economic headwinds, thus offering a measured hedge from potential, further economic uncertainty. Earnings come out later in July, and ILMN’s relative strength line hit a new high this week ahead of the stock, which looks quite positive going into the earnings announcement at the end of the month.

Illumina, Inc. (ILMN) Gilmo Report Chart

Like I said, I prefer to focus on stocks that have shown contrarian strength during the month of June rather than those showing these snap-back v-shaped movements, and another stock showing this type of action which is also a medical-related name is Questcor Pharamaceuticals, Inc. (QCOR), shown below on a weekly chart. Since breaking out in early April, QCOR has steadily moved higher in a pattern that has something of an ascending look to it. This past week, however, the stock appears to have broken out of a six-week base with a lot of tight weekly closes in the pattern. QCOR has tended to break out of these short little ranges and then spend time pulling back as the market has gone about its gyrations. But it is possible that the stock will gain more upside momentum if the weight of the general market were to lift, so this is something to keep an eye on. I consider the breakout point from this recent base to be 24.49, thus the stock is somewhat extended right here based on Friday’s close at 26.50. I would view any pullback down to 25 or so as buyable. Mutual fund sponsorship has been steadily increasing over the past year, with nearly 100 more funds in the stock compared to a year ago at 330 vs. 233 as of the March reporting periods in 2011 and 2010, respectively.

Questcor Pharamaceuticals, Inc. (QCOR) Gilmo Report Chart

In my report of two Wednesday’s ago I pointed out the series of pocket pivot buy points in Fortinet, Inc. (FTNT) as the stock just began to emerge from this recent base-like formation it has been moving around in since early May, as we see on the daily chart below. Along with BIIB, FTNT was the only other long idea I’ve discused in my June reports, and like BIIB, FTNT is now up 12 out of 15 days in a row or better, as the small black triangular “ants” on the chart indicate. I would look for any small retracement back down to the 10-day moving average at 25.75 down to the breakout point right around 25, as I see it, as an opportunity to enter the stock. FTNT remains the #1 global provider of unified threat management (UTM) solutions, and thus maintains its status as “best in class” among network/computer security stocks. Since splitting 2-for-1, FTNT’s liquidity has improved as daily average volume is now over 2 million shares a day while earnings growth has accelerated from 0% five quarters ago to a sequential acceleration of 20%, 29%, 57%, and 125% over the ensuing four quarters.

Fortinet, Inc. (FTNT) Gilmo Report Chart

Netgear, Inc. (NTGR), which has mostly focused on producing wi-fi routers, has a new twist to their business that I find somewhat compelling. The company has been growing earnings and sales with newer products such as wi-fi boosters and networked storage devices that allow users to access stored data and files, whether they be photos, music, video, or otherwise, and stream them to any device on their home network. This is potentially a big area of growth for NTGR as the number of devices we all use expands from desktop and laptop PCs to smaller, more portable devices like tablet PCs such as the iPad and Xoom products. I’ve been watching the stock build this eight-week flat base throughout May and June, and NTGR finally broke out this past week on a pocket pivot type of move that took the stock to new highs. While you can’t see the pocket pivot of June 24th on the weekly chart shown below, the breakout on the weekly chart is quite clear. The stock pulled back on Friday right to the top of its breakout point at 42.98, closing the day at 43.37 where it remains quite buyable, in my view. Earnings growth is expected to pick up to 50% next quarter from 35% this past quarter, and the way the stock has held up well during the market’s June swoon puts NTGR at the top of my buy list.

Netgear, Inc. (NTGR), Gilmo Report Chart

The hype and hoopla of the Linkedin Corp. (LNKD) IPO seven weeks ago has dissipated recently, and the stock plummeted down to the 60.14 price level during the market’s corrrection in June. It is always best to ignore the initial excitement and price volatility associated with the first few days a hot new IPO begins trading as a true future leader will always build some sort of buyable consolidation and price base that can provide a lower-risk entry point as the stock has had time to digest a strong gap-up opening from its $45 IPO price. LNKD is now trying to break out of this 51% deep base that is looking very much like a cup formation with selling volume drying up along the lows, as I’ve indicated on the weekly chart below. The past two weeks have seen volume pick up as LNKD has moved back to the upper part of the cup base and in fact made a new weekly closing high this past week. Given the sharp, two-week, 55%-plus move back to the upside from 60.14 to Friday’s close at 94.54 I would not treat this weekly move as a buyable break-out. Instead, I would allow the stock some time to build a handle here as it consolidates the sharp upside move straight up from the lows of the base. I would expect that any handle forming here would be around 10% or so on a pullback, so watch for this as the stock potentially pulls back into the mid-80’s, perhaps a little lower. This is still in its early, formative stages, as I see it, but definitely promising enough to watch.

Linkedin Corp. (LNKD) Gilmo Report Chart

Fusion-IO, Inc. (FIO) was another IPO that garnered quite a bit less hype and hoopla than LNKD did, but I tend to find the company’s business and product line to be much more compelling than LNKD’s. FIO has also maintained a 96 Relative Strength rating during the market’s June swoon while LNKD has a much weaker RS rating of 34. FIO’s technology is revolutionary, as I see it, since it decentralizes data storage by enabling the performance of thousands of disk drives into a single server. The basic idea is that processing speeds are sped up significantly by keeping the data, previously accessed from a disk drive, on the server where it is being utilized. The NYSE, for example, is using this technology in their new Mahwah, New Jersey trading facility. FIO has formed a short three-week “IPO U-turn” type of formation that reminds me somewhat of EBAY in 1998, although EBAY’s “U-turn” formation was a couple of weeks longer. I’m still waiting for a more coherent base structure to form as the stock has been quite volatile, running from a low of 19.28 to over $36.98 on an intra-day basis in the eight trading days that ended on Tuesday of this past week. This needs some time to settle down, as I see it, to build a more coherent base structure, but the company’s game-changing technology means it belongs on our watch list as we wait for a coherent buy point to emerge.

Fusion-IO, Inc. (FIO) Gilmo Report Chart

Sequans Communications (SQNS) is another interesting tech IPO that came public back in mid-April, as we see on its daily chart below, and it also represents a company at the forefront of 4G wireless tecnology. SQNS makes chip-sets for both mobile WiMAX and LTE (Long Term Evolution) wireless access technologies with a leading market share in 4G WiMAX SoC’s for smartphones and early LTE penetration in China and India. Generally I don’t care much for stocks trading in the ‘teens, but recent IPOs are one exception to the rule. SQNS formed a short base after coming public and then gapped out on big volume later in May. This led to a sharp price rise up towards the $20 level before the stock got smacked back down when the general market began to correct. Now the stock appears to be rounding out the lows of a potential new base and in fact flashed a pocket pivot buy point four days ago, as I’ve indicated on the daily chart below. Since then the stock has held very tight along the $14 price level and looks potentially buyable here on the basis of the pocket pivot of four days ago. SQNS is expected to earn 50 cents in 2011, and then grow that by 82% to 91 cents in 2012. Despite correcting 39.4% off of its early June price peak, SQNS still sports a 97 RS rating, and I would look for it to hold above the 10-day moving average at 13.34 on any pullback from here.

Sequans Communications (SQNS) Gilmo Report Chart

In the month of June I’ve had several questions regarding whether Caterpillar, Inc. (CAT) is a short, and my short answer has been “no” in each case. CAT remains the biggest of the big construction/mining machinery stocks in the market, and I found it very interesting that the stock actually flashed a pocket pivot buy point as it came up through its 50-day moving average on Thursday of this past week. CAT may not have nine lives, but it has exhibited buyable strength this past week as many investors were trying to conjure it up as a short-sale target. CAT may be in a late-stage phase in this bull market that began off the lows of March 2009, but it certainly itsn’t dead yet. I’m not sure whether it is something I want to play currently as I prefer to look for fresher merchandise, e.g., stocks that may be in earlier phases in any potential price moves. But its strength, along with strength in other machinery names like Joy Global, Inc. (JOYG) and Parker-Hannifin (PH), both of which also flashed pocket pivots on Thursday of this past week, may be a positive sign for the market. We shall see.

Caterpillar, Inc. (CAT) Gilmo Report Chart

With the market engaged in v-shaped machinations during the month of June, investors may find themselves a bit frustrated. That is to be expected, but as I see it there is no reason to maintain this sort of attitude, as frustration is just another emotion, and emotions have no role to play in the investment process. While I consider the short side of the market to be off limits, I do see some potential ideas here on the long side with low-risk entry points, such as NTGR, for example, and there is certainly no problem with investors taking positions in measured fashion should this rally continue to pan out. Meanwhile, let things prove themselves and build profits cushions as you keep exposure to reasonable levels. Expectations appear to remain low for this market, so perhaps the crowd is primed to be fooled and the market will push to higher highs. But the only way one can intelligently play any continued uptrend is by taking positions in stocks that are currently in low-risk buy zones and which displayed contrarian strength during the market’s June swoon. I myself sit in cash over this three-day July 4th holliday weekend, but remain open to any potential windows of opportunity in individual stocks as we look to approach the market as a market of stocks and less as a stock market.

My scheduled Gilmo Report Month-End Review video was delayed a couple of days due to technical difficulties at GoView, but it is now available for viewing at:

http://goview.com/?id=51d8ae53-c2ca-4fd0-a1b5-0bb73e0a4b36

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, 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, 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. ©2011 Gil Morales & Company, LLC. All rights reserved.

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. ©2008-2018 Gil Morales & Company, LLC. All rights reserved.