The Gilmo Report

June 26, 2011

June 26, 2011

The major market indexes are struggling to hold their 200-day moving averages, as the daily chart of the NASDAQ Composite Index below illustrates so well. Volume was much heavier on Friday as the NASDAQ closed just above the 200-day line, but this was due to Russell Index rebalancings at the close. The S&P 500, not shown, also held above its 200-day moving average, which currently serves as a clear line of demarcation between a rally attempt and the specter of lower lows. The market action over the past four days has been characterized by a fair bit of volatility and choppiness as stocks figure out which way they want to go. In the short-term, news-oriented volatility might dominate as the “Greek question” plays out. As an example, news late in the trading day on Thursday concerning a Greek agreement to a proposed “austerity” plan triggered a furious rally that carried into the close and brought the NASDAQ back into positive territory on Thursday, but the rally was short-lived by Friday. For now I would tend to see the short side of the market as being potentially played out in the short-term as the break off the peak in the first thirteen days of June turns into a logical “chop swamp” that yields little in the way of progress one way or the other. With the Greek parliament set to vote on an austerity plan on Tuesday, the market’s short-term news-orientation might continue.

NASDAQ Composite Index Gilmo Report Chart

 

To some extent this makes sense given where the indexes are on this recent pullback of 7% on the S&P 500 and 8% on the NASDAQ Composite Index 2010. Given that the end of QE2 is another event for the market to deal with as it sorts out the potential for QE3, then looking back at last April-June 2010 when QE1 ended might provide a possible road-map for what to look forward to. The infamous “Flash Crash” of May 6th accelerated the market’s break off the peak which occurred in wildly accelerated fashion as the market broke down for a mere three days before finding support at the 200-day moving average back then, as we see on the daily chart of the NASDAQ from that period, below. The next test of the 200-day line led to a month-long period where the index did little more than oscillate around the moving average. Notice how this oscillation resulted in a short rally up to “A” followed by a three-day break to “B” which then led to a seven-day rally up to “C” and the 50-day moving average. The market then broke hard to “D” which constituted the market’s final low during that correction. If you are a short-seller in this current market, the first optimal window of opportunity on the breakdown off the peak is over, and it is now a matter of watching for another window, perhaps something similar to the “C” to “D” move in June 2010, to open up.

NASDAQ Composite Index 2010 Gilmo Report Chart

Examining where our recent short-sale target stocks are currently within their chart patterns after their sharp breakdowns in roughly the first half of June gives some perspective and aids in planning for the next short-sale window of opportunity. Sina Corp. (SINA), which I first discussed as it was just coming down through its 50-day moving average in my report of June 5th, broke down hard with the market in early June before undercutting its 200-day moving average and then attempting its first real bounce this past week. In this position, what is the probability that SINA is going to turn and plunge below its 200-day moving average? Do the odds favor a period of consolidation of the prior downtrend before SINA can indeed move lower? These are questions short-sellers must look for answers to in the stock’s forthcoming action as it plays out from here. As the 50-day moving average begins to turn down it is possible that the stock could rally up further to eventually meet up with the 50-day line before encountering any real resistance. In general, however, I don’t think short-sellers can count on another immediate sharp break like we had in the first half of June, as it may take a little more time for the stock to set up again. If the general market breaks below its 200-day line, then SINA would likely follow suit.

Sina Corp. (SINA), Gilmo Report Chart

We can also consider Travelzoo, Inc. (TZOO), which has rewarded short-sellers since my June 5th report with a nice break towards the 200-day moving average. The ensuing weak bounce only carried as far to the upside as the 65-day exponential moving average, before encountering stiff resistance, as we see in the chart below. For now that resistance is holding. You can see how adhering to the 20% profit rule in TZOO would have had you covering any short position and taking profits at least in the mid-50 price area, maybe a little higher. Now the question is whether the stock will attempt to move back above the 65-day exponential line and meet up with the 50-day moving average which is turning downward. I would watch TZOO carefully here since I tend to think that at some point the 200-day moving average down at 48.87 will come into play at some point. The question is how far the stock rallies from here, if at all. For now, however, the 65-day exponential moving average, the black line on the chart, serves as a near-term reference for upside resistance. If you try to enter a short position on TZOO here, then the 65-day becomes your stop.

Travelzoo, Inc. (TZOO), Gilmo Report Chart

Aruba Networks, Inc. (ARUN) has been in bounce mode over the past week, and as I discussed in my mid-week report of this past Wednesday I would use that day’s intra-day high at 27.69 as my guide for a stop if I take a short position here. It is not clear, however, that the stock is just going to immediately give it up right here and head back towards its descending neckline in its overall H&S top formation, as I’ve outlined on the daily chart below. ARUN’s 50-day moving average is turning down, and if the general market tries to rally off of its 200-day moving average then ARUN could rally further to the upside as it potentially meets up with its 50-day line. Unless, this current market correction is over and done with, I would tend to think that ARUN will eventually retest its neckline, but this may take some time to develop. As with all short-selling, the general market action becomes critical in determining how these patterns play out.

Aruba Networks, Inc. (ARUN) Gilmo Report Chart

Apple, Inc. (AAPL) is yet another stock playing around its 200-day moving average, not unlike the market itself. After gapping down hard on Monday and finding support at around the 210 price level, AAPL’s “undercut & rally”
took it up through the 200-day moving average on Thursday and into the “zone” of resistance I talked about in my mid-week report of this past Wednesday between the 200-day line and the 330 price level, more or less. Now this is starting to look like a zone of resistance between the green 20-day moving average and the red 200-day moving average. I still think AAPL is headed lower, eventually, but as one of the biggest of former “big stock” leaders selling at a “mere” 13 times forward estimates, I’m sure there is always a value manager or two waiting to hide money in the stock on any significant pullbacks. AAPL is only 10% off of its 52-week high, so if this is in fact a topping formation in the stock then it is still in its nascent stages and may take longer to develop. AAPL failed to hold above its 200-day moving average by Friday, and I still consider this potentially shortable using the 20-day moving average at 331.60 as an upside guide for a stop.

Apple, Inc. (AAPL) Gilmo Report Chart

The most successful short-sale set-up that we have seen come out of my reports in recent weeks has been Finisar, Inc. (FNSR) which broke down 10 points from the 24 level where we first looked at it as a short-sale target. FNSR’s head and shoulders pattern, which I don’t show here, was the classic set-up where the right shoulder forms well below the left shoulder, much like CROX in 2007. We saw how UA’s right shoulder was pretty much even with its left shoulder, indicating a less weak pattern, and of course we were stopped out of that one very quickly at the 50-day moving average. Rockwell Automation, Inc. (ROK), shown below on a weekly pattern, looks more like FNSR with its “lean to” look as the right shoulder is well below the left shoulder, creating the optimal descending neckline instead of a flat or ascending neckline. Note the stalling action over the past two weeks as the stock has tried to rally. Optimally I would be interested in shorting a rally into the 83-84 level on this one, although one could enter a short position here using the 84 level at the 10-week/50-day moving average as your upside stop.

Rockwell Automation, Inc. (ROK) Gilmo Report Chart

A lot of what happens in terms of short-selling windows of opportunity is going to depend on what the general market does from here. I’ve discussed how we can look at May-June of 2010 as a potential road-map for what we might expect here as the general market indexes come into contact with their 200-day moving averages. Of course, things don’t have to play out the same way, and any broadening of European sovereign issues beyond Greece (like Italy) could spark further “forced selling” as institutions might continue to raise liquidity. Whatever the market does decide to do, short-sellers will likely have to be very nimble and willing to test short positions based on what sorts of signals the market is giving before finding that next sweet spot. In the meantime, for stocks I have not already discussed in this report, below are my current trading diary notes on short-sale target stocks from previous reports in June:

CF – stock is still hovering around its 50-day moving average and closed Friday below the 50-day line. Shorting here uses a 5% stop to 147.97, the high of three days ago.

GOOG – still moving lower and no logical areas of support have been reached yet. Next area of support is at the 447.65 low of late August 2010.

LULU – as with UA, quickly stopped out five days ago at 50-dma.

LVS – still finding resistance at the 40 level, roughly, which remains the nearest level at which to place an upside stop.

NTAP – still finding resistance at the confluence of the 50-day simple and 65-day exponential moving averages between 51.27 and 51.62 which remains your guide for an upside stop. Stock got hit with heavy volume on Friday as it again tests support at 49. A breach of the 49 level brings the 45 price level into play as a downside target.

NFLX – still holding above its 50-day moving average, so is not a short-sale target yet. The stock must breach the 50-day line on heavy selling volume to be considered a true late-stage
base-failure.

VMW – Late-stage
base-failure still in play with 68.55 prior breakout point as the upside stop.

During my appearance on Fox Business News this past Thursday morning, I discussed the potential for further selling in stocks to eventually drag down precious metals as everything gets sold off in a bout of “forced selling.” The Wall Street Journal reports this weekend that “…fresh concerns about Europe triggered steep declines in stocks and commodities and forced some traders to sell the safe-harbor asset [gold] to meet margin calls.” The bottom line for our GLD position is that Friday’s first close below the 50-day moving average now sets up the potential for a violation of the moving average if the GLD moves below the 145.97 intra-day low of Friday. Thursday’s huge-volume gap-down was certainly a sign to back away from the GLD if one was playing an aggressive position. Could the precious metals be telling us that a further dollar rally is in the cards? If so, then QE3 is certainly off the table and a continued dollar rally might also spawn more downside in stocks. For now, stick to your stops in gold and silver.

While the GLD has seen heavy selling, I note that the iShares Silver Trust (SLV), shown below on a daily chart, hasn’t seen similar heavy volume on the downside. Institutions tend to favor gold over silver, and I think the heavier volume in GLD as it sells off compared to the volume in the SLV is an indication that silver is mostly getting dragged down with gold. Silver, as the “poor man’s gold,” finds more favor among individual investors, in my view, and is subject to wider swings given that it tends to be 2-3 times more volatile than gold. The SLV looks primed to test its 200-day moving average, and I would look for this moving average to provide support for silver on any continued pullback next week, which I think is likely. I have not tried to play silver for some time, preferring instead to stick with a small position in the much better-acting gold. But with both precious metals breaking down I expect that my quick downside stops will be hit in the GLD this week. I will stick to my rules and wait for the violation to actually occur before unloading the position.

iShares Silver Trust (SLV) Gilmo Report Chart

Despite all the carnage in the market, there are still a few bright spots on the long side, although these are admittedly quite far and few between. Nevertheless, stocks exhibiting strength in the midst of so much market weakness should be kept on watch lists just in case the market does, by chance, find a bottom and stage some sort of follow-through day. Medical-related stocks have been among the top-performing groups as of late, and this strength becomes obvious when one looks at the daily chart of “big stock” bio-tech Biogen Idec, Inc. (BIIB) shown below. BIIB flashed a pocket pivot buy point nine days ago, but this wouild have been tough to buy in the midst of a sharp market sell-off. Four days ago BIIB staged a buyable gap-up but failed to hold the 100 price level, which might invoke the Livermore “Century Mark Rule.” BIIB picked up some sharp upside volume on Friday as it cleared to new highs. If the general market is able to rally up off its 200-day moving average, look for BIIB to move higher with the idea that it should at least hold above the $100 price level.

Biogen Idec, Inc. (BIIB) Gilmo Report Chart

Fortinet, Inc. (FTNT), a stock I’ve discussed many times before, is another one holding up quite well in a weak market. FTNT found support along its 50-day moving average as the market came down to its own 200-day moving average, as we see in the daily chart below. Then four days ago, a pocket pivot buy point showed up as the stock moved up sharply off the 50-day line. On Friday FTNT broke out to all-time highs on big volume. The only caveat with FTNT, and perhaps BIIB as well, is that the volume that came into these stocks on Friday may have been related to the Russell Indexing rebalancings, so I will be very interested to see how these pan out next week, particularly if the market is able to rally for a few days from the 200-day moving average.

 

Fortinet, Inc. (FTNT) Gilmo Report Chart

In my report of last weekend I noted that bearish sentiment was increasing, the CBOE Volatiltiy Index (VIX) had spiked, and the index and equity put/call ratios had both moved sharply above 1.00, indicating that the sell-off was getting quite obvious. This past week has seen little movement from last week’s levels as the indexes held along their 200-day moving averages. This weekend I note that bearishness has lifted somewhat while the VIX and the put/call ratios have backed down. If you are looking to be bullish currently, the only thing working in the bulls’ favor is the fact that the market is technically still in a rally attempt off the lows of seven days ago. Depending on whether you want to interpret the low of seven days ago as a rally attempt given that the market closed in the upper half of its trading range on that day, June 16th, we are either in the fifth or seventh day of an attempted rally, with the potential for a follow-through day (FTD) to show up at any time. I would, however, tend to look at any rally where a follow-through does not occur as a potential opportunity to get bigger on the short-side again. If a follow-through did occur, then I might look for a failed follow-through as a sign to become more aggressive on the short side, as I did in my report of June 1st when the phony FTD of May 31st failed in short order. For now we’re mostly in a wait-and-see position as the market resolves its struggle against the 200-day moving average. Stay tuned.

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 positions in DGP, 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. ©2008-2017 Gil Morales & Company, LLC. All rights reserved.