The Gilmo Report

March 17, 2013

March 17, 2013

The market finally had its pullback on Friday, but the only index that was hit with a distribution day was the lagging NASDAQ Composite, shown below on a daily chart. Volume was up on Thursday as the NASDAQ traded in a tight range, implying a bit of churning action, while Friday’s options-expiration-bloated volume comes off as a clear distribution day. Meanwhile, market leaders present a mixed bag, as upside progress and follow-through is lacking after the follow-through day of nearly two weeks ago. But for now the uptrend remains intact, at least for the indexes.

 

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Even with the Dow making all-time highs and the S&P 500 Index approaching to within about 2% of its all-time high, it is not as if one can just throw darts and make big money – you’ve got to be in the right stocks at the right time, and occasionally what seems to be the right stock at the right time isn’t, as investors have discovered more recently with a stock like Silica Holdings (SLCA), which breaks out on a big-volume gap-up and then announces a secondary offering that sends the stock back down 23% off of its recent peak, as we can see in its daily chart, below. This is the type of action that will lead to early hair-loss, which is something I refer to as a “toupee-breakout” – a big, promising move followed a rapid “whack-a-mole” clobbering that sends the stock back into its hole.

 

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Admittedly, the follow-through day of two Tuesday’s ago wasn’t the start of a fresh new bull move after a period of corrective decline as it came after what was more of a big shakeout in the indexes in February that for all practical purposes looked like a certain death knell for the indexes. One might consider it more of a “continuation” follow-through in a manner similar to the continuation pocket pivot buy points that help you add to your successful stock positions as they continue to move higher. But remember that we still live in the age of QE, which has morphed from QE1 to QEternity to what I consider to be more of a QE morphine-drip in the form of an $85 billion injection of liquidity coming in every month. This, I believe is why you see the Dow-led rally in turn being led by names like the heavily price-weighted 14% earnings grower International Business Machines (IBM), which has been on a tear, the 0% junk-food “growth” story known as McDonald’s (MCD), and the -2% earnings “grower” and manufacturer of the defective “Dreamliner,” Boeing (BA), all of which I show below in a first-of-its-kind Gilmo Report daily chart “trip-tych.” Other Dow stocks leading the charge are Bank of America (BAC), a 5% earnings grower, Three M Company (MMM), a 4% earnings grower, and United Technologies (UTX), a -10% earnings grower.

 

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One might also notice that all of these stocks, except for BAC, are high-priced stocks trading at 85 or higher, and given that the Dow is a price-weighted index, these stocks have an even greater effect in driving the index higher. This is the nature of the QE morphine-drip market we are in, apparently, because for the most part it does not seem like an environment that emphasizes the growth characteristics that are favorable to our methodology. If only someone had told me in January to just buy the ProShares UltraPro Dow 30 (UDOW) ETF and go to sleep, a lot of effort could have been conserved!

 

Meanwhile the NASDAQ 100 big-cap stocks have lagged severely, helped by the underperformance of Apple (AAPL) so far in 2013. AAPL forced shorts to cover on Friday as it moved up through its 20-day moving average on a pocket pivot volume signature, so maybe it has a chance of helping to resurrect the floundering NASDAQ 100 with a rally back up towards its 50-day moving average, currently at around 466.50. This unfortunately would still not put an end to its overall downtrend. But it could cause the lagging QQQ-based ETFs to “catch up” to the rest of the market and provide further impetus to the market’s uptrend.

 

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But as AAPL tries to ressurect itself from the grave, other big NASDAQ 100 stocks’ heartbeats are starting to flutter and flat-line as we see in Amazon.com (AMZN), a recent breakout that is now failing as it breaks through its 50-day line and now becomes a possible late-stage failed-base short-sale type of set-up on rallies back up to the 50-day line.

 

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Intuitive Surgical (ISRG) has blown apart in March as its big, wide-ranging base formed over the past 11 months has now failed in earnest. ISRG first broke down in late February after its Da Vinci robotic surgery systems were reported to be the subject of a government “investigation,” and this was followed by a big gap-up back above the 50-day moving average. Since then, however, the stock has come under more fire and we can consider its late-stage base-failure to now be complete.

 

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In my January 3rd report I suggested that one might buy the SPDR Select Financials (XLF) ETF, not shown here on a chart, on its gap-up move of that day that closed at 16.86. Aside from a pullback to its 50-day moving average in February, that ETF has continued to make new highs as a leading sector of the current market rally. While we saw BAC break out on Friday, the real financial sector leader in terms of earnings growth in my view has to be Goldman Sachs (GS), which posted a 204% earnings growth number in the most recently reported quarter. GS violated its 10-day moving average in February, issuing a sell signal following its rapid run-up over the prior two months, but the stock has since settled down a bit and regained its footing. GS has moved back above its 10-day moving average and tracked along the line over the past couple of weeks, enabling it to flash a continuation pocket pivot buy point on Friday, as we see on its daily chart, below. If this pocket pivot is going to lead to higher prices, then I would expect GS to hold above the 150 price level, roughly. Thus if the market’s follow-through of two Tuesdays ago was simply a “continuation” follow-through, this continuation pocket pivot in GS should likewise lead to further upside. True, earnings estimates for next quarter are -8%, but in this market such tenuous earnings numbers have been more of an asset than a liability, as stocks like MCD and UTX can attest to.

 

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The action of Splunk (SPLK) continues to follow the constructive path that I outlined in my report of last weekend, March 10th, as it moves tight sideways along the 39 price level in the process of forming a two-week handle to what is so far a 26-week cup-with-handle formation, as we can see on the weekly chart, below. While SPLK did grow earnings 200% in the most recent quarter, it is doing so on hard numbers of only a few cents, but the company’s technology places it on the cutting edge of data-mining which in turn makes it a strong buyout candidate. Most analysts believe it is more a matter of when, not if, the company will be taken out, and as I’ve previously discussed, the steady movement of institutional sponsorship into the stock provides some confirmation of the stock’s compelling fundamental story. One could view this handle as a “three-weeks-tight” type of formation, but it could spend another few weeks moving sideways in such a manner. With SPLK resting along its 10-day moving average, a pocket pivot or outright base breakout would be a confirming buy signal for the stock, although I have felt it could be accumulated on pullbacks to the 36-37 level. Unfortunately, the stock has not shown any willingness to do so as it has found ready support on any pullbacks as we can see in the longer “tails” on the weekly bars over the past two weeks.

 

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I last discussed Commvault Systems (CVLT) in my report of March 3rd as it was pulling back to its 50-day moving average on very light volume. At that point it was simply a matter of waiting for a bona fide buy point to show up in the pattern, and while this did not occur on a pocket pivot type of move off the 50-day moving average, something I would have preferred given the stock’s tendency to act sloppily following sharp moves to the upside, it did break out on Thursday on huge volume. There was nothing substantial in the way of news to drive this breakout, which in my view makes it more legitimate. You can see in the daily chart of CVLT, below, that such big breakouts have never led to sustained upside as the stock generally slops around as it slowly trudges higher in volatile fashion. Of course, some stocks can do this for a period of time after which a new breakout leads to a more concerted move to the upside. Perhaps this is CVLT’s “time” so to speak, but at Friday’s closing price the stock is well extended from the breakout level at around 78-79. Thus it would only become buyable on a pullback closer to 82, in my view. This is one of the few big, actionable breakouts we’ve seen recently in a leading stock.

 

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Making progress in this market is not easy, as even one of what have been proclaimed as the leading groups in this market, the homebuilders, has had its moments of ugly action. I discussed Pulte Group (PHM) in this past Wednesday’s report of March 13th as attempting to recover off of its 50-day moving average with a very subtle pocket pivot buy point on the day, and the stock did manage to move higher over the next two days. D.R. Horton (DHI), however, pulled back from a new 52-week high on Friday as volume picked up. Most of these homebuilders, however, are trying to round out bases, such as Ryland Group (RYL). RYL broke out on Thursday from a short, six-day range that formed along the 50-day moving average, and it did so on very strong volume, as we see on its daily chart, below. The stock is extended from the 50-day line at this point, so it is not actionable at current prices, but it does illustrate how the homebuilders are trying to build new bases and therefore should be monitored for actionable buy points as they occur in real-time.

 

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While the market uptrend continues, the rally is being powered by a lot of stocks that would not normally fall within the range of growth characteristics that we would normally look for given our specific methodology. While this is not necessariy a problem, it does mean that one must be very selective in their choice of stocks, but even this does not guarantee overall success as even a few of the most fundamentally attractive stocks have been beset by breakout failures and/or powerful upside moves that soon fizzle, as we saw in the example of SLCA, which had a strong move quashed by the announcement of a secondary stock offering, something we have seen in other nascent leaders. Some market environments can test one’s patience, and this is certainly one of them. When small-caps provide a bulk of the leadership, as they have in this current rally, volatility can increase. This, combined with the fact that unlikely stocks showing little to no, or even negative, earnings growth, populate the list of leaders moving higher, makes this a challenging environment, despite the steady movement of the indexes as they continue to move ever higher. The key is to remain in the game, be patient, and minimize damage when a stock you own begins to act negatively, as we wait for the trend to impart more of its momentum into a broader range of stocks that exhibit the qualities of more liquid, quality growth leaders.

 

Gil Morales

CEO & Principal, Gil Morales & Company, LLC
Managing Director & Principal, MoKa Investors, LLC
Managing Director & 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 no position, though positions are subject to change at any time and without notice.

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