The Gilmo Report

March 20, 2011

March 20, 2011

In my report of this past Wednesday I noted that the market appeared due for a reaction rally, and the last two days of the week served up exactly that. In my view this is textbook, to the extent that a “QE market” can be textbook, as the news flow provides little more than an alibi for the selling, and then an “all clear” excuse for gap-up rallies such as we saw Thursday and Friday. News of an impending electric power line being hooked up to the crippled Japanese nuclear reactors led to a gap-up open on Thursday while news of Libyan leader Moammar Ghadafi calling a truce after the United Nations Security Council voted to take military action sent the indexes gapping higher on Friday’s open. As I see it, these news events of the past two days have served to provide excuses for a natural reaction rally that is masking severe underlying weakness in leading stocks. While

Friday was an options expiration day, which helps to alibi the heavier volume, the bottom line is that the past three days’ worth of gap-up opens have been sold into as we see on the daily candlestick chart of the NASDAQ Composite Index below. Three big red candles delineate the action of the past three days as each day has closed far below its open, with the last two being big gap-up openings. Notice also that the rally over the past three days has not been able to get above the close of this past Tuesday, and so this appears to represent near-term resistance.

NASDAQ Composite Index Gilmo Report Chart

In the midst of this week’s poor general market action, the U.S. Dollar quietly slipped to new lows, as we see in the daily chart of the U.S. Dollar Index below. In my view, this continues to bode well for precious metals as they trade less as industrial commodities and more as “money,” while other commodities potentially languish in a weakening global economic environment as a result of a “demand vacuum” coming out of Japan. Already some Japanese tech firms have announced that they are shutting down operations for a week, which could put a damper on commodities in the short-term. Over the long run, however, I tend to think the bull case for commodities and precious metals holds, and I continue to hold positions in both gold and silver, for now, but as I stated in my Wednesday report, silver must hold its 20-day moving average, as a violation of that moving average in the near-term might signal further correction and/or consolidation. At the very least, I do not view continued deterioration in the dollar as constructive for U.S. stocks.

U.S. Dollar Index  Gilmo Report Chart

One of the few big leading stocks that has shown any positive action in recent days has been Netflix, Inc. (NFLX), shown below on a daily chart and which benefited from a buy recommendation and $300 price target from none other than Goldman Sachs. Generally, however, a buy recommendation from Goldman usually means “buy this because we have clients who need to sell it.” As I wrote on Wednesday, this caused a pocket pivot buy point as the stock launched above the 50-day moving average, but I pointed out that I would not buy this pocket pivot. Wednesday brought above-average selling that sent the stock back down to its 50-day line on Friday with selling volume also picking up that day. Unless the market rights itself and launches back to the upside with a follow-through day, I would watch NFLX for a possible high-volume breach of the 50-day moving average as a potentially shortable late-stage failed-based (LSFB) type of set-up if the market continues to correct, as I find it possibly telling that NFLX was not able to add to its move on Tuesday by rallying on big up days for the market on Thursday and Friday, an odd divergence.

Netflix, Inc. (NFLX) Gilmo Report Chart

Apple, Inc. (AAPL) continues to deteriorate following Wednesday’s violation of the 50-day moving average, a breakdown that also took the stock below the black 65-day exponential moving average on the daily chart below. Notice how AAPL was unable to rally even back above the 65-day e.m.a. on Thursday and Friday, despite the big gap-up market rallies on those days. You may also notice that the two peaks up around 360 form a “split-top” type of head with the left shoulder “hump” forming to the left of that in January. I would look for AAPL to continue lower, perhaps to the 320 level or so before attempting a rally to form a right shoulder. AAPL is one of the biggest former “big stock” leaders in this market, so it may take more time to set up with perhaps several right shoulders coming into play. For now I consider any rallies into the 65-day e.m.a. at 339.46, initially, or the 50-day moving average at 346.45, secondarily, as potentially shortable rallies. Certainly, with so much good AAPL news at its disposal, the crowd is likely not yet ready to believe in an AAPL top, so you can take it from there.

Apple, Inc. (AAPL) Gilmo Report Chart

Among my initial short-sale target stocks, namely the cloud-plays as discussed in my report of February 27th, F5 Networks, Inc. (FFIV) has been the weakest as it has gone right to my lower downside target at the neckline in what is now a bona fide Head & Shoulders top formation.

F5 Networks, Inc. (FFIV) Gilmo Report Chart

VMware, Inc. (VMW) has also broken below its 200-day moving average.

VMware, Inc. (VMW) Gilmo Report Chart

In both FFIV and VMW I would look for weak bounces back up into the 200-day moving average to short into, but the way both are acting as they breach their 200-day lines leads me to conclude that Salesforce.com (CRM), the third cloud-play I discussed as an initial short-sale target in my report of February 27th, may soon follow them below its own 200-day line as well. In my report of this past Wednesday, I surmised that CRM might soon follow VMW and FFIV down to its own 200-day moving averages, which it has now done, so with VMW and FFIV now breaking that key moving average, CRM probably follows suit as well. As we see on the daily chart below, CRM bounced off of its 200-day line on Friday, and I would look for it to perhaps bounce weakly or hold along the moving average before continuing lower, so would add or initiate shorts on weak upside bounces from here, using the 10-day moving average at 125.51 as a guide for a trailing stop. Notice how over the past two weeks both FFIV and VMW have “obeyed” their 10-day lines to the downside before breaking their 200-day moving averages, so look for CRM to do the same.

Salesforce.com (CRM) Gilmo Report Chart

On pages 8 and 9 of my March 2nd report I discussed Las Vegas Sands (LVS) as a late-stage failed-base (LSFB) short-sale set-up, even comparing it to Qualcomm (QCOM) in 2000 (refer to that report for the chart). Since then the stock has continued lower, even breaking its 200-day moving average this past week. In the same way that I considered the mass of breakdowns in cloud-stocks as a sign to tag those stocks as short-sale targets, the Leisure-Gambling stocks are also coming further into focus as short-sale targets with first LVS breaking down and now Wynn Resorts (WYNN) starting to fail from its recent cup-with-high-handle breakout. In the “old days,” cups with “high handles” used to be faulty patterns, and in fact they still remain failure-prone. Note that WYNN is now breaking down through its 50-day moving average which appears to “seal the deal” on a potential late-stage base-failure. I view WYNN as shortable here using the 50-day line at 121.19 as a guide for an upside stop. You can see how the initial breakout failure bounced off the 50-day line, but this is typical for LSFB set-ups as the second failure is more likely to lead the stock lower.

Wynn Resorts (WYNN) Gilmo Report Chart

In my Wednesday report I discussed two other potential LSFB set-ups in Deckers Outdoor, Inc. (DECK), not shown, and Citrix Systems (CTXS), shown below on a daily chart. Both, howevever, haved moved a little bit lower over the past two days but remain in shortable positions here. With DECK I would use the 50-day moving average at around 82 as my guide for an upside stop, while looking for a move to the downside that potentially undercuts the lows of the previous base at around 71.18. CTXS, as we see on the chart below, reversed back below its 50-day line on Friday with volume coming in above average, so I consider this shortable here using Friday’s high at 69.37 as a guide for an upside stop. CTXS looks a bit like WYNN, further above, in that the initial breakout failure led to a bounce to new highs, but it is this second failure through the 50-day simple moving average and the 65-day exponential that may be the one that leads the stock to significantly lower lows with an initial downside target at around 60-61 and the 200-day moving average.

Citrix Systems (CTXS) Gilmo Report Chart

As I’ve written in previous reports, as the market initially breaks down off of its prior peak levels, your first observable short-sale set-ups are likely to be Late-stage Failed-Based types of set-ups, as most Head & Shoulders patterns are not far enough developed, with FFIV being a notable exception. Therefore you want to keep a close eye on former leading stocks that may be showing some signs of breaking down from late-stage bases. Using LVS, CRM, VMW, and CTXS as models, we can observe that Lululemon Athletica (LULU), as we see on its daily chart below, is one such stock to monitor as it is bouncing along and clinging to its 50-day moving average. On Thursday the company announced strong earnings and the stock responded by reversing on heavy volume, despite Thursday being a big up day for the general market indexes. That huge volume spike tells me to be alert to a potential break of the 50-day moving average that would potentially qualify LULU as a bona fide LSFB short-sale set-up. From here I would look at any downside move as having the potential to reach the lows of the prior base at around 65, but watch for the 50-day break first.

Lululemon Athletica (LULU) Gilmo Report Chart

As well, we might observe big leading stock Chipotle Mexican Grill (CMG) as it bounces along its 50-day moving average following a breakout failure after announcing earnings in mid-February. This is an interesting one to analyze, as the huge-volume breakout occurred after the stock was coming straight-up-from-the-bottom (the old “SUFB” flaw) which is not the position you want to see a later-stage breakout coming out of. All of that huge buying volume failed to take the stock any higher as it essentially went nowhere following the breakout to new all-time highs. Note also that CMG sold off over the past two days as it diverged from the general market and actually moved lower to test its 50-day moving average on Friday. While the stock is still holding its 50-day line, like LULU, it may very well end up breaking down through this key moving average, which currently also coincides with the 65-day e.m.a. as LVS, CTXS, DECK, CRM, and VMW have done in previous LSFB short-sale set-ups I’ve discussed in this and previous reports. Watch this one carefully. While the pullbacks to the 50-day line might appear benign, there are some cracks forming here, and at the very least if I were long CMG I’d be very careful here.

Chipotle Mexican Grill (CMG) Gilmo Report Chart

While the general market indexes have been able to gap up big at the open over the past two days, each day has led to a close well below the intra-day highs. This is particularly noticeable in the chart of the NASDAQ Composite Index, which was hit hard by the big NASDAQ stocks as the NASDAQ 100 Index actually closed down on Friday in divergence to the other major market indexes. And of course we see the cause of this weakness in the charts of stocks like AAPL as well as in the tech sector at large. Allegedly, tech will do well in a slow economy, something the pundits have been quick to point out, but with so many stocks showing weak action (and this is not just limited to tech stocks) such as we see in the chart examples I’ve shown in this report, we can clearly see that the past two days’ of big gap-up moves in the general market indexes are masking underlying weakness. While the market could indeed rally again early in the week on some news alibi such as some positive developments in Japan or Libya, I would continue to look at rallies as potentially shortable events, keeping my short-sale target list handy at all times. Meanwhile, until further notice, I would avoid the long side of the market.

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 AGQ and 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.