Market Comment

March Sadness

March 14, 2011

“Show me someone who has done something worthwhile, and I’ll show you someone who has overcome adversity.”

                     — Lou Holtz

The Japanese disaster, as sadly horrific as any, is not anything that a seasoned veteran of California’s earthquakes could come close to imagining. A 9.0 Richter Scale shaker is many times more intense than the 6-7 Richter temblors that occasionally rattle the nerves of Californians.

Let alone a ferocious tsunami and a full-blown nuclear crisis.

Here’s to some mighty rescue efforts by the brave rescuers for the thousands of Japanese missing, a safe resolution of the faltering reactors, and food, shelter, and clothing for the unfortunate.

At this writing, the Nikkei lost 10.6% in Tuesday’s wild Tokyo session, bringing the index its worst two-day loss since Black Monday 23 years ago. At one point Tuesday, the Nikkei futures were down close to 17% before recovering.

Prior to the disaster, the big picture had been a market discounting a late-’11 slowdown in emerging markets brought on by higher inflation and rising interest rates. This was manifested by weakening fertilizer issues, e.g. Mosaic (MOS), Potash Saskatchewan (POT), Agrium (AGU), CF Industries (CF), and Intrepid Potash (IPI), some displaying head-and-shoulders topping patterns.

Other high-profile groups have also forecast a growth slowdown, including coal stocks Patriot Coal (PCX), with its head-and-shoulders, and Peabody Coal (BTU), with its failed breakout,

Ditto for metal ores
stocks such as Cliffs Natural Resources (CLF), Cameco (CCJ), and Freeport McMoran (FCX).

Our prophetic friend, Dr. Copper, is another signaler of an economic slowdown in EM.

In the wake of a historic one-way move that began Sept 1 – not to mention equity indices doubling off their bear market lows faster than any time since ’36 – that the Nasdaq up to Tuesday’s (15) open is off only as much as 5.6% in the face of the Japanese disaster, the 27% surge in crude over a three-week period, and some negative developments in the eurozone, speaks of a semblance of underlying firmness.

Though this firmness is not present at the surface, subsurface it is seen in the action of a number of leading stocks, especially late last week.

Under Armour (UA) appears poised to come out of a four-week ledge and could be taken above the 3/8 high of 70.69. The stock is under extreme accumulation, with estimates of 23%/22% for ’11/’12, though not in a top group.

Rightnow Technologies (RNOW) recently broke out of a four-month pattern on volume 111% above normal, stalled for two days, then followed through on solid turnover before spinning its wheels Thursday (10) and Friday (11). We would not be buying the stock here, but note it as an example of the speculative sentiment that remains on a soft boil.

Aruba Networks (ARUN), similar to RNOW, is extended, and thus does not represent an attractive entry, but is more evidence of an underlying institutional bid. That these names are speculative is a plus in terms of sentiment needed to produce further upward revaluation in the averages.

Whether the averages need more time to correct is beside the point, the point being that if things were ready to go somewhere in a handbag, you would not be seeing RNOW and ARUN, among others, begin to prance on the tape.

Ditto for Jazz Pharmaceuticals (JAZZ). Extreme accumulation, nice sequential rev growth, big estimates (68%/48% for ’11/’12), but extended and not to be touched for the time being.

Another plus is the “It stock” (AAPL) bubbling just a few percent beneath its high as it respects its 50-day for the second time in a fortnight.

It is important not to view leaders like this as leading indicators of market weakness. They may be leaders in a bull market; but a leader in a bull market is not the same thing as a leading indicator. Some leaders will indeed break down in advance of a serious correction or bear market, while many other leaders will serve as institutions’ sacred cows, holding up until the end of a general market correction, when an institution or institutions will have to throw them out like the baby with the bathwater, one example of this being the leadership going into the ’98 bear market.

Polycom (PLCM) is forming a fairly tight four-week shelf which is potentially buyable above the 2/14 high of 49.99. Solid estimates of 37%/25% for ’11/’12, a strong group, four quarters of revenue acceleration.

Opentable (OPEN) cleared a two-week high on Friday (11) and appears poised to attack its Valentine’s Day high of 95.97. We like its estimates of 31%/51%, the solid accumulation, the strong group, the six quarters in revenue growth acceleration, and the increasing number of fund sponsors over the past few quarters. The character of the stock indicates it is more likely to pull back after breaking out, as opposed to following through. For this reason, we would take a junior-sized position on a breakout, if at all.

Verisign (VRSN) is showing slightly more distribution in its base, but we would monitor this expected 39%/29% grower for ’11/’12 to see if it can break out above the 2/14 high of 37.57.

Baidu (BIDU), up a dozenfold in this bull market, cleared a two-week high on Friday (11). Our favorite stock in the two-year bull market due to its high EPS growth rate in combination with its mega-capitalization. Names like this do not grow on trees. Potential entry point for a junior position would be above today’s high of 125.40.

Chipotle Mexican Grill (CMG) acts v well as it bases in classic fashion, and could potentially be entered via a junior position above the 3/7 high of 258.64. A logical stop would be just beneath the 2/4 low of 234.48.

A recent new issue like Broadsoft (BSFT) that moves up 500%+ in four months is the exact type of thing that grabs our attention. EPS estimates for ’11/’12 are 48%/65%. Extended now, but worth watching.

Gartner (IT) is one of the first of the leaders to complete a five-week base, shows good estimates of 27%/26% for ’11/’12, and could potentially be entered above the 3/11 high of 39.21with a junior position, using a stop below the 2/17 low of 35.83

Cloud play Rackspace Hosting (RAX), with estimates of 60%/50% for ’11/’12, is one of the biggest winners of the bull market, is showing some distribution in its four-week base, but is behaving fairly well on the weekly chart. Worth watching for a standard breakout opportunity.

Like RAX, Lululemon Athletica (LULU) is another leader working on a four-week base that, at the present time, does not offer attractive entry ahead of a standard breakout.

Ulta Salon (ULTA) is extended, but is evidence of the speculative sentiment, as are Intralinks Holdings (IL), Sodastream International (SODA), Accretive Health (AH), (YOKU), and Sina (SINA), the latter
breaking out today, but too v-ish for our taste.

Our research has shown that an O’Neil follow-through day carries more weight when it comes amid an 8%-12% intermediate-term correction than something shallower such as the current reaction. Therefore, we are less interested in this at present.

While the breadth of a market advance may be the best indicator we know of to tell us where we are in the long-term trend, it does nothing to tell us how deep an intermediate-term decline in the averages will be.

The backdrop includes the risk that unrest in certain Arabian nations, particularly Bahrain, Yemen, and Oman, will impact Saudi oil. Although the market is telling you it is not assigning a high probability to either of these scenarios – otherwise this would be a full-fledged correction, not a reaction – we have long felt that it is only a matter of time before the Saudi monarchy is overthrown. The advent of the Internet and advanced communications have hastened the spread of technology and weaponry which has leveled the playing field between governments and opposition movements.

Too, history has shown that empires or dynasties, whether it is the Greek, Roman, Persian, Ottoman, British, French, Spanish, Russian, Portuguese, Japanese, Italian, etc., all go into decline eventually.

Despite Saudi being a very different situation than Egypt and Libya, we would not entirely rule out events changing there.

In our last report of February 9, we wrote that “…this is believed to be a go-slow market, for despite the overall good tone of the averages and generally sound tape of the leaders, the historically extended nature of the averages (SPX > its 50-day for 111 straight days) and lack of high-expectation stocks building bases of five weeks or more augur for caution in terms of fresh-money buys. Participants in a generous cash position should not feel any urgency to become invested so as to not miss out on the advance. That time has come and gone.”

The situation today is believed to be closer to the opposite of the above paragraph.

In summation, despite the distribution seen at the surface and in the late-cyclical titles over the past month, a number of speculative growth stock glamours are resisting the outbound tide. There is a message here. The averages have come off and the coiled-spring action of some leading titles suggests that in the coming days or weeks the market may be closer to a low-risk entry point than it has for some time. It is logical to think that this might coincide with a lifting of the uncertainty related to the Japanese nuclear reactors. Risks are a total meltdown of one or more Japanese reactors, a series of expected ECB rate hikes wiping out any semblance of economic recovery in the eurozone, and a deterioration in the Saudi oil situation. The intermediate-term speculator should remain alert to the possibility of a series of breakouts in some of the leaders mentioned in this report ahead of, or coincident with, a potentially more-obvious advance in the averages.

Kevin Marder

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.