The Gilmo Report

May 15, 2011

May 15, 2011

The past week has seen the market engage in a little bit of calisthenics with the past four days resulting in little more than two repetitions of “push-ups.” The daily candlestiick chart of the NASDAQ Composite Index shows the up-down-up-down routine the market has followed over the past four days as it ended the week roughly where it started. On the surface, the index continues to hold above its trendline breakout of about one month ago and the 2800 price level, but “under the hood” the situation continues to deteriorate and more leading stocks have come under pressure in recent days. Meanwhile, the lack of volume as the NASDAQ had its largest down day since it bottomed on March 16th makes the decline on Friday look fairly benign, but it was far from being the case if you happened to own the wrong leading stock this past week. As I’ve been writing, this is a time for caution. There is little that I have found compelling as a new buy over the past couple of weeks, and spending most of the past week in Las Vegas at the 2011 MoneyShow was likely a much more constructive, if not more entertaining, use of my time.

NASDAQ Composite Index Gilmo Report Chart

When it comes to faltering leadership, the Chinese internets, specifically Baidu, Inc. (BIDU), have been one formerly shining pack of stocks that has now become lost in the woods. As we see in the daily chart below, the leader of this pack, BIDU, has now broken decisively below its 50-day moving average, and a further movement below the intra-day low of Friday’s price range would constitute a bona fide 50-day moving average violation as we measure it. BIDU is headed for its prior breakout level right around the 125 price area where it may find some support, but as I see it this is starting to look more and more like toppy action in a big-stock leader. And if one watches one’s stocks first and the indexes second, as I often prescribe, then it may be time to toss BIDU if one hasn’t done so already. Certainly the heavy selling off the peak after BIDU announced earnings was your first clue that the stock’s illustrious uptrend was not going to continue forever. And the carnage is not limited to the Chinese internets as a number of former leaders among “stuff stocks,” including energy, machinery, metals, and agricultural stocks have broken down further. In my view, the market’s message currently is quite clear in its warnings “under the hood” to back off and exercise caution as it confirms what I was seeing well over a week ago.

Baidu, Inc. (BIDU) Gilmo Report Chart

The break in precious metals nearly three weeks ago was likely the initial “shot across the bow” that served as a warning of things to come. Even today, after silver has split wide open following a parabolic move and climax top, I find it almost comical that I still am getting asked the question, “Is it time to buy silver?” Let’s make it quite clear – the silver party is over and done with. The daily chart of the iShares Silver Trust (SLV), below, tells the story in one neat picture. The second half of the party started in February when the SLV broke out through the 30 area, and even then many remained skeptical of silver’s ability to go higher. Goldman Sachs provided the last buying opportunity in early March with its “sell commodities” call as silver quickly recovered and set off on its final parabolic move towards the $50-an-ounce level. At that point, even the neighbors, who normally keep to themselves, were starting to take notice, but it wasn’t long before the police showed up at the top and sent everyone scurrying out of the party.

iShares Silver Trust (SLV) Gilmo Report Chart

In my view, the fact that many who suffer from what I might call “hindsight greed and envy” continue to think that they can buy silver “on the cheap” here, as if it will suddenly zoom back to new highs, tells you that it will be some time before silver can consolidate and set up again. In fact, it will likely take several months, maybe longer, before everyone forgets about silver and we can then, perhaps, operate according to our axiom that you want to “buy it when it’s quiet.” The same likely goes for gold, represented on a daily chart of the SPDR Gold Trust (GLD) below. The GLD got a little frothy right along with silver at the top, and the yellow metal has corrected sharply as well, albeit not as severely as the white metal has. The GLD is showing something of a “Wyckoffian retest” of its low of seven days ago as it backed down over the past week with volume drying up, which can be seen as constructive. The question is whether gold and silver will mount any significant reaction rallies and bounces off of their very recent lows.

SPDR Gold Trust (GLD) Gilmo Report Chart

In my view, the story behind the metals and also the market is the sharp move off the lows in the U.S. Dollar Index, shown below on a daily chart. As I wrote in my report of May 4th, the U.S. Dollar Index was in a critical position down near the 70 lows and “needed” to rally to prevent what could (emphasis on “could”) lead to a run on the dollar. With QE2 coming to an end in the next month or so and Fed heads starting to sound more hawkish in recent days, the dollar may be sensing an end to the liquidity party. Certainly the precious metals were the first shot across the bow, and with the dollar now breaking through its downtrend line, as I’ve drawn it on the chart, as well as its 50-day moving average on the upside, the stage is potentially set for further dollar appreciation, at least in the short- to intermediate-term, which may be a negative for stocks and commodities.

U.S. Dollar Index Gilmo Report Chart

When things stop working so well on the long side, it inevitably leads to questions about whether now is the time to plunge in on the short side. The short answer to that question is quite simply, “No!” With the market indexes still roughly holding above their recent breakout levels at 2800 on the NASDAQ and 1339 on the S&P 500, a decisive breakdown has not yet occurred. However, it is smart, in my view, to begin building your list of stocks that are currently forming a potentially proper short-sale set-up formation and thus may be in position to break down if and when the market also breaks down. Among these, I have Finisar Corp. (FNSR) on my short-sale watch list currently as it looks to be building a proper head and shoulders top formation here. As we can see from the weekly chart, FNSR formed the right side of the “head” with the massive-volume breakdown after missing earnings on March 8th. The past nine weeks have seen the stock build a possible right shoulder in the pattern, and we also see a “black cross” forming with the 10-week (50-day) moving average now crossing below the 40-week (200-day) moving average. FNSR comes out with earnings in June, but the technical action of the stock does not seem to indicate that investors have high hopes for the stock going into earnings. As far as H&S formations go, however, FNSR is one of the better “poster child” examples coming through my short screens currently.

Finisar Corp. (FNSR) Gilmo Report Chart

F5 Networks (FFIV), which had a massive-volume price break back in January that formed the right side of the “head” in its formation, has been bumping up against potential resistance at around the 110 level and the 40-week (200-day) moving average recently, as we see in its weekly chart below. Depending on how you want to “tilt” the neckline of this head and shoulders formation the stock has either rallied off of a declining neckline (red dotted line) or rallied into resistance at a flat neckline (yellow highlighted band). In my view, if FFIV is unable to rally above the 110 price level then it may be headed for a retest of the lows at around the declining neckline and the 90 price level. Over the past four weeks, however, upside volume has come in better than downside volume, so this one is still unclear. It may simply be that only a decisive downside break in the general market will bring FFIV into “synchrony” so that it also begins to break down from this potential head-and-shoulders top formation. So far the stock has put in two “waves” to the downside off the peak in January, so a third wave to the downside might be a “logical” technical development that takes the stock down again. FFIV competes with Cisco Systems (CSCO), which reported on Wednesday that they see business slowing down in their space, and so FFIV’s action over the past four months has been prescient in this regard.

F5 Networks (FFIV) Gilmo Report Chart

It will take some time for a longer list of viable, potential short-sale candidates to get into position, assuming the market does in fact begin to break down (we could just as easily see a sloppy sideways move through the summer), but when I see what I think qualifies as one you can be sure I will discuss it here. Last weekend I discussed Las Vegas Sands (LVS), which has morphed from a late-stage failed-base (LSFB) to a pocket pivot buy and now back to an LSFB set-up as it falters once again. On the weekly chart of LVS, below, we can see last week’s high-volume reversal following earnings, followed by this past week’s reversal on lighter volume as the stock could not hold above the 10-week (50-day) moving average. In my view, if LVS cannot get back above the weekly high of 44.88 it may test the March lows down in the mid-30’s. Of course, as with any short-sale set-up, a significant break will likely have to occur in synchrony with a general market breakdown, so would-be short-sellers should always be mindful of where the general market action may be leading.

Las Vegas Sands (LVS) Gilmo Report Chart

Because the market is still technically just moving sideways after recently breaking out to new highs, as we saw in the daily chart of the NASDAQ at the outset of this report, the situation remains fluid and mostly unclear. Obviously, the continued deterioration of market leadership is a strong clue that things are not entirely right “under the hood” of the market, but currently I see no reason to take a strong side either way – bullish or bearish. In fact, right now it may be most prudent to take no stand at all, preferring to “take a sit” instead by laying back and building watch lists, both on the long and short side, as one waits for the market action to resolve itself. There have been a small handful of leaders still acting okay, as my colleague Kevin Marder relayed and discussed in the report on Wednesday of this past week as he filled in for me while I was out on the road in Las Vegas, such as Amazon.com (AMZN), which has moved above the $200 level, and VMware, Inc. (VMW) which looks like it is trying to build a handle in a possible cup-with-hande formation. In the stock market, there are times when what you DON’T do is more important than what you actually DO, and right now I think it is important that investors DON’T do too much here and instead focus on preserving and keeping their powder dry for the purpose of capitalizing on the next strong window of opportunity when it opens up. Things can change very quickly in the market, so 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 no positions, though positions are subject to change at any time and without notice.

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