The Gilmo Report

May 18, 2014

May 17, 2014

I wrote in my report of this past Wednesday that the S&P 500 Index was in position for a bull trap on the low-volume breakout to all-time highs that occurred on Tuesday. On Wednesday the breakout began to falter and the trap door snapped shut on Thursday as the index broke down decisively below its breakout point and selling volume increased sharply from the prior day. As we can see on the daily chart of the S&P 500, below, the index was able to find intraday support at the 50-day moving average on Thursday, and this was followed by an options expiration day bounce on Friday on roughly the same volume. Objectively, the Tuesday breakout was a bull trap, and it remains to be seen whether the NYSE-based indexes can muster another run at the highs, assuming that the support we are seeing along the 50-day moving average in the S&P 500 and the Dow can hold.




The NASDAQ Composite Index was also hit on heavier volume Thursday, but found support near this slightly triangular trading range it has been locked in over the past month. As we can see on the daily chart of the NASDAQ, below, the top of this range is defined by the slightly descending black 65-day exponential moving average on the top and an area just above the rising 200-day moving average on the bottom. The NASDAQ suffered a sharp distribution day on Thursday as selling volume picked up substantially from the prior day.

From my perspective, nothing has changed as the NASDAQ remains in a “right shoulder rally” type of zone where a series of zigs and zags since the April 15th lows when the index bounced off of the 200-day moving average define a series of right shoulders in its pattern. This action is being mimicked by a number of former leading stocks, and this is what makes me think that we are heading lower at some point. Whether the NASDAQ rallies back up to the top of its current range as it continues to oscillate in a sideways range I cannot tell you for sure, but so far the action seems to argue for a right shoulder rally or “RSR” phase that is in progress. This can take several weeks to work through, assuming that the market doesn’t somehow regenerate itself and begin a fresh new rally that is also seeing strong, nascent, and dynamic leadership among individual stocks. Right now we are a long way from that, outside of big reflex rallies we might see in former leading stocks that have been decimated and sit down in what might be considered the “dungeon” of their current chart patterns.




Most of my time is spent monitoring rallies in short-sale target stocks as the market works through this right shoulder rally type of phase, in anticipation of another leg to the downside. It is normal, however, for this RSR phase to go on for a period of time, and I have shown in previous reports how the 2007 market top spent two months after the initial break off the peak before it headed lower (see the May 11th report). The wrinkle this time around is that the NYSE-based indexes are near their highs in a sharp divergence from the NASDAQ and the Russell 2000, so I have considered the possibility that a new down leg in the NASDAQ might coincide with a sharp break off the peak in the S&P 500 and the Dow.

That is one scenario that I’m leaning towards currently, particularly given the fact that there does not appear to be anywhere near enough a critical mass of constructive action in the underlying stock leadership at the current time. So far this week’s bull trap and failed breakout attempt by the NYSE-based indexes provides some confirmation of my theory, at least for now. I would be open to more bullish evidence to the contrary, but so far that is virtually non-existent.

Reviewing some of my short-sale targets, one can get a strong sense of how all these names are simultaneously engaging in RSR type of action and in the process mimicking the NASDAQ Composite quite closely.

Netflix (NFLX) mimics the NASDAQ by continuing to work on its RSR phase, as we can see in the daily chart, below, and so far the stock has managed to throw up two rallies into the 200-day moving average after undercutting the prior 312.10 low in late April. The first rally failed last week as the stock dropped below the 320 level before making another attempt at the 200-day line this week. NFLX managed to close just above the line by Friday as it forms a little flag along the moving average. Selling volume is not drying up here, however, as the stock ran into some increased selling volume on Thursday. I consider NFLX shortable at current price levels, but we can see that the 50-day line is continuing to move lower as it comes down to the 362 price level and only 3% away from where the stock closed on Friday.




On the weekly chart below we can see that the 10-week line is lower than the 50-day moving average as it drops down to within exactly two points of the 40-week moving average. The 10-week line is currently at 354.03 while the 40-week line is at 352.03. I would look for the stock to find resistance on any further bounce to the upside at these two moving averages and as far up as the 50-day line up at 362.35. You can see how NFLX has now spent the past five weeks working on two right shoulders in the pattern which looks normal for a possible head and shoulders top.


GR051814-NFLX Weekly


Facebook (FB) broke down further from the 65-day exponential moving average where it was running into resistance as I discussed in my Wednesday report. Volume picked up on Thursday as the stock held relatively tight, but my expectation is that the stock is likely to test the 200-day moving average down at 54.03. Having shorted the stock up at the 65-day line, I am using that as my upside stop.




The weekly chart of FB, below, shows the head and shoulders formation with the right shoulder slightly higher than the left shoulder. I have discussed the fact that there are many examples of H&S formations with a higher right shoulder that have worked, even in the current market environment, as we’ll see a little later in this report. What I note on the weekly chart is the persistent stalling on heavier volume on rally attempts up to the 10-week moving average. The past three weeks have seen FB wedge up along the lows and stall at the 10-week line. The phrase “wedging up along the lows” refers to the fact that the lows of each weekly price range are slightly higher than the prior week’s low and volume is declining at the same time. Is FB “hammering out” the lows of a new base, or is it just consolidating the prior break off the peak in early March? My view is that as long as the stock cannot clear the 65-day line and, ultimately, the 50-day moving average, to the upside, then I am inclined to take the latter view of the stock for now.


GR051814-FB Weekly


Las Vegas Sands (LVS) finally met up with its 200-day moving average, my initial downside price target for the stock, as we can see on the daily chart, below. For my money, I am inclined to cover the stock here at the 200-day line and see if another shortable rally into the 75 price area, more or less, allows me a re-entry point. I was initially looking for the stock to bust through the 200-day line and undercut the prior 71.09 low from mid-April, but the stock closed off its intraday lows on Friday and near the peak of the daily trading range as selling volume remained somewhat muted and LVS closed above the 200-day line.




Baidu (BIDU) continues to find resistance at its downward-sloping 50-day moving average, as we can see on the daily chart below. I’ve outlined the overall head and shoulders pattern on the chart, and we can get a sense of how BIDU is another former leading stock that is engaging in RSR type action as it too mimics the action of the NASDAQ Composite. Interestingly, the 50-day moving average is now dead even with the 200-day moving average as it sits on the cusp of a bearish “black cross.”




The weekly chart, below, gives us a better picture of BIDU’s big H&S formation that is still in process as it builds what looks like a second right shoulder in the pattern. Here we can see that the 10-week moving average has now crossed below the 40-week moving average, completing a bearish black cross on the weekly chart. BIDU is churning and stalling around this 10-week/50-day and 40-week/200-day moving average confluence, and I still consider the stock to be shortable on any rally up near the 157-158 price level.


GR051814-BIDU Weekly


Trulia (TRLA) announced that they were seeing strong consumer interest as 7,000 new subscribers joined their house-hunting website, and this led to a sharp upside jerk on Friday. In a weak, massive H&S pattern like the one TRLA is in, I tend to view any such news-related rallies as opportunities to short the stock. Unfortunately, my attempts to short TRLA at around the 34 price level on Friday were cut short by the fact that I could not borrow the stock! Foiled again! In any case, TRLA gave up about half the rally as it closed at 33.19 on above-average volume, as we can see on the daily chart below. I still view TRLA as a short here as another 7,000 subscribers doesn’t do much to change the fact that the company will continue to lose 36 cents a share for all of 2014 before turning a 19 cent profit in all of 2015, according to analysts’ estimates. Even with the estimated profit for 2015, TRLA still sells at 173.7 times those forward estimates, and in my view stocks with massive P/E ratios are not going to thrive in the current environment. Thus TRLA is a short here using the 34.41 intraday high of this past Friday as your upside guide for a stop.




Celgene (CELG) has finally run into stiff resistance at its 200-day moving average, as we can see on the daily chart below, after rallying in choppy fashion throughout April and early May. When we consider how far CELG fell from the early February peak, the bounce off the early April lows looks quite normal given the context of the overall chart. I still view CELG as shortable at the 200-day line, as I wrote in my report of this past Wednesday, using the moving average as an upside guide for a quick stop. CELG is also an example of a stock that formed an H&S pattern with the right shoulder higher than the left which still worked on the downside.




The weekly chart of CELG, below, shows the rally over the past five weeks that stalled at the 40-week moving average on increased volume this past week. You can also get a sense of how the rally off the mid-April lows has not been accompanied by buying volume that is anywhere near the intensity of the selling volume as the stock broke down below the 40-week moving average back in March with volume picking up for six weeks in a row as the index closed near the lows of its weekly range each week. We can also see how the bounce off the mid-April lows saw two higher-volume weeks that were both stalling weeks with one occurring at the 10-week line four weeks ago and the other at the 40-week line this past week.


GR051814-CELG Weekly


Biogen Idec (BIIB) is yet another RSR situation as it ran into resistance at its 65-day moving average this week and rolled over on Thursday with the rest of the market. BIIB has already formed one right shoulder and the latest rally up into the 65-day line appears to be forming the second.




The weekly chart also gives us further insight into how BIIB is setting up within this overall, potential H&S formation. We can see how the stock broke down and reversed off the peak eight weeks ago after pushing up towards the 360 price level. That first week off the peak and the next three weeks all closed right near the weekly lows on very heavy selling volume. This is a severe, initial sign of weakness that leads me to believe that the action over the past five weeks is merely an RSR process that serves to consolidate the prior break off the peak as well as form more right shoulders in the H&S pattern in preparation for further downside. I continue to view BIIB as shortable on rallies up to the 65-day line at around the 300 price level, using the 50-day line at 303.67 as your maximum upside stop.


GR051814-BIIB Weekly


In my Wednesday report I discussed Pharmacyclics (PCYC) and its strong-volume rally into the 50-day moving average as something to keep an eye on should the stock show signs of failing at the 50-day line. Interestingly, on Thursday PCYC failed and reversed right at the line, as we can see on the daily chart, below. This occurred on light volume, however, whereas I would have liked to have seen this fail on more substantial volume. From here the 50-day moving average is about 5% higher so I would not be looking to short the stock here. I would instead prefer to see another attempt at the 50-day line that occurs on weak volume, whereupon I might be willing to short the stock as close to the line as possible.




LinkedIn (LNKD) remains in “no-man’s land” as it hangs in mid-air underneath the lows of the base it formed from May to July 2013 and above the massive first-stage base it built after coming public in May of 2011, as we can see on the weekly chart below. While I tend to think the stock is going to eventually test the top of that big post-IPO base down around the 125 price level, what it does from here is anyone’s guess. For the moment the 152-153 price level has served as near-term resistance, but I would only consider the stock to be a “juicy” short candidate on a rally back up near the highs of May 1st around 164. If you study this chart right around the peak, you can see how LNKD also formed an H&S pattern between the beginning of August and the end of October where the right shoulder was higher than the left shoulder. If you’ve been short LNKD from the start, I don’t necessarily see any reason to cover the position right now, but I would not be surprised to see the stock bounce up towards the 160 level where short-term resistance currently exists.


GR051814-LNKD Weekly


I discussed Goldman Sachs (GS) in my Wednesday report as being in position for a short-sale at around the 160 level that constitutes the “neckline” of its H&S formation and the lower-end of near-term resistance on several rally attempts over the past month, as we can see on the daily chart below. GS closed up off its lows on Friday as volume picked up but remained below average. This remains in play if one is short closer to the 160 price level, using the 50-day line at 161.43 as your guide for an upside stop. For the most part, GS has been locked in a range between 162 on the upside and 154 on the downside since finding a near-term low at 151.65 in mid-April as we wait to see whether the stock will eventually “break out” to the downside through the 154 price area.




3-D printer maker Stratasys (SSYS) has been a short since I first discussed the stock when it last rallied up to its 50-day moving average back in early April (see April 2nd report). As we can see on the daily chart, below, SSYS has now undercut the 89.90 low of the base it built in September and October of last year and is sitting right on top of the six-month base it built from February through July of last year. For now the stock looks somewhat played out to the downside, and I would only be interested in shorting the stock on a rally up to the 50-day moving average, currently at 102.74 on the daily chart, not shown, or the 10-week line up at 100.31.


GR051814-SSYS Weekly


The primary theme that drives my thinking in this current market environment is this right-shoulder-rally or RSR synchrony between a broad number of fallen former leading stocks and the NASDAQ Composite Index. The last time I saw something this broad in terms of stocks closely mimicking the RSR action of the indexes was in late summer of 2008, and we know what happened once the summer of ’08 ended. Of course we don’t know for sure that the current environment will play out the same way, but the overall macro-picture does not look constructive to me.

Certainly, I see nothing to buy, and no reason to play the long side of this market in any meaningful way outside of “quick and dirty” trades if one is going to try and play reaction bounces in beaten-down former leaders. But that is far from a concrete and sound approach to the long side of any market, and if we are left with trying to hunt around for “shakeout-plus-N” type set-ups then the long side of this market is in sad shape indeed. Meanwhile, I am looking for a scenario where a NASDAQ break to new lows coincides with a sharp break off the peak in the NYSE-based indexes which have held up near their recent highs. In the meantime, the RSR action could continue for another several weeks or it could resolve into fresh lows before then.

The key is to be ready and in position on the short side or at least able to get short in a hurry if one is inclined to play a downside move. Otherwise, cash remains a good place to be. In my view, bullish evidence to the contrary will have to start coming in hard and fast before I see what I need to see in order to completely abandon the short side of this market and move to the long side. For now you know where I stand.


Gil Morales

CEO and Principal, Gil Morales & Company, LLC
Managing Director and Principal, MoKa Investors, LLC
Managing Director and 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 had a position in FB, though positions are subject to change at any time and without notice.

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