The Gilmo Report

November 9, 2011

November 9, 2011

A run on Italian bonds added a new dimension to Europe’s sovereign debt crisis and the news flow that has been responsible for much of the market’s volatility over the past four weeks, as illustrated by the daily chart of the NASDAQ Composite Index, below. Even with a broadening list of stocks that have been starting to act somewhat constructively in recent weeks, there still has been little net progress on the long side of this market. So far the action has been just “constructive” enough to suck everybody into this market. For all we know, given the extreme bearishness we saw at the lows in early October, this rally has been a contrarian product of all that bearishness, and it’s now time for the market to roll over and play dead again. The 50-day moving average looms ahead to the downside at 2575.04 on the NASDAQ, and that may be a potential area of support that comes into play. All I know is that if I’m long this market I want to be a lot less long after today as this is the second break to the downside off of the 200-day moving average on the NASDAQ Composite Index, and given the relatively ligher volume on the last move back up through the 200-day moving average yesterday, a test of the 50-day line looks to be the most likely probability, barring some “happy” news announcement coming out of Europe. My view is that if you are long stocks and aren’t making progress, then cutting back or going to cash should be considered here.

NASDAQ Composite Index Gilmo Report Chart

The only trade that continues to show us any love is the gold trade, and with the news out of Europe arguing for the demise of the Euro, there is a good case to be made for continued upside in the yellow metal. The only problem with things like gold ETFs and gold mining stocks, for that matter, is that if expanding trouble in the European sovereign debt crisis leads to forced selling as financial institutions and institutional investors are forced to raise liquidity by selling assets, then ETFs and mining stocks become ready sources of cash and could be sold right along with everything else. That was the case with gold today, as we see on the daily chart of the SPDR Gold Shares (GLD), below. Note that the daily trading range saw the ETF move higher early in the day before it, too, succumbed to the waves of selling engulfing the market, and turned to the downside, closing just above its 10-day moving average. For me, there is a very simple way to handle this trade, and that would be to use the 50-day moving average as your ultimate selling guide on the GLD.

SPDR Gold Shares (GLD) Gilmo Report Chart

In my view, if the market is going to give up the ghost and roll over here, then we should see more big leading stocks bite the dust in the process. I wrote in my November 2nd report that a breakdown in the general market would likely bring me in on the short side of Apple, Inc. (AAPL) as I would expect it to bust its 50-day moving average and head for the 200-day line at around 362. Today AAPL closed below the 50-day line for the first time since the death of Steve Jobs with selling volume picking up sharply, as we see in the daily chart below. This is the signal I’ve been looking for, and this is a simple short sale using today’s high at 400.89 as a quick stop. My theory here is that the previous two-weeks-down-and-one-week-up-to-new-highs type of action that occurred in late September (two weeks down) and then early October (one week up to new highs) may be a sell signal on AAPL. Thus this would be confirmed by a breakdown through the 50-day moving average on heavy volume. So far, the evidence is playing out according to this theory, and thus going short here means going after a big, but wounded leader like AAPL as part of a simple two-pronged strategy.

Apple, Inc. (AAPL) Gilmo Report Chart

The other prong in this shorting strategy is (AMZN), which I also discussed in my November 2nd report as flashing its own sell signal similar to AAPL’s, a two-weeks-down-and-two-weeks-up-to-new-highs type of maneuver in late September (two weeks down) and early October (two weeks up to new highs. This sell signal resulted in a massive-volume gap-down in AMZN to its 200-day moving average two weeks ago that then resulted in a logical bounce and a wedging rally up towards the 50-day moving average. AMZN, however, was never able to get past the 200 price level, which I now see as a logical upside stop for any short position in the stock. However, given the prior wedging rally and today’s increasing volume sell-off as the stock peels away from recent highs on this wedging rally, I would be looking for the stock to break down from here and make a move towards retesting the 200-day moving average. Again, the theory here is that the 2-up-and-2-down sell signal is valid, and we may consider the big-volume gap-down two weeks ago as confirmation of its validity. The ensuing wedging rally merely provides us with a fortuitous rally to short into. (AMZN) Gilmo Report Chart

I don’t necessarily feel like I have to go after a whole laundry list of short-sale targets right here as big stocks like AAPL and AMZN will work fine IF the general market breaks down further from here. After-hours we see Green Mountain Coffee Roasters (GMCR) getting blown to smithereeens, currently trading down around 46 as I type after the close, down from its closing price of 67.02. This gets it much closer to my downside prediction of the low 40’s for GMCR that I made in my report of October 23rd. Another one that may have more downside in it is Chinese internet Sina Corp. (SINA), shown below on a daily chart., Inc. (NTES), another Chinese internet, gapped down through its 50-day moving average today on huge selling volume, and I see both SINA and NTES as potentially shortable here using the 80 price level on SINA and the 50-day moving average of 44.94 on NTES as your upside stops. I generally like it when I see at least two stocks in the same group blowing up together, as this adds some measure of confirmation to the weakness, so we can add SINA and NTES to our list of four short-sale targets.

Sina Corp. (SINA) Gilmo Report Chart

The daily chart of (NTES) illustrates today’s gap-down move in the stock. I generally like these sorts of gap-down breaks on heavy volume as they have a higher probability of carrying through to the downside, such as the way Netflix, Inc. (NFLX) blew apart once it gapped down through the 200 price level in mid-September. NTES is also somewhat convenient in that the 50-day moving average is less than 2% away on the upside as your stop. (NTES) Gilmo Report Chart

Despite the market’s rally off the early October lows, you have not seen a lot of leaders go on any impressive price runs – progress has been slow and halting, and we’ve noted this in previous reports recently. While some stocks may simply go sideways for a period of time, today’s action severely compromises the long side of this market, while potentially opening the window again on the short side.

It’s not clear that the window of least resistance is now on the downside, but the next few days will be key in determining how serious the situation in Europe is with respect to the potential for more forced selling.

Gil Morales

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

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