The Gilmo Report

October 2, 2011

October 5, 2011

What some were looking for to show up as “end-of-quarter window dressing” turned into something more like end-of-quarter window jumping. Big investors weren’t interested in dressing things up – more like dressing things down, and by the close the market was left without a shred of clothing, shivering naked in the cold of a sharp 2.63% decline in the NASDAQ Composite Index, shown below on a weekly chart. Using the weekly gives us a different view of what is going on with this, the leading index among the three big market indexes that include the NASDAQ, the S&P 500, and the Dow 30. Since the break in early August, the market has been working through the “Chop Zone” where we see a lot of volatility in the wide, loose weekly ranges. Notice also that four of the last five weeks have seen the index close well in the lower part of the weekly range, which appears to be a clue of systematic institutional selling and liquidation into rallies. In addition, this week saw three gap-up openings fade as smart money distributed stock to the dumb money, and the distribution continued right into Friday. The dominant feature of this week’s technical action, if not most of the action within the “Chop Zone,” is that of distribution into rallies, and this all argues for the possibility of lower lows and another leg down in an overall and continuing bear market phase.

NASDAQ Composite Index Gilmo Report Chart

Not that the broader market hasn’t already tested and gone through the August lows, since we can see that the much broader NYSE Composite Index, shown below on a daily chart, previously undercut its August lows last week. This triggered a short “undercut & rally” type of bounce extending into early this week and now the index is starting to roll over with volume picking up on Friday. The weakness in the market and the broad breakdown in leading stocks, with some getting quite decimated on the down side, shows why one cannot rely on sentiment indicators alone to tell you which way the market wind is going to blow. Sentiment has been extremely bearish in a number of surveys, most notably the Investors Intelligence Adviser Sentiment survey which has been in a “crossover” with bears exceeding bulls for the past four weeks. Yet such a preponderance of bearishness has not resulted in any meaningful market rally or constructive action in leading stocks over the past four weeks. In fact, as we see in the chart of the NYSE Composite Index, that particular index has been in a downtrend throughout September. This is probably no surprise to those who have been attuned to the deteriorating breadth as the market tried to move higher mid-way through September.

NYSE Composite Index Gilmo Report Chart

In my Wednesday report I pointed out why I am watching Apple, Inc. (AAPL) closely as a bellwether for this market and why I think it is likely to fail on its recent breakout, similar to what it did in late 2007/early 2008 as the general market embarked on a second leg down that coincided with AAPL’s top back then. On Thursday, with NASDAQ 100 stocks getting pummeled in stark divergence to the Dow 30 and S&P 500 stocks, AAPL’s inability to hold the critical 400 price level became a shortable event, as I saw it, based on Livermore’s “Century Mark” Rule. Remember that in 1907 Livermore used his rule to short Anaconda Copper after its failure at the $300 price level after originally buying the stock on the basis of his rule. But when it could not hold that level, he considered the movement “false” and thus used that as evidence to short the stock instead. The same held true for AAPL in late 2007 at the $200 level, and it is possible that the $400 level in 2011 is working the same way, as we see on AAPL’s daily chart, below. Friday saw the stock drift below the 50-day moving average on light volume. Recall that I noted in my Wednesday report that despite volume drying up earlier in the week, it dried up in response to intra-day attempts by AAPL to move higher. In each case, buying interest was unsustainable as the stock slumped back into the red.

Apple, Inc. (AAPL) Gilmo Report Chart

Any members looking for an expanation of Livermore’s “Century Mark” rule on both the long and short side should refer to pages 6-7 of my October 17, 2010 report, available in the Past Reports section of the website. For now, in my view, AAPL’s action at the 400 level is something to watch closely here, as it may not bode well for the stock or the market. We are also seeing some of the other recent “breakout” leaders like AAPL start to wobble and fail. Chipotle Mexican Grill, Inc. (CMG), shown below on a daily chart, is one of these, and it has in fact failed from its recent breakout from a wide, loose, and choppy double-bottom/cup-with-hande base “thingie.” Thursday saw the stock get hit on heavy selling volume as it drifted below its 50-day moving average, and on Friday the stock simply fell away from the 50-day line on the downside as nobody seemed interested in dressing up their windows with shares of CMG. CMG’s current base looks to be setting up as a late-stage, failed-base, short-sale set-up, which is how I am treating it currently. As we know, however, these set-ups can take some time to develop, but for now I’m looking for the stock to test the 200-day moving average, using the 50-day line as a quick upside stop.

Chipotle Mexican Grill, Inc. (CMG) Gilmo Report Chart

In my Wednesday report of this past week I wrote a quick note on (PCLN) describing the stock as “potentially shortable here using the 50-day moving average at 514.17 or the 20-day at 525.20 as potential guides for upside stops.” If you came after PCLN on Thursday you were rewarded very quickly as the stock plummeted down to 449.46 by Friday’s close. At this point I would be looking for PCLN to undercut its mid-August low just above the $400 price level and at that point it might stage an “undercut & rally,” so I would set that low of 441.55 as my downside price objective on any PCLN short. PCLN has been one of the few big-stock NASDAQ leaders that has held up, as it recovered almost instantly from its big breakdown through the 200-day line in August before trying to break out last week. PCLN, in my view, is now a full-blown late-stage failed-base short-sale set-up, and it adds another nail in the market’s coffin as former leaders become nothing more than so many hapless victims of the market’s brutal selling treatment. (PCLN) Gilmo Report Chart

Netflix, Inc. (NFLX) “broke out” to the downside from the short, very tight bear flag or “ledge” it was forming as of Wednesday of this past week. As I discussed in my report of that day, the stock appeared on the verge of an imminent downside breakout based on this negative technical formation. As we see on the daily chart, below, NFLX did exactly that. And by closing at 113.27 on Friday, 62% off of its peak of only three months ago, it has fallen below the downside price target of $115 that I’ve seen some analysts put on the stock now that the fundamental picture for the company has changed. Of course, NFLX had already topped and was in the midst of forming a head and shoulders formation when the news of a subscriber revolt against the NFLX service price increase hit. In this case, the technicals were telling you the story long before the fundamentals were, and NFLX is another example of why we buy on the basis of technicals and fundamentals, but we sell or short on the basis of technicals ONLY. If I were still short NFLX I would probably book my profit here and let the stock settle out for a while as it is coming down on top of a prior base formation from last summer.

Netflix, Inc. (NFLX) Gilmo Report Chart

From BIDU to SINA to FOSL, OPEN, and others, former leading stocks have broken down quite severely at this stage, and so this brings up the question of whether there is anything “fresher” to look at on the short side. In a bear market, usually the stocks continuing to hold up as the sell-off progresses merely become the next ones ready to fall, although this is not always the case since if they hold up extrmely well in a bear market they may be the upside leaders when the next bull starts. Thus as I run through my screens this weekend I’m looking for weekly patterns that may be preparing to break down if the market continues to move through the August lows in what may develop as the second leg down in an overall bear market. Breakdowns from head and shoulders formations often coincide with a synchronous movement in the general market, and in this light I am watching Biogen Idec, Inc. (BIIB), which has formed a clear head and shoulders type of formation on its weekly chart, shown below. Note that this past week saw the stock stall and close below its 10-week (50-day) moving average on heavier selling volume. This could be tested on the short side here using the 50-day line at 94.69 as your guide for an upside stop.

Biogen Idec, Inc. (BIIB) Gilmo Report Chart

Another former leader setting up in a possible head and shoulders formation is Tibco Software, Inc. (TIBX), shown below on a weekly chart. TIBX reminds me, as a small technology stock, of other head and shoulders tops we’ve seen in former small technology leaders like Aruba Networks (ARUN) and Finisar (FNSR) that I have discussed in previous reports (see June 29th report for ARUN and May 15th for FNSR) and which have also broken down from textbook head and shoulders top formations. TIBX stalled out this week at the 10-week (50-day) moving average and what could be the peak of a possible right shoulder in an overall head and shoulders topping formation. TIBX’s formation has the optimal “lean to the right” look that implies a stock that is beginning to “tilt” to the downside. It’s hard to draw a neckline on this pattern, but I suppose if I did it would show up somewhere around the 18 price level on this chart, so that would be my downside target for TIBX, using the 23.95 high of this past week as my ultimate upside stop guide.

Tibco Software, Inc. (TIBX) Gilmo Report Chart

Some notes from my trading diary regarding other short-sale targets I’ve discussed in previous reports.

BIDU – the initial profit target at 114.14 was hit on Thursday, and BIDU closed at 106.91 on Friday, well below that profit target. At this stage, a bounce in BIDU could be expected. But if one is still short the stock, then one could use the 114.14 profit objective as an upside stop if one wants to try and play the stock out for a larger gain. This would be while maintaining a stop that locks in profits based on the original downside price target and profit objective when the trade was first made near the 200-day moving average.

SINA – the initial profit target at 76.48 was hit on Thursday, and SINA closed the week at 71.61. If one is still short the stock from the 200-day moving average or the 90 price level one could handle this similarly to BIDU, using the 76.48 as a trailing stop if one wants to try and play the stock out for a further gain. This will all depend on whether the general market continues lower next week, so watch for the Chinese internets to move lower with the general market should that occur.

FOSL – as I discussed in my Wednesday report of this past week, the stock was quite shortable just above the 200-day moving average and below the 50-day moving average. On Thursday and Friday, FOSL blew wide open, and we are now looking at the 72.26 low from mid-August as our initial downside profit target.

TIF – another retailer I discussed as shortable in my Wednesday report, TIF has blown apart in similar fashion to FOSL, If you were able to get short the stock near the 50-day moving average on Thursday, you are sitting pretty and should use the 66 level, more or less, as a trailing stop and the 57.21 low of mid-August as your price target and profit objective.

RAX – bouncing along recent lows in the 33 price area, remains potentially shortable on rallies up into the 20-day moving average at 35.72, using the 50-day moving average as a secondary short-sale point on further rallies, using the 50-day line as a guide for your upside stop.

OPEN – stock is rolling off the 10-day moving average on the downside, continue to use the 10-day line as a trailing upside stop if you are still short this, as it has already hit our downside profit target at around 44-45 last week.

SODA – stock has moved sharply lower over the past three days and on Friday undercut the 32.50 low on the left side of what is now a right shoulder within an overall head and shoulders top formation. Looks like it could stage a small bounce from here but I would expect any such bounce to be contained to the 36-37 price level. Downside target for now remains the 27 low from early January of this year.

ACOM – looking like it’s ready to test the 20.67 low of last week. Stock has come down over the past four days on declining volume after running into resistance at around the 26-27 price level. I would look for this to remain under the 10-day moving average at 25.46 on any possible upside bounce from here.

Even if the market were able to find its feet and stabilize in a meaningful way somewhere along these lows, it would likely take some time for the conditions necessary for a new bull market to take hold. The damage in leading stocks is widespread and severe, and the only dynamic among leading stocks has been the steady “knocking off” of those that have been holding up until recently. Thus the only way to play this market is on the short side, and for those of you holding any inverse index ETFs there is no reason to change your posture towards the market. For now the trend is down, and we continue to look for the market to move to new lows in a potential new downleg within an overall deeper correction/bear market environment.

The most objective way to test whether my view that this market is a short-seller’s market is to simply measure the objective results. If the market is rewarding the short side of this market then this will show up as a “material result,” as Bill O’Neil used to say. Doing a quick “back-of-the-napkin” figuring of my own gains over the past eight trading days since the NASDAQ broke down from its peak on this rally off the August lows, I come up with a rough 38.6% upside gain in eight days playing the short side. That’s all I need to know to confirm that my present assessment of the market has me on the right track, and until further notice the short side of this market remains in force.

On an administrative note, I will be appearing on Fox Business News’ Stuart Varney & Company show Monday morning around the opening bell, so be sure to catch that if you can. My last appearance on Thursday of this past week they asked me about copper, which I don’t really pay attention to other than as a key industrial commodity that can presage economic strength or weakness. I’m not sure why Fox continues to think of me as some sort of “metals guy,” but I hope to use Monday’s appearance to get back to being what I really am, which is a “stock guy.”

Dr. Chris Kacher and I have just signed the contract for our next book, which is scheduled to be completed by the end of March 2012. The book will be a follow-up to our first book, “Trade Like an O’Neil Disciple,” which was published in August of 2010 and has been a “stand-out success,” according to our publisher, John Wiley & Sons. The book will function as a workbook and study guide that will give readers more of a “hands-on” feel for the techniques and topics covered in the original work.

Last but not least, Dr. K and I are scheduled to give two workshops at the November Traders Expo in Las Vegas to be held November 16-19. We will give a free one-hour workshop on Thursday, November 17th on the topic of “Market Context,” and then on Friday the 18th we are doing a paid 4-hour intensive workshop covering all of our buying, selling, shorting, portfolio management, and market modeling techniques. If nothing else, it provides a good excuse to “cut loose” in Las Vegas for a few days, and we hope to see a number of you there.

Finally, my month-end video review of stocks discussed in The Gilmo Report during the month of September is available at:

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, and/or Gil Morales & Company, LLC held a position in AAPL, CMG, and TZA, 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, 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.