The Gilmo Report

October 26, 2011

October 26, 2011

The market has the distinct whiff of QE in the air, and the persistence of the indexes on the upside is evident even on days where they look weak. Today, for example, all of the major market indexes gapped up on the open, as illustrated by the daily chart of the NASDAQ Composite Index, shown below, and then reversed hard to the downside before finding support and closing back up at their highs for the day. This gives the NASDAQ’s daily trading range, for example, the look of having a “long tail” on heavier volume, which can be construed as supporting action. Of course, underneath the surface there is a lot more going on than meets the eye if one is only paying attention to the indexes. In many ways the market remains somewhat bifurcated as some stocks try to exert leadership while former leaders get pummeled on the downside. My view is to continue treating the market as a market of stocks, assessing opportunities on both the long and short side on a stock-by-stock basis. All we know for now is that the market continues to re-assert its uptrend, and leadership may still take time to develop.

NASDAQ Composite Index Gilmo Report Chart

One sign that QE may be coming back into play in this market is the action in the precious metals, silver and gold, both of which have been trying to hammer out bottoms in their patterns after sharp pullbacks in September. The SPDR Gold Shares (GLD), shown below on a daily chart, in fact flashed a bottom-fishing type of pocket pivot as it came up off of its 10-day moving average and up through its 65-day exponential moving average. This looks like a valid buy point to begin trying to build positions in gold and/or silver again via the GLD and SLV ETFs, using the 65-day exponential line on the GLD at 163.97 as your downside selling guide. The one caveat is that this pocket pivot from yesterday is occurring underneath the 50-day and 200-day moving averages, but it is playable in terms of beginning to edge back into the precious metals. The Eurocrats may be delaying their announcement of a “final solution” to their sovereign debt crisis, but the metals may be telling us that in the end it will only amount to so much fiat money-printing. Take your cue from gold and silver, as I see it, as they may do well even if stocks decide they don’t like QE given the general record of QE in failing to produce real economic growth.

SPDR Gold Shares (GLD) Gilmo Report Chart

On the other hand, I have to admit that playing the short side of this market so far this week has been far more profitable than trying to nurse long positions, mostly thanks to my #1 short-sale target, Green Mountain Coffee Roasters (GMCR), shown below on a daily chart. GMCR is turning out to be a textbook short-sale model stock, and along with Netflix, Inc. (NFLX), offers a classic example of the type of optimal short-sale set-ups we look to capitalize on within our specific shorting methodology. GMCR undercut the 63.05 low of its little consolidation during the month of April, earlier this year, which looks to me like a good spot for the stock to try and bounce. Ultimately I think GMCR can get down to $40, but this is getting pretty obvious as a short here, so I would consider taking profits here and waiting to short into a weak rally, should that occur. Over the weekend I noted that GMCR was shortable on rallies up into the 200-day moving average at around 74-75, using that as a guide for an upside stop, and the stock gave us another 20% worth of downside in just three days, even as the market held up.

Green Mountain Coffee Roasters (GMCR) Gilmo Report Chart

Netflix, Inc. (NFLX) got plastered after disappointing on earnings Monday after the close, and big-stock NASDAQ leader Amazon.com (AMZN) then got “Netflixed” itself after it announced earnings yesterday and gapped down towards the $200 price level, closing just above its 40-week/200-day moving average. As I wrote a couple of weeks ago in reference to AMZN, I would not be buying the stock on its extreme V-shaped rally to new highs. What I should have pointed out at the time was that the stock was, in fact, forming a classic example of the old “two-down-and-two-up” type of topping signal on the weekly chart, which I show below. This is one rule that most misinterpret, but generally when a stock has had a big upside price run and then flashes this type of up-and-down action to new highs on the weekly chart, it is a reliable sell signal if you are long the stock. At this point, AMZN may be developing into a bona fide late-stage failed-base and I will be watching it closely as it potentially bounces off the 200-day/40-week moving average after this huge-volume breakdown off the peak.

Amazon.com (AMZN) Gilmo Report Chart

Apple, Inc. (AAPL) continues to cling to the $400 price level, as we see on the daily chart below, and it likewise remains above the 50-day moving average. But AAPL will not likely break as long as the general market continues moving higher, even though the stock may underperform the market during any such continued rally. My tendency is to consider that AAPL remains a “market stock” and so any shorting thesis on AAPL has to take into account the general market trend. If it isn’t down, then AAPL won’t provide any profitable shorting opportunities, in my view. For now I do think the stock is worth keeping an eye on as a market bellwether, if for no other reason. A high-volume breach of the 50-day line, however, might be cause to go after AAPL on the short side, and I would expect that such a breach would coincide with a general market breakdown from this current rally.

Apple, Inc. (AAPL) Gilmo Report Chart

This week has seen my short-sale targets FOSL and PCLN get stopped out, and I would avoid doing anything with either as both stocks will be announcing earnings soon. This also goes for Baidu, Inc. (BIDU), which announces earnings tomorrow, Thursday, after the close. BIDU continues to find resistance at its 50-day moving average, as we see on the daily chart below, and this looks to be occuring at the peak of a possible right shoulder within an overall head and shoulders top. This is not 100% clear at the moment, however, and the situation may not provide any more clarity until BIDU announces earnings. I would keep an eye on this, however, as a bad earnings reaction could be the catalyst that sends the stock “over the falls” to the downside to complete the right shoulder. I would expect any such breakdown on earnings in the stock to carry down to the neckline and the $100 price area around the prior, late September/early October lows.

Baidu, Inc. (BIDU) Gilmo Report Chart

Sina Corp. (SINA), which I have also been following as a short-sale target, acts much weaker than BIDU, which is evident on its daily chart below. Note how the stock got hit with heavy volume selling today as it ran into resistance at its 50-day moving average, while BIDU closed near the peak of its range after selling off earlier in the day. SINA has the look of stalling at the 50-day line while BIDU has the look of trying to push up through the 50-day moving average. If you are still short either of these at or around the 50-day moving average, consider backing away into BIDU earnings and waiting to see how things develop in both of these stocks. Remember, any catalyst that sends these stocks to the downside, such as a poor BIDU earnings announcement, may simply set off a sustained downside move. This would be similar to how the negative comments by one hedge fund manager sent GMCR on a huge price break from the mid-90’s into the high-50’s in two weeks’ time. A profitable trend does not begin and end in one day!

Sina Corp. (SINA) Gilmo Report Chart

I still tend to think that playing the long side of this market is as simple as picking a strong, “big stock” that is exhibiting leadership characteristics currently and which has already announced earnings, such as CMG and ISRG, as I discussed over the weekend. Today I noted strength in Questcor Pharmaceuticals (QCOR), when it announced earnings today, but it is extended on a buyable gap-up (not shown on a chart here). Biogen Idec (BIIB), however, also staged a buyable gap-up move today as it leapt out of a 17-week base on news that its experimental pill for multiple sclerosis, potentially a blockbuster drug, was showing very positive test results. BIIB announces earnings on Friday morning, and it is interesting to see the stock gap up so strongly two days before. If one takes a properly scaled position, this is probably buyable here using the 114.28 intra-day low of today as your downside selling guide per the standard rules for buying gap-up moves like this. Earnings growth for BIIB is expected to come in at 13%, so I don’t think the upcoming earnings announcement will be that important for the stock’s price/volume action.

Biogen Idec (BIIB) Gilmo Report Chart

As I see it, if I’m going to play this market either way, long or short, I want to see a nice “fat” pitch coming down the middle of the plate to swing at. GMCR was a nice fat pitch to swing at on the short side, but the truth is that with my other short-sale target stocks the action has been choppy and uneven, resulting mostly in short-selling day trade expeditions that have been profitable but not in a big way. Meanwhile, the long side has been spotty as previously strong-acting, big-stock leaders like AAPL and AMZN have gotten hit on earnings. Thus the long side presents something of a mine field during “earnings roulette” season. With GMCR played out to the downside for now, in my view, and the market still in flux with respect to any potential leadership, I am in a wait-and-see position here before I go much beyond the simple strategy I outlined in my report of this past weekend, October 23rd. This called for looking to buy big-stock leaders like CMG and ISRG if I want to play the long side while staying alert to potentially developing leadership in other names as they pop up through my screens, such as BIIB, for example. As well, the SLV and GLD offer some initial buy signals that can be acted on, in my view, in measured fashion, as one seeks to properly build positions. Stay tuned.

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 GLD, though positions are subject to change at any time and without notice.

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