The Gilmo Report

October 7, 2018

October 6, 2018

The weakness in bonds earlier this past week combined with numerous divergences as discussed in Wednesday’s report came to fruition on Thursday as the indexes broke hard to the downside. The instigator was alleged to be spiking interest rates. The 10-Year Treasury Yield ($TNX) moved to its highest levels since the financial crisis of ten years ago, pegging at 3.225% on Friday.

 

GR100718-$TNX

 

The spike in rates across the board spooked the indexes, and the NASDAQ Composite Index broke sharply to the downside on Thursday. A -1.81% decline on higher volume was followed by a similar decline on Friday, but volume declined. At the same time, the index undercut the August 15th low and rallied back above it, triggering a short-term undercut & rally move.

At that point on Friday, the selling in leading stocks, which in many cases began earlier in the week, had reached a crescendo. The oversold condition in many leading stocks, combined with the undercut of the August 15th low, sparked a rally off the intraday lows. The index remains, however, in a compromised position, and remains below near-term resistance at its 50-dma.

 

GR100718-$COMPQ

 

The S&P 500 Index also ended the week with two sharp down days, but by the close on Friday held near-term support at its 50-dma. Volume was slightly lighter, although the chart below shows slightly higher volume. I wrote on Wednesday that consistent stalling and churning along the highs was likely a sign of systematic distribution. And, as I wrote, “If this is the case, then we can look for confirmation in the coming days.”

Thursday and Friday provided that confirmation. The indexes are now on opposite sides of the fence, meaning the 50-dma, with the NASDAQ below its own 50-dma while the S&P holds above its 50-dma. If the NASDAQ is soon joined by the S&P breaking below its own 50-dma, then we might start to see a full-blown correction develop. For now, however, the indexes are in a position for a reaction rally and bounce, so we’ll see whether that materializes in the coming week.

 

GR100718-$SPX

 

The Russell 2000 Index continued moving lower throughout the week as it diverged from the major indexes. On Friday, it finally ran into its 200-dma as it undercut the prior lows of late June and early July. That set up a logical intraday bounce and the Russell managed to close off the lows of the day and back above the prior summer lows.

The position of the Russell 2000 adds some weight to the argument for a reaction bounce and rally in the general market when trade resumes on Monday. This is, however, by no means guaranteed.

 

GR100718-$RUT

 

In any case, my skepticism toward this current market, even as the Dow and the S&P 500 were forging all-time highs has been validated to some extent. A market full of extended leaders and later-stage base breakouts with very little, if anything, in the way of fresh, first-stage situations were the primary drivers of my skepticism, which has been percolating for more than a week or so. More recently, the piling up of divergences early this past week added to that skepticism, and the action turned starkly negative on Thursday and Friday.

In the process, leading stocks that were pulling back began to trigger as short-sale targets. I wrote on Wednesday, that I would keep an eye on Netflix (NFLX) in the event of a negative market context developing. I noted that a breach of the 10-dma and/or 20-dema would trigger a short-sale entry, and we can now see how context of a general market sell-off on Thursday and Friday set this off.

NFLX busted the 10-dma and 20-dema on Thursday as selling volume increased. On Friday, it moved lower still, closing below its 50-dma on much higher and heavy selling volume. As it did so, it also undercut a mid-September low in the pattern and rallied slightly above it by the close on Friday. With the index below its 50-dma, I’m not so convinced that this is a buyable U&R type of move that will result in significant upside.

In fact, from here, any small rally up to the 50-dma would put it in another short-sale position, but with the idea of using the 50-dma as a guide for a tight upside stop. Any rally that clears the 50-dma would then bring the 20-dema into play as a possible secondary short-sale entry point. Obviously, in this position, things get tricky, and the proper short-sale entry occurred at the 10-dma on Thursday.

Note that the move to higher highs as the stock poked through the $380 price level and the top of the September price range was a shortable move, not a buyable one. The trigger was the break below the 10-dma, as I discussed in my last report, and the stock is now in a position where it may back and fill slightly or simply break further to the downside. We’ll see how NFLX develops from here in the coming days, but the first short-sale trigger occurred Thursday morning, end of story.

 

GR100718-NFLX

 

Apple (AAPL) failed to hold Wednesday’s low-volume breakout to all-time highs and has sold off with the general market over the past two trading days. Selling volume picked up on both Thursday and Friday, but AAPL was able to close above its 20-dema on Friday. That said, the pattern doesn’t strike me as buyable based on the increased selling volume.

 

GR100718-AAPL

 

After reversing near its prior highs on Monday, Amazon.com (AMZN) spent the rest of this past week sliding lower. This culminated in a high-volume violation of the 50-dma on Friday. The technical violation results from the fact that on Thursday the stock first closed below the 50-dma, and then on Friday closed below the intraday lows of Thursday.

That is a technical violation of the 50-dma, but also note that in the process AMZN undercut the 1865.00 low of two Mondays ago. That was when the stock pulled a U&R long set-up at the 50-dma, and then rallied back up to its prior highs. The net effect is that the stock has simply chopped around for the past month or so as it begins to look quite weak, with a lot of high-volume down days in the pattern.

In this position, weak rallies into the 50-dma would serve as short-sale entry points, using the 50-dma as a guide for a tight upside stop. The flip side is that you have a U&R set-up based on Friday’s action, but with the stock underneath the 50-dma I’d need to see it confirm by clearing the line convincingly. Play it as it lies.

 

GR100718-AMZN

 

Nvidia (NVDA) would have been buyable on a constructive pullback to the confluence of the 10-dma and 20-dema, as I wrote on Wednesday, but Friday’s action was anything but constructive. Instead, the stock triggered as a short-sale at the moving average confluence early in the day and kept moving lower until it finally found support near the 50-dma.

This takes you almost all the way back to the prior U&R long set-up of the prior week. It illustrates quite well why buying the U&R was in fact the true buy point, while the breakout to new highs two Fridays ago was a bull trap. In this position, I’d watch for a feeble rally back up to the 10-dma/20-dema confluence as a possible short-sale entry point, using the two moving averages as your guide for a tight upside stop.

 

GR100718-NVDA

 

Another episode of the well-known stock market soap opera, As the Tesla Turns, played out on Thursday after the close. Even after coming to a settlement with the SEC, Tesla (TSLA) CEO Elon Musk couldn’t resist the urge to mock the SEC by tweeting a reference to that august regulatory body as the “Short-seller Enrichment Commission.” Investors didn’t seem very happy with that, sending the stock lower on a test of its prior September lows.

TSLA was last a short at the 200-dma as I tweeted on Tuesday, and it now looks like it may simply break below the prior September lows. Despite the company meeting its Model 3 production guidance when it reported on Tuesday morning, investors dumped shares for the rest of the week. The stock is now testing the 260.55 low of the prior week on September 28th and may yet test the September 7th low at 252.56.

Obviously, the proper short-sale entry occurred at the 200-dma on Tuesday, and the stock is now extended on the downside. As it approaches its September lows, we will see whether it can muster any kind of undercut & rally move, but any of these might just result in pauses in what may develop into a more pronounced downtrend from here. Things are looking bleak for TSLA.

 

GR100718-TSLA

 

I didn’t give Facebook (FB) much of a chance of succeeding on Wednesday’s U&R long set-up attempt, and my lack of faith was confirmed. As I wrote on Wednesday, “Volume was weak today, and if FB can’t clear the 10-dma in confirmation of yesterday’s U&R move, then it may be short-lived.” And short-lived it was.

Resistance at the 10-dma remained in force, and FB gapped lower on Thursday. It then broke to lower lows on Friday. Volume was light, indicating that investors are shunning the stock. From here, I would not be surprised to see the stock test the 149.02 low of late March.

 

GR100718-FB

 

It’s clear the big-stock FANG names are not providing this market with the new leadership we might have expected to see as the Dow and S&P 500 broke out to new highs earlier in the week. In fact, it’s clear that not much is looking all that healthy, as leading stocks across the board come under selling pressure.

Financials, which were seen as a potential new area of leadership two weeks ago, also haven’t panned out. Higher interest rates are automatically viewed as positive for banks and other financials, but in this case higher rates don’t seem to be sparking sharp upside price moves in these names. That may be because higher interest rates will slow what in my view is still a fragile economy dependent on an ocean of free money.

The economy has also gotten a boost from the sugar high of continued, massive government spending. In the latest government fiscal year, which ended September 30th, the Trump Administration and Congress ran the national debt up another $1.2 trillion. It now stands at $21.516 trillion. Higher interest rates may now begin to tip the economic scales in the other direction, however, and that may be what ails the financials.

After a failed breakout attempt two weeks ago (yet another argument for treating base breakouts with a high degree of skepticism), J.P. Morgan (JPM) broke to the downside for six-straight days before undercutting its prior base lows. That also brought it near its 200-dma, triggering a short rally up into the 50-dma, which stalled and churned on Thursday amid heavy volume. By Friday, a third day of churning along the 50-dma appeared, and the stock looks primed for another test of the 200-dma.

The area between the 200-dma and the 50-dma is only a little over 2% wide, so we’re not talking about big short-sale profits if one hit the stock short on the failed breakout. I’ve found better short-sale opportunities in the prior high-flyers, but I view the financials as a barometer for the impact of higher interest rates.

If higher interest rates truly indicate a strong economy, then financials should benefit. If higher interest rates are potentially the catalyst for an economic slowdown as the Fed fails yet again to engineer a so-called soft landing, then financials will falter. That is, so to speak, the long and the short of it. So, if you think you can scalp a couple of bucks shorting JPM here along the 50-dma, then it is certainly actionable using the 50-dma as a tight stop.

 

GR100718-JPM

 

Square (SQ) has been unsuccessful in three prior attempts to clear and close above the $100 Century Mark.

 

GR100718-SQ

 

I prefer going after some of these high-flyers that are starting to fail in earnest. In my Wednesday report I wrote that I wouldn’t be surprised to see Etsy (ETSY) bust its 50-dma. That’s what happened on Thursday as the stock briefly rallied into the 10-dma before reversing and busting the 50-dma on higher selling volume.

A brief rally back up into the 50-dma on Friday morning also reversed, sending the stock to lower lows and a technical violation of its 50-dma. In this position, ETSY is now a late-stage, failed-base (LSFB), short-sale set-up. Weak rallies back up into the 50-dma can be viewed as short-sale entry opportunities, using the line as a guide for an upside stop.

 

GR100718-ETSY

 

Proof that I was not foolish enough to get sucked into the massive rally and bull trap that materialized on Monday after the U.S. and Canada allegedly settled their trade differences was found in the fact that I posted two short-sale ideas on the live blog on Monday morning. It is also interesting to see that the short side was in fact developing on that day and began to gather momentum even as the Dow was posting all-time highs on Wednesday.

PayPal (PYPL) was one of these short-sale ideas I posted on the blog, just as it was starting to breach the 50-dma. A brief rally on Wednesday amid all the Dow’s new-high hoopla was short-lived and the stock then plummeted to its 200-dma on Thursday and Friday. The 200-dma was my initial downside target for the stock, and it reached it on an intraday basis on Friday.

From here, one can either cover and bank their profit, looking to re-enter on a feeble rally, or one can use the prior 84.22 low in the pattern as a trailing stop. Note also that the 10-dma and 20-dema are starting to break sharply to the downside, so they may also move lower in the coming days to provide references for additional, shortable rallies. For now, this one has achieved my near-term objectives, and we will see how and whether it rallies to potentially set up another short-sale entry opportunity.

 

GR100718-PYPL

 

I also blogged about ZScaler (ZS) as a short-sale set-up at the 50-dma on Monday. It has since broken down as it undercuts the prior 37.08 low in the pattern. From here, I would look for any rally back up close to the 50-dma, or the 10-dma/20-dema moving average confluence now that both are below the 50-dma, as short-sale entry opportunities. From the 50-dma, ZS had about a 15% downside move, which is more than reasonable before a reaction rally might take hold.

 

GR100718-ZS

 

I also haven’t been shy about viewing Square (SQ) as a short at the $100 Century Mark given its inability to convincingly clear 100. Thus, as I wrote on Wednesday and last weekend, it becomes a short-sale entry at the Century Mark until proven otherwise. So far, that has worked as a short at the 100 level, but the move has only carried down as far as the 20-dema.

The 20-dema now becomes a critical level of support for the stock, such that a breach of the line would trigger SQ as a short-sale at that point, looking for a test of the 50-dma. Note that SQ is also sitting right on top of the prior flag pattern it formed in September. The flip side of this is that it could technically be viewed as a lower-risk long entry right here, looking for another test of the $100 Century Mark while using the 20-dema as a tight selling guide.

This is obviously a fluid situation, but the SQ story has become about as rosy as it can with the recent news of the company adding a payroll app to their product line. But with its cousin, PYPL, wavering as a nice short-sale play this past week, it may be throwing up a cautionary flare for SQ as well. It will be interesting to see how it plays out from here, whether as a long or a continued short.

 

GR100718-SQ

 

Okta (OKTA) was discussed as a short in my last report as it sat along the 20-dema. As I wrote on Wednesday, “Thus, OKTA would become a short here using the 20-dema as a guide for a tight upside stop.” I was looking for a test of the 50-dma, but so far, the stock has only approached the line as it simultaneously undercuts the prior 65.20 low in the pattern.

OKTA failed to pull a complete U&R move on Friday by clearing that 65.20 low, closing just below at 65.11. From here, I’d look for a weak rally back up into the 20-dema at 67.75 as a potentially lower-risk short-sale entry. Note also that a U&R move through the 65.20 low would set up a quick swing-trade on the long side with the idea of playing it up to the 20-dema, and then possibly flipping short at that point.

 

GR100718-OKTA

 

Roku (ROKU) breached the 20-dema on Thursday, which I indicated in my Wednesday report as being my tightest selling guide for the stock. It is now trying to find support near its 50-dma. In my view, you could see this coming as the stock became ever more extended on the upside. After all, I first discussed this as a buyable situation down around 35 back in April, and the stock more than doubled since then, peaking at 77.57 on Monday.

It then spent the rest of the week breaking over 15% to the downside, such that it made a very nice “LSA” type of short-sale target. The acronym LSA stands for Late-Stage Assumption and is a new short-sale set-up that I make use of whenever the market appears to be getting into trouble. I run a screen that looks for these names, with the primary parameters being a move of 75% or more in the past six to twelve months, a massive P/E expansion (even better if the P/E is infinite), and a breach of the 10-dma and 20-dema from an extended upside position following a near-term high.

I have found this sort of set-up gives short-sellers the best downside velocity, hence time-value, for short trades in a market where the short side has been primarily tactical. When I say tactical I mean short-term, and often the moves are profitable only until they undercut a prior low in the pattern or meet up with the 50-dma.

In this case, we see ROKU approaching the 50-dma after busting the 10-dma on Tuesday. Note also that the breach of the 10-dma occurs as the stock fails on a breakout from a short ascending type of flag formation. This is a trickier type of short-sale set-up to play and depends heavily on contextual factors such as the state of the general market.

From here, it’s possible that weak rallies up into the 20-dema could provide lower-risk short-sale entries, but the bottom line is that the break from the 10-dma down to Friday’s intraday lows produced a very nice short-term, short-sale profit. I would note that similar breakdowns this past week occurred in names like TWLO, TTD, and FTNT, to name a few examples.

 

GR100718-ROKU

 

If one finds the LSA short-sale set-up a bit too scary, then there’s always the traditional late-stage failed-base (LSFB) short-sale set-up that has been well-catalogued and discussed in my two prior books on short-selling. A week ago, I noted three breakouts in three stocks all occurring around the same time. Those were: Acacia Communications (ACIA), Canada Goose Holdings (GOOS), and Planet Fitness (PLNT).

ACIA broke out last week on strong volume. But that breakout went absolutely nowhere as the stock then drifted lower over the next three days. On Friday, it failed outright when it busted the 20-dema on increased selling volume before meeting up with the 50-dma and holding support.

From here, rallies into the 20-dema at 40.20 would provide lower-risk short-sale entries, but the major caveat here is that the stock only trades 666,249 shares a day on average, which is well below my minimum liquidity requirement of one million shares a day for short-sale targets. However, a smaller account taking smaller position sizes could traffic in this one. In any case, chalk up as another failed breakout in this market of failed breakouts.

 

GR100718-ACIA

 

Canada Goose Holdings (GOOS) began to fail on a recent trendline base breakout as early as Tuesday once it had breached its 20-dema. That is always the first sign of an impending late-stage breakout failure, and in this case the stock just kept going lower until it finally busted the 50-dma on Thursday. On Friday, a rally up into the 50-dma went no further as volume declined.

Technically, this is in a short-sale position here using the 50-dma or Friday’s intraday high as a guide for an upside stop. Even better would be any kind of reaction rally that carries as high as the 20-dema, now at 58.91. Remember that how any of these potential LSFB short-sale set-ups play out from here will depend on how far the general market is able to rally from Friday’s lows. If it’s not much, then the 50-dma may be the end of the line for GOOS, while if it’s more, then the 20-dema may come into play as more reliable resistance.

 

GR100718-GOOS

 

Planet Fitness (PLNT) is the third of the now-failed breakouts I discussed a week ago. Note that it briefly rallied into the 20-dema on Friday before breaking to the downside and breaching the 50-dma. From here, rallies into the 50-dma at 50.52 would present lower-risk, short-sale entries. Keep in mind, however, that the stock could make one more push to the 20-dema, which in my view would present an even more optimal short-sale entry point.

It may be telling that three breakouts I discussed in my report of exactly one week ago have all now failed miserably. In the case of ACIA, it’s merely trying to rally up from its lows (recall that it was a “high, tight, flag” a little over a year ago right at the top around 120), while GOOS and PLNT are more typical of late-stage breakdowns at the tail-end of long upside price moves.

 

GR100718-PLNT

 

My notes on other stocks discussed in recent reports below – note that many are now busted patterns:

Bilibili (BILI) failed to hold Wednesday’s gap-up move on news that Tencent Holdings (TECHY) is taking a 25 million share stake in the company. It is now back down to its 10-dma and 20-dema moving average confluence as volume recedes. But I’m in no mood to try and buy shares here given the action in other Chinese names.

CyberArk Software (CYBR) – trading below its 20-dema.

Fortinet (FTNT) trading below its 20-dema. Rallies back up into the 20-dema at 88.06 might present lower-risk, short-sale entry opportunities from here.

Intuitive Surgical (ISRG) decisively busted its 20-dema on Thursday before finding support at its 50-dma.

Momo (MOMO) was slammed hard on Tuesday as it busted its 50-dma before finally finding support way down at the 200-dma.

Palo Alto Networks (PANW) was last shortable along the 20-dema per my reports over the past week or so. On Thursday it busted its 50-dma and then posted a technical violation of the 50-dma on Friday.

Perspecta (PRSP) is holding near-term support at its 20-dema, but I would not be looking to buy shares up here. Instead, I would use the 20-dema as a selling guide, as the stock is likely to move lower if the general market continues to get into trouble.

Sailpoint Technologies (SAIL) broke hard to the downside on Thursday and ran into its 50-dma on increased selling volume. It has closed below its 20-dema for two days in a row. I don’t care for the action here and would look for a more opportunistic pullback to the 50-dma down at 30.06 as the lowest of the lower-risk entry points.

Twilio (TWLO) has breached the 50-dma and is extended on the downside. From here, I’d look for any opportunistic entries on the short side that might show up on a rally back up through the 50-dma and into the 20-dema, now 82.01. Note that TWLO was an LSA-type of short-sale on Monday and Tuesday as it breached the 10-dma and 20-dema.

Zebra Technologies (ZBRA) busted support at its 20-dema on Tuesday, and then broke below its 50-dma on Friday. This pattern is now busted.

For newer members: Please note that when I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple (the magenta line), 20-day exponential (the green line), 50-day simple (the blue line) and 200-day simple moving average (the red line). On rare occasions, I will also employ a 65-day exponential moving average (thin black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

The faint odor in this market that I referred to at the close of my last report has now ripened into a full-fledged stench. I also closed my report by advising members to “review their selling guides and strategies for existing positions, and to be ready to act in case the strange action we’ve seen over the past few days reveals something ominous.” Most of the names on my watch list of favored long ideas have now breached near-term support, so in many cases selling guides were triggered this past week.

The sharp downside breaks we’ve seen in a broad swath of stocks over the past several trading days has proven that my caution and skepticism toward this market as early as the prior week was well-placed and well-considered. When the Fed Chairman starts saying that the U.S. is experiencing a “remarkably positive set of economic circumstances,” and that “There’s no reason to think this cycle can’t continue for quite some time, effectively indefinitely,” the hubris is starting to get a bit deep for my tastes.

The Fed Chair’s comments struck me as implying that they have been entirely successful in engineering a so-called soft landing. In my 27-year investment career I have never once seen the Fed engineer a soft landing. The idea that they can easily do it after embarking on the most massive pumping of easy money liquidity into the financial system ever seen in recorded history strikes me as a bit over-confident. But then, what do I know.

All I know for sure is what the stocks are telling me, and this past week has been a bonanza for short-sellers as leading stocks of all stripes were pummeled. And the set-ups on the short side were starting to appear as early as Monday, when I gave members two ideas on my live blog, both of which have worked reasonably well thus far.

Right here, right now, the market appears to be in position for a reaction bounce given the positions of the major indexes with the NASDAQ undercutting its prior mid-August low and the S&P 500 holding support at its 50-dma. We’ll see how this plays out, and whether the market is once again able to find its feet and continue its merry way.

But something smells a bit differently this time around, and it isn’t just all the hubris coming from the Fed Chairman. Any rally from here as most stocks become oversold will provide us with useful information regarding the sustainability of such a reflex move. The situation remains fluid, but the short side was the place to be this past week.

We’ll see where things go from here, and let the real-time technical evidence tell us how to proceed in the coming days as things potentially start to get interesting. If things stabilize and we begin to see more U&R long set-ups work, then maybe the long side comes back into focus in typical Ugly Duckling style. As always, just play it as it lies.

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 held no positions, 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.