Market Comment

Of FTDs & Liz Hurley

March 27, 2011

“When you find anyone agreeing with you, change your mind.”

–John Maynard Keynes

Shares put in a follow-through day Thursday (24), testing the top of the intraweek range and going out well, though Nasdaq volume was not impressive. The speculative sentiment that we mentioned in our last report remained part of the equation.

The Nasdaq has now gone seven sessions without a distribution day, quite a change from the previous several weeks. The below chart shows the follow-through day (FTD), and how its volume appears rather meek compared with the distribution days of the past.

In our last report, we spoke of our research indicating that an O’Neil follow-through day carries more weight when it comes following an 8%-12% intermediate-term correction than something shallower, such as 5%. Last week’s FTD in the Naz transpired after an 8.3% drop from the 2/18 intraday high to the 3/16 intraday low.

Having seen many FTDs over the years, these are our observations:

  1. Too many followers assign a sort of magical elixir status to the FTD.
  2. During an intermediate-term 8%-12% correction in the averages within the confines of a primary bull trend (such as has been seen since March ’09), prior to a follow-through day it can be advantageous to enter one (or more) of the current cycle’s outstanding market leaders as it breaks out from a base or takes out a minor high within a base, on volume.

    An example is Baidu (BIDU), which on 2/10/10 broke out of a ledge on volume 190% greater than normal. This transpired a few days after the Naz hit the bottom of a 9.7% intermediate-term correction, but days before a follow-through day.

    This does not apply to a primary bear trend.

  3. The success rate of a FTD varies dramatically with the general market climate. Ergo, adjust your expectations accordingly. For example, in the ‘Eighties and ‘Nineties, the success rate approximated 80%. Since then, it has been lower.
  4. Micro-analyzing the first few days of advance following a sharp decline in either a stock or an index can do more harm than good. In particular, many a good bottom will be made not by a lot of buying on the first few days of advance, but rather by strong volume on the way down just prior to the low. In other words, a firm bottom is made by sellers, not by buyers. All that volume that accompanies the last few down days of the decline creates a vacuum of sellers which results in a market that can then rise just by breathing on it.

    The moral here is not to penalize a market or stock following a sharp decline just because volume on the first few days of advance is light or “wedging.” After all, there is a reason why the first few days of rally following a decline are to be ignored. Obviously, the exception is if the first few days are powerful up days. It is to be remembered that the unexpected is that to which we accord particular importance.

In our last report of March 14, we wrote that “…despite the distribution seen at the surface…a number of speculative growth stock glamours are resisting the outbound tide. There is a message here…the coiled-spring action of some leading titles suggests that in the coming days or weeks the market may be closer to a low-risk entry point than it has for some time. It is logical to think that this might coincide with a lifting of the uncertainty related to the Japanese nuclear reactors. The speculator should remain alert to the possibility of a series of breakouts in some of the leaders mentioned in this report ahead of, or coincident with, a potentially more-obvious advance in the averages.”

Two points regarding the above:

  1. We were surprised when the market did not respond more convincingly just prior to, and coincident with, the lifting of uncertainty related to the nuclear reactors. Of note was the fact that the low was put in a day after logic would have dictated. Had the market’s pent-up demand been substantial, similar to other tense moments of uncertainty related to overseas events (1st Persian Gulf war, 2nd Persian Gulf war), the averages would have staged a more impressive snapback.

  2. The volume on the FTD was below average. This, combined with No. 1 above, shows there is not as much conviction among large investors as we would prefer.

On the bright side, if not on a hard boil, the speculative sentiment is still percolating. One sign of this is the small-capitalization sector, which has been outperforming since mid-January, and whose relative strength line a week ago hit a new high ahead of price, which has still yet to reach a peak.


Another positive, but shorter-lived, and therefore less of value, is the recent outperformance of emerging markets.

On the minus side, the brokers, which have often peaked prior to the averages at the end of a primary bull trend, are lagging. Similar to the breadth of an advance, the behavior of this group tells us nothing about the all-important intermediate-term trend, though it can tell us where we are in the context of the long-term trend. For now, it is too early to tell us anything, yet we watch it nonetheless.

Elsewhere, China, after a 133% move in nine months off the November ’08 lows, remains in a long consolidation. Given the litany of imbalances which are building, and will build, this is a mild positive.

Among the names, Opentable (OPEN) is a favored title. It is a member of the 20/20 club (estimates of 20%+ in the current and next fiscal years), with growth estimated to pick up from 33% in ’11 to 51% in ’12, is under extreme accumulation, is in a top group, and Thursday (24) it came out of a five-and-a-half week base on volume 60% above average, closing well. In our last report we noted that due to its historical character, OPEN is more likely to pull back following breakout rather than follow through. Don’t be afraid to vary the size of your initial entry in a position so as to take into account the volatility, liquidity, position in the pattern, overall risk/reward ratio, etc. For ecample, if a stock is more volatile, less liquid, a bit extended, etc., a junior position (one-half of your normal sized entry) can be considered, with the subsequent add-on entry to be sized proportionately.

Shutterfly (SFLY) is another early breakout that migbt lend itself to a pullback, given its one-way advance up the right side of its base. (PCLN) an institutional favorite for its growth rate and size, showed tepid volume last week as it moved to a high, indicative of the warm-but-not-hot tone of the market.

Sina (SINA) came out of a four-week pattern two weeks ago that was too v-shaped for our taste, considering its extent (four weeks) and magnitude (22% depth). But earnings are estimated at 1% growth this year followed by a jump to 39% next year, plus it was one of the first to come out well ahead of the averages. Thus, we would watch it, due to its leadership status, but would not enter it here.

Ultimate Software (ULTI) is a thinner name, at just 205,000 shares average daily volume. Although we give it points for consistently respecting its 50-day (five times since start of year), Friday’s volume was mediocre.

Accretive Health (AH) is a thinner issue, but with major estimates (83%/59%), a member of a top group, under extreme accumulation, a recent new issue that tripled since November, it deserves attention despite its current extended posture.

Over in the oil patch, Petroleum Development (PETD) has ’11/’12 estimates of 667%/133%, is in the top-performing oil & gas explorers group, and is potentially buyable above 50.

United Rentals (URI) is showing estimates of 364%/75%, is in a top group, commercial services – leasing, has proven it knows how to lead (+1,190% since March ’09), is showing strong growth in institutional sponsorship over the past few quarters, two weeks ago respected its 50-day, and is setting up in a crisp, 14% deep, six-week, flat base. It is potentially buyable above the 2/14 high of 33.63.

IPG Photonics (IPGP) is in a top group, has estimates of 68%/29%, has rising institutional sponsorship over the past few quarters, v fast sequential revenue growth (18%-30% over past three quarters), was one of the first names out of the chute last week. This one may not pause long enough to form the five-week flat base that the speculator would like to see.

Concho Resources (CXO) is in a top-ranked group, oil & gas exploration, is showing major estimates (40%/45%), is showing sequential revenue growth of 10%-30% in recent quarters, and has respected its 50-day. Although the stock has been beset by a good amount of distribution in its base, it is nevertheless up 616% in this bull market, and is, therefore, worth watching.

Like people, stocks with perfect characteristics are more apt to appear in textbooks rather than in real life. Did you know that Elizabeth Hurley has large ears?


Brigham Exploration (BEXP) is another explorer, has major estimates of 97%/71% in ’11/’12, shows mounting institutional sponsorship over the past few quarters, and could potentially be taken above the 2/28 high at 37.10.

Cloud play Rackspace Hosting (RAX), with matching estimates of 60%/50% for ’11/’12, and one of the biggest winners of the bull market, up some ninefold, is building a 16% deep, six-week base. A junior position could potentially be purchased here, with the add-on entry taken on the standard breakout above the 2/11 high of 40.62.

Netflix (NFLX), with estimates of 48%/45%, upward estimate revisions, mounting levels of institutional sponsorship in recent quarters, several quarters of accelerating revenue growth, and six weeks into a cup base, should be monitored closely.

Molycorp (MCP), the producer of rare earths, and highlighted here a few times since Oct 17, is up fourfold since going public eight months ago. The Street estimate for ’12 is for eps growth of 444%. As we said in one of our mentions of MCP, “Estimates are only estimates. But this is what the market trades on.”

Major volume on two days last week indicates the stock may be preparing to launch. This is v liquid, with average daily dollar volume of just over $300MM. The aggressive speculator might consider a junior position above the 3/24 high of 56.78, which would allow for the use of a wider-than-usual stop, which is appropriate given the higher level of volatility with this number.

A few other titles, including Lululemon Athletica (LULU), are deserving of note.

A bull market will not always favor growth stocks. We mentioned this possibility in a couple of recent reports. In the event of institutional rotation out of growth, we have highlighted a few cyclicals in the oil & gas explorer group. These stocks are not likely to trade in exactly the same manner as growth stocks, which are, for the most part, recession-resistant vehicles that march to the beat of their own drummer.

Even then, some speculators who only need five names in an account may find all they need in the growth sector, as there are still a good assortment of stocks showing the right tone.

In summation, despite the tepid interest at the surface, as evidenced by the FTD volume and the market’s hesitation by one to one-and-a-half days to move convincingly on the resolution to the Japanese reactor situation, there is enough conviction seen in some of the speculative growth stock glamours to indicate the path of least resistance is up.

Kevin Marder

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.