The Gilmo Report

September 21, 2011

September 21, 2011

The official commencement of “Operation Twist” sent the general market indexes twisting and writhing to the downside today, but one could say that the action was quite “logical” given the NASDAQ Composite Index’s position at the 50-day moving average and the prior resistance “zone” surrounding the 2611 price level. Resistance at these levels in mid-August was turned back on heavy volume, and as we see on the NASDAQ daily chart below the same thing occurred today as volume picked up sharply on the day. It would appear that we are headed for the lows of this current uptrend channel off the August lows. The NASDAQ’s move off the lows also has the look of an “ascending wedge,” so a clear breach of these lows at around the 2500 level would be very bearish, and could potentially constitute a “breakout” through what I have continued to see as a bearish inverted flag setting up the market’s next leg down in a continuing correction/bear market. It was just a matter of how long the rally was going to last. The market’s current rally has been led primarily by big-cap NASDAQ 100 stocks while the S&P 500, the NYSE Composite Index, and the Russell 2000 have all lagged, with the Russell lagging the most.

NASDAQ Composite Index Gilmo Report Chart

If we look at the daily chart of the iShares Russell 200 Index ETF (IWM) juxtaposed with NASDAQ volume, below, we can clearly see the relative weakness in the Russell. This is what I was talking about over the weekend when I indicated that I had switched from the 3-times leveraged inverse NASDAQ 100 ETF (SQQQ) into the 3-times leveraged inverse Russell 2000 ETF (TZA) and ramped up the position on this recent rally back up into logical resistance at the 50-day on the NASDAQ Composite and S&P 500 Index. You will notice that the Russell 2000 never even got close to its 50-day moving average on this last rally up into the 72 price level on the IWM. The IWM is also breaking out to the downside through the rising trend line I’ve drawn along the lows that the Russell 2000 has logged since early August. There were many signs of a faulty rally, not the least of which was the narrow breadth consisting mostly of big-stock, big-cap NASDAQ leaders like Apple, Inc. (AAPL) and Amazon.com (AMZN), for example. With the odor of institutional selling wafting about this market, I am happy to take profits in any long trades, such as AAPL, and move to the short side again.

iShares Russell 200 Index ETF (IWM) Gilmo Report Chart

Holders of gold and silver ETFs should heed the pick-up in selling today as it appears to me that these will move lower. The stock market is likely to come under further pressure, creating a critical mass of margin calls as it continues to drop, and this will eventually weigh on the precious metals. Today I unloaded ½ of my precious metals ETF positions and am ready to unload the rest if they continue to get dragged down with the market. My view is that capital is better off being utilized on the short side, and thus would shift funds out of the precious metals and add it to any existing inverse ETFs such as the TZA, the SQQQ, or the SPXU – all my favorite 3-times leveraged inverse index ETFs for the Russell 2000, the NASDAQ 100, and the S&P 500, respectively. While I continue to believe that gold and silver will continue higher over the longer-term, I prefer to optimize the use of my capital by retaining it for the short side at the current time. We can always return to the GLD and the SLV in force if and when they stage new breakouts from these consolidations they are working on currently.

GLD Gilmo Report Chart

What has bothered me most about this recent rally in the market back up to the 50-day moving averages on the NASDAQ Composite and the S&P 500 has been the poor breadth. I’ve also noted that a number of materials and machinery stocks, including oils and the trannies, have been very weak over the past several weaks. When the biggest of the big-stock machinery companies, Caterpillar, Inc. (CAT), shown below on a daily chart, is unable to rally with the market in September it is a very subtle clue that all is not right with the economy going forward. You can look at a number of symbols that have a similar breakdown and downside breakout look to them, such as HAL, JOYG, CLF, FLS FLR, SLB, GGG, UNP, CSX, BWA, MOS, MON, AGU, POT, etc. Combine this with the weakness in financials and real estate stocks like SPG, AVB, HME, EQR, etc., as they flirt with lower lows and it all makes for a very evil-smelling elixir bubbling through this market currently.

Caterpillar, Inc. (CAT) Gilmo Report Chart

The shining examples of upside performance recently have of course been the big-stock NASDAQ 100 leaders, led by Apple, Inc. (AAPL), shown below on a daily chart. AAPL is running into some resistance at around the 420 level after rallying up through the $400 price level. Over the weekend, I considered AAPL a long play on the basis of Livermore’s Century Mark rule, and so far it has lived up to expectations. My view now, however, is that I would be looking for AAPL to fail here if the market continues to weaken. When you observe the daily price ranges and price moves in AAPL’s daily chart since late July and compare them to the daily price ranges during AAPL previous base, they have expanded quite a bit, which tells us that AAPL is changing character here slightly as it becomes somewhat more volatile. Since early June, AAPL’s 40-day Average True Range has doubled, and so it will be very interesting to see what happens with AAPL from here, but my bet would be that a market move to new lows will be accompanied by a late-stage breakout failure from AAPL and other big NDX leaders that have broken out over the past few days.

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I discussed the downside breakout through the neckline of Netflix, Inc.’s (NFLX) over the weekend and its implications for further downside in the stock. At this point the stock is down nearly 30% since last Thursday, and so it is prudent to take profits if one was able to short the stock on Monday or earlier. I know that I was not able to discuss the stock until the weekend, after it had already dropped below the 160 level, but it was possible to come after the stock at that level given the huge downside velocity in the price/volume action of the stock. As I wrote over the weekend, whether NFLX was able to bounce back to the upside in the short-term or not was not the issue since the stock is quite clearly going much lower, in my view. I would, however, begin to anticipate and look for a bounce in the stock from current levels as yesterday’s huge selling may constitute short-term selling capitulation. Notice that the stock did not budge much today despite the massively-weak general market action.

Netflix, Inc.'s (NFLX) Gilmo Report Chart

In recent reports I’ve focused on Sohu.com (SOHU) as a prime short-sale target among the Chinese internet stocks, and since it rallied up into resistance at the 84 price level it has never hit my upside stop-out levels, even after rallying once back above the 200-day moving average two weeks ago. SOHU hit a new low today, and the negative situation with Chinese internets has broadened as I now view Baidu, Inc. (BIDU) as being in a potentially shortable position here as it breaks down through the 50-day moving average on heavy volume following the potential late-stage failed-base (LSFB) move of early August, as I note on the daily chart below. I say this is quite shortable here using the 50-day moving average at 145 as your maximum upside stop, about 5%, more or less. As with the long side, when a group of stocks begins to weaken together, en masse, it lends authority to the developing trend.

Baidu, Inc. (BIDU) Gilmo Report Chart

Sina Corp. (SINA), shown below on a daily chart, is a post-climax-top consolidation that is now starting to break down, as we see on the daily chart below. The climactic top, which occurred in mid-April of this year, has led to a long period of choppy action as the stock has tried to build a base, but for the most part the action has been wide and loose. This was very shortable today on the rally back up into the 200-day moving average as the stock dropped back down to just below yesterday’s intra-day lows around the $90 price level. I would watch for any bounce in SINA from here as a potentially shortable event, the closer to the 98 price level and the 200-day moving average the better, although I think one could scale a position properly enough to be able to sit through an 8% bounce in the stock if a short position were to be taken at current levels. As always, it is going to depend on what the general market does from here.

Sina Corp. (SINA) Gilmo Report Chart

We’ve been following Sodastream International Ltd. (SODA) ever since I first discussed it in my August 21st report when it broke down from its price highs to form the right side of the “head” in its continuing head and shoulders top formation. I discussed SODA again more recently in my report of September 14th as it rallied to form what looks like the peak in a potential right shoulder within the head and shoulders topping formation. As we see on the weekly chart, SODA has found resistance up in the 44-45 area, right in the middle of the area of congestion and resistance from January through May of this year, as I’ve highlighted on the weekly chart below. The prior two weeks as the stock rallied up to form the left side of this potential right shoulder saw some stalling within the weekly price ranges with volume picking up, which I see as a clue that the rally was sold into. I continue to view the stock as potentially shortable up here, as I discussed in my September 14th report, and I would use the 44 high of this week as my upside guide for a stop. If the market rolls over here I believe SODA will potentially move sharply lower.

Sodastream International Ltd. (SODA) Gilmo Report Chart

Over the weekend I discussed WYNN and MA as potentially buyable stocks based on their action last Friday, but at this point I don’t consider the long side where I want to be. MA initially began to move higher this week but sold off hard today, while WYNN did the same but reversed very hard today, moving back below its 50-day moving average. Only AAPL has held up among the long plays I discussed this weekend. I have to admit, however, that I wasn’t expecting too much from them but I felt it was necessary to have at least a couple of long ideas in one’s quiver in the event of a continued rally with breadth improving. That has not happened, and the market has in fact deteriorated very sharply over these past two days. Thus the short side is where I prefer to play right now, and for the most part is not necessary to do much more than sit on inverse index ETFs as I am doing with the TZA. As I discussed in my report of this past weekend giving the NASDAQ Composite 1% leeway to the upside above the 2611 level before being stopped out was the proper way to handle the index action and allowed quite nicely for the upside jiggling we saw yesterday before the market rolled over. In the meantime, some notes from my trading diary regarding prior short-sale ideas that remain viable:

FOSL – still in the right shoulder of a possible head and shoulders formation. Potentially shortable here using the 50-day moving average at 104.87 as a guide for an upside stop.

OPEN – continues to move lower, watch for 44-45 level as a potential area of support from which the stock could bounce.

RAX – has recently formed a “black cross” as discussed in my September 14th report and has failed to hold the 200-day and 50-day moving averages. The 38.50 intra-day high of four days ago should be your maximum upside stop.

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 positions in AAPL, AGQ, BIDU, DGP, SINA, and TZA, though positions are subject to change at any time and without notice.

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