Market Comment

The Wild Card

February 2, 2011

“I use technical analysis a great deal and it is terrific, but I can’t hold a position unless I understand why the market should move.”

        –Bruce Kovner, Market Wizards: Interviews with Top Traders

Shares are being driven by an economic expansion that until recently was not taken seriously by many market participants. Also at work is a rotation out of bonds, whose yields may have seen their generational lows.

Technically, of import is the elevated volume seen thus far in ’11. This can contribute to higher volatility, which we like because volatility = price movement and price movement = opportunity.

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The following chart puts the current advance into perspective. The Naz has come a long way, 32% to be exact, with nary an 8%-12% intermediate-term correction.

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Meanwhile, emerging markets, tarnished by higher interest rates and rising inflation, are generally basing, but have lagged the SPX by about 10% over the past three months. This underperformance comes as the market is discounting slower growth for developing nations down the road.

Tuesday’s (1) activity, as well as high-profile breakouts by some high-profile glamours, renders the Egypt situation to be moot. For now.

The vast majority of geopolitical incidents represent buying opportunities, and not the beginning of new bear markets. The current one hinges on whether social unrest moves from Tunisia and Egypt to threaten the governments of Gulf states such as Saudi Arabia and the Emirates. The view here is that this will not, as these nations are wealthier and in much better shape economically than places such as Egypt, Yemen, and Jordan.

As mentioned in our last report, we are at the point in a cycle that often sees leadership rotate from early-cycle interest-sensitive, consumer, and growth sectors to late-cycle capital equipment (including technology) and basic resource segments. The big question, in our mind, is whether the recent rotation seen from growth into cyclical allows growth to outperform, albeit in a back seat role to the metal ores, coals, oils, and cyclical technology (e.g. the semis), or whether large participants begin dumping growth due to rich valuations relative to cyclical.

Among the names, Netflix (NFLX) tipped its hand with last Thursday’s (27) breakout on the greatest volume in nearly six years. We believe that day’s volume, the opening gap, and especially the ’11/’12 estimates of 42%/44% earnings growth warrant taking a junior position right here, which is 8.5% above the 1/18 high of 194.84. A junior position, or half-sized position, would allow for entry in a stock that has leadership potential should the market continue forward. At the same time, a junior position would allow for a wider-than-normal stop to be used. So if a 9%-10% stop was used, this would only amount to a 4.5%-5% loss if the position was of normal size. Friday’s (28) high of 218.00 could then be used as the add-on point for the remaining half of the position.

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Baidu (BIDU) gapped out of a 12-week pattern Tuesday (1) on volume 182% above average, closing well, and holding the gain today on drying volume in true, up-and-tight action. The Street eyes ’11/’12 growth of 56%/42%. This is sensational growth for a $41B market-cap company. We believe the stock could be entered here using a junior position and a stop that would be below the 1/18 high of 109.25, or 7.4% below entry.

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If institutions have any sort of appetite for growth stocks going forward, NFLX and BIDU are likely to fit the bill, we think, given their prodigious estimates and large-capitalization status.

The It stock, meanwhile, is working on a three-week ledge. Though we own the stock, this pattern is a bit too obvious for a fresh-money buy…for aggressive players only.

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Walter Energy (WLT) and Patriot Coal (PCX) are a couple of the leading coals, currently a top-performing group. We like Teck Resources (TCK), which also produces metal ores. The market is loaded with these three-week ledges, of the type seen in TCK. We are watching the stock but would not be a buyer on a break of this pattern unless there is a more extended period of basing. However, the group is hot, being part of the overall basic materials sector, and deserves monitoring. To its credit, TCK shows a 99% expected eps growth rate for ’11.

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Opentable (OPEN) acts as though it is raring to go higher, but caution ahead of its earnings report due in about a week may have put the damper on today’s short-lived peek into new high ground. Again, like most of the other shelves, we will pass on OPEN if it decides to vault in the next few sessions. Strong group and 54% estimate for ’11 keep it on our list.

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Priceline.com (PCLN) has built a base-on-top-of-a-base pattern. The stock has about as good of a chance as any of the liquid glamours to retake the leadership reins, given its 33% ’11 estimate, strong group, extreme earnings stability, and appeal among institutions. The question is whether institutions still have an appetite for growth stocks as opposed to late-cyclicals.

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Wynn Resorts (WYNN), mentioned in our last report as one of the two horses in the gaming group, sets up in a three-month, cup-with-handle and an ’11 estimate of 48%. Its group is a B+.

Las Vegas Sands (LVS) is the other name in the gaming segment that might be interesting in due course by virtue of its 76% ’11 estimate and its earnings and revenue acceleration over the past few quarters.

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Lululemon Athletica (LULU) is working on a six-week flat base that is 12% deep, is under extreme accumulation, and expects 24% EPS growth in the January ’12 fiscal year, per the Street. We would consider entry above either Tuesday’s high (1) of 73.79 or the base high of 74.60, but only on volume.

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Molycorp (MCP). After pulling back to its 50-day, this July 29 IPO perked up today on the heaviest volume in a week. This one is guaranteed to generate excitement, either up or down. We would not do anything with this now, but are watching to see how this plays out, especially if it forms a near-term high and then pulls back. Sister stock Rare Element Resources (REE) also woke up today.

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Broadsoft (BSFT), a telecom software play,
broke out today from a four-week ledge on major volume after neatly bouncing off its 50-day a week ago. The 81% EPS estimate for ’11 and > 10% sequential revenue growth over the past two quarters are especially attractive, as is the strength of its industry group. We would not chase the stock here, but would monitor it.

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Acme Packet (APKT), not shown, is another telecom issue in a top group that has a similar pattern to BroadSoft’s, breaking out today from a four-week ledge on heavy volume and a nice gap. We like the 30%/30% growth estimates for ’11/’12. Like BSFT, we would not chase this but would be watching it.

Nvidia (NVDA) lends credence to the fact that the pretty ones often play the hardest to get. The stock bottomed last August on hopes for an earnings turnaround. Another one we will be watching, but extended at present and not buyable.

Travelzoo (TZOO) came out of a two-week ledge on big volume today, however a four-day drop of 19% followed by seven days up into new high ground is, for us, not something to pursue at present.

In summation, a number of growth stock glamours, including BIDU, NFLX, OPEN, APKT, and LULU, etc. are showing better tone. Though a few of these can be entered using junior positions, we are alert to the possibility of institutional rotation out of growth and into the hot, late-cyclical groups such as the oils, metals, and coals. Since ’73, the wild card to any investment thesis has been oil. Though we do not see any near-term risk to the large Gulf producers, no one can foresee the endgame of the Mideast.

There is a reason why it is the wild card.

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.