Market Comment

Against The Odds

July 31, 2011

“Don’t get caught up trying to catch every possible move. Successful traders don’t stand out in the open with a shotgun, they hide in the bushes with a rifle.”

            — James Hearndon

Last week’s fraying at the edges in a number of the cycle’s speculative growth stock glamours was enough to tilt the scale negatively.

Up to this point, there had been very little to warrant anything more than “wading in” to the market, as we put it in a report shortly after this advance began in mid-June. Wading in, to us, means perhaps a 20% exposure. Perhaps. And, to its credit, leadership among the liquid glamours has been solid. This indicates institutions are not running for the exits.

Yet this has been the sole strength of the advance. As the below chart shows, price

printed a lower low on Friday, turning the medium-term trend down. In itself, this is not enough to set off alarms.

Of import, however, is the lack of volume seen on this advance, and we have commented on this, here and elsewhere. In particular, there has been only one major accumulation day in the past five weeks, as the above chart shows.

The advance is narrowing. The cumulative NYSE advance-decline line, our favored long-term breadth measure for many years, has lost its value due to ETF proliferation. For example, a 1% advance in the S&P is accompanied by a 4:1 advance-decline ratio for the day, or even more. In the pre-ETF era, a 1% advance would have equated to something less than 2:1. Big difference.

The below chart illustrates the narrowing of the advance. Point One: At each of the last three highs in the Industrials, fewer stocks are above their 200-day moving average, a proxy for the long-term trend. Point Two: If the average was at its 200-day average, and assuming that the broader market was in gear with the average, there would be 50% of issues trading above their 200 SMA. On Friday, the figure dropped to 41%, yet the average sits 1.4% above its 200 SMA.

Another breadth measure compares Friday to the last session that traded in the same general price range, which was in June. This is admittedly an imperfect comparison, but does show considerably more stocks making new lows now than then.

A final breadth measure, again imperfect, shows the cumulative Nasdaq advance-decline line peaking Feb. 18 while price continues higher for the next 2.5 months.

Momentum is one of the best leading indicators of price – if not the best. The breadth of an advance is a momentum measure. It is long-term in nature, and not especially useful for an intermediate-term speculator. It is imprecise, sometimes peaking many months ahead of the ultimate bull market top in the averages. But for those who try to understand where we are in a bull – a long-term animal – it is nevertheless of value.

In terms of leadership, a leading stock typically breaks out of a base on volume at least 50% above its average daily volume, advances 20%-25%, then backs and fills, perhaps forming another base, before attempting another advance. This is typical, an average. It is obviously not what always happens.

Looking at the speculative growth stock glamours since the June 16 low in the Nasdaq, very few have shown volume on their breakout + an advance of at least 20%. Lululemon Athletica (LULU), Fossil (FOSL), Ulta Salon (ULTA), Virnetx (VHC), and Sodastream (SODA) are some of the only names that fit this bill. (The latter actually broke out on May 18, a month before the market advance began. And when it did come out later, on July 1, it did so from a three-week ledge, not a base.)

Virnetx broke out on volume, moved up 33%+, then returned to its pivot.

As mentioned, the liquid glamours have been stout. This includes Apple (AAPL), (AMZN), Baidu (BIDU), and Green Mountain Coffee Roasters (GMCR). Netflix (NFLX) has been the exception, while (PCLN) reports Aug. 3.

Gold and silver ETFs have been the preferred vehicles recently. It is logical to expect a pullback in these once the debt ceiling situation has been resolved. Friday, we exited our position in ProShares Ultra Silver (AGQ), the 2x ETF. This decision was based upon a short-term model that issued a sell signal with mild-to-moderate confidence midway through Thursday’s session. The model has historically been accurate 75% of the time. Therefore, we pay attention to it. The model says nothing about extent or duration of a signaled move, and often the effect of a signal extends just a few days.

In summation, since Day One of the six-week advance in the averages, we have been concerned with volume at the surface. A week ago, we said “the clear tone beneath it is a market seeking upward revaluation – once the dust ultimately settles. This is evident by the lack of selling pressure at the surface…” Last week’s two Nasdaq distribution days did not help. The liquid glamours hold up, yet it is last week’s performance of the speculative glamours, suffering from the market’s narrowing breadth, that underscores this being an advance whose odds we will let others play.

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. ©2008-2019 Gil Morales & Company, LLC. All rights reserved.