The Gilmo Report

April 10, 2016

April 10, 2016

The market ended the week in the same volatile manner that has been typical of the action over the past week-and-a-half. In the process the NASDAQ Composite Index has chopped back and forth along its 200-day moving average. However, the past two days have revealed some cracks in the market’s armor. Thursday saw the index break to the downside as it reversed back below its 200-day moving average. This was followed by a big futures-led gap-up open on Friday that eventually ran out of steam, sending the index back below its 200-day moving average.

Taking the long view of the NASDAQ Composite on the daily chart, below, we can see that it is running into resistance along the lows of the price range it formed in November-December 2015 of last year. This comes after the index has trended quite obediently along its 10-day moving average all the way up from the February lows.

A wholesale breakdown from the 200-day line would be a bearish development. As we begin to move through the heart of earnings roulette season over the next four weeks or so, some clarity may be forthcoming. Many former leaders that entered a severely broken-down state going in to February have rallied hard off of their recent lows, but such rallies can be killed instantly by a less-than-satisfactory earnings report.

 

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The S&P 500 Index is also running into resistance as it approaches its prior November/December highs. As it does so, its consolidation over the last couple of weeks has become a little sloppy as the index has swung back and forth over the past six trading days. Certainly, one can argue that the indexes are at least in need of some consolidation after the sharp move off of the February lows. Within that context, even a 2-3% correction off the highs would be relatively normal.

 

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As I discussed in my Wednesday mid-week report, I am watching the broader NYSE Composite Index which has been in a very wide, very choppy bearish trend channel since its May 2015 peak. Currently the index continues to run into resistance at its 200-day moving average.

A breakout through the 200-day line would be a bullish development. In contrast, a movement that sees the index peel away from the 200-day line on the downside on heavy volume would be a bearish development. So far nothing terribly conclusive has emerged as the index more or less remains in a three-week range just under and along the 200-day line.

 

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The real question to be answered is what sorts of opportunities will emerge from a market rally failure or continuation. I think most of this will center on the action of individual stocks in reaction to positive or negative earnings reports over the next few weeks.

Friday’s big gap-up that fizzled out was given some impetus by a roundtable forum attended by four present and previous Federal Reserve Board Chairpersons: Paul Volcker, who served under President Ronald Reagan and is credited with killing off the inflation of the 1970’s once he took over in the early 1980’s; Alan Greenspan, famous for his wrong-way “Irrational Exuberance” call in June of 1997; Ben Bernanke, who got the current QE bubble off to a raucous start in 2009, and current Fed head Janet Yellen, who is simply continuing the policies put in place by former Chairman Bernanke.

Ms. Yellen assured everyone that the U.S. economy “is not in a bubble,” a remark I found rather odd considering that the Fed didn’t see the bubbles of 2000 or 2008 coming. The idea that they somehow might be able to determine whether another bubble-bursting is coming or not is certainly not supported by their historical track record in this regard.

My own view is that when governments around the globe are printing money in such haphazard fashion as to begin viewing negative interest rates as a viable policy tool, bubbles have to be forming somewhere. But bubbles can keep growing much longer than anyone thinks. After all, it was Alan Greenspan who felt that the stock market in 1997 was in a bubble state when he uttered the euphemism of irrational exuberance. But 1999 and the dot-com frenzy proved that he was a couple of years too early with that call.

In any case, the comments of the four Fed heads that included Yellen’s continuing caution with respect to raising rates, in combination with an overnight rise in oil prices, helped send the indexes flying higher on Friday morning. I was looking for some sort of response from precious metals on Friday, but the SPDR Gold Shares ETF (GLD) sat tight in a position just above its 10-day and 20-day moving averages. On Thursday the GLD dipped below its 50-day moving average but reversed to close back above the line on higher volume.

This did not qualify as a pocket pivot, but it does show that gold simply remains in a slight consolidation and pullback that extends back to the early March peak. Its movements from here, including any potential breakout to higher highs, will likely continue to revolve around what the Fed does or doesn’t do. For those enamored with the yellow metal, then buying along the 50-day line remains your lowest-risk entry point within this one-month consolidation.

 

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The dollar did respond on Friday by moving lower, however. The daily chart of the PowerShares US Dollar ETF (UUP) below shows a lower low in a downtrend that extends all the way back to early December of last year.

What I find interesting, however, is that the continued slide in the dollar over the past month has given little to no impetus to precious metals, which remained mired in sideways consolidations during that period. From my own perspective, the best dollar trade over the past few days has been to short the dollar against the Japanese Yen, which has been on a tear over the past six days.

 

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The big story on the final day of trading for the week, in my view, was what happened to Facebook (FB). After stalling at the 10-day line on Thursday as buying interest waned, the stock broke through its 20-day moving average on heavier selling volume than we saw on Monday.

Monday’s high-volume decline to the 20-day moving average was fueled by analyst’s expression of fears regarding a soft quarter when FB announces earnings at the end of April. Friday’s decline, however, was fueled by news of a sharp decline in FB’s website traffic during the first three months of 2016.

Whatever the news is, my view of the stock has centered on its ability to hold at the 20-day moving average. Despite being able to hold the line on Wednesday, FB did not muster any significant buying volume on Thursday as it stalled at its 10-day moving average. At that point, my suspicions regarding the stock’s ability to hold the 20-day line were growing, so I decided to test a position out on the short side.

On Friday, the stock briefly rallied with the general market, but quickly reversed to the downside. Once it breached the 20-day line, it was time to pile on the stock as a short-sale target, looking for a move at least down to the 50-day moving average at 109.11. FB didn’t quite get there by the close, but I am looking for a test of the line to perhaps emerge this coming week.

 

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The essence here is that we are seeing a big-stock leader, which had previously been rallying back to its all-time high on below-average volume, suddenly get hit with some significant selling volume. This gives the current pattern the look of a possible double-top type of situation. And since I use a breach of the 20-day line as possible confirmation of a late-stage base-failure, FB is now on failure-watch.

In fact, I would tend to look at any weak rallies back up into the 20-day line as potential short-sale opportunities. As I’ve pointed out many times before, things can change rather quickly in this market, and you are either on top of the real-time action or you aren’t. If you aren’t, then you may end up suffering from some pain, as anyone who sat too long in Smith & Wesson Holdings (SWHC) has discovered.

SWHC became a shortable gap-up in rapid fashion on Monday when it gapped down back below its 20-day moving average on huge selling volume. One way or another, I think this thing is headed for the 200-day line down at 20.08. However, I would like to see a quick rally back up into the 50-day line at 25 as the most opportune place to short it.

In the meantime, the stock is forming a short four-day bear flag with volume drying up. If one were going to try and short it here, then doing so as close to the Tuesday high at 24.11 as possible is advisable. Otherwise you’re looking for some sort of extended dead cat bounce back up into the 50-day moving average.

 

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Anyone who bought SWHC down near the 26 level or better based on my initial discussions of the stock back in mid-February and then sold on the move into the 30 price level did well. But if one sat there thinking there were going to play out a big gain in classic O’Neil style, they have seen those gains dissipate in rapid order. Such is the nature of this market. Take your 10-15% profits (IBD’s 20% profit-taking rule falls a bit short in this market) when you have them.

Hawaiian Holdings (HA), not shown, has been the standout name in the airline group as it closed at a new all-time high on Friday. This comes within an overall shallow uptrend that continues to trek higher along the 10-day moving average. However, the airlines have offered a mixed bag as of late, and in some cases are starting to look like potential short-sale targets after their big Ugly Duckling rallies off of the February lows.

In my Wednesday mid-week report I discussed the possible POD top that might be forming in Alaska Airlines (ALK). After the high-volume gap-down on Monday following news that ALK was buying out Virgin America (VA), the stock is still holding in a short four-day bear flag just below the 20-day moving average at 79.66.

Since it is not so clear to me just how high of a probability short ALK is here, if I’m looking to short it then I want to use the 20-day line as a guide for a tight stop. Meanwhile, given that ALK is expected to announce earnings on April 21st, I would then look for a trade-able move down to the 200-day line at 75.97 as my profit objective.

 

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While smaller airlines like HA and ALK have been decent performers since mid-February, the big airlines have started to come apart over the past week or so. This includes American Airlines (AAL), United Continental Holdings (UAL), and Delta Air Lines (DAL). While AAL and UAL have streaked well below their 50-day and 200-day moving averages, Delta is still in a shortable position just below its 200-day moving average.

On Thursday the stock busted the 200-day line on heavy selling and undercut a prior low in the pattern from early March. This set up a small undercut & rally move on Friday that carried back up towards the 200-day line, bringing it into shortable range. This looks quite shortable here using the 200-day line as a guide for a tight upside stop. Keep in mind, however, that DAL is expected to announce earnings on April 14th, so shorting it here means you are looking for some sort of breakdown before earnings are reported this coming Thursday.

 

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If you bought Silicon Motion (SIMO) back in early- to mid-February on the base breakout I mentioned in the report back then and didn’t sell into the upside streak of eight trading days ago on the chart, you might now be looking at a second chance. SIMO gave up more than half of its prior gains earlier this past week before finding support around its 20-day moving average. This then sent the stock flying back up towards its prior highs near the 40 price level on Thursday before it stalled and reversed to close in the lower half of the daily price range.

On Friday it drifted back up to the 40 level on lighter but above-average volume. With the stock expected to announce earnings at the end of April, one should probably consider whether this retest of the prior highs presents an opportunity to lock in profits before earnings. At the very least I would advise using the 10-day line at 38.17 as a guide for a trailing stop.

 

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For the most part, the semiconductor names I’ve been discussing in recent reports have continued to act reasonably well. For example, Broadcom (AVGO) has continued to hold along its 10-day moving average as it moves tight sideways over the past eight trading days. The stock is somewhat extended from its double-bottom breakout point in early March when I first discussed the stock (see March 6th report). For this reason I would prefer to continue looking to use pullbacks into the 20-day moving average, now at 152.06, as the most opportunistic entry points.

Note that AVGO pulled down into the 20-day line two Fridays ago, which set up a reasonable entry point for those who were alert to it. The good news is that AVGO isn’t expected to announce earnings until late May, so the need to play earnings roulette is still far off in the relative future.

 

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M/A-Com Technology Solutions (MTSI) is still holding more or less at its prior double-bottom breakout point, but unlike AVGO has been unable to generate any significant upside from there. After pushing to a new high two Fridays ago, the stock has dropped back below the prior breakout point at 41.32 as it looks set to test its 50-day moving average.

Volume has been relatively low on this current descent towards the 50-day line, so one might keep an eye on this to see if it actually ends up meeting up with the line. If it did, this would take it a little further below its March 24th low and trigger a possible undercut & rally move. MTSI is expected to announce earnings on April 26th.

 

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Nvidia (NVDA) flashed a pocket pivot move this past Wednesday, as I noted in my Wednesday mid-week report. However, the move came after an intraday pullback down towards the 20-day moving average, which was really where you wanted to buy shares if you saw the pullback during the day.

The ensuing pocket pivot action is constructive, but now we would want to see the stock hold tight along the 10-day moving average with volume drying up. And in fact this is more or less what we have seen in the stock over the past two days as volume has declined and the stock has held at the 10-day line. The stock is currently about 10% or so extended beyond its cup-with-handle breakout of mid-March, so I would still tend to look for pullbacks down towards the 20-day line at 34.54 as the most opportunistic lower-risk entry opportunities.

 

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Maxlinear (MXL) is still clinging to its 20-day moving average after retaking the line after its huge-volume spin out and shakeout down to the 50-day moving average two weeks ago. But the stock is still having trouble making any significant progress from its mid-March base breakout.

Friday’s reversal off the peak on above-average volume brought the stock back into its prior breakout point and the 20-day moving average, which theoretically puts it in a lower-risk buy position. The stock is by nature a volatile little beast, so buying on weakness is your best shot at a reasonable entry opportunity.

 

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What I find interesting about MXL is that here you have a semiconductor name showing huge triple-digit earnings gains of 900% and 820% over the past two quarters with a 389% gain expected next quarter when it announces in early May.

This contrasts sharply with a name like AVGO which grew earnings at a tepid 15% in the past quarter in a rapidly decelerating progression from 151% earnings growth four quarters ago. At the same time, AVGO’s sales growth has gone from 130% four quarters ago to 8% in the most recent quarter. Next quarter that deceleration is expected to worsen with analysts looking for 12% earnings growth.

But remember that all of this is backward-looking stuff. Just because a company has X number of quarters of prior earnings growth is no longer a reason for institutions to be all that interested in the stock because that is old news. Everybody already knows it.

What seems to be driving AVGO is an expectation of 23% annual earnings in 2017 while MXL is expected to grow annual earnings at a very slow 5% in the same year. Therefore, we might conclude that AVGO’s steadier upside price performance as compared to MXL’s indecisive and volatile price performance is due to their respective forward-looking fundamental prospects, not what everybody can see in the rear-view mirror.

I have to admit that I was somewhat surprised by the action in GoDaddy (GDDY) this past Thursday after it priced a 16.5 million secondary stock offering by selling shareholders at 30.25 a share and then gapped up above 31. Usually, this much stock on an offering that is priced below the last close will take the stock down to around where the offering was priced.

Instead, GDDY gapped up to the 20-day moving average but stalled and churned around at the line on heavy volume. So how do we interpret this? My initial view is that what we have here is a failed cup-with-handle breakout that immediately broke down to the 50-day and 200-day moving averages. This was followed by a rally back up into the 20-day moving average, where the stock is churning around on heavy volume. The huge volume is, of course, created by the release of the secondary offering into the after-market.

 

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On that basis, we cannot necessarily interpret it as selling pressure per se. The next day the stock trades above-average volume, but holds above the 20-day moving average as it closes just about mid-range. Notice also that the gap-down move to the 200-day moving average found days ago shows some supporting action as it closes mid-range. The next day the stock moves back above the 50-day moving average on above-average volume.

While I do have a small short position in the stock, it’s not clear to me that I won’t end up flipping this back to the long side. The action is somewhat mixed and confusing, since when a secondary offering is priced and released into the after-market it will tend to open at or below the offering price level and then trade higher. This is usually a bullish sign following the pricing and release of a secondary offering.

In GDDY’s case the stock gapped up from the 30.25 offering price and then churned around the 20-day line on heavy volume. The next few trading days will likely provide the clarification I’m looking for. I am prepared to move with the stock based on how that plays out. Big banks and brokers have been moving lower over the past several days. Most are not in what I would consider to be in optimal short-sale positions. The group looks to be in trouble again, which of course may have implications for the general market.

I notice that Goldman Sachs (GS) busted its 50-day moving average on Thursday on a sharp increase in volume, which brought it up on one of my short-sale screens (price break below 50-day line on higher volume). On Friday the stock pushed back up into the 50-day line which put it in a shortable position. It then closed at the lows of the day on lighter volume. Its position just under the 200-day line makes it an easy short-sale target using the line at 152.27 as a tight upside stop. Optimally, I’d like to see GS closer to that price level before launching a short position.

That’s because GS is actually bouncing along the lows of the sideways price range it has formed since early March. This is short-term support from which I’d prefer to short a bounce, although a high-volume breach of support might send it lower. However, that might not happen until April 19th when GS is expected to announce earnings.

 

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When I study this chart of GS closely, there are some other interesting features to take note of. Notice the three peaks that formed between March 4th and April 1st. Each takes the stock to a slightly higher high, but each time the stock comes right back in. The third peak on April 1st looks like a breakout to higher highs, but notice that volume at that point has been coming in at well below-average levels. That breakout then fails on equally light volume as the stock holds at the 20-day moving average for two days. It then breaks the 50-day line on Thursday.

The three peaks also illustrate the Rule of Three in the sense that when the stock could not follow-through on a third breakout attempt it was “three and out” as it broke to lower lows. Another big financial that is in a more shortable position is J.P. Morgan Case (JPM), which I show on a different type of chart than GS. This chart shows JPM as somewhat weaker than GS given that it has two peaks during the same March-April period. Notice how the peak in the middle of March is a big-volume gap-up that looks quite powerful.

However, as is often common with this type of situation where a stock is in a bear flag, you see a number of breakouts within the pattern, and they can look very convincing. But they end up going nowhere, as was the case with JPM. On Thursday the stock busted through its 50-day moving average on increased selling volume. But this undercut two prior lows from mid-March, triggering an undercut & rally with the market on Friday. However, this rally failed at the confluence of the 10-day and 20-day moving averages as the stock reversed and closed back below the 50-day line.

If one was watching this as a short-sale target, the rally into the 10-day and 20-day moving average confluence on Friday morning was a perfect shorting opportunity. This looks shortable here, using the 20-day line at 58.62 as a guide for a reasonably tight stop, given that it lies a little over a point from Friday’s close.

 

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Notice all the various gaps to the upside and the downside that are evident in JPM’s chart, especially during the month of February. I especially like the random “outlier” gap-down in mid-February that turned out to be a big exhaustion gap and shakeout. That gap-down on massive volume looked like certain death for the stock, but it simply gapped back to the upside and back within the comfortable confines of its bear flag price range. If this doesn’t help to illustrate how random and volatile certain stocks in this market can get, nothing does!

Netflix (NFLX) has been running into consistent resistance at its 200-day moving average over the past six trading days. Volume levels have been drying up sharply on this little pullback towards the 10-day line. So is this a buyable pullback? Possibly.

The flip side is that while a pullback into the 10-day line on very light volume might be buyable, the stock could just rally back up into the 200-day line where it could morph back into a short-sale trade once again. With earnings expected to be announced on April 18th the stock may simply go nowhere until then. For now I would still consider looking at this as a short-sale target on such rallies into the line, now at 106.36, while using the line as a guide for a tight upside stop. However, I would view this as only a short-term trade as I would prefer to have no position going into earnings.

 

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My little wolf pack of Ugly Duckling tech names continues to act reasonably well, despite the general market volatility. For example, Mobileye (MBLY) continues to track well along its 10-day and 20-day moving averages. On Friday, it held a small rally back up to the highs of the price range it has built since mid-March.

That was reasonably decent action on increased buying volume on a day when the general market rally stalled and fizzled. But as it has done each time it has pushed just above the 38 price level, it has stalled slightly. However, as long as it can continue to hold the 20-day moving average, currently at 35.73, I am still willing to buy the stock on pullbacks to the line.

 

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Salesforce.com (CRM) has met up with its 10-day moving average as it consolidates the strong upside move it had six trading days ago on the chart. Friday’s move back down to the 10-day moving average came on volume that was -62% below average, so it qualified as a “voodoo” pullback. Therefore, this is in a buyable position here using the 20-day line at 73.22 as your selling guide. CRM doesn’t announce earnings until after mid-May, so earnings roulette does not come into play for some time.

 

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CRM’s close cousin and competitor, Workday (WDAY), has also met up with its 10-day moving average as it consolidates a strong five-day rally that made it up as far as the 80 level by Monday of this past week. Volume on Friday, as the stock held tight at the 10-day line, came in at -61% below average. If one has been playing this since it was in the low 70’s, this might represent an add point for the stock. However, my preference would be to look for some sort of pullback to the 200-day line at 74.82 as a more opportunistic entry opportunity.

 

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Splunk (SPLK) continues to hold tight along its 10-day and 20-day moving averages in a very shallow ascending pattern. On Friday the stock showed a little bit of spunk by posting a pocket pivot off of the 10-day moving average. However, the move, while constructive, did not take the stock to higher highs, and it remains stuck in this ever-so-slightly ascending price range it has formed since late February. My view of the stock remains that it is buyable on pullbacks to the 20-day moving average, currently at 47.74. Earnings are not expected to be announced until late May.

 

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When I look at MBLY, CRM, WDAY, and SPLK, I see four tech-oriented Ugly Ducklings that continue to act constructively. Some of them, like SPLK, look like they want to launch. As I pointed out in my Wednesday mid-week report, however, some of these are in steep v-shaped rallies on their weekly charts, currently carrying up into areas of potential overhead congestion and resistance.

This therefore indicates at least a rising probability of potential price failure back to the downside. But as I’ve also pointed out, concrete evidence would need to show up on the daily charts before such a failure was confirmed. Breaches of the 20-day moving averages on any of these would serve to provide such confirmation, and therefore should be watched for. This in turn sets your parameters for downside stops on the long side as well as any signals that these stocks should again be treated as short-sale targets.

Ambarella (AMBA) looked like it was launching to higher highs this past Thursday as the stock jacked over 1.80 points to the upside early in the day. This rally, however, found resistance at the prior highs, as I’ve highlighted on the chart, and the stock closed near the intraday lows.

On Friday AMBA pulled into the 10-day moving average, which has now caught up to the stock, on volume that was -56% below-average. It may just be working off some overhead from the left side of the pattern around the early March highs. Given the indecisive action following the big-volume gap-up move of nine trading days ago, I would prefer to take an opportunistic approach and wait for a pullback to the 20-day line at 42.78.

 

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Panera Bread (PNRA) is in a buyable position as it sits right on top of its 10-day moving average in a five-day consolidation following the pocket pivot move of six trading days ago on the chart. If you like the stock, this is where you buy it. You can use the 50-day line at 204.59, a little over 2% away from Friday’s close, as a guide for a tight downside stop. Keep in mind that PNRA is expected to announce earnings on April 26th, so I would like to see a nice trade-able upside move back up to the prior highs around 220 before then.

 

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Fabrinet (FN) has pulled all the way back to its 20-day moving average and its 20-day moving average following a powerful-looking base breakout a little over two weeks ago. The pullback has also brought it right back into its prior breakout point at around the 30 price level. Volume picked up slightly as the stock closed about mid-range and above the 20-day line in a show of supporting action.

As I pointed out in my Wednesday mid-week report, despite the fact that FN was pulling into its 10-day moving average at the time, “I would only view a pullback into the 20-day line at 30.20 as the most optimal opportunistic entry from here.” This assessment was primarily due to the volatile nature of the stock and the fact that it was looking a little wobbly at the 10-day line.

So, if you’ve been wanting to buy this thing since it broke out on March 24th, this is your big chance. Buy it here using the Friday intraday low of 29.78 as a guide for a very, very tight stop. Otherwise, one could give it more room down to the 50-day line at 28.77.

 

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Below are my current Trading Journal notes on other names I’ve discussed in recent reports:

Acuity Brands (AYI) is holding tight and starting to settle down following Wednesday’s buyable gap-up move after announcing a strong earnings report. The stock got as low as 245.24 on Thursday, about 2% above the 239.08 intraday low of Wednesday’s gap-up price range. If 2% is within your risk-tolerance levels, then the stock remains in a buyable position. The 239.08 low, plus another 1-3% of downside porosity, depending on your risk preferences, would serve as your selling guide.

Apple (AAPL) has closed below its 10-day moving average for two days in a row now after stalling at the 200-day moving average earlier in the week. I am willing to test the stock out on the short side on any rallies into the 200-day line at 110.96, but keep in mind the company is expected to announce earnings on April 25th. It’s possible that it doesn’t do much of anything ahead of earnings.

Amazon.com (AMZN) is holding tight as it meets up with its 10-day moving average with volume drying up sharply on Friday. If one buys into this pullback then the 20-day line at 582.71 would be your maximum downside selling guide. AMZN is expected to announce earnings on April 28th.

D.R. Horton (DHI) is holding tight at the 10-day moving average as volume dries up. The 10-day line has actually moved to a higher high over the past couple of days following Wednesday’s pocket pivot off of the 20-day moving average which was discussed in my Wednesday mid-week report. The best spot to try and pick up shares of DHI is on pullbacks down towards the 20-day line at 29.70. Keep in mind, however, that the company is expected to announce earnings on April 21st.

Southwest Airlines (LUV) has been able to hold its 20-day moving average over the past three trading days as it has retested the line. With the airlines looking like a mixed bag, I would watch for a failure down through the 20-day line on heavy volume as a possible short-sale signal. LUV is expected to announce earnings on April 21st.

Square’s (SQ) is still extended. As I wrote in my Wednesday mid-week report, I would prefer to just lay back and look to buy this on a pullback to the 20-day moving average at 13.59. SQ has had a big move since its mid-March breakout at the 12.05 price point, and likely needs some time to digest that move.

Tesla Motors (TSLA) has spent the past two days pulling back on above-average but steadily declining volume after getting over 10% extended from its 200-day moving average. In my Wednesday mid-week report I pointed out that if one bought the pocket pivots at the 200-day line last week, this was a good spot to take profits. The stock is now heading for its 10-day moving average at 242.98, where it might become buyable again, but we won’t know for sure until it gets there and selling volume begins to dissipate.

Vantiv (VNTV) made an all-time closing high on Friday on the heels of Wednesday’s pocket pivot off the 20-day moving average and up through the 10-day moving average. The stock stalled a bit on Thursday, however, on above-average volume. So it’s still a matter of looking to buy this on weakness rather than chasing strength. VNTV is expected to announce earnings on April 26th.

As I’ve pointed out several times in recent reports, I remain somewhat cautious on the market given its extended state. Currently I’m seeing some action in individual stocks that looks more shortable than buyable, and this may be providing some validation to my cautious view. From a practical standpoint, this pushes me into a more bifurcated position, where I am looking to play set-ups long or short, depending on what the market and the individual stocks show me in real-time.

Currently I have a solid list of possible short-sale candidates as well as a similar list of long side candidates. Lately my research and screening process has brought more short-sale targets back into focus, but there are also a number of long set-ups that continue to make it through as well.

While this could be inkling at a potential shift in this market, it is not altogether clear one way or the other. It could also be telling us that the market will trade in a choppy sideways range as we move through earnings season. In this case, the only practical approach is to take a bifurcated approach based on the set-ups you are seeing in individual stocks.

As we move through earnings season, as well, some very trade-able opportunities may emerge on either the long or short side. Buyable gap-ups, such as that seen in AYI, are one sort of opportunity. But we have also seen cases where an upside reaction to a favorable earnings report can produce a shortable gap-up (think SWKS last August), while a downside reaction can produce a shortable gap-down (think AMZN in late January).

This remains a swing-trader’s market, which necessitates a more active approach than perhaps all investors are comfortable with. If one is firmly entrenched in an O’Neil frame of mine, then one might still cling to the idea that you simply buy a breakout in a leading stock and hold out for a “big gain.”

Frankly, I don’t think this is that type of market, and the empirical evidence tends to make that point. But even strict O’Neil types can adjust by taking a more active approach to banking profits. I would, however, use a rule of 10-15% as a guide for taking profits, rather than 20% profits, which are far rarer in this market.

Occasionally you may get an SQ where a 32% gain is seen from a breakout point, but even SQ demonstrates that active profit-taking and buyback-on-pullbacks strategy is more optimal. In addition, a strict O’Neil would have missed SQ because it does not meet the earnings and sales growth requirements based on a rear-view mirror view of the stock.

Earnings roulette season will no doubt provide some opportunities, and investors should remain focused on this idea while being open to a bifurcated approach. The indexes are certainly at a point where a potential downside failure could occur. By having a few short-sale targets in mind, as well as conditions by which a current long idea might morph back into a short (as was the case with FB this past week), we are prepared for whatever number the earnings roulette wheel spins for us.

 

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 a position in FB and GDDY, though positions are subject to change at any time and without notice.

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