The Gilmo Report

April 11, 2012

April 11, 2012


The NASDAQ Composite Index broke hard along with the rest of the general market averages Tuesday, but found logical support right around its 50-day moving average, as we see on its daily chart below. This was followed today by a big gap-up opening that churned around all day and closed below where it opened up, accounting for the red color on today’s price bar, which indicates a lower close relative to the open. Volume was tepid on the gap-up, which comes off looking as if it were “phonied up” to some extent. The next few days will reveal the truth, but the amount of distribution concentrated over the past two weeks is not a positive sign for the market, although there remain some leading-stock hold-outs. However, we have seen more leaders getting smacked off of their recent price peaks. Overall my tendency is to consider that the recent action looks weak enough to take us down to around 2900 on the NASDAQ, as I see it, and a break of the 50-day moving average on the NASDAQ would confirm this.


NASDAQ Gilmo Report Chart

This argument is supported by the action in the S&P 500 Index, shown below on a daily chart, which busted through its 50-day moving average on heavy volume yesterday. Today the index gapped up and rallied back up into its 50-day moving average on weaker volume, so this comes off as little more than a simple reaction rally. Near-term the 50-day line becomes resistance while a potential test of support down at the 1340 level looms. Sentiment-wise I think the crowd wants to buy the pullback, as the Investors Intelligence survey of Invesmtent Advisers shows 21.5% bears, the lowest since just before last August’s market plunge. The American Association of Individual Investors also shows low bearishness, and while individual investors are less bullish than the advisers, the lack of bearishness implies a sort of complacency. As I discussed in my report of April 1st, the low levels in the Volatility Index ($VIX), not shown, are also indicative of a certain level of complacency. This week has seen the VIX spike from these levels, and we shall see if this portends further volatility ahead.

S&P 500 Gilmo Report Chart

Trying to find individual stocks to sell short is not a simple matter since most short-selling set-ups are still in the early phases, assuming they are at all. An example would be something like big fertilizer stock CF Industries (CF), which I have previously liked on the long side way back in early January when it first gapped up and staged a bottom-fishing pocket pivot up through its 50-day moving average. Since then CF has gone on to form a big, sloppy, improper double-bottom type of formation that also has the look of a Punchbowl of Death (POD). Over the weekend I noted some POD-like structures in Cummins (CMI) and Caterpillar (CAT), which have broken down further since then. CF is just starting to teeter a bit at its 50-day moving average, as we see on the daily chart below. The stock has broken its 50-day moving average twice before on heavy volume, but each time recovered and closed back above the line. Yesterday’s action carried below the 50-day line and represents an actual 50-day moving average violation. Today the stock rallied back up into the 50-day line where it ran into resistance on weak buying volume. This is something that is testable on the short side, with the idea that it will not rally much past the 50-day moving average, certainly not more than 3-5%.

CF Industries (CF) Gilmo Report Chart (AMZN) has been setting up for a long time in a big, ugly head and shoulders type of formation where the second right shoulder has exceeded the peak of the first right shoulder but still topped out well below the peak of the left shoulder, as the daily chart below shows. AMZN has flopped back below its 200-day moving average and is now resting on top of its 50-day moving average. I think that if AMZN breaks the little rising lows trendline I’ve drawn on the chart, it could make a break for the neckline of the H&S pattern and so would be potentially shortable, so this is something to watch for from here. AMZN ran up above the 200-day line on big volume going into the end of March, but this is not uncommon for the right shoulder of an H&S pattern – often the stock’s action can look pretty good as it moves higher to form the peak of a right shoulder, as AMZN has done. Now the question is whether it will break support levels and begin to plummet further from here. That likely depends on the action of the general market, so I would keep a close eye on AMZN here as a short-sale target. It is certainly one former big-stock leader that has acted weakly throughout the rally phase so far this year, and would likely be the one to break in the event of further market weakness. (AMZN) Gilmo Report Chart

This is a short report in light of the market conditions. As I wrote over the weekend, a 7-8% correction would not be the end of the world, and it may be something the market needs to undergo if there is to be any further upside progress in the cards for 2012. Leading stocks can correct 11-12% as a matter of course during longer-tem, overall upside price moves, and so far this week we’ve seen Apple (AAPL) pull back to its 10-day moving average, (PCLN) close below its 10-day moving average for the first time since this market rally began, and Intuitive Surgical (ISRG) violate its 10-day moving average, which it did today. If this pattern continues and leading stocks issue short-term sell signals by, for example violating their 10-day or 50-day moving averages, then more downside is likely in store for the market. This is how 7-8% intermediate corrections happen. Whether this turns into something worse than that remains to be seen, so for now it is possible to let the situation develop while, if one is so inclined, testing or being alert to a couple of short-sale targets like CF and AMZN. Otherwise the short-side remains nascent at best, but things can start to develop quickly if the market starts to unravel further. Given the weak bounce today, one possible strategy would be to buy inverse, leveraged index ETFs into the bounce with the idea that the NASDAQ will eventually bust its 50-day moving average and test the 3900 level, and that the S&P 500 will fail at its 50-day moving average and test the 1340 level. In each case yesterday’s intra-day high would be a quick-stop on the upside.


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, Virtue of Selfish Investing, LLC, and/or Gil Morales & Company, LLC held a position in CF, though positions are subject to change at any time and without notice.

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