The Gilmo Report

April 13, 2014

April 12, 2014

The market’s reaction rally and bounce, led by the S&P 500 Index’s bounce off the 50-day moving average on Wednesday, gave way in short order Thursday as the S&P 500 blew through its 50-day moving average on huge selling volume, as the daily chart below illustrates. I wrote in my report of this past Wednesday that after the sharp upside rally on that day we were essentially “watching and waiting” to see whether the bounce developed into something more substantial on the upside or whether it would soon fail. As it turned out, we didn’t have to do much watching or waiting as the market immediately failed on Thursday, reversing from an early-morning rally attempt before blowing to the downside on heavy selling volume. As we can see on the daily chart, below, the S&P 500 is now going “code red” as the longer-term weekly Bongo indicator at the top of the indicator bars that adorn my charts joins the party and finally turns red, a development that is generally indicative of further downside. With the S&P 500 blowing through its 50-day moving average over the past two days the 200-day moving average comes into play as the next potential area of support.


GR041314-SPX Daily


With the S&P 500 and the NASDAQ Composite Index engaged in a race to their respective 200-day moving averages, we might surmise that the NASDAQ is in the lead. The NASDAQ moved to a lower low on Friday, as we can see on the daily chart below, and is not far from the 200-day moving average and the early February low, which might, emphasis on might, provide some sort of short-term support level. So far, however, support levels have merely served as downside milestones for the indexes to break, and one cannot make any assumptions.

All we need to know for now is that the market indexes are in clear downtrends, but leading stocks told us all we needed to know in early March, well before all of the current carnage came to pass. And those who, in their need to sound smart on financial cable TV, tried to pass off “rotation” into stocks that were nothing more or less than lower-P/E, slower, big-cap defensive types of names as “constructive” have been proven to be dead wrong. In my view, this rotation was indicative of a mass movement by institutions into a “hunkered down” position as they seek to hold up relatively better than the rest of the market, and I have articulated this phenomenon repeatedly over the past six weeks. The writing was on the wall, and while it certainly wasn’t necessarily obvious in the indexes, it was certainly obvious in the action of individual leading stocks. Again, the stocks tell you all you need to know well before the indexes do, and at this stage stocks need to start showing me that they are stabilizing and setting up in constructive, buyable positions within their chart patterns before I can get positive on stocks again. For now, finding such set-ups is akin to finding a needle in a haystack.




As stocks were pummeled again this past week, gold trended further above its 200-day moving average, as we can see on the daily chart of the Gold Index ($GOLD) below, and is now back above its 50-day moving average. I wrote last weekend that with gold re-taking its 200-day moving average one could take a position in the yellow metal via the SPDR Gold Shares (GLD) ETF, for example, and use the 200-day line as a tight stop since a resumption of the upside move in gold must by definition hold above the line. Hence if one is interested in owning gold then buying as close to the 200-day line while simultaneously using the line as a quick downside stop is the low-risk way to go about it. With gold now back above the 50-day line, that can serve as a selling guide in the same manner if one is hot to buy gold here, just above the $1300 price level. What I find interesting is that when stocks sell off they usually take everything down with them, including commodities, as forced selling and the overriding need to meet margin calls takes holds. Over the past week gold counter-trended stocks, and this has been fueled by a huge gap-down move in the dollar on Tuesday following the release of the Fed’s “QE-forever” meeting minutes




A chart of the U.S. Dollar Bullish Fund (UUP), a close proxy for the dollar, shown below, reveals that the dollar gapped down off of the peak of a short-term reaction rally on Tuesday, a day before the Fed meeting minutes were released, and is now right at the March lows. If one looks at charts of M1, M2, and M3, the three different measures of money supply, not shown, it isn’t hard to see that both M1 and M2 have been shrinking since late 2011 while M3 is roughly flat over the same period. QE Forever isn’t working, and the continuous need to print dollars as declared by the Fed on Wednesday will only serve to debase the dollar, perhaps sooner than later.




The chart of the M1 Money Multiplier put out by the St. Louis Fed, below, shows the multiplier moving to an all-time low. Thus QE seems to have very little effect in growing the money supply while errant economic policies and regulations keep economic activity and hence the velocity of money in a tepid state. The essential definition of the money multiplier is “the expansion of a country’s money supply that results from banks being able to lend.” The money multiplier provides a de facto indication that banks are hoarding cash, and have not become confident enough, at least in their actions, to lend it out in any meaningful way. In my view, none of this is positive news for the economy, and the idea that the economy is “recovering” in the face of such weak money supply growth and multiplier numbers strikes me as a hopeful fantasy. Perhaps this is when gold disconnects from stocks and other asset classes as the dollar collapses and drives investors into alternative currencies. Food for thought, I suppose, but I can’t say that any of this looks good.




LinkedIn (LNKD) ran into stiff resistance at the 10-day moving average and the descending neckline of its long head and shoulders formation, as we can see on the daily chart, below. I discussed this as a shortable position in my report of this past Wednesday, and the stock has pulled down over the past two days as it looks to retest the lows of this past Monday. If you are short the stock at the 10-day moving average or higher in the pattern based on my numerous discussion of LNKD as a short-sale target over the past several weeks, it is still a short, using the 10-day line as a trailing upside stop.




The weekly chart of LNKD, below, gives us a better picture of the Monday undercut of the base that the stock formed between May and July of last year. This past week’s price action shows the stock stalling on a bounce attempt as it closed tight with the prior week’s close, a sort of bearish tightness in the pattern that appears to argue for the fact that the stock is merely and only likely to be building a short bear flag here before moving lower.


GR041314-LNKD Weekly


Cree (CREE) is testing the lows of the past couple of weeks as the indicator bars along the top of the daily chart, below, go “code red.” If you study the chart carefully you will notice three rallies up into the green 20-day moving average over the past two weeks that have all failed to produce further upside. For now the 20-day moving average provides a ready reference point for a trailing upside stop as the stock starts to look like it wants to “break out” to the downside. Earnings will be announced within a couple of weeks, but there is a good chance CREE will break down before then.




The weekly chart of CREE, below, gives us a nice macro-view of what exactly going on. We can see quite clearly that not only is CREE bumping along the lows of the past two weeks, but it is also bumping along what has been a more intermediate to longer-term area of support right around the 54-55 price area. We can easily make out the two-headed “hydra and shoulders” formation as well as a sort of “reverse” cup-with-handle formation with the last three weeks forming the reverse handle as well as a sort of bear flag three-weeks-tight formation. Notice also that each weekly price range over the past three weeks has a long upper “tail” and then closes at the lows of the weekly range. If you turn the chart upside down and look at it in a mirror, you would probably see the pattern as very bullish in reverse. Thus the set-up on the weekly chart looks to me like an impending “breakout” to the downside and through the neckline of what is an 11-month double head-and-shoulders topping formation is likely at hand. CREE is still short here using the 20-day moving average at 57.38 as your maximum upside stop, although I might prefer to use Friday’s intra-day high at 56.27 as a tighter stop.


GR041314-CREE Weekly


I have frequently and jocularly tweeted to members recently that Pandora Media (P) is now known as “P is for Pounded,” and the stock continues to live up to that comedic moniker by moving ever lower, as we can see on the daily chart below. After reaching our first downside price target on Monday when it finally reached its 200-day moving average as I have specified in previous reports, P became shortable once again near the 30 price level as I discussed in this past Wednesday’s report. That was a good spot to re-enter a short position on the stock, and it rewarded those who did so by plummeting back below its 200-day moving average to fresh lows on Thursday and Friday. This was accompanied by heavy selling volume, and with the stock back below the 200-day moving average, this now becomes your trailing stop on any P short position.




The weekly chart of P, shown below, illustrates a phenomenon I am seeing in a broad number of former leading stocks over the past few weeks. As P is actually rounding out the right side of a “head” within what is likely a longer-term head and shoulders topping pattern, we can see that over the past three weeks the stock has closed right at or near the lows of each weekly price bar. Rally attempts both this past week and the prior week have reversed and closed at the lows as P finally plummeted through its 40-week moving average on huge selling volume this week. In the past, when I’ve seen a stock in an uptrend where it closes at the peak of the weekly range for 3-5 weeks or more on heavy volume, I have considered that to be very bullish action. One example I can think of is (AMZN) back in March of 2003 when it closed at the peak of its weekly range five weeks in a row, had one pullback to the 10-week line and then more than double from there over the next six months. Conversely, I have to consider a pattern where a stock in a downtrend closes three weeks or more at the low of the weekly on heavy volume as very bearish action. P is just one example of this type of bearish weekly price/volume action as there are numerous others out there in this current market environment, which, any intermittent upside reaction bounces notwithstanding, likely argues for further downside in this market.


GR041314-P Weekly


Another even more bearish example of this type of weekly price/volume action can be found in the weekly chart of Celgene (CELG), below. While P has closed three weeks in a row at the lows of the weekly price range on heavy volume, CELG has outdone P in this regard by closing at pretty much the absolute low of the weekly price range five weeks in a row. The past two weeks have seen the stock try to rally back up to its 40-week moving average only to reverse and close at the weekly lows on heavy selling volume. This past week’s selling volume was huge as the 10-week moving average moved below the 40-week moving average in a classic “black cross.” You might also notice that CELG is sitting just below the neckline of a head and shoulders pattern that extends back to October of last year.

It looks to me like CELG is on the verge of plummeting to the downside from here, perhaps closer to the 120 price level. The best way to test that theory is to take a short position on any bump up to towards the 140 price level using the Friday intraday high at 142.70 as a quick upside stop. The stock closed at 136.90, so if no bounce is forthcoming one might consider just shorting the stock given that you’re looking at a 4-5% upside stop for those who can handle that. This just looks ugly to me, and if there is by chance some sort of sharp rally in the stock back up to the 40-week line I would consider that imminently shortable based on the weak weekly price/volume action over the past five weeks. CELG is expected to announce earnings within the next two weeks.


GR041314-CELG Weekly


Stratasys (SSYS) is another short-sale target that rallied only briefly with the general market on Tuesday and Wednesday after undercutting the 100 initial downside price target we had for the stock, as we can see on the daily chart below. SSYS was first shortable on the rally up to the 50-day moving average two weeks ago, per my reports at that time, but now it is breaking out to the downside and one can be short the stock here using the 100 price level as a guide for an upside stop.




SSYS’ head and shoulders is much more discernible on the weekly chart, below, where we can see that the stock has broken through the neckline of the H&S formation on huge selling volume. SSYS doesn’t report earnings until sometime in mid-May, but my guess is that the stock will be well below 90 before then. SSYS is another example of a stock that is saturated with institutional ownership, similar to LNKD, which has over a thousand funds owning about half of the 104 million share float. SSYS, as of the last reported period at the end of December 2013, had 414 funds owning 17 million shares, a fair bit more than half of the 39 million share float. First quarter 2014 institutional ownership data isn’t out just yet, but my guess is that we will begin to see an exodus of institutional money out of SSYS that will send the stock lower as has been the case with Three-D Systems (DDD), not shown, a stock I was trying to short at the peak of a right shoulder at around $80 in late February but for which I could never obtain a borrow. SSYS has been intermittently borrowable, but for those who are experienced using options, buying puts on SSYS is another viable way to play further downside in SSYS.


GR041314-SSYS Weekly


Goldman Sachs (GS) hit my short-term downside price target on Friday, undercutting the 152.83 low of early October 2013, as we can see on the daily chart, below. Since the stock was a short at around 163 per my discussion of GS as a short-sale target in last weekend’s report, I am perfectly happy to bank my profits on that position here. The stock may move lower from here, and if the general market continues to get smacked as I tend to think it will, the odds of that happening are pretty good. But going into GS’ expected earnings announcement next Thursday I consider a bird in hand to be worth two in the bush at this stage. As well, there have been plenty of other short-sale targets to go after in this market, as this report illustrates quite nicely.




As far as I’m concerned, this market remains in trouble. The selling in former leaders has been characterized by a deliberate, methodical persistence that has shown virtually no let-up as many former leaders are decimated. About three weeks ago I received an email from someone who was adding to their FireEye (FEYE) position at the 10-week moving average given that this was the stock’s first pullback to that moving average since its big buyable gap-up move in early January. In my view, buying FEYE at the 50-day line was based on what I consider to be the imprecise application of O’Neil-style rules. At that time FEYE was trading at around 78. I had already discussed the stock as a clear sell following the huge-volume gap-down off the peak and the 50-day moving average violation in my March 23rd report, but this individual decided that they were playing the stock for a “long-term move.”

This illustrates the hard reality that if one blindly follows the “rules” of the O’Neil strategy without considering the contextual aspects of the stock’s overall action and the general market one may experience severe pain. As the daily chart of FEYE shows below, the stock that this person bought at the 50-day moving average and the 78 price area is down nearly 40% from there as it now moves below the intraday low of its early January buyable gap-up day. While the O’Neil-style methodology can be very rewarding on the upside, you can lose a lot of money on the downside if you don’t know what you are doing and fail to have some method of managing risk in what are inherently risky and more volatile high-growth stock situations. FEYE is now 51% below its prior all-time high achieved in early March, so it took the stock just over 4-5 weeks to achieve such a severe breakdown. This is a burst bubble, and when bubbles like this burst, a stock that is down 50% can easily go down another 50%.




I remember after the top of the big dot-com bubble market in March of 2000 Bill O’Neil said to me: “Watch – people are going to be shocked at how low some of these stocks go.” Shock might be an understatement as we saw names like big-stock technology stalwart Cisco Systems (CSCO) hit a peak of 82 in March of 2000 and then trend down to around 40 over the next year where it was hailed by market guru Elaine Garzarelli as an “incredible value play.” CSCO finally bottomed at 8.12 a share in late 2003. Another favorite example of just how dangerous sitting too long in a former leader can be, even a stalwart big-stock tech leader like CSCO, is seen in one of the biggest of the big-stock semiconductor names, Micron Technology (MU), shown below on a weekly chart from the 2000-2003 market period. MU hit a peak of 97.50 in early 2000, and in three years’ time it finally bottomed out at 6.60.

What all of this speaks to is the simple reality that without a well-considered selling plan and some basic rules such as we employ with the Seven-Week Rule as described in the book I wrote with my colleague Dr. Chris Kacher, “Trade Like an O’Neil Disciple: How We Made 18,000% in the Stock Market” and the follow-up book, “In the Trading Cockpit with the O’Neil Disciples,” one is destined for doom in the stock market, especially if one traffics in the types of stocks that are typically exploited using O’Neil-Wyckoff-Livermore (the “OWL” as we refer to them) investing methods.




I believe it is a fair question to ask whether we are seeing the beginning of the end for what has been a five-year bull market phase pushed along by the most extreme, off-the-charts, monetary stimulus and propping seen in the history of mankind. While the bubble of March 2000 popped and resulted in a brutal, three-year bear market, one can only imagine what a popping of an even larger, tauter bubble might produce on the downside. But all of that is mere speculation, and trying to predict what sort of macro-trends might emerge over the next several months is not necessary for the purpose of making excellent profits on the short side of this market. This breakdown off the peak, while still really in a relatively early stage, has produced some outstanding downside moves and profits so far in our short-sale target stocks.

My tendency here is to consider that the action we’ve seen over roughly the past six weeks is the first shot across the bow in what may be the start of a new and potentially severe bear market. That seems to be what the market’s message is telling us right now, but in the meantime we only need to pay attention to what the stocks are telling us in real time. For now that message is that further downside is likely, short reaction rallies and bounces notwithstanding, until new evidence to the contrary presents itself. In this environment, cash remains king, but short-selling has become the emperor!


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

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.