The Gilmo Report

April 15, 2012

April 15, 2012


While it doesn’t paint a picture of loveliness, the NASDAQ Composite Index, shown on a daily chart below, remains the market’s leading index. But then that’s only because the others look downright ugly. The NASDAQ has been able to bounce off of its 50-day moving average, but as I wrote in my Wednesday report the bounce was logical coming off of the 50-day line. Weak volume accompanying the bounce made for a poor showing of strength and support at the 50-day moving average, and so Friday’s action saw a tiny pick-up in volume as the index set about retesting the 50-day line. Whether it goes through it next week remains to be seen, but I am willing to bet that it does. Downside volume appears to be dominating the action over the past month, almost, as the blue upside volume bars in the chart have remained quite small relative to their taller red downside volume brethren. While trying to project where the market might go from here is always an inexact science, the market’s correction remains in force until we see some sort of attempt at a follow-through, which technically could happen on Monday given that we are still three days in a rally attempt off of this past Tuesday’s lows. The market has done stranger things, but such a move would probably need some sort of catalyst, in my view. Nevertheless it remains an outside possibility given the position of the indexes.

NASDAQ Gilmo Report Stock Chart

While the NASDAQ tests its 50-day moving average, the weaker S&P 500 Index, shown below on a daily chart, rallied back above its 50-day moving average on Thursday before dropping back below the line on heavier volume Friday. Like the NASDAQ, the S&P 500 is in a position for a fourth-day follow-through, although it too looks like it is more likely to move lower from here. As I wrote in my Wednesday mid-week report, a test of 2900 on the NASDAQ and 1340 on the S&P 500 looks possible, certainly as much as a fourth-day follow-through. However, the action of the market going into Friday’s close as it suddenly gave up the ghost and broke to new intra-day lows in the last half-hour, virtually retracing all of the prior day’s upside move on the S&P 500 while retracing all and more of the prior day’s upside move on the NASDAQ tends to argue for further weakness. So while I am quite cautious here I am also open to the idea that this correction could also end with a follow-through in the next few days. With earnings season moving into full-force this week, there could be a number of catalysts either way, so it will not pay to cling to any particular outcome – just let the evidence play out and present itself in real-time.

S&P 500 Gilmo Report Stock Chart

The broadest major market index, the NYSE Composite, is the weakest index of them all as it is down 9% from its recent peak, far more than the 3% that the NASDAQ and S&P 500 are, and just one percent ahead of the Russell 2000, a broad small-cap index that is down 8% from its recent peak. On the daily chart of the NYSE Composite, below, we can see that it, like the Russell 2000, is well below its 50-day moving average and undercut its prior March low on this past Tuesday. This set up a logical “undercut & rally” type of situation, which is what occurred. NYSE volume picked up ever so slightly on Friday as the NYSE Composite rolled over, and appears primed to test Tuesday’s lows. The ugliness of the index charts as I’ve shown them here has not escaped the attention of the investing public. For example, the American Association of Individual Investor’s sentiment survey showed a strong spike in bears to 41.6%, up sharply from where it was last week around 28%. Is this a bullish development? The best way to find out would be to see a fourth-day or later follow-through if the market can hold above the Tuesday low this coming week.

NYSE Composite Gilmo Report Stock Chart

I suppose a two-day market bounce wasn’t going to make it three-in-a-row if it didn’t have the help of Apple (AAPL), the market’s “ultra-glamour” bi-stock leader. As everyone knows, and no one doubts, it appears, AAPL will soon be trading at $1,000-a-share. But charges of e-book price-fixing from the U.S. Department of Justice have laid such visions of sugarplums aside as the stock has cruised below its 10-day and 20-day moving averages. On Thursday it closed a few cents below its 10-day moving average, and then on Friday continued lower, violating the 10-day and piercing through the 20-day. The latter is shown as the green line on the daily chart below, which the stock has bounced off of twice in 2012 without ever penetrating. Will the DOJ’s targeting of AAPL send it down on a test of the 50-day moving average? Is the idea that AAPL has no place to go but to $1,000 a sign of complacency among AAPL buyers and holders? If you don’t count Thursday’s close of just a few cents below the 10-day line, then a move below Friday’s intra-day low at 603.51 would constitute a 10-day moving average violation and a short-term sell signal.

Apple (AAPL) Gilmo Report Stock Chart

When it comes to 10-day moving average violations, Intuitive Surgical (ISRG) offers an interesting nuance and twist on the concept since it did issue a 10-day moving average violation on Tuesday, as we see on the daily chart, by moving below the intra-day low of the prior day which was itself the first close below the 10-day line. Notice, however, that the two days closing down below the 10-day line on Monday and Tuesday also closed in the upper part of their daily trading ranges, implying support, and Tuesday’s close remained above the intra-day low of Monday’s close. So ISRG held on by the skin of its teeth by faking a 10-day moving average violation and then on Thursday came through with a continuation pocket pivot buy point. This is an example of how the 10-day moving average is not a panacea, and shakeouts can occur. Therefore if one can stand the additional risk one could wait until the close to see if the stock shakes out as ISRG did on Tuesday.

Intuitive Surgical (ISRG) Gilmo Report Stock Chart

One argument in favor of a possible end to the current correction and the potential for a follow-through in the coming days might be found in the action of the leading stocks. Leading stocks can pull back 11-12%, on average, during overall upside moves, and most leading stocks have not gotten there yet. Some have even pushed to higher highs, such as our favorite LinkedIn (LNKD), shown below on a daily chart. LNKD flashed a pocket pivot buy point on Thursday on an analyst’s upgrade, and on Friday the stock pushed a bit higher. This move is coming on volume that is average or just above average, and since it does represent a potential breakout from LNKD’s big base extending back to last August I would prefer to see some meaningful volume come in here on any breakout. LNKD announces earnings later this month, and it may be that earnings will provide the big-volume catalyst that sends LNKD launching out of this base, or not.

LinkedIn (LNKD) Gilmo Report Stock Chart

Aside from the few short-sale set-ups I’ve discussed in recent reports, there is not a lot to be found in this regard. However, if the market is indeed going into a more significant correction we would expect to see more and more leading stocks break down and begin to set up in potential short-sale formations. While Head & Shoulders formations are far and few between, the positions of a number of leading stocks are similar to F5 Networks (FFIV), shown below on a daily chart. I’ve previously mentioned POD-like formations in Caterpillar (CAT) and Cummins (CMI), those massive cup formations that are more like giant Punchbowls of Death, and these stocks have broken down further from the right sides of these POD-like formations. FFIV is another one that is breaking down sharply ahead of earnings this coming Wednesday. The stock has gapped down below its 50-day moving average on very heavy volume and has tracked sideways over the past two days as it engages in what I might term a “dead cat splat” with little to no bounce. FFIV’s earnings and sales have been decelerating sharply over the past four quarters in sequence at 69%, 57%, 47%, 34%, and 17% while sales have decelerated from 46% seven quarters ago to 41%, 35%, 26%, 24%, and 20% in the ensuing quarters.

F5 Networks (FFIV) Gilmo Report Stock Chart

I also notice on FFIV’s weekly chart, below, that the rally off the lows over the past six months or so has come on less and less volume – essentially a giant wedging uptrend. This past week saw the stock’s selling volume spike in sharp contrast to the prior four upside weeks where the stock shows a bit of stalling action on the weekly price bars with volume almost non-existent. Goldman Sachs came out on Friday and recommended buying FFIV into earnings, but it appears that investors are choosing to sell FFIV into earnings next week. Will the stock be resurrected as a result of earnings, or will that be the final nail in the coffin after this past week’s terrible price/volume action? Using the 65-day exponential moving-average as a quick upside stop in the 128-129 price area, I would look for FFIV to break down further going into Wednesday’s earnings, so I’m basically looking for a three-day trade on the short-side here, probably down closer to the 110 price level. Even with Goldman Sachs urging investors to buy into FFIV before earnings, the stock does not seem to be getting any lift here at all. The other option here is to wait for earnings to see if the stock does get a bounce, which I would expect to carry up into the 10-week/50-day moving at 128.55, at most, to short into.


FFIV represents the type of leadership breakdown that argues in favor of further correction in the general market indexes, while those leaders that act well, issuing pocket pivots or buyable gap-ups as we’ve seen in LNKD, ISRG, Tractor Supply Co. (TSCO) and others this past week might argue for a follow-through this coming week and a resumption of the market’s uptrend. However, market breadth shows that fewer and fewer stocks are leading the market, so we might expect to see more emerging leaders step up to the plate if the market is going to resume its uptrend. The bottom line for me right now is that the market is on the fence right now, as I see it, and while I see no reason to deploy fresh capital here I also see no reason to expect that the market is on the verge of blowing apart. The situation is still developing, and with earnings season coming into full bloom there are catalysts for both the upside and the downside in individual stocks. Thus it becomes a matter of watching individual stocks. If the market rolls over again, I see the 2900 level on the NASDAQ and the 1340 level on the S&P 500 as initial support. And with these indexes only about 3% off of their peaks, we must also consider that another 4-5% on the downside would be normal for an intermediate-correction. Keep in mind that markets don’t always have to top at once, as the NASDAQ daily chart from 2011 shows.

Tractor Supply Co. (TSCO) Gilmo Report Stock Chart

From October 2010 through February 2011, the market had a nice run, not unlike the run we’ve seen since late December 2011 to the present, and began to wobble in late February 2011. This led to a decent intermediate-term correction and the market then turned around and went to higher highs in late April before correcting sharply again, only to turn around once more and move to even higher highs in early July before blowing apart in early August. You can see that there are playable downtrends as the market corrects off of each of the peaks in February, April, and July, but these are of measured duration. Before the phenomenon of QE adorned the markets with endless liquidity, market breaks off the peak such as those seen in July and October of 2007, January 2005, January 2004, or March 2000 were quite abrupt and sharp to the downside. In my view, QE3 will eventually have to show up somewhere, since with continued fiscal deficits in the neighborhood of $1.5 trillion somebody will have to buy up all the Treasury debt issuance needed to finance these astronomical deficits. The Fed purchased 61% of Treasury debt issued in 2011, and with even more required in 2012 it is not clear to me, at least, who or what is going to buy all this new Treasury debt if it isn’t the Fed. It’s not like they are going to hold a bake sale to finance the government’s spending addiction. Meanwhile, August 2011 shows that QE does not always provide a floor underneath the market, and if the Fed stands pat, keeping its proverbial powder dry and waiting to act on QE3 until it absolutely must, the market could continue to correct. For now, all we know for sure is that the market remains in a correction of unknown duration, but I would not assume that a bear market is starting any more than I would assume that another round of QE is coming AND that it will propel stocks higher.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC
Principal and Managing Director, MoKa Investors, LLC
Principal and Managing Director, Virtue of Selfish Investing, LLC

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