The Gilmo Report

April 2, 2014

April 2, 2014

A funny thing happened on the way to a deeper market correction – the S&P 500 Index, shown below on a daily chart, made a new all-time high yesterday, putting the market in the position of a de facto rally resumption. The past two days of rallying to new highs in the S&P 500 have also produced two days of declining volume. This seems like the perfect bull trap, given that the strength in the NYSE-based indexes like the S&P 500 has been primarily seen in defensive and big-cap, low-P/E names. I tend to not trust a rally to new highs in the S&P 500 when it has mostly been driven by these types of names. But I’m willing to give it a chance to develop, and so I think that if one is going to buy into this rally resumption the best strategy is to find situations where risk can be kept under control given the potential for failure.




While the S&P 500 shows its mettle by breaking into new-high price ground the NASDAQ Composite Index remains under its prior highs but has regained its 50-day moving average, as we can see on the daily chart below. In contrast to the S&P 500, the NASDAQ has seen volume pick up steadily over the past two days. Volume peaked today as the NASDAQ closed below its opening level, showing churning tendencies that resulted in a red color-coded price bar on my NASDAQ daily chart as you can see. As it stands the NASDAQ has rallied up through the 50-day moving average and up into near-term resistance, as I’ve highlighted on the chart. If I’m really going to believe this new uptrend I would like to see the NASDAQ confirm it by moving to new highs as well. So with some mixed messages here, my approach is to look at both long and short ideas as the market rallies and to take shots where I think I have good chances of making a profit and I can keep risk under control.




Over the weekend I lamented the fact that so many former leading stocks had become so oversold yet none were thus far able to produce much in the way of logical reaction rallies. For the most part, this has remained the case as a broad number of former leading stocks remain beneath their 50-day moving averages, such as Alexion Pharmaceuticals (ALXN), Facebook (FB), Workday (WDAY), FireEye (FEYE), Netflix (NFLX), Tableau Software (DATA), Biogen Idec (BIIB), (AMZN), Gilead Sciences (GILD), Celgene (CELG), Google (GOOG), SolarCity (SCTY), Qihoo 360 Technology (QIHU), Splunk (SPLK), Yelp (YELP) etc. In these situations, the 50-day moving average represents a potential area of resistance. We can see how this works in the daily charts of FB, WDAY, and BIIB, below.

FB remains well under its 50-day moving average as a three-day rally ended today in a reversal on the heaviest volume over the past three days that was also slightly above average. As we can see on the chart, FB closed near the lows of the daily trading range. Not the kind of action you’d expect from a big-stock leader as the market supposedly goes back into a “confirmed” rally.




WDAY pretty much sums up the action in the smaller, recently hot technology stocks that led the market earlier in the year. It ran right into its 50-day moving average today before turning tail and closing in the red. Volume came in well above average as sellers took advantage of the rally to unload shares. Given how oversold WDAY is, this is pathetic action in a supposed market rally.




BIIB can “represent” for the badly decimated bio-tech sector as it sums up the action for that area of the market. Not quite two weeks ago, it busted to the downside on huge selling volume near mid-March. BIIB hasn’t been able to muster up much of a rally as the 65-day exponential moving average, the black moving average on my chart, seems to be providing stiff resistance for the stock on any and all rally attempts since that big downside break nine trading days ago on the chart. Volume was lighter today, which could be seen as constructive or simply the fact that buying interest was non-existent on a day when the market is allegedly in a new rally phase.




What this leaves you with is a small handful of former leading stocks that are in a position where they have held above their 50-day moving average during the NASDAQ’s 5% correction, and I’m not sure this is enough to convince me that we are set to launch on a massively bullish move here on balance. So I’ll let things prove themselves as we go along.

In the case of bounces off of 50-day moving averages, a big-stock leader and the only one of the so-called “Four Horsemen” to hold above its 50-day line during the market’s correction, Tesla Motors (TSLA) is in play here as it bounces off its 50-day moving average on above-average volume, as we can see on the daily chart, below. As of March 14th, TSLA has 28,660,129 shares sold short, not too far off its peak short interest of 31,295,800 reported at the end of February. So if one wants to know what can power a TSLA rally here, that high short interest level might be one factor to take into consideration.

From my perspective, as I came to the realization that the S&P 500 was going to make a new high and put the market in a de facto rally resumption yesterday, I began to look at my buy watch list for big-stock leaders that were at or near their 50-day moving averages, and TSLA qualified. That proved fortuitous today as the stock rallied 6.14% off of its 10-day moving average. TSLA is extended from the 50-day line at this point, but a pullback to the 10-day line at 219.27 might offer a second entry point. I doubt very much if the stock is going straight back to its new highs, so a little backing-and-filling here might be constructive after a decent two-day move off the 50-day line.




iRobot (IRBT), which is a smaller stock that would be susceptible to getting smacked around during a market correction, provides an example of a leading stock that has held its recent breakout and its 50-day moving average during the correction. As we can see on the daily chart, below, IRBT has successfully tested the 40 price level, roughly, multiple times as it also met up with and dipped slightly below the 50-day moving average without ever violating the line. Today saw a slight increase in volume as the stock lifted off the 50-day moving average, but I would have liked to have seen some sort of pocket pivot come into play here. With the market supposedly in a new rally phase, some of these leaders should be showing strong upside volume here as they recover in order to convince me that they are viable. IRBT still remains buyable on pullbacks to the 50-day line, or even at current levels using the 50-day line as a quick downside stop.




It is fascinating to observe the sea change in the now #3 ranked solar group these days as every single solar stock that I track, from CSIQ to JASO to SPWR to TSL, has failed on a recent breakout attempt and in some cases the stocks are still underneath their 50-day moving averages. Back in late February, when all of these solar names were looking hot and breaking out, First Solar (FSLR) was lagging. Since then, however, the situation has turned 180 degrees. As we can see on the daily chart, below, FSLR broke out of a 17-week cup-with-handle base in mid-March, and then during the market correction the stock held its 10-day moving average as it quietly went about its business of building a short flag formation. This puts the stock in a position where a pocket pivot along the 10-day moving average should be watched for, but I’m actually okay buying some shares here along the 10-day moving average in anticipation of such a move, using the 10-day line as a quick exit point.




All three of the oil names I discussed over the weekend have demonstrated quite well over the past three days why you want to buy these stocks on pullbacks rather than getting sucked in on strength. Diamondback Energy (FANG), which had flashed a pocket pivot last Thursday, pulled right back into the top of its prior base and the 10-day moving average yesterday where one could have stepped in and purchased shares in opportunistic fashion. That would have worked out well as the stock moved back up again today on a successful test of that prior breakout and the 10-day line, as we can see on the daily chart, below.




Continental Resources (CLR) also pulled back to last Friday’s breakout point and the top of the Thursday pocket pivot, as we see on its daily chart, below, before bouncing today on another pocket pivot move off the 10-day line. Can oil stocks lead the market higher? I suppose we’ll get the chance to see soon enough if names like FANG and CLR can follow through on these recent breakouts and pocket pivots with further upside movement.




The smallest name among the oil stocks I discussed over the weekend, Antero Resources Corp. (AR), was also buyable yesterday on a pullback to the top of its prior base and the lows of the buyable gap-up move of mid-March. AR got as low as 61.37 yesterday, well within 2% of the 62.35 low of the BGU day. This is reasonable downside porosity for a smaller, thinner oil name like AR. If you like oil names, then narrow down your list to what you consider to be the best ones, as I did over the weekend, and look to buy them on weakness. Again, it is not really clear to me that oil names will be hot new leaders in a continued market rally, but if they present themselves at the right price points for purchase, then one can certainly take a shot or two in the group.




If the current rally resumption fails, then we will want to keep our eyes on my current list of short-sale targets. All four of the stocks I’ve been tracking on the short side undercut prior lows in their patterns last week, setting up logical “undercut & rally” moves that are approaching potential overhead resistance.

Cree (CREE) undercut the 55.76 low of early February last week, as I discussed in my weekend report, setting up the standard “undercut & rally” move that has taken the stock right back up into resistance at the 58 price level and the 10-day moving average. CREE was shortable at the 10-day line, but closed mid-range today as volume picked up, reflecting some support off the intraday lows. Ideally, I would like to short the stock on a rally that carries up to the 50-day moving average at 60.15, but this would likely only occur in a continued market rally. If the market rally fails quickly here, then the 58 level and the 10-day line at 58.01 are your likely short-sale points. The other issue is whether one wants to try and short stocks into this so-called rally resumption at all. But my view is that with the weird action and divergences in the market one could easily take the approach of treating the market as a market of stocks and not a stock market. As members know well by now, this means taking things on a stock-by-stock basis, evaluating the trade, either long or short, on its merits while paying less attention to the action of the general market.




Pandora Media (P) also undercut its own early February low at 30.93 last week and proceeded to rally back up into resistance, as we can see on its daily chart, below. P pushed beyond the 10-day moving average today after an analyst firm “sampled” some “sequential improvement” in the company’s “audio ad load,” whatever that is. In any case, the rally was short-lived as P rallied right up into its 20-day moving average before turning tail and closing down on the day. I would use any further rallies from here into the 20-day moving average at 32.90 as short-sale opportunities.




Stratasys (SSYS) benefited from an analyst upgrade this morning to gap above the neckline of its head and shoulders formation before stalling out and closing below mid-range on the day on heavy volume, as we can see on the daily chart, below. This is typical behavior for a stock on an “undercut & rally” type of move after the stock dipped below its early February low last week. SSYS’ neckline in the H&S pattern is around the 110-111 area, more or less, and today’s rally took the stock up above the 114 level, about 2% away from the 50-day moving average. In my view this becomes a shortable area using the 50-day moving average as your ultimate upside guide for a stop.




LinkedIn (LNKD) undercut the 185.03 low from mid-February last week, resulting in an “undercut & rally” right up into its 10-day moving average, where I viewed the stock as shortable per my discussion of LNKD in this past weekend’s report. So far the 10-day line has presented consistent resistance for LNKD, and that was the case again today as the stock staged an outside reversal on light volume, as we can see on the daily chart, below. I still view the stock as shortable on rallies up into the 10-day line, using that as your upside guide for a stop. LNKD reversed today on light volume, which probably reflects weak buying interest in the stock. If the market is able to sustain a new rally phase, then LNKD probably might just bounce around for a while longer, but I believe any kind of rally failure would likely set the stock up for a move lower. In any case, I am willing to stay short the stock here until it proves to me that it can clear the 10-day line on the upside.




As I wrote over the weekend, one did not want to get locked into a bullish or bearish frame of mind coming into the trading week. Because so many leaders have been so oversold for so long, a sharp reaction bounce is something I’ve been looking for. However, most of what we are seeing in this regard are weak bounces up into the 50-day moving average while only a scant few former leaders that held above their 50-day lines provide us with any kind of downside selling guides and reference points in case the rally fails.

As I survey my short and long screens and watch lists, I see a very mixed bag of potential opportunities. Thus my approach shifts to one of taking things on a stock-by-stock basis and evaluating opportunities both long and short based on the merits of the trade alone. In the meantime, I would like to see the NASDAQ confirm the S&P 500’s move to new highs as a sign that the market is returning to normal health after the March correction. Otherwise I remain skeptical of this new rally resumption and will continue to take a two-sided approach as reasonable opportunities arise.


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

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