The Gilmo Report

April 9, 2014

April 9, 2014

I wrote over the weekend that “At this stage the S&P 500 looks to me like it is set to test its 50-day moving average down at 1838.07.” This occurred yesterday after several of my short-sale targets had undercut or hit their downside price targets, most notably LinkedIn (LNKD), which undercut the 160 level on Monday. Given that this was the near-term downside price target for the stock, one would automatically cover the position, looking to re-short on a bounce. Again, the stocks told you what was going on before the indexes did, as the S&P 500’s test of its 50-day moving average resulted in a bounce that seems to fit in with the current scenario. With so many leading stocks so extremely oversold and decimated, all it takes is for the S&P 500 to find support at its 50-day line to generate a bounce.

Throw in the Fed meeting minutes which were taken as an indication that the Fed was not as hawkish as they might have come off as a couple of weeks ago, and you have the ingredients for a very logical, very textbook reaction rally. And in my view this all makes perfect sense as my short-sale targets for the most part all hit their downside targets on Monday. Thus it was a simple matter to cover there and stand back as I look to test the rallies on the short side as the market bounces.

 

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The NASDAQ Composite Index remains in “no-man’s land” between its 200-day and 50-day moving averages, as we can see on the daily chart, below, but after getting shellacked this past Friday and Monday the index was due for a reaction rally. That started yesterday in conjunction with the S&P 500 bouncing off of its 50-day moving average, and now we see a two-day wedging rally back up towards the 50-day moving average. The index could push further and meet up with the 50-day moving average, so the situation remains fluid here until we see some sort of failure. In the meantime, unlike other times over the past year where we have seen the market rally sharply off of its correction lows, there are virtually no leading stocks in buyable positions. In prior bottoms, such as in late January and early February, a number of leading stocks were setting up. This time around, I see nothing that I consider actionable on the long side, unless one is interested in trying to trade short-term bounces off the lows in some pretty ugly patterns that litter this market.

 

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The “undercut & rally” phenomenon in short-sale target stocks was really the thing to keep an eye on, as I believe investors should operate according to what the stocks are telling them, relying less on the indexes as something to key off of. This has been the predominant theme of my approach as I’ve discussed in numerous prior reports over the past five weeks. Individual stocks have been the most reliable indicators of where things are going in this market, and so far I see no reason to change my approach in this regard. And on Monday, with short-sale targets hitting their downside price targets, these stocks were telling you that the market was setting up for a potential bounce. This is why one must maintain their short-side discipline, even in the face of a very ugly sell-off on Monday where the indexes closed at or near their lows, and cover short positions when the stocks hit the prescribed downside profit target. Bulls make money, bears make money, and pigs get slaughtered. Avoid the temptation to get “piggy” and stick to your shorting plans and profit targets.

As I wrote at the outset of this report, on Monday my biggest and most favorite short-sale target LinkedIn (LNKD) undercut the 160.20 low of the base it formed between May and July of last year. Since that was my near-term downside price objective on the short position, that was a cover point. Notice now how LNKD has rallied sharply from that point as we can see on the daily chart below. This is pretty standard behavior for short-sale targets on an “undercut & rally” type of move. With LNKD pushing up into the 10-day moving average at around 178, I initially look to short the stock anywhere between today’s close and the 10-day line on this bounce, using the 10-day line as my quick cover point. Notice that this also coincides with the “neckline” of the rolling tops head and shoulders formation LNKD has been working on since last September. This is an additional reason why I look at the 176-178 price zone around the 10-day line as a possible short-sale zone on the undercut & rally move. If the stock continues higher from there then I use the 20-day moving average at 183.97 as my next reference point for trying to re-enter on the short side. The key here is to test these rallies with small positions, looking to get heavier if the stock’s price/volume action confirms that the “undercut & rally” reaction bounce has run its course.

 

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Cree (CREE) undercut the late March low of 54.45 on Monday, as we can see on the daily chart below, and has embarked on what is so far a two-day rally up towards the first point of resistance at the 20-day moving average, currently at 57.78, and the 58 price level where I see definite resistance on the upside. The stock can give way sooner, however, depending on how strong the undercut & rally move is, and in CREE’s case this has been fairly weak so far given the extremely light upside volume we saw today. Thus I will start to test the stock on the short side as it moves up into the mid-57 price range. The next point of resistance in the pattern is up at the 50-day moving average at 59.49, which isn’t really all that far from today’s close. CREE is expected to report earnings on April 22nd.

 

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Over the weekend I discussed the fact that Pandora Media (P) had hit its 200-day and 40-week moving averages on the daily chart and the weekly chart, respectively, on Friday of last week. This was my first downside price objective for the stock as I’ve discussed in the past several reports. The stock has since rallied off of the 200-day line, as we can see on the daily chart, below, and has run right up to the 10-day moving average and the 30 price level, where I see near-term resistance. Thus if the market bounce gives way Thursday or Friday, one might consider re-entering P on the short side, using a very tight stop of 3-5%. P is expected to report earnings on April 24th.

 

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Stratasys (SSYS) is yet another undercut & rally situation from Monday after dipping below my initial downside target of $100 on that day, as we can see on the daily chart, below. Like the rest of my short-sale target stocks, this undercut & rally move has resulted in a bounce off the 100 level and up towards the 10-day moving average, currently at 106.72. Any further rally from here would likely encounter ultimate resistance at the 200-day moving average, currently at 109.86. SSYS is not expected to announce earnings until mid-May.

 

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Goldman Sachs (GS), which I discussed over the weekend as a new short-sale target in the financial sector, blew through the neckline of its head and shoulders pattern on Monday, as we can see on the daily chart, below. If you got a short off in GS right at the open on Monday, that was immediately successful as the stock plummeted lower over the next two full trading days before undercutting some lows in the pattern from mid-October, way over on the left side of the chart. At this point I’m using the 160 price level as a trailing stop on that short position. GS is expected to announce earnings on April 17th, which gives us plenty of time to see what the stock does between now and then and then decide whether we want to cover the position going into earnings or not.

 

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Citigroup (C) also undercut a prior February low on Monday before bouncing over the past couple of days on light volume. Optimally, I would prefer to try and short C into a rally that takes the stock up into the 50-day moving average, currently around 48.42. Given that C is expected to announce earnings next Monday, April 14th, my preference is to wait and see what happens after earnings. This is in light of the fact that there are only two trading days left until the expected earnings announcement to generate any kind of reasonable downside cushion in a short position going into earnings. C is a wait-and-see short-sale target pending its earnings announcement for now.

 

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Over the weekend I wrote that “What bothers me most about this market is the difference in how the current correction has played out with respect to the action in leading stocks vs. prior corrections over the past year.” The current problem with leading stocks is that most of them are mired in deep corrections as they trade under their 50-day and/or 200-day moving averages. Facebook (FB), one of the biggest of the big-stock leaders at the beginning of the year, is still 4% below its 50-day line, and of all the former leaders that I’m tracking currently it is the only stock that is showing anything that might come close to a buy point. Studying the daily chart, below, carefully, we can see that on Friday and Monday FB undercut the 57.98 low from late March, setting up a possible shakeout-plus-five buy point in the stock. With a $60 stock I would use 4-5 points as the variable “x” in the “shakeout-plus-X” equation, making a buy point somewhere around 62-63. FB closed today at 62.41 on volume that was 52% above average, which is decent buying volume. While it is something of a stretch, it is a potential buyable set-up, so it bears watching. If one chose to enter a long position in FB, assuming the market’s reaction rally holds up, then using a stop at the 61-62 level would make sense.

 

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Among other names that I’ve discussed in recent reports that are sitting within what look like decent technical positions, Finisar Corp. (FNSR) is holding above its mid-March base breakout, as we can see on the daily chat, below. The bounce over the past two days off the top of the base, however, has come on light volume, but it remains on my buy watch list. In the meantime FNSR doesn’t announce earnings until mid-June.

 

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First Solar (FSLR) is also hanging tight within a three week flag formation after a mid-March breakout on huge upside volume, as we can see on the daily chart, below. Last week I thought this might be buyable along the 10-day line IF the general market was able to find its feet back then. But as we know now, that didn’t happen and the indexes plummeted lower on Friday and Monday past. FSLR was able to hold above its 20-day moving average on those very weak general market days, and yesterday tries to clear through the top of the three-week flag formation on volume that was only slightly above average. This one remains in position, but I would still like to see a pocket pivot type of move somewhere along the 10-day moving average as confirmation of the stock’s strength. Yesterday’s move would have been a pocket pivot if it had come a day later, as it was slightly lower than the downside volume of 6,875,000 shares that traded on March 25th, exactly ten trading days prior to yesterday. Volume on FSLR yesterday came in at 6,768,000 shares, 108,000 shares shy of that required for a pocket pivot buy point. Nevertheless, the stock acts well, and we know for now that the 20-day moving average represents a strong potential area of support on pullbacks, thus that would make a reasonable downside stop. FSLR is expected to report earnings in early May.

 

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Today the market, which was already in a position to rally anyway, given yesterday’s bounce off the 50-day moving average, responded positively to the Fed meeting minutes, which essentially confirm what I’ve been saying for a long time, which is that the Fed is stuck in QE mode without any real idea of how or when they will finally put an end to the most massive and off-the-charts monetary stimulus and propping maneuver in the history of planet Earth. When it ends, in my view, it will not end well.

In the meantime, for the most part, I don’t really see anything that I consider all that “juicy” as a long idea in the event that this bounce follows through into a more discernible market rally phase. With so many stocks so deep and dirty in their patterns, juicy long set-ups are virtually non-existent. Thus for now we are left with watching our short-sale target stocks that were (hopefully) covered on Monday when they undercut their initial downside price targets, looking for the possibility of re-entering on the short side into these logical “undercut & rally” moves.

If this market bounce develops into something more significant, we have plenty of time to wait for and identify “juicy” buy set-ups as they occur in real-time. If you decide to step into any long position, particularly in beaten-down leaders that might be showing something in the way of a shakeout-plus-x buy point like FB, keep a tight stop to ensure that you don’t step into doo-doo instead! For now we are mostly watching and waiting. Stay tuned.

 

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 CREE, GS, and LNKD, though positions are subject to change at any time and without notice.

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