The Gilmo Report

August 3, 2016

August 3, 2016

I noted in a blog post this past Monday that I an interesting and perhaps cautionary divergence had been developing for past several at that time. Per my blog post, I could see that the NASDAQ Composite Index has been handily out-performing its NYSE-based brethren, the S&P 500 and the Dow Jones Industrials Indexes.

That was on Monday during what looked like a fairly benign day. Yesterday, however, the indexes finally ran into some significant distribution as they all came off on higher volume. This was followed by a small bounce off the 10-day moving average on lighter volume today.

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The NASDAQ’s outperformance strikes me as mostly due to a narrowing of money flows into big-cap NASDAQ 100 Index names. Thus the daily chart of the NASDAQ 100 closely mirrors that of the Composite itself.

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Meanwhile, the S&P 500 Index has been running in place as it tracks sideways for the past three weeks. A lot of this is due to lagging transportation, financial, and oil names, but we should remember that last year we saw weakness in these areas presage a severe market correction in August of 2015.

For now, I would consider the divergence between the NDX and the rest of the market as a developing potential issue, and not much more. In fact, the divergence would be completely negated if we were to see the S&P 500 bust out to higher highs in the next few days. This might be accompanied the similarly lagging Russell 2000 Index, not shown, breaking out in similar fashion.

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Back in July 2015 the NASDAQ bolted to an all-time high, which was greeted with much fanfare by the financial media. The move came after the index started looking questionable in early July as it undercut prior lows from May and June. I show a daily chart of the NASDAQ in 2015 below.

Like today, however, the index ended up pulling a big undercut and rally maneuver after undercutting those lows. That big shakeout then set up a move to all-time highs. That breakout was led mostly by big-cap NASDAQ 100 names, however.

GR080316-$COMPQ 2015 Daily Chart

At the same time the broader market was not participating. In fact, as measured by the broad NYSE Composite Index, the broader market had topped back in May of 2015 as can be seen on the daily chart from last year.

That was a significant divergence, and it presaged the massive downside break that we saw in August. For those members who were around at the time, that was a very profitable month on the short side of the market. We caught a number of significant breaks in failing, leading stocks as they came crashing down.

GR080316-$NYA 2015 Daily Chart

Whether August 2016 turns out like August 2015 or not is not something we can know for sure. However, the divergence we are seeing in terms of the performance of the NASDAQ and the NASDAQ 100 vs. the rest of the market may at least be a cautionary sign. But it can also correct itself, and the market would again be on its merry way.

Ultimately, it all comes down to what the individual stocks are doing. Back in August of last year we saw a number of leaders get hit hard, not the least of which was Apple (AAPL) and its cousin supplier stocks like Skyworks Solutions (SWKS) as well as other names like Mobileye (MBLY).

I show the weekly chart of MBLY from last year below. Members can go back in the Gilmo Report archives and see that I nailed this on the short side. I was even showing how the pattern was setting up before broke down after failing on a POD-with-handle breakout failure.

GR080316-MBLY Weekly Chart 2015

So from an individual stock perspective, we will know whether this current divergence is an indication of something negative brewing IF we begin to see leading stocks fail. It took a little while for the 2015 top to develop once the divergence became quite glaring in the middle of July 2015, and that could be the case today. But the 2015 top initially became most obvious in individual stocks.

But before I get to that allow me to do the usual “precious metals segment” of our show. Basically, the situation remains the same. Both metals made new closing highs yesterday on the heels of last week’s post-Fed pocket pivots. Today finally saw them pull back, both in similar positions.

The iShares Silver Trust (SLV) dipped in slightly toward its 10-day moving average but didn’t quite get there. The SPDR Gold Shares ETF (GLD), not shown here on a chart, also nudged down towards its 10-day moving average today. Both the SLV and the GLD traded lighter volume.

Pullbacks into the 10-day line in either would represent potentially lower-risk entry opportunities, should they occur. The SLV’s and GLD’s 10-day lines now sit at 19.11 and 127.89, respectively.

 

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The metals stocks I follow, Silver Wheaton (SLW), Agnico Eagle Mines (AEM), and First Majestic Silver (AG) are all holding tight as the metals themselves pull back only slightly. Today I’ll let AEM’s chart speak for the three stocks as they all look pretty much the same.

AEM experienced the largest volume dry-up today as it held tight on volume that was -41.4% below average. All three stocks sit well above their 10-day moving averages, which would provide your best reference for a buyable pullback. As always, my preference is to look to enter on weakness.

 

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Facebook (FB) has continued to drift back in towards the top of its prior base after it failed on a buyable gap-up (BGU) attempt last week after earnings. Anybody who bought into that move was left high and dry. As I wrote over the weekend, that BGU failure might have been a function of FB receiving a Statutory Notice of Deficiency from the Internal Revenue Service.

That notice, which could result in a tax liability of $3 to $5 billion tax liability, might be weighing on the stock as it continues to slip to the downside. FB closed below the 10-day line today as volume continued to decline and came in below average.

As the stock moves lower it is coming into contact with the top of the prior base and approaching the 20-day moving average. The 20-day line down at 120.79 might represents the most opportunistic entry point as this more or less coincides with the top of the prior base.

If FB can hold here and turn back to the upside, then this pullback may provide a lower-risk entry. Otherwise, the thing to keep an eye out for is any big-volume failure through the 20-day line as this would bring the stock into play as a possible late-stage failed-base type of situation.

 

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I tend to think that if the general market is really going to get into trouble here, then you’ll see the current big-stock leaders start to materially break down. And based on where some of these are trading, like FB, we know what concrete evidence would support a bullish or bearish conclusion to the current price/volume action.

If we consider Apple (AAPL) we might conclude that as long as it continues to hold above its 200-day moving it remains viable as a long situation. As I’ve discussed in the past two reports, the buyable gap-up following earnings last week was actionable.

In addition, stock’s subsequent ability to hold the 10-day line last Friday as volume dried up sharply was bullish. If the stock can continue to hold up, the 112 price level would be a reasonable upside target. However, if it were to bust back below the 200-day line on heavy volume, it could easily morph back into a short-sale target again.

This is a fluid situation, but for now, as long as AAPL holds the 200-day line, it remains a bullish situation. The 200-day line at 103.56 would continue to serve as a selling guide and would easily force one out IF the general market starts to get into serious trouble.

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Amazon.com (AMZN) is pulling back down towards its 10-day moving average, which brings it into a potentially lower-risk buy position. Volume, however, has been coming in at above average.

My thinking here is that as long as AMZN can hold the 10-day line, or at least the 20-day line at 744.65 it remains sound as a long idea. Should the stock bust the 20-day line on heavy volume, then we have some evidence that things are not as sound as we thought.

So far with FB, AAPL, and AMZN, it is easy to see how I can maintain a concrete view of these stocks and be willing to play them long or short depending on how they play out. I have no bias. So far we could be looking at some very buyable pullbacks and so we want to be open to that, particularly if we have very tight, nearby selling guides in case things go awry.

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Alphabet (GOOGL) is another big-stock leader to keep an eye on. Here we can see that following last Friday’s buyable gap-up after earnings GOOGL is holding tight just under the $800 price level. At the same time volume is drying up sharply.

With GOOGL just under the $800 Century Mark, the potential for Livermore’s Century Mark Rule in Reverse to come into play, which would turn the stock into a short-sale situation, is always there. However, with volume drying up as the stock holds tight following last week’s BGU, the action is in fact bullish and constructive.

Only a high-volume move where the stock peels away from the 800 price level to the downside would confirm the stock as a short-sale target. Otherwise it remains a big-stock NASDAQ name that is acting well, and which should be acted on according to the real-time evidence.

This keeps things on a concrete level, without putting us in the position of playing any guessing games.

 

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Netflix (NFLX) was able to clear its 20-day moving average on Monday, something I was looking for as a sign of near-term strength and viability on the long side. Monday’s move ran into the 50-day line however, which also presented stiff resistance to the stock today.

The ensuing pullback brought the stock back down to the 20-day moving average with volume drying up to -45.8% below average. So it’s not as if we’re seeing any heavy selling at the 50-day line. Therefore, the move back into the 20-day line brings the stock back into buyable range, using the 20-day line at 92.32 as a tight selling guide. Otherwise the 10-day line at 90.69 gives the stock a bit more room on the downside for those who prefer it.

Now, in order to develop a bearish thesis on NFLX we would want to see it start to break to the downside on heavier selling volume. A sharp volume failure through the 20-day line might bring the stock back into play as a short-sale target. For now, however, the action remains constructive pending further evidence.

GR080316-NFLX

Mobileye (MBLY) remains a name that I consider thematically compelling, particularly after its announcement of a partnership with Intel (INTC) and auto-maker BMW. After a big post-earnings shakeout, the stock rallied all the way back up to its 10-day moving average where volume petered out and it began to drift back to the downside.

Volume picked up and came in above average on Monday as the stock breached the 20-day moving average, not necessarily constructive action. Volume has continued to dry up, however, as the stock engages in something of a Wyckoffian Retest of the low of seven trading days ago.

Therefore, as I said, look for pullbacks into the line as potential lower-risk entry opportunities. The stock may need to settle in a bit longer here if it is to remain viable on the long side. My preference was to sell the sharp move off the lows of seven days ago and then look to re-enter on a constructive pullback.

So far the pullback is somewhat undefined as the stock remains below the 20-day moving average. I might look for a retest of the 50-day line at 42.71 as a very opportunistic buy point should that occur. Otherwise this needs to show some constructive consolidation along or around the 20-day line before I’d want to get aggressive in it again.

GR080316-MBLY

Fabrinet (FN) was unable to recover in meaningful fashion after busting down to its 50-day moving average last week. Because that sell-off was in sympathy to a weak earnings report from a much weaker stock in the same sector, there was potential for this to become an opportunistic entry point using the 50 -day line as a tight selling guide.

Well, anyone who bought the stock at the 50-day line last Thursday might have noted the weak-volume, “voodoo” rally up into the 10-day and 20-day lines on Monday. The next day FN blew through its 50-day moving average on even heavier selling volume, which confirmed the stock as a late-stage failed-base type of situation.

If FN traded more than a million shares a day I would certainly consider this a clear short-sale target. Earnings are expected on August 15th, so it’s not clear whether this would produce a shortable rally or further downside. Either way, FN provides concrete evidence of a leading stock that has failed, end of story.

GR080316-FN

Gigamon (GIMO) is pulling down closer to its 10-day moving average as volume dries up sharply. The 10-day line lies about 2% below where the stock closed today, so I would prefer to look at picking up shares closer to the line.

Volume dried up to -43.9% below average today, which is what you want to see on a pullback after last Friday’s very strong upside move following earnings. The 10-day line is at 43.18, so I’d be looking for a little more low-volume drift down to the line from here as a lower-risk entry opportunity.

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I still consider the whole cloud theme to remain a compelling one for the long side of this market in any continued market rally. But as with anything else in this market, selling into extended strength in the cloud names and then looking to re-enter on constructive weakness remains my preferred way of handling these names.

For example, selling into the big post-earnings jack in ServiceNow (NOW) that also occurred in sympathy to Oracle’s (ORCL) buyout of Netsuite (N) was a smart move. The ensuing pullback has been fairly sharp at about 10% off of last Thursday’s peak of 78.77.

Notice, however, that as NOW pulls into the 200-day and 20-day moving averages it appears to find some above-average supporting volume. This looks constructive, although I prefer to buy shares as close to the 20-day line at 72.41 as possible.

In my view, until the 50-day line at 71.49 is breached with some authority, in other words significant selling volume. This remains viable on the long side on pullbacks into the 200-day or 20-day lines.

GR080316-NOW

Workday (WDAY) has also proven to be another strong-acting cloud name that becomes something to sell whenever it displays extended strength. It too pushed to higher highs on the news of the ORCL for N buyout, but that move did not result in any further upside.

Instead, the stock has pulled right back into its prior June-July base formation where it is finding support along the 20-day line. While the breakout attempt failed, this is where the Ugly Duckling can come into play when the stock appears to be breaking down in less-than-optimal fashion.

In this case, the pullback to the 20-day line as volume dries up presents a reasonable, lower-risk entry for anyone willing to use the 20-day line or the 50-day line at 78.27 as a tight selling guide. In my view, this is the only way to buy these stocks, with the idea of being ready to cut and run if they cannot hold your selling guide. Simple, easy, and much lower-risk than trying to chase upside strength.

GR080316-WDAY

Salesforce.com (CRM) looks somewhat putrid here as it posts a technical violation of its 50-day moving average. The stock busted through the line on Monday on above-average selling volume, and yesterday moved below the Monday intraday low to confirm the technical violation.

Of course, when such “technical violations” occur, that is precisely when the Ugly Duckling can suddenly show up. Maybe CRM is on the verge of buying another cloud-related company, and this is being reflected in its price/volume softness. If this were the case, then I might consider NOW or WDAY to be likely acquisition targets.

Barring that, watch for an Ugly Duckling rally by the stock back up into the 50-day line from here. CRM did manage to hold tight today as volume dried up, which could make this buyable using yesterday’s low at 79.60 as a tight selling guide. As long as CRM doesn’t go buying anyone, this may have a shot at moving higher ahead of earnings which are expected on August 29th.

GR080316-CRM

Splunk (SPLK) is another one of my cloud-stock favorites, and it has fallen back into its base after a pocket pivot breakout five trading days ago on the chart. While the stock has fallen back into its June-July base, it has also been able to hold above its 20-day moving average and today managed to close back above the 60 price level, which I consider to be the highs of the prior base.

SPLK isn’t expected to announce earnings until August 25th, about three weeks from now. This pullback brings it into a lower-risk buy position using the 20-day line at 59.29 as a tight selling guide or the 50-day moving average at 57.65 as a less-tight selling guide for those who desire it.

GR080316-SPLK

Both Adobe Systems (ADBE) and Citrix Systems (CTXS) not shown here on a charts, are looking less appetizing as they start to show signs of weakening. I do show ADBE on a daily chart, below, which might still be viable since it has not seen above-average selling volume whereas selling volume in CTXS over the past three days has been heavy.

Here we see ADBE busting its 50-day moving average yesterday and at the same time undercutting a prior July low. What we should note here is that while selling volume did pick up yesterday on the breach of the 50-day line it did not come in at above average.

This creates something of a possible Ugly Duckling type of set-up where the undercut on below-average volume sets up a move back to the upside. As with all potential undercut & rally set-ups, the parameters are simple. Once the stock moves back up through the prior low, in this case at 96.08, the stock can be tested on the long side using that low as a selling guide.

One can give it another 1-2% of downside “porosity” if so desired, but that is basically how the set-up works. There are no tricky “shakeout-plus-(insert random number of points here)” things going on here. In most cases, this approach is sufficient in catching any possible move further to the upside following the undercut and rally.

GR080316-ADBE

Electronic Arts (EA) announced earnings yesterday after the close and sold hard this morning, but eventually found its feet and posted a big-volume outside reversal back to the upside. While this is not a new base breakout, it is a pocket pivot, and is buyable using the 10-day line at 76.68 as a selling guide.

My preference, of course, would be to look for any kind of little blip back into the 10-day line as a lower-risk, opportunistic entry point should it occur. EA’s cousin, Activision Blizzard (ATVI), not shown here on a chart, is expected to announce earnings tomorrow. It is currently sitting right at its 50-day moving average so we will see whether it offers any kind of actionable opportunity following earnings.

GR080316-EA

Zendesk (ZEN) gapped-down big at the open this morning after beating on earnings and raising guidance yesterday in the after-hours. The gap-down took the stock just below the 50-day moving average right at the open where it found support and immediately rallied sharply back to the upside.

The close was sloppy, however, as the stock closed just above mid-range and below the 20-day line but well above the 50-day moving average. There is one small constructive detail here, which is that the stock did manage to close above the prior breakout point from early July, and did so after undercutting the prior late July lows.

For this reason, one could consider the stock buyable here using the prior 28 breakout level, as I’ve highlighted on the chart, as a very tight selling guide or the 50-day line at 27.25 as a wider one.

GR080316-ZEN

Here’s an interesting bottom-fishing buyable gap-up move in our old friend Fitbit (FIT) that I think is actionable, and it presents a very simple trading proposition. FIT announced earnings yesterday after the close and jacked higher this morning, gapping out of its three-month low-base range at the open.

After setting an intraday low at 13.92 the continued higher, ending the day just under the 15 price level. The move came on huge volume, and may have legs as the stock still has fairly heavy short interest levels. 37% of the float, about 35.97 million shares, has been sold short as of the last reported date.

The interesting thing about FIT is that sponsorship reached a peak as of the most recently reported date in June. 279 funds own 55 million shares, up from 233 funds owning 48 million shares in March. That’s a big shift, and shows that institutions may have some faith in the forward-looking story for the stock.

I think this is buyable using the 13.92 intraday low of today as a selling guide. I know that’s about 6.7% below where the stock closed today, but this is well within the range of reasonable downside risk. I would just take a smaller position and let any potential upside squeeze do the work for you.

GR080316-FIT

Below are Notes from my Trading Journal regarding other long ideas discussed in recent reports. Most of these have earnings coming up in the next few days so should be watched for anything actionable that might develop following their respective earnings reports:

Acacia Communications (ACIA) – dipping below the 10-day line as volume remains light. Earnings are expected out on August 11th, so it’s not clear to me whether there is a huge amount of upside from here given the extent of the prior post-IPO price run.

Alibaba (BABA) – stock actually posted a pocket pivot off the 10-day moving average on Monday, and the stock is holding the line as volume dries up to -67.2% below average.  This would put it into a lower-risk entry position after Monday’s pocket pivot. Earnings are expected out on August 10th, so while the stock could have an upside move from here before then, one would have to decide whether it is sufficient to hold through earnings.

Ambarella (AMBA) – dipped below the 10-day line yesterday and ran into the 20-day moving average at 55.99 today where it found support. This would bring it into a lower-risk entry position using the 20-day line as a tight selling guide.

Atlassian Corp. PLC (TEAM) – Earnings are expected tomorrow, August 4th. Nothing to do until then.

Barracuda Networks (CUDA) – your reference point for a lower-risk entry would be a pullback to rising 20-day line at 20.44. The stock has so far been able to hold the 10-day line on pullbacks as it did today, but if one is trying to enter this one up here it might be better to let it set up a little better before pulling the trigger.

CyberArk Software – Holding along the 10-day line where it found some volume support today. Earnings are expected to be announced on August 9th.

GrubHub (GRUB) – stock has held along the buyable gap-up highs around the 39 price level but probably needs to come in a little bit. Your first reference for an opportunistic entry on any pullback would be the 10-day line at 34.89. Otherwise the intraday low of this past Friday at 36.69 would provide a secondary reference point on any kind of low-volume Wyckoffian Retest.

Imperva (IMPV) – Nothing to do here. Earnings are expected to be announced tomorrow, August 4th, after the close.

Nvidia (NVDA) – is holding tight along the 10-day moving average in very constructive fashion with earnings expected to be announced on August 11th. A pullback to the 20-day line at 53.98 would present a highly opportunistic entry from here.

Palo Alto Networks (PANW) – continues to find support at the 20-day moving average and today managed to clamber back above the 50-day moving average. I still think this remains in an Ugly Duckling type of buy position using the 20-day line at 128.53 or at most the Tuesday low at 125.47 as a selling guide. The stock is currently about 3% above the Tuesday low. Earnings are not expected until September 14th.

Silicon Motion (SIMO) – was able to rally off of its 20-day moving average on Monday as I discussed it might in my weekend report. It continues to hold tight along the 20-day line as volume declines. Thus it remains in a buyable position using the 20-day line at 51.74 as a tight selling guide.

Square (SQ) – earnings were announced today after the close and the company beat estimates. Watch this tomorrow for a possible buyable gap-up as the stock is trading up after-hours.

Tesla Motors (TSLA) – earnings came out today after the close and the stock isn’t doing anything in after-hours trading as it remains more or less flat around the 225 price level. If there

Twilio (TWLO) – has skidded below its 10-day moving average and is trying to find support along the 20-day moving average. TWLO is expected to be announced on August 8th.

Weibo (WB) – broke out to a new high yesterday but buying interest just wasn’t there. The stock reversed to close down on the day. Today it held tight along the 10-day line as volume dried up sharply, putting it back into a lower-risk entry position. Earnings are expected to be announced on August 16th.

Yirendai Ltd. (YRD) – stock went into something of a short-term climactic run on Monday. Needs to settle down ahead of earnings.

Zayo Group Holdings (ZAYO) – stock has continued to drop down to the 50-day line as it fails on its recent breakout attempt. While one can use the 50-day line as their “last stand” selling guide, this needs to come up and off of the line quickly here.

The divergence of the NASDAQ 100 as it has carried the NASDAQ Composite higher while the rest of the market has been running in place does represent a potentially cautionary signal for the bulls. However, it can easily be corrected, and I thought yesterday’s pullback was one step in the right direction with respect to this.

The bottom line, as always, has been the action of leading stocks. I have outlined in this report the precise price/volume action I would need to see in current big-stock market drivers AAPL, GOOGL, FB, and NFLX in order to draw bearish conclusions. But in all cases the current action can be viewed as more positive than negative, but we know where our market cues will come from if weakness begins to prevail.

Otherwise I want to remain in sync with my chosen approach of selling into extended strength and then looking to re-enter on constructive weakness. In this market, re-entry chances occur on a daily basis. So an active approach can work in this regard. However, those looking to play more trending moves on an intermediate- to longer-term basis need only rely on knowing where their out points, e.g., trailing stops, are in the event of developing market weakness.

While an active approach can help to maintain profits as an optimization strategy, many names, such as WB or NVDA, have remained in constructive uptrends. Thus a slower approach can also work in this market. It’s simply a matter of knowing your out points and then letting the market force you out if things take a turn for the worse.

I would like to see the current divergence between the large-cap NASDAQ names and the rest of the market come to an end by seeing the rest of the market play catch up. That could easily happen, and I am encouraged by the fact that the selling over the past couple of days hasn’t gotten out of control. Therefore, just stick to your trading plan and watch your stocks.

 

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 held positions in FB, FIT, and NFLX, though positions are subject to change at any time and without notice.

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