The Gilmo Report

August 5, 2012

August 5, 2012

The market’s action continues to trace out something more akin to an “algo” ping-pong match as it has all summer long, and this past week’s action was no different. With little in the way of steady and methodical accumulation of individual stocks going on, as I see it, all that is left for the market to react to the news of the day and as algorithmic trading programs sell into overbought strength and then buy into oversold weakness. Meanwhile, for those who desire to label the market as being in a confirmed uptrend, under pressure, or in a correction, we might say that the indexes are in an uptrend currently, but the way things have been going so far this summer, if you don’t like the market action this week then all you need to do is wait until next week. The European Central Bank took center stage on the news front once again to close out this trading week just as it did last week, and I suppose if one wishes to build a trading strategy based on monitoring the lip-servicing offered by Eurocrats and Fed heads regarding “bold”

solutions to what is still the unsolved problem of countries spending beyond their means then maybe, just maybe, one can extract profits from a zig-zag market that now sees the NASDAQ Composite, shown below, testing its early July peak for the third time, but, we should note, on the weakest upside volume seen so far.


The S&P 500 displays the same sort of extreme swings as the NASDAQ, but has managed to remain in a very sloppy and wide uptrend channel that some may see as an “ascending wedge,” but yet the index has managed to move to a higher-high since starting this incoherent rally off of the early June lows. What I find troublesome about the market action is that it appears to be mostly an index rally as the task of finding nascent leadership is a tricky one at best. And it isn’t as if investors have just a zig-zag market to contend with, as the added excitement of a Knight Capital Group (KCG) computer trading program running amok on Wednesday for a full half-hour before anybody was able to stop it brought to mind images of the “ED-209 Enforcement Droid” from the movie Robo-Cop that malfunctions and goes berserk, killing a junior executive during a product “demonstration.” But that was a movie, and KCG’s errant computer program cost the firm over $400 million in real money, while doing little to bolster investor confidence in today’s computer-driven markets. All that aside, the S&P 500’s move straight down and then straight back up to new highs on low volume looks suspect, and so I do not see it as a reason to get aggressively long, if at all, in this environment.


Apple (AAPL) continues to work on a cup-with-handle base, but Friday’s breakout attempt, as we see on the daily chart below, was not accompanied by any strong buying interest as the stock gapped-up and churned around on low volume. The stock did manage to close at its highest level since early April, but it seems to benefit mostly from the fact that institutional investors appear loathe to sell the stock as a 20% grower trading at 12 times forward earnings. While AAPL appears to act well on a technical basis, the fundamental situation for the stock has deteriorated as earnings and sales which were growing at 92% and 59% in the March quarter decelerated sharply to 20% and 23% in the June quarter, while estimates for earnings growth next quarter remain at around 20%. Unless some serious buying interest comes into the stock, I would not be surprised to see it retest the lows of the handle around the 50-day moving average, currently at 587.50. Sure, a big-volume breakout through the 619.87 high in the handle, as I’ve discussed in recent reports, would be a clear buy signal, but that is yet to happen, and Friday’s gap move on low-volume looks suspect, at best, particularly if we see no follow-through buying this coming week.

Apple (<a href=AAPL) Gilmo Report Stock Chart" title="Apple (AAPL) \" />

LinkedIn (LNKD), which I successfully shorted and profited from earlier this week before the company announced earnings on Thursday and covered near the 40-week moving average on Thursday, preferring not to look a gift horse in the mouth, reversed course after earnings by staging a big upside reversal for the week on big volume by the close on Friday, as we see on its weekly chart, below. The question now becomes whether LNKD’s strong showing on Friday indicates an impending breakout to new highs. If that is going to be the case, then I would like to see some follow-through buying this week on a decisive move up through the 109.90 high in the stock’s somewhat wide and loose handle to what appears to be a cup-with-handle type of base formation. There is some subtle, minor weekly supporting action in the handle, which is constructive, and as the only social-networking company with a real business plan that does not rely entirely on advertising or a need to shift their business from a PC-based platform to a mobile platform like Facebook (FB) does, it is the only one that has a shot at becoming a nascent leader currently, as I see it, if it can break out, so that is something to watch for here.

Bio-tech stocks have slowed up a bit in the past week, and the group has dropped back to #2 from #1 last week. In some cases we’ve seen strongly-acting bio-techs like Onyx Pharmaceuticals (ONXX) fizzle out, but it is, as I discussed in my report of July 22nd, going to lose money for the foreseeable future. The one that bears watching, in my view, is Regeneron Pharmaceuticals (REGN), which I first discussed in my report of July 29th, and which has strong, money-making fundamentals. Last quarter the company reported 264% earnings growth on a hard number of 90 cents a share and record sales of $304.4 million representing accelerating 182% sales growth. Quarterly after-tax margins over the most recent two quarters doubled from 17.3% to 33.4%. REGN’s hot new drug, Eylea is a treatment for wet age-related macular degeneration, and in April the company raised their 2012 sales estimates for Eylea from a range of $250-300 million to $500-$550 million. This is material evidence of strong growth for Eylea, and likely a reason why the number of mutual funds owning the stock has jumped from 439 to 502 in the most recently reported quarter. REGN still needs time to complete its base, in my view, and did close tight this past week in a wild market environment, so I continue to view the stock as buyable on pullbacks to the 130 level, pending a strong-volume breakout from its current 14-week cup base.

Regeneron Pharmaceuticals (REGN) Gilmo Report Stock Chart

“LinkedIn (LNKD) Gilmo Report Stock Chart” title=”LinkedIn (LNKD) \” />

If the market’s low-volume move towards its highs since the early June lows is a harbinger of an unsustainable rally, then I am willing to pick on the weakest stocks as short-sale candidates. In my report of this past Wednesday, Tibco Software (TIBX) was one such candidate I discussed, and while it did rally with the market off of its lows on Thursday and Friday, the stock remains in a vulnerable technical position, as we see on its daily chart below. I like the idea of shorting the stock into this wedging rally up into the 200-day moving average, and Friday’s action gave us a precise opportunity to do so very near to the 200-day line. The beauty of this trade given its closing price on Friday, in my view, is its proximity to the 200-day line at 28.20, and I did in fact put out a short position into the rally at around the 28 price level. The stock closed at 27.82 on Friday and remains in a very shortable position here using the 200-day line as a guide for an upside stop a mere 1.5%, roughly, from the stock’s current price, thus is actionable on Monday if it opens up within 2-3% of the 200-day moving average.

Tibco Software (TIBX) Gilmo Report Stock Chart

Older leaders in this market have been dropping like flies, one by one, and I note the building weakness in AutoZone (AZO), shown below on a daily chart. To me this is a typical late-stage failed-base type of set-up where we see the breakout attempt from a later-stage six-week base in late April failing within 2-3 weeks. So far this fits in well with my models of such types of short-sale set-ups where the stock first fails on a late-stage breakout and plummets sharply through the 50-day moving average on heavy volume, and then follows this up by staging several rallies back up into and/or slightly above the 50-day line. AZO has now rallied up off the 360 price level and up into the 50-day moving average three times now, and Friday was unable to sustain a sharp rally that occurred in conjunction with the general market, reversing sharply to the downside and closing at its intra-day lows on heavy volume. While I would much prefer to short AZO into a bump back up into the 50-day line, but the stock is within 3% of the line so is still shortable here using a 3-5% maximum upside stop. In my view, if AZO is going to pan out as a short-sale set-up, it has likely “ripened” to the point where it should be actionable right here, right now.

AutoZone (<a href=AZO) Gilmo Report Stock Chart" title="AutoZone (AZO) \" />

With the market allegedly in a “confirmed uptrend” at the present time, I believe investors should consider such market labels within the context of the zig-zag action throughout the summer of 2012. As well, the “lay of the land” with respect to potential leadership in this market is rather uneven and characterized by peaks and valleys that continue to shift location on a short-term basis. Thus as we move through the final month of summer, at least from the market’s perspective, I remain cautious and mostly short-term oriented in my trading activities primarily because sustainable trends in individual stocks combined with choppy and at times random action in the market indexes appear to rule the action, and a coherent trend has yet to be established, in my view.

As I wrote in my Wednesday report of this past week, the market has less the feel of institutional money steadily accumulating potentially leading stocks and more the feel of “Algo Wars” where large computer programs are simply batting the market around like giant cats playing with a large ball of yarn. I am often asked whether this market has a different “feel” to me as a professional with over 21 years of experience in the markets, and my answer is that it does to some extent likely due to the bizarre effects of still-huge QE liquidity that remains in the system. The individual investor has been pulling money out of equity mutual funds at a steady pace since 2009, and so the rally over the past three years is less a function of secular money flows into the market, as the chart below illustrates.


Some argue that the fact that money flows out of equities and into bonds have reached such extremes (see chart below) that it argues for a “return to the mean” whereby money flows reverse course out of bonds and into equities. This may occur at some point, and I would agree that when it does it could establish a firm basis for a strong, sustainable, secular bull market trend, but that could take months to occur, and in the meantime the status quo could remain. In the meantime we can only rely on the market’s price/volume action to make decisions in real-time, and on this basis it is difficult to see much that is actionable currently. Some opportunities may exist on a stock-by-stock basis, independent of the market’s zig-zag trend and the news-of-the-day, and for now that is what I am focusing on both in my reports and my own trading at the present time. Stay tuned.

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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