The Gilmo Report

December 23, 2018

December 22, 2018

My rallying cry, pun intended, this past week, has been to “Short all rallies!” I have not been shy about tweeting and blogging about this idea in real-time over the past couple of weeks. This, so far, has remained a very viable approach as rallies get sold into, time and time again. It worked on Fed Wednesday when the market shot up and it worked again on Friday when the market suddenly shot up to plus 381.7 Dow points before rolling over to close -351.98 Dow points in the red.

On Friday, the market was floundering again before one of the Fed Heads by the name of John Williams went on CNBC and started babbling something about the Fed being more flexible than the market thinks it is. For some reason, that sent the Dow Jones Industrials Index flying to the upside, precisely 394.99 points into the great green beyond. But, as I tweeted at the time, this was probably another short-the-rally opportunity, and it was.

The Dow then reversed to streak 661.82 points to the downside over the next hour-and-forty-five-minutes, hitting a low point at -221.8 points in the red. It then shot back up to the upside, nearly reaching the unchanged line before rolling over again. It spent the rest of the day chopping its way lower to end the day at -414.23 points in the red, a lower low and -16.27% off its early October all-time high. Altogether, a total of 809.22 Dow points from peak to trough in one day, the essence of a v-squared market condition.

More swirling about throughout the day on Friday was also attributed to the impending government closure, but in my view, this is just an alibi. At some point a settlement will take hold and it will then provide an alibi for a rally as the coast seemingly becomes all clear again. Meanwhile, it has been a case of selling all rallies, because this bear market is being driven by something far more sinister than a simple government shutdown. And a bear market it is, now that the NASDAQ Composite Index closed at a lower low today and -22.14% off its August all-time high.

 

GR122318-$COMPQ

 

Supposedly, the definition of a bear market, at least according to others, is a decline of 20% or more. To me, this is irrelevant since by the time these people start telling you that you’re in a bear market, stocks have already been beaten to a pulp. It’s a bit too after-the-fact for me, but it does illustrate how brutal this market has been since it rolled over in early October.

What is probably more significant is that the NASDAQ has now blown through its February lows, joining the Dow and the S&P 500 Index at fresh 2018 lows. The long-view chart below gives a dramatic view of the breakdown thus far. We have one sharp leg down off the peak of about 11.7% in magnitude, a six-week bear flag consolidation, and then a second leg down that is now about 14.3% in magnitude.

Usually, the second leg exceeds the first leg in magnitude, so things are playing out according to the standard bear market script. This is somewhat surprising, since it’s been a while since this market has followed any traditional script. But, if my theory that money is now exiting the market in a steady, methodical flow, after steadily being injected into the market since 2009, then it is logical for the market to act in historically-consistent bear market fashion.

 

GR122318-$SPX

 

And if you want a bear market, then look no further than the small-cap Russell 200 Index, which is down -25.83% from its late-August peak. That’s a brutal decline with the second leg showing greater downside acceleration in parabolic fashion with the index down 12 out of 13 days in a row and eight straight. Now, that’s a spicy meatball!

 

GR122318-$RUT

 

With this latest leg down exceeding the magnitude of the first leg down in all the major market indexes, we are getting close to a point, however, where the second leg may reach its terminus. This would then lead to another consolidative phase, complete with sharp reaction rallies, which could turn out to be playable as long swing-trades for nimble traders.

The catalyst for such a reaction move now would of course be a favorable resolution to the current government shutdown news that has provided the alibi for this past week’s brutal sell-off. However, as of the time I am writing this report, nothing has transpired to stave off a partial government shutdown, which went into effect Friday night. The next few days may see some sort of agreement emerge, but for now the situation remains uncertain.

Meanwhile, whatever the news, most stocks on my short-sale watch list have been easily campaigned on the short side. This idea of working or campaigning a stock on the short side makes it unnecessary to hold positions overnight if one does not want to be exposed to the random news that occurs from time to time to drive big futures gap-up opens, the bane of short-sellers. Campaigning a stock on the short side is essentially a method of covering short positions at or before the close every day and then looking to re-enter the next day. This is useful in this regard.

Microsoft (MSFT) exemplifies how this can work. The initial short entry occurs on the breach of the 20-dema two Fridays ago. The stock then breaks to the 200-dma, which is a short-term cover point. A rally up to the 20-dema on Wednesday after the Fed announcement provides a convenient re-entry point, and the stock breaks down to the 200-dma again.

It then breaches the 200-dma on Thursday, triggering another short-sale point, and then offers one more opportunity to short the stock at the 200-dma on Friday. This can actually be played each day, entering a position at the correct point and then covering before the close, or when a cover signal shows up on the intraday 620-chart.

 

GR122318-MSFT

 

We can see on MSFT’s 30-minute intraday price chart, where each price bar equals 30 minutes of time during the trading day, how one could have campaigned the stock on the short side every day over the past three trading days. The closes and the opens have tended to be about the same, and in some cases one gets the opportunity to short the stock a little higher than where it closed the prior day. This is the ideal, of course, and not all stocks are this cooperative, but many are. This is how I tend to work the short side of any stock.

 

GR122318-MSFT Intraday

 

With the NASDAQ breaking to fresh 2018 lows, a wide swath of big-stock NASDAQ names has done the same. AAPL, AMZN, GOOG, NFLX, NVDA, and Facebook (FB) among others all broke to lower lows on Friday. Quadruple-witching selling volume was heavy and relentless.

FB was the most recently shortable, however, when it ran right up into the 50-dma earlier in the week. I discussed shorting the stock at the 50-dma in last weekend’s report, and the stock has come unglued nicely since then. In this position, it is now extended to the downside. If short the stock, or working the stock on the short side, I’d use a rally back up through the prior November low as a possible trailing stop if one began shorting the stock at the 50-dma earlier in the week.

 

GR122318-FB

 

The FTD Four, which I’ve been discussing in my reports for nearly two months, consist of Twilio (TWLO), Tableau Software (DATA), Etsy (ETSY), and Planet Fitness (PLNT). These four stocks all gapped up and broke out at the time of the phony market follow-through day of November 7th, thus were all suspect as breakouts that might fail based on my LSA-Method of targeting short-sale opportunities. Since all four stocks broke out with the follow-through day, my assumption was that if the follow-through day fails, they may likely fail as well.

The other criteria in my LSA-Method (LSA = Late-Stage Assumption) is that these were stocks that had already had massive PE-expansions and were trading at even higher valuations on the breakouts. Even after rolling over in recent days, three of these, TWLO, DATA, and ETSY, still trade at more than 111 times trailing 12-month earnings. TWLO remains the most egregious of these, selling at 692 times next year’s estimates of 11 cents a share for the full year.

In a bear market, names like these will be subject to equally massive PE-contractions, and it is this, combined with a) a possible market top as we saw in early October, and b) a recent breakout on a phony follow-through, that made them LSA-Method short-sale targets. Over the past few weeks, the stocks have broken down, rallied, broken down, and rallied again several times, making them tactical shorts, and even longs) as the market chopped around in its November-through-December bear flag consolidation (see S&P 500 chart above).

In my December 9th report I wrote, “So, while the stocks have been playable short, then long, then short again so far this week, my Gilmo sense tells me that eventually they will resolve as full-blown, late-stage, breakout failures and hence late-stage, failed-base (LSFB), short-sale set-ups. How long they take to resolve this, however, is another question altogether, and will no doubt be influenced by the general market action as we move through year-end, maybe sooner.”

With the general market indexes breaking out to fresh 2018 lows on a second leg of a bear market this past week, these stocks have now fulfilled their destiny, to paraphrase Darth Vader, as a new wave of late-stage, failed-base (LSFBs), short-sale set-ups. I bring this up not to say I told you so, but to round out this overall discussion since it illustrates how I develop theories about stocks and the market, and then look to act on these theories when I finally see what I’m looking for with respect to the real-time evidence.

I’ve always found that handling the market, whether a QE market or a more traditional one, is equal parts art and science. There is a lot of observation that leads to conclusions about likely behavior going forward, and there is also a reasonable amount of creativity that comes into play in figuring what such observations are telling you. How might things play out? What conditions might need to be present to confirm a specific theory? Where are we in the cycle? Is money flowing into or out of the market? All these questions and more are part of the process.

Hopefully, what we are seeing take place with the FTD Four over the past few weeks brings the entire process full circle. I formulated my LSA-theory regarding these stocks several weeks ago, have followed them closely in each report since then, and now finally see the fruits of my labor as they break down in synchrony with the second down leg of this current bear phase. Hopefully, observing this process in action was helpful to members in understanding how to think for yourself.

Moving onto the stocks themselves, we can see that Twilio (TWLO) is following through on Monday’s initial breach of the 20-dema, triggering it as a potential, late-stage base-failure at that point. After loitering along the 20-dema for a couple of days, offering short-sale entries at the line each time on Tuesday and Wednesday, the stock then blew right through its 50-dma on Thursday.

On Friday, TWLO briefly rallied small and right into its 50-dma before turning tail and breaking for lower lows. From here, any rallies back up into the 50-dma would offer further short-sale entry opportunities. Hopefully, however, anyone shorting the stock down here has already started working and campaigning the stock on the short side since it breached the 20-dema on Monday and moved lower in synchrony with the general market’s breakout to lower lows.

 

GR122318-TWLO

 

Tableau Software (DATA) gave latecomers a chance to catch a decent short on Thursday as it hung along the 20-dema. It then breached the line on Thursday, moving lower on an intraday basis before rallying back up toward the 20-dema. That just allowed for a nice double-dip if one took their profit on Thursday based on what they were seeing on the five-minute 620-intraday chart because the stock again set-up at the 20-dema and rolled over on Friday.

It closed just below the 50-dma on Friday on above-average volume. While this could be viewed as a new short-sale entry point, keep in mind that the stock could still try and rally back up through the line on another test of the 20-dema. That’s unclear right now, and mostly means that if one did short the stock here, the 50-dma would have to serve as a guide for a tight upside stop.

 

GR122318-DATA

 

Etsy (ETSY) has also followed the LSA script after sliding below its 20-dema on Monday. After pirouetting around the 20-dema for a couple of days, it finally broke lower on Wednesday, and closed just above the 50-dma on Thursday. On Friday, it then breached the 50-dma, triggering another short-sale entry at that point.

It is now extended on the downside. Rallies up to the 50-dma can now be watched for as possible short-sale entry points from here. It is now down -25.07% below its 58.30 peak of three weeks ago.

 

GR122318-ETSY

 

Planet Fitness (PLNT) offered short-sellers a convenient entry at the 20-dema on Thursday before breaking lower on the day. It then slashed through the 50-dma on Friday, triggering another short-sale entry at that point. As with the rest of the FTD Four, each stock has triggered at least two short-sale entries over the past week as they all break down in unison and in synchrony with the second market down leg.

From here, any small rally into the 50-dma would offer a lower-risk short-sale entry. With all four of these stocks breaking down, there is always the possibility that they will noodle around their 50-dmas for a while, and some of this action may entail shortable rallies within the pattern. Some of these may poke just above the 50-dma, some may attempt to push up to a declining 20-dema.

We’ll see how they continue from here, but so far, the initial breakdowns through the 20-demas have been profitable for timely short-sellers. If the general market continues lower, these will all likely continue lower. But it is normal to see some consolidation around the 50-dma, even between the 50-dma and the 20-dema as the stocks set up to move lower. Just play them as they lie.

 

GR122318-PLNT

 

Canada Goose Holdings (GOOS) is coming completely undone here as it streaks lower, dropping 11 out of 13 days in a row as it has now slashed through its 200-dma. The breach of the 200-dma on Wednesday was the latest short-sale entry point, coming on the heels of prior short-sale entries at the 20-dema and the 50-dma. What is surprising is the steepness of the stock’s decline.

GOOS is now breaking to fresh lows and is obviously extended on the downside. Rallies up to the 200-dma can be watched for as possible short-sale entry points. However, the stock is now -41.55% below its November all-time high of 72.27. So much for a “leading stock breaking out” back then as it provides a striking example of why buying breakouts in this market is a dangerous game.

 

GR122318-GOOS

 

Tesla (TSLA) is yet another recent breakout failure after slashing through the 20-dema on Monday. As I wrote last weekend, if the general market embarks on a new down leg, the stock is likely to break down with it. That has certainly been the case this past week, with the stock slashing lower and through the 50-dma on Thursday.

On Friday, TSLA held support at the 200-dma, wedged between it and the rising 50-dma. This could rally back up to the 50-dma from here, which would provide a nice short-sale entry possibility at that point, or it could continue further toward the declining 20-dema. As I wrote earlier in this report, LSFB and breakout-failure types of short-sale set-ups can often noodle around the 50-dma, and/or between the 50-dma and the 20-dema.

Obviously, if one caught the breach of the 20-dema on Tuesday, then there is plenty of wiggle room to campaign the stock down here as it potentially tries to bounce off the 200-dma. However, a breach of the 200-dma would provide a new short-sale trigger at that point should that be where the stock goes over the next few days. Play it as it lies.

 

GR122318-TSLA

 

Workday (WDAY) provided short-sellers with a clean breach of the 20-dema on Thursday, triggering a short-sale entry at that point and serving as the first clue of a possible late-stage breakout failure. Note, however, that the stock’s intraday decline on Thursday filled the late-November upside gap and then rallied off the intraday lows, which is logical.

If one was working the stock on the short side, being aware of the potential for an intraday bounce after a gap-fill maneuver while also watching the 620-chart closely might have enabled one to bank a decent intraday short profit. The intraday bounce on Thursday then set up another entry at the 20-dema, and WDAY cooperated nicely by slashing lower before approaching the 50-dma. Note that is has now broken below the prior base breakout point.

But, as I discussed in last weekend’s report, the straight-up-from-the-bottom look of this breakout on the weekly chart made it suspect and prone to failure, as I saw it at the time. That turned out to be prescient, and WDAY is now a late-stage, failed-base (LSFB), short-sale set-up in progress. Further rallies into the 20-dema would provide lower-risk short-sale entries from here, while a clean break below the 50-dma would constitute a new short-sale entry trigger.

 

GR122318-WDAY

 

As a cloud name, WDAY’s breakout failure has also resulted in further breakdowns in its cousins, Salesforce.com (CRM) and Splunk (SPLK). Both are now extended on the downside after setting up as shorts on rallies up into resistance earlier in the week. Below we see CRM move to a lower closing low after rallying into the 200-dma on Wednesday to offer short-sellers a nice, lower-risk short-sale entry opportunity. It is now extended on the downside.

 

GR122318-CRM

 

Splunk (SPLK) ran into resistance at its 10-dma on Wednesday as it approached its 200-dma as well. This led to a reversal back to the downside, and the stock posted a lower closing low on Friday. Note, however, that it did provide a second short-sale entry trigger on Thursday when it breached the 50-dma. From here, rallies back up into the 50-dma would now provide lower-risk short-sale entries.

It’s interesting to see how the Black Cross of about a month ago, where the 50-dma crossed below the 200-dma, portended a bearish outcome for the stock. Note also that CRM has also now posted a Black Cross, which occurred this past week. The Black Cross was something that worked very well in past markets as an indicator of further downside to come but has worked less effective in the QE market of 2009-2018.

More recently, the Black Cross has shown to have much higher predictive value. This may be telling us that we are now in a more standardized bear market environment, which is generally characterized by a steady flow of money out of the market. What was once old is now new again, and this may be meaningful for a continued bear market in 2019.

 

GR122318-SPLK

 

Shopify (SHOP) is now back down to its prior October and November lows after last being shortable on the rally up to and reversal at the 50-dma on Wednesday. Note how the stock’s decline over the past three days allowed short-sellers to work/campaign the stock on the downside, covering before the close each day and then re-entering when the stock opened and rallied slightly above the prior day’s close.

As I’ve discussed frequently in my written and video reports, SHOP offers short-sellers a wonderful combination of price volatility with price velocity. This has made it a favorite short-sale target of mine in the reports, as its slashing moves up and down add up to rapid profit potential for anyone focusing on this stock.

From here, I’d be looking for a rally back up toward the 50-dma as a new short-sale entry opportunity, but for now the stock is essentially out of position for any kind of short-sale entry. We’ll have to see whether it holds these lows and rallies, or whether it just breaks down further from here.

 

GR122318-SHOP

 

Twitter (TWTR) is now in free-fall after feeling the wrath of a negative Citron Research Report that was released on Thursday. The report referred to the company as “toxic” to investors and advertisers, comparing it to Facebook (FB), and was supported by a Citron Research tweet, ironically enough, stating that, “TWTR has become the Harvey Weinstein of social media.”

I was onto the stock as a short well before Thursday’s report, stating two Wednesday’s ago that I would be more inclined to short the recent breakout than buy it. The report sent the stock slashing through the 50-dma, which presented a new short-sale entry trigger as it crossed below the line on Thursday. The stock then plummeted to lower lows as it now tests its October low and is quite extended on the downside. Fascinating.

 

GR122318-TWTR

 

For newer members: Please note that when I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple (the magenta line), 20-day exponential (the green line), 50-day simple (the blue line) and 200-day simple moving average (the red line). On rare occasions, I will also employ a 65-day exponential moving average (thin black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

The market has made me look smart over the past few days, if not over the past few weeks. My December 5th comparison of the current NASDAQ Composite chart to the one from late 2007/early2008 has been dead on, so far. However, it is important to understand that just comparing a current chart to another historical chart is not meaningful in and of itself.

There must be other associated factors that make underlying conditions similar. Some are obvious, while others are subtle. One obvious similarity is that we have been in a severe asset price bubble for some time, not unlike the one we saw back in 2007-2008, and probably much worse. In addition, we’ve seen big-stock leaders get pummeled left and right. The anecdotal similarity of Apple (AAPL) when it hit $200 in late 2007 to its attainment of a $1 trillion market cap in 2018 is another similarity between the 2007 market top and the 2018 market top.

Maybe it’s just my imagination, or maybe it isn’t. But I do know that after doing this for 27 years certain things will resonate in my subconscious when comparing current action to things I’ve lived through in the past. It’s not always an apples to apples comparison (although it might be an AAPL to AAPL comparison!), and it’s not something that can be distilled down to a few rules of thumb.

The other characteristic of this current market, despite its resemblance so far to late 2007, is that it is very difficult to handle on an intraday basis. Even if I get the macro-picture exactly right, the intraday action, which is where the rubber truly meets the road as trade decisions are made in real time, is not always perfect.

Case in point is Friday’s early-morning rally when Fed head Williams made his comments on CNBC, sending the Dow up 394.99 points in a heartbeat. I was short a couple of stocks at that point, and quickly backed away, re-entering once the rally had exhausted itself and began to reverse. Thus, a great deal of nimble flexibility is required to navigate this market.

This is why this remains a market for nimble traders, while those seeking more stable trend-following conditions on the long side can remain in cash. We’ve got one week left in the 2018 trading year, and it may be a tumultuous one. Some of you may be feeling a little piggy after three-straight down weeks for the market. Keep this in mind and remain on high alert since we are in a position to post a sharp reaction rally. If you have been working the short side, you do not want to get caught flat-footed if this occurs.

The short side tends to come in waves, and one trick to successful short-selling is to understand when you may be wearing out your welcome, or so to speak, at least in the near-term. Some traders, flush with what seems like easy profits on the short side after a sharp, short market break, can get carried away and continue flogging the short side, overstaying their welcome and instead getting flogged themselves.

That said, I have no idea whether this week will offer more profitable short-side action, or whether a year-end reaction move, which would be logical, is coming. All I know is that we must all remain alert and ready to move with the real-time evidence. In other words, play it as it lies!

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 no positions, though positions are subject to change at any time and without notice.

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2019 Gil Morales & Company, LLC. All rights reserved.