The Gilmo Report

February 2, 2014

February 1, 2014

The market spent the last week trapped within a short bear flag following last week’s break off the peak. The NASDAQ Composite Index daily chart, below, looks a little better than the charts of the other major market indexes as it managed to finish the week just above its 50-day moving average. The bottom line, however, is that the market remains in the throes of at least a short-term correction with the indexes down 3-4% depending on which one you’re looking at.




While the NASDAQ is finding some pockets of strength among individual names that make up the index, the broader market as measured by the NYSE Composite Index, shown below on a daily chart, remains quite weak. The NYSE Composite is doing its best to hold support at its November and December 2013 lows, as I’ve highlighted on the chart, but it remains trapped within a short bear flag. The $60 million question is whether this resolves itself to the downside, or whether the market is able to find its feet after a 3-4% correction and begin trundling back to the upside.




Representing the so-called “risk-on” side of the market is the iShares Russell 2000 (IWM) ETF, shown below on a daily chart. Like the NYSE Composite, the Russell 2000 is locked in a short bear flag but might be considered to be holding up a little better than its NYSE counterpart. In my view, the overall picture presented by the indexes indicates that trying to take the long side of this market is still a risky proposition. While I am all for remaining opportunistic as we might seek to buy leading stocks on pullbacks, I tend to think that patience should be exercised at the present time as we let this current correction/pullback play out.




Gold seems to be primarily a play on emerging market currency fears as its action has been characterized by a series of erratic gaps up and down, although the SPDR Gold Shares (GLD), shown below on a daily chart, has been able to hold the 119 stop-out level. It appears to me, however, that a big upside move would only be forthcoming in the event of a full-blown crisis and panic as a result of the meltdowns we are seeing in a number of emerging market currencies. It may be that we will need to see a decisive breakout up through the 1300 level before we can say that the yellow metal is in a true uptrend again, as it has yet to break through the declining tops trendline extending back to October 2012.




The NASDAQ lost one of its big-stock leaders this week when (AMZN) blew apart after announcing earnings Thursday after the close, as we can see on the daily chart below. This massive-volume gap-down and breakdown through the 50-day moving average now puts AMZN in the position of becoming a late-stage, failed-base, short-sale set-up. Obviously, the stock is too far extended to the downside to short it at this point, but I will be closely monitoring the first bounce and reaction rally once it finds a short-term low as this is generally where an optimal short-sale point will emerge.




Facebook (FB) pulled a classic “ugly duckling” maneuver by gapping up to all-time highs following a blow-out earnings announcement Wednesday after the close. This resulted in a buyable gap-up move, as we can see on the daily chart below, using the 60.46 intra-day low of Thursday, the gap-up day, as your selling guide with an additional 1-2% for good measure. If the market is able to find its feet and turn soon I think FB has the potential to move higher from here. Otherwise, a continued market correction might just keep the stock in a sideways flag formation as the market works things out. Definitely one to keep on your buy watch list, although one could be long the stock on the basis of Thursday’s buyable gap-up, using the 60.46 intra-day low plus another 1-2% as your selling guide. You might notice that FB pulled down below the 60.46 price level on Friday early in the trading day but only got as low as 60.17 before finding its feet and reversing to a new high on above-average volume. Thus if you were using a stop 1-2% below the 60.46 intra-day low of the BGU day you were not pushed out of the stock.




Netflix (NFLX) continues to hold above the $400 Livermore “century mark,” as we see in the daily chart, below. Despite a weak tape on Friday, NFLX was able to edge to an all-time high as volume picked up on the day and came in at just above average. As I wrote in my report of last week, if you are long the stock, the $400 price level offers a convenient trailing stop in the event that a continued market correction starts to drag the stock back down.




It is interesting to see that while the general market has gone into a short-term correction we have seen the “Four Horsemen” become someone resurgent. While FB and NFLX move to all-time highs, Tesla Motors (TSLA) has also snapped out of its funk as it comes right up to the highs on the left side of its base, as we can see on the daily chart below. TSLA also illustrates how operating on the basis of pocket pivots is far superior to trying to label a base as “improper” based on some sketchy concept of a breakout from a “low handle.” As I wrote in my report of January 15th, while the base might be subject to failure at some later stage, the fact is that the pocket pivot on January 14th was most certainly buyable and produced a nice upside trade from there. At this point, however, I would be inclined to take profits, assuming I were long the stock, going into earnings later this week.




The only one of the Four Horsemen that is still trying to find its head is LinkedIn (LNKD), which I have seen more as a short-sale target than something I’d like to be long. The stock remains in a downtrend, and the early-January, bottom-fishing, pocket pivot that came after a wedging rally failed right at the declining tops downtrend line, as we can see on the daily chart below. Currently LNKD is dancing around its 200-day moving average, and on Friday found resistance at the 50-day moving average after a sympathy rally on the heels of FB’s strong gap-up move on Thursday. LNKD is expected to announce earnings on Thursday after the close, but I do not plan to have any position in the stock going into the report since I am not a fan of playing “earnings roulette” in most, if not all, cases. While FB, for example, illustrates how an ugly duckling can transform into a beautiful swan following a strong earnings announcement, AMZN illustrates how an ugly duckling can transform into a dead duckling following a weak earnings announcement.




Twitter (TWTR) rallied on the heels of FB’s earnings announcement and upside gap on Thursday, but as we can see on the daily chart, below, Thursday’s gap-up was accompanied by volume that was below average. As well, Thursday’s volume bar did not meet the required level for a pocket pivot, so TWTR was left without a bona fide, actionable buy point which is just as well since the stock is expected to announce earnings this Wednesday after the close.




TWTR has tended to be somewhat “noisy” and volatile as it has worked its way through what is so far a 4- to 5-week flag formation following its sharp price run-up in December. The weekly chart, below, serves to eliminate much of this noise and what we notice is that the past three weeks have seen somewhat tighter weekly closes with this past week showing slight supporting action off the 10-week moving average as volume picked up for the week. So despite the volatility in the daily chart, the bottom line is that TWTR continues to work on a new base, and with FB making all-time highs, it may be primed for another breakout which could occur following earnings. Obviously, Wednesday’s earnings announcement brings up the possibility of a buyable gap-up move on Thursday if the announcement is positive, and that is certainly something to watch for. Thus FB and TWTR hold top spots on my current (and short) buy watch list.




I last discussed Proto Design Labs (PRLB) in my January 15th report as it was starting to round out the lows of its current base, and we can see on the daily chart, below, that it has since been able to move above its declining 50-day moving average. Thursday saw the stock bounce off the 50-day line and reverse back up to a higher high in what was a bona fide pocket pivot buy point coming up the right side of a potential new base. PRLB is expected to announce earnings on February 11th, a little over a week from now, so while the action here is constructive I’m not sure I would necessarily want to be holding the stock into earnings. It is interesting to note, however, that as other 3-D printing names have been getting hit with some sharp sell-offs lately, PRLB is quietly turning off the lows of a potential new base and flashing pocket pivots along the way. There was even a “deep doo-doo” pocket pivot that came shortly after the gray oversold bar appeared right at the lows of mid-December.




Workday (WDAY) remains one of my favorite stocks as it backs-and-fills here following a prior breakout and strong 10%-plus upside move, as we can see on the daily chart. WDAY pulled right back to the top of its prior base early in the week before rebounding back above its 20-day moving average but remains just below its 10-day moving average. What I’m watching for here is some kind of secondary buy point in the form of a continuation pocket pivot off the 10-day line. I should also point out that YY, Inc. (YY), is in a similar position on its daily chart, not shown, and should be watched for a similar continuation pocket pivot should that occur.




As with TWTR, the weekly chart of WDAY gives a less “noisy” picture of what is going on with the stock. Last week saw light-volume selling off the peak as the market went into its correction, and this past week’s pullback to the top of the prior base also found support at the 10-week line. Another constructive feature on the weekly chart is the much larger upside volume bars relative to last week’s red downside volume bar over the past four weeks since the stock broke out from its prior base. Theoretically, the first pullback to the 10-week line is buyable given that a standard 6-7% downside stop would keep you above the prior 84 breakout level, the general market correction notwithstanding. WDAY is expected to announce earnings on March 6th, so earnings roulette day is still more than a month away.




I like the action in Finisar (FNSR) as it forms what is now a three-week handle to what is so far a 15-week cup-with-handle formation. As I wrote in my report of January 15th, at that time FNSR needed “more time to work on the handle and drift slightly downward, which would be preferable to see rather than this slight wedging up along the weekly lows that we are seeing over the past four weeks [prior to January 15th].” Three weeks later the stock is forming a constructive handle where the two weeks prior to this past week pulled down to the 10-week moving average on below-average weekly volume while this past week saw weekly volume pick up as the stock found support at the 10-week line in the midst of a market correction. Notice also the huge upside volume spike at the absolute lows of the cup followed by a very tight weekly close the following week, and then a four-week drift back up towards the highs of the cup.

FNSR is expected to announce earnings on March 6th, and so far the stock appears to be setting up in a nice cup-with-handle. Whether it can break out before earnings remains to be seen, but given that earnings are more than a month away I would be willing to give the stock a whirl in the event that a bona fide buy point appears before then, and then decide whether I want to hold into earnings. Of course, all this depends on what the general market does over the next few days and weeks, as the current correction could deepen, putting the long side on hold.




Among my short-sale targets, Cree (CREE) pulled in Friday after pushing back up to the 10-day moving average, as we can see on its daily chart. The stock is now right back at its 50-day moving average, and in this case I will cover my position here with the idea of waiting to see whether it can bounce or whether it breaks down through the 50-day line. There really hasn’t been any decisive volume one way or another in the stock, and a full breakdown through the 50-day moving average may only come if the general market also breaks down to lower lows. Thus CREE is still in play as a short-sale target as we watch to see what it does along the 50-day line in the coming days. I still consider rallies up to the 63 price level as potentially shortable, using a tight stop from there of 2-3% max.




Among my other short-sale targets, Michael Kors Holdings (KORS) and Lumber Liquidators (LL), both not shown here on charts, KORS is trying to hold along the 80 price level and in my view may not fully resolve until after it announces earnings in a little less than two weeks from now. Meanwhile, LL is expected to announce earnings a little over three weeks from now, so it is a matter of seeing whether the stock undercuts its 85.58 low from early December before then as that would provide a very neat and tidy cover point to bag profits in the stock before earnings and then waiting to see what happens after LL reports.

As has been the case with most market corrections since last January, the action of leading stocks sometimes gives you a better picture of what is going on before the indexes do. As the market corrects, it is interesting to see three out of the Four Horsemen of FB, NFLX, LNKD, and TSLA become resurgent with two of them, FB and NFLX, making all-time highs in the midst of a market correction. TSLA will announce earnings later in February, while LNKD is expected to report on Thursday, so we will have a chance to see whether a big earnings surprise can propel either stock to new highs as well. In the meantime, I am keeping my eyes out for constructive action in a handful of leading stocks that make up my short buy watch list currently, using both daily and weekly charts to make my assessments. Remember that it is important to keep a close watch on the weekly action as this helps to take out a lot of the noise that can occur on the daily chart and help to present a clearer picture during a market correction.

While the short side doesn’t strike me as a place where you’re going to make piles of money, the long side remains tenuous as long as the general market continues to correct. If the market does eventually find its feet, my guess is that social-networking names like FB and TWTR will be where the upside “juice” shows up. I like the action in a handful of other names, but will continue to monitor situations as they develop. If the market turns at any point, I don’t need a lot of stocks to make a lot of money on the upside – just the right ones. 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 held a position in LNKD, though positions are subject to change at any time and without notice.

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