The Gilmo Report

February 24, 2021

February 24, 2021 6:48 pm ET

The week started off with a sharp rotation out of technology shares, something we were already seeing signs of last week, and into stuff stocks. As market interest rates rise, it is clear that markets see inflation coming down the pike, despite Fed Chair Powell’s comments yesterday that it was merely an expression of “confidence” in the economy. This helped send stocks back to the upside as the S&P 500 Index found support at and bounced sharply off its 50-day line.

The main issue here, in my view, is that if the market is going to raise rates independent of the Fed then the Fed is vulnerable to losing control of its monetary policy. In response, the markets are dumping higher-PE stocks like tech while rotating into commodity-related names and economic re-opening plays, what I call phase-shifters. None of this should be a surprise since we’ve been discussing this for at least the past couple of weeks, even longer.

All of this shows up in the charts below where we see a noted divergence as the NASDAQ Composite clung to support at the 50-dma yesterday and pushed higher today while the S&P is shooting right back up to its prior highs. The NASDAQ remains deeper down in its pattern than the S&P 500, while the Dow, not shown, pushed to all-time highs as big-stock industrials and financials in the index rocketed higher today.

 

 

What this all sets up, as I see it, is a rotation into commodity-related names in anticipation of higher inflation. However, the important question is whether this is a positive rotation that will drive the market significantly higher or a defensive rotation where money piles into lower-PE stuff-stocks and phase-shifters as a defensive move ahead of an anticipated difficult market environment. This is a key point to monitor.

Futures were up in pre-open trade when things got going around 4:00 a.m. PST my time, but suddenly broke to the downside a little over an hour before the open. At the same time, I noticed that the 10-year Treasury Yield was making higher highs, pushing above 1.40%. Later in the morning after the opening bell, the yield dropped below 1.40% and the market began to rally in earnest.

 

 

Rising interest rates, and by inference rising inflation, put a lid on PE-expansions and the greater these PE-expansions have been over time, the less attractive such stocks become. That’s why money has come flying out of techs and into stuff stocks, and it has been the story of this market over the past couple of weeks as a comparison of the charts of the SPDR Select Sector Technology ETF (XLK) and the SPDR Select Sector Materials ETF (XLB) shows only too clearly.

 

 

We’re also seeing movement into the “phase-shift” stocks I discussed in the weekend video report. I also concluded my written weekend report with Walt Disney Company (DIS), which is on my list of phase-shifter stocks. Phase shifters are essentially stocks that will benefit from a new market phase where commodity inflation and economic re-opening themes potentially come into play in a serious way.

As I discussed over the weekend, DIS was buyable along the 20-dema, although it was a little tricky as the stock gapped below the line first thing Monday morning before finding its feet and moving higher. After three days to the upside, it is now stalling in new-high price ground, so perhaps vulnerable to a pullback. In any case, it is extended.

 

 

Other obvious phase-shifter areas of the market would include things like airlines, travel, lodging, theme parks, oils, etc., and I discussed several names in these areas in my weekend video report. My tendency is to favor the commodity-inflation names, since it is still unclear just how fast the economy will return to full-normal.

But in either case, it is simply a matter of going with the set-ups at hand and keeping risk to a minimum, as would have been the case with DIS on the pullback to the 20-dema. As long as one adheres to this simple principle, sticking to proper set-ups at the proper buy points while keeping risk to a minimum, then I think it’s possible to take any of these stuff-stock and phase-shifter trades.

With commodity-inflation helping to drive strong moves in the silver miners this week, silver continues to hang tight along near-term support. The Sprott Physical Silver Trust (PSLV) posted a strong-volume pocket pivot on Monday but pulled in with the market yesterday morning before finding support at the 20-dema and rallying nicely off the intraday lows.

Today it pulled in to the 10-dma and found support there as volume came in above average, making it two days of support, first at the 20-dema and then at the 10-dma on above average volume. In conjunction with Monday’s pocket pivot, the PSLV looks like it wants to move higher.

 

 

Silver miners leveraged the constructive action in the white metal by launching higher in what has been something of an industrial metals festival so far this week. Gold, not being an industrial metal, is lagging, but may eventually come to life if silver starts moving with better upside velocity. In the group chart below, we can see pocket pivots this week in Coeur Mining (CDE), Gatos Silver (GATO), and Pan-American Silver (PAAS), while one of my more favored names recently, MAG Silver (MAG), is simply continuing to push higher off the 50-dma where it started moving last week.

 

 

First Majestic (AG) had been closely mimicking the chart of the PSLV until today when it broke free of the 10-dma and pushed to higher highs. It also posted a pocket pivot at the 10-day line on Monday. These names look good, and as I said before, it may be that owning the miners is better than owning the ETFs since if there is in fact a physical shortage then it’s the miners that actually have the goods, and so there they go.

 

 

I tend to favor the metals here, and we are seeing some sharp movement in the various industrial metals names. Copper producer Freeport-McMoRan (FCX) came in yesterday morning with the market and tested its 10-dma without quite getting to the line before bouncing to close nearly unchanged. It held tight today but would only be buyable on pullbacks to the 10-dma like we saw yesterday.

 

 

Alcoa (AA) posted a big-volume pocket pivot last Friday, as I noted in the weekend report, and has continued higher since then. Like FCX, yesterday it came within 2% of its 10-dma early in the day before bouncing sharply off the intraday lows. Today it broke out to a 52-week high on heavy volume, but I have to say I’m not inclined to buy it here given the sharp V-shaped moved off the lows of late January – better to watch for pullbacks closer to the rising 10-dma as lower-risk entries from here.

 

 

With its metallic cousins pushing to 52-week highs, perhaps U.S. Steel (X) is looking to make a run for its prior January highs as well. The action here is a little trickier as X regained the 50-dma on Monday on above-average volume before falling back below the line on Tuesday. That ended up creating a shakeout at the line and a moving average undercut & rally type of long entry set-up, which is now extended, so we would look for any pullbacks closer to the 50-dma as potential lower-risk entries from here.

 

 

Keep a close eye on other steel names such as Steel Dynamics (STLD) and ArcelorMittal (MT). While STLD, not shown, is extended on the upside, MT is sitting just above its 10-dma from which it moved higher today after shaking out at the 10-dma and 20-dema yesterday. In this case, I would look for pullbacks to the 10-day line as potential lower-risk entries from here.

 

 

In most cases, my favored commodity-related names are extended after three days of wild action that has sent them higher. Both Caterpillar (CAT) and Deere & Company (DE) are representative examples as they both continue to streak higher.

 

 

Fertilizer names have also been moving as of late, and in this report, I’m going “full-fert,” so to speak, by showing all four of my favored fertilizer names in a single group chart. CF Industries (CF), Intrepid Potash (IPI) and Mosaic (MOS) are all extended, but MOS did post a re-breakout today and remains within buying range of that for those of you who like to buy breakouts.

As I noted last week, however, the recovery along the 20-dema as the stock was hit hard on an ugly reversal following earnings on Thursday was a better entry point if one was bold enough to take it when MOS tested the 20-dema yesterday. Nutrien (NTR) is the only one of the four that is sitting in a buyable position along the 10-day line while using it as a tight selling guide.

 

 

Agricultural names Bunge (BG) and Corteva (CTVA) are not currently in buyable positions. BG dipped below its 10-day line today on declining volume, I would favor the opportunistic route here and look for a deeper pullback to the 20-dema as a lower-risk entry if I can get it. Meanwhile, CTVA is extended as we look for pullbacks to the 10-dma as potentially lower-risk entries from here.

 

 

Lithium names remain a mixed bag, and the unfortunate thing with this group is that while they are stuff-stocks as miners/producers of lithium, certainly something that qualifies as stuff, they are also linked to electric vehicles, and the EV space is lagging badly, and this seems to have an effect on most of these names.

In the group chart below, the only one that looks attractive is Piedmont Lithium (PLL) which posted a pocket pivot and trendline breakout today. This is therefore in a buyable position, with the trendline at around 61 as a selling guide. I would certainly not be inclined to use a standard, but in fact mindless, 7-8% stop on this one.

Albemarle (ALB) and Livent Corp. (LTHM) have regained their 50-day moving averages, where they can be viewed as buyable using the 50-dma as a tight selling guide. Of the two, LTHM has the better-looking quick-shakeout type of action vs. the choppiness in ALB just below the 50-dma over the prior four days.

Lithium Americas (LAC) also shook out at the 50-day line yesterday but is too extended from the line at this point to be buyable on that basis. However, it did post a U&R at the prior 18.56 low today as it approaches the underside of its 20-day line. The stock closed at 19.80, which is about 6.6% above the prior 18.56 low, which is too far away. And so we can watch for any pullback closer to 18.56 as a potential lower-risk entry using the same low as a tight selling guide.

 

 

Most of the FOMO areas of the market have come apart or are starting to come apart, including Electric Vehicle names, EV Battery/Charging names, Space names, and a variety of SPAC-related plays. It appears as if the speculative fire in this market has been snuffed out, and it is not clear whether this has implications for the market. All I know for sure is that for now the less-exciting stuff-stocks and phase-shifters are in control.

The four examples below give a reasonable idea of what is going on with most of the former FOMO mania stocks. The one that I find most interesting is Arcimoto (FUV), a name I previously discussed in my video reports a couple of months ago. The company makes little three-wheeled EVs, and generated so much enthusiasm that it eventually garnered a more than $1 billion market cap despite selling only 31 vehicles.

But, as we already know, when FOMO is in charge, fundamentals go right out the window. And, of course, the other three names on the group chart, NIO, PLUG, and SPCE, are also losing money with no signs of profits on the horizon just yet.

 

 

There’s the old saying that when the generals stop leading, the market is in trouble. If we consider that the big-stock techs that I like to refer to as the S&P Five, Apple (AAPL), Amazon.com (AMZN), Facebook (FB), Alphabet (GOOG), and Microsoft (MSFT), are mostly looking quite troublesome, then should we conclude that the market is in trouble? Perhaps, but all I know is that I’ll take a good stuff-stock over one of these names, at least for now.

 

 

Tesla (TSLA) also wasn’t looking so great over the weekend, and its situation deteriorated significantly on Monday when it gapped below its 50-dma and then headed lower on Tuesday morning before staging an oversold type of bounce. It is now headed back up toward the 50-day line on declining volume, and this may set up a short-sale entry near the line, so is something to watch for. Bottom line: TSLA is another big-stock general that has come apart.

 

 

In my view, while stuff-stocks and phase-shifters are working right now, I remain alert to any changes based on the fact that we’ve seen many leading names and areas of the market come apart significantly over the past few days and weeks. This may be problematic for the market, especially as interest rates, at least market rates, continue to rise.

As I’ve previously discussed in both my written and video reports, I view cloud names as the most vulnerable group currently. A move to stuff-stocks generated by the market’s perception of higher inflation and therefore higher market interest rates will likely compress the massive PE-expansions these names have had over the past year.

So, in this spirit, I offer four cloud names that are currently on my short-sale action watch list, and I am ready to act on these depending on how they play out from here. Now, I don’t discount the fact that they could simply recover outright, but if the market gets into trouble, this would be my go-to area on the short-side.

All six names below, Avalara (AVLR), CrowdStrike (CRWD), Okta (OKTA), Ring Central (RNG), Twilio (TWLO), and ZScaler (ZS), all have two things in common. The first is that they are cloud-related names, with various cloud sub-themes. The second is that all six are pushing up into or just past their 20-dema or 50-day moving averages. Therefore, I believe that if the general market gets into trouble, for any reason, these may fail at their 20-day or 50-day lines and trigger as short-sale entries, so I can keep them in my back pocket as possible short-sale ideas if needed.

The one name just below its 20-dema but still above its 50-dma is TWLO, which recently failed on a breakout attempt. A break below the 20-dema initially confirms this as a potential, late-stage, failed-base (LSFB) type of set-up, and the current rally back above the 20-day line can be watched for any break back below the line, at which point it would trigger as a short-sale entry.

 

 

Notes on Terminology

Note #1 – Moving Averages: 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 (black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

Note #2 – U&R Set-ups: A U&R, or undercut & rally, is a long entry signal that occurs when a stock undercuts (moves below) a prior meaningful low in its chart pattern and rallies back above that low. The precise entry occurs at the prior low, which then becomes your selling guide. There are no other special requirements for a U&R other than the price action. It is similar to Wyckoff’s Spring. A MAU&R, or a moving average undercut & rally, is essentially a shakeout at a moving average where your entry point occurs at the moving average as the stock is coming up through the line. This then becomes your selling guide. You can run things tight by using the actual price levels as stops or allow for 1-3% of further downside (otherwise known as downside porosity) before being stopped out.

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Like I wrote over the weekend, “The market situation strikes me as a bit more complicated than simply labeling it bullish or bearish.” And I would say the action so far this weekend confirms that point. The action among individual stocks and groups remains highly divergent. While there have been some nice long situations over the past few days, there have also been some exceptional short-sale set-ups to take advantage of.

Since I tend to let the set-ups tell me which direction to go, right now I find that I am getting a distinctly mixed message in this regard. For this reason, I strongly recommend sticking to concrete set-ups on the long side where buy points can be found as close to nearby support as possible. I would certainly not look to chase anything that has moved higher over the past few days, including some of my strongly-performing stuff-stock names.

At the same time, for those comfortable with the short side, it is certainly a compelling idea to short weak names among formerly leading areas of the market. This is certainly the case if the set-up is right and if risk can be kept to a minimum by looking to short weak names as they rally up into an area of overhead resistance, like a moving average, or at the point of impact as they breach a moving average, generally the 20-dema or 50-dma.

This is not an easy environment, particularly this week where we’ve seen some sharp volatility as both the index and individual stock charts clearly show. So, play it close to the vest, and 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 positions in AG and PSLV, though positions are subject to change at any time and without notice.

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