The Gilmo Report

February 5, 2014

February 5, 2014

The major market indexes wasted no time resolving their short bear flag formations that I discussed in my weekend report by breaking to the downside on blistering selling volume, as we can see on the daily chart of the NASDAQ Composite Index, below. The NASDAQ has so far tried to hold support around the 4000 level. I wrote two weekends ago that the intensity of the selling likely indicated a so-called “initiation climax” where the market became so oversold so quickly that it was more a sign of further downside rather than a quick pullback and turn back to the upside as has often been the case in a QE-influenced market since last January.  This morning the NASDAQ undercut its 3979.59 intra-day low of December 18th, as I’ve shown on the chart, forcing a bit of an undercut & rally situation. Most market pundits and commentators had cited the 4000 level on the NASDAQ as a critical support level, and when that was broken this morning perhaps things got a bit too obvious on the downside. So far the bounce is just that: nothing more, nothing less.




The S&P 500 Index, shown below on a daily chart can match the NASDAQ for ugliness as it broke down hard on huge volume Monday before undercutting its November low and trying to stage an intra-day turnaround from there today. After-hours I’m watching Twitter (TWTR) reverse into negative territory as I type after it initially jacked above the 70 price level right after its earnings announcement. Tomorrow LinkedIn (LNKD) announces, and it may be that the social-networking group is going to turn out to be juiced rather than provide any juice once LNKD’s earnings are out as well. The situation remains as I indicated over the weekend – the price/volume action of the major market indexes makes the long side of this market simply too risky, and patience is required as we wait to see how this correction pans out. For all we know we could be seeing a major top in the making as Philly Fed President Charles Plosser indicated that he would like the Fed to wind down its bond purchases faster than planned and to end it outright by mid-year. Fed heads seem to think that the economy will grow at 3% this year but in my view most of the “growth” that shows up in wildly massaged and essentially fictional government data is an illusion. Meanwhile, the market remains in a correction.




Earnings roulette season continues to produce its share of gap-up and gap-down moves. I wrote over the weekend that Michael Kors Holdings (KORS) was not likely to resolve itself until after it announced earnings, and that is exactly what happened as KORS blew out earnings estimates and gapped above the 90 level on what might normally be considered a buyable gap-up. While it was possible to hit KORS a couple of times on the short side on a tactical day-trading basis, there was no reason to try and be a hero and hold a short position in the stock going into earnings. Earnings roulette remains exactly as I describe it – a binary gamble either way. With that said, KORS’ gap-up move yesterday is theoretically buyable using the 89.22 intra-day low of the gap-up day plus 2-3% on the downside as your selling guide.

The critical fly in the ointment here is the general market environment, which remains in a pretty severe correction, and I would in fact advise leaving anything like this alone until the general market finds its feet. Perhaps KORS will simply continue to move sideways if the general market continues to correct in a manner similar to Facebook (FB) following its gap-up move after earnings last week. I have to admit, however, that the one thing that would bother me the most about owning KORS at these prices, even in a market uptrend, is management’s tendency to file for secondary offerings that in the past have tanked the stock. Lightning has struck twice before for KORS shareholders in this regard – can it strike a third time? File that one in the “Things that Go Bump in the Night” category!




Holders of Three-D Systems (DDD) didn’t even have to sit through a spin of the earnings roulette wheel as the company pre-announced this morning and promptly blew apart, dropping over 25% in a massive-volume gap-down move, as we can see on the daily chart, below. By the close, the stock ended down “only” 15.4%. “Knife-catchers” apparently thought the stock was just too cheap to resist as it traded down into the low 50’s as buyers emerged around the 200-day moving average to help keep the stock above the line by the close, but this is a busted pattern no matter how you slice it. DDD is also instructive since one can see on the chart that the stock never violated the 10-day moving average all the way up since late October.

The two-day breakdown through the 10-day moving average was never a bona fide violation because the stock closed below the line once and never moved below the intra-day low of that day afterwards. Finally, in January, DDD violated the 10-day moving average, whereupon holders of the stock could have unloaded their shares and bagged profits. By early January, DDD had been obeying the 10-day line for at least seven weeks, triggering the Seven-Week Rule, whereby one would be using a 10-day moving average violation as their strict selling guide.




Another bright spot in the face of a difficult general market environment is Tableau Software (DATA), which blew out earnings estimates yesterday after the close and jacked on a big buyable gap-up this morning. But alas, the general market environment doesn’t put one in the mood to be buying much of anything, even if it is a very impressive gap-up move in a hot, young, and recent IPO like DATA. However, I have noticed over the past week or so that gap-up moves in stocks announcing earnings have been able to hold up as the general market sells off. Besides KORS we’ve also seen names like Harman Industries (HAR) and UnderArmour (UA), both not shown here on charts, as well as Facebook (FB) gap up after earnings and hold their gaps over the ensuing days as the general market has continued lower. Perhaps if the general market were able to find its feet in a more substantial way, stocks like KORS and DATA will build flag formations and present actionable buy points somewhere along a key moving average once the market finishes its correction, assuming that a “correction” is all we are in for here.




As one stock that had already announced earnings, Cree (CREE) was my favorite short over the weekend and it didn’t let me down, hurling itself through the 50-day moving average in a beautiful (if you were short the stock) act of self-immolation, as we can see on the daily chart, below. Offering a short window to nail it on the short side Monday morning right above the Friday close of 60.28, CREE proceeded to head for its mid-December low at 55.36, just missing it today by less than 1% before rallying with the market. If you were shorting in the 63 price area, the drop down below 56 today was a nice 11% downside move, and once it gets close to the December low one can always think about taking at least partial profits. CREE still looks butt-ugly as I see it, and a rally back up into the 60 price area and the 50-day moving average would present a nice short-sale opportunity.




Lumber Liquidators (LL) also tested its December lows on Monday, as we can see on the daily chart, below, before it bounced after hedge fund concern SAC Capital announced a 5% stake in the company. One could have taken profits in any short position in the stock once it began to test the December lows as it did undercut the lows on a closing basis. The other thing to consider on that day, Monday, was the fact that the stock was coming down towards the December lows on below-average volume, and “close enough” works for horseshoes, hand grenades, and short positions when looking to take profits. At that point the stock was over 10% down from its 200-day moving average. Given the position of the major market indexes on Monday as they approached critical support levels, one can also take that into account as an area from which the market might bounce and thereby decide to take any short profits. I generally operate on the short side with one eye on the daily chart of my short position and the other on a daily chart of the general market indexes. In any case, the stock remains well below its 200-day moving average, and earnings are not expected until the latter part of February.




One new short-sale idea that has recently come through my screens and which has the added benefit of having already announced earnings is Align Technology (ALGN), shown below on a daily chart. ALGN broke out in January but failed rather abruptly after announcing earnings in the latter part of January and then breaking down through its 50-day moving average and the prior breakout point on the base on heavy selling volume. After testing the lows of the prior base the stock pulled the usual maneuver for a late-stage failed-base type of short-sale set-up and rallied back above the 50-day line once before rolling over again on Monday. Now the stock is in a short two-day bear flag as it hangs along the lows of the prior base. Optimally I would like to short this thing on a rally up into or just above the 50-day line as I’ve highlighted on the chart. The other possibility is that it just heads lower from here. Whether it can bounce up into its 50-day line may turn out to be more a function of what the general market does from here. If one did short it here one could use the intra-day high of today at 55.51 as a “hyper-stop” on the upside with the idea of re-shorting the stock if the bounce continues up to the 50-day moving average. ALGN has more than doubled since October 2012, and with the stock busting the 50-day line after announcing 96% earnings growth in the most recent quarter, perhaps the market sees that ALGN is done for now.




For now I think members should take note of these stocks that are having strong, buyable gap-up type moves following strong earnings announcements and/or surprises, as these may provide a nice short list of buy ideas if the market is able to find its feet and come out of this correction. If the market does continue to correct, I would expect the stronger names to build flag formations and try to set up again before the actual turn in the indexes. Names on my list currently include FB, NFLX, KORS, HAR, UA, and DATA.

In the meantime, given the present action of the indexes as they have moved to lower lows and are again knocking at the door of “critical” support levels, cash is king and the short side is something to consider as well. With both the NASDAQ and the S&P 500 undercutting their December and November lows, respectively, we are of course set up to try and bounce here, but then we were set up to bounce last week, and they simply ended up moving lower. During past corrections in 2013, when the market finally found its feet one could find a number of leading stocks setting up in tight formations along their 10-day or 50-day moving averages, and right now I’m just not seeing much of this type of action at all.

Thus, at least as far as the long side is concerned, I’m content to wait and watch as I believe investors should remain quite cautious given that sharp and further downside is still a real possibility. 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

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