The Gilmo Report

January 26, 2014

January 25, 2014

By Wednesday of this week the market looked as if it were primed to push for higher highs, especially on the heels of what was going to be a big price gap-up for Netflix (NFLX) the next morning following that stock’s after-hours earnings announcement on Wednesday after the close. That was certainly conventional wisdom, and hard to argue against, but the stock market is a place where things can change quickly, and conventional wisdom can quickly go out the window. That is exactly what happened on Thursday as the indexes quickly gave up on their rally and blew to the downside over the next two days, as the daily chart of the NASDAQ Composite Index, below, shows. The “Naz” broke down through support at the 4190 price level and appears to be en route to a rendezvous with its 50-day moving average, which could occur on Monday.




The S&P 500 Index, shown below on a daily chart, one-upped the NASDAQ by not only breaking down through its own support at around the 1810 price level but also smashing through its 50-day moving average on heavy selling volume. Thursday’s opening gap-down was initially written off as a short-term reaction to weakness and concerns regarding China as well as a collapse in the Argentinian peso, not surprising given the preponderance of bullish sentiment in the media and in the sentiment polls. As I tweeted to members early in the day on Thursday, “Think about locking in profits where you have them, and if underwater on any new positions just hit the reset button and sell.”

By Friday this was all turning into a full-blown breakdown in emerging markets and currencies worldwide, and that advice turned out to be prescient as the market got hammered with both the S&P 500 and the NASDAQ Composite Indexes down over 2% on the day. The way the market has suddenly gone “schizo” on us over the past two days is not a good sign, in my view, and at least raising cash is the most prudent response, assuming one didn’t go to cash altogether as I did on Thursday waiting to see whether and how the market potentially sets up for the long side again, assuming it does so at all.




The stock market’s action with respect to leading stocks has been fairly typical, and in my mind has only served to reinforce my approach of trying to get a jump on a stock just before or right as it begins a potential price move and then selling into gains of 15-25% or more. In 2013 it was something of what we might term “signature action” for leading stocks which would have strong price moves and then pull back sharply to give up all or most of those prior gains. The action for leading stocks in January 2014 is not much different, and confirms why I will maintain my active strategy of anticipating potential moves in leading stocks and then selling into them when they occur once a particular profit objective is reached or the technical action deteriorates. This strategy worked in 2013, and it has so far proven to be the right approach in 2014.

What is notable about the sell-off over the last two days is just how broad and ugly it was. If we look at the chart below of the NYSE Common Stock Advance Decline Lines (©, used by permission), we can get a sense of this by the deep red bars showing for the Advances minus Declines (Net A-D) and Advancing Volume minus Declining Volume. Over the past six months, bottoms at the end of short corrections have been market by extreme downside red bars as I’ve circled in the chart.

What is different now is that while these deep red bars previously occurred after several days or even weeks of a short-term correction, this severe action is occurring right off the peak while the S&P 500 was moving tight sideways and the NASDAQ was in fact making higher highs. This is a pretty severe break off the peak, and reminds me a little of March 2000. So while the action looks “climactic” it may also fit the technical term of an “initiation climax” where the extremely ugly break off the peak marks the initiation of a further downside move that may take place over the ensuing days or weeks. While the market looks quite “oversold” on the basis of the chart below, sometimes an extreme oversold condition right off the peak is in fact a sign of weakness as oversold potentially becomes even more oversold.




Of course, none of this is written in stone, but I tend think that the ultimate definition of complacency in a QE market is the belief that no matter what happens the Fed and its QE policies will always be able to rescue the markets. In my view, you have to pay attention to what your stocks are telling you, and this week the message was pretty clear.

As stocks get crushed, gold continues higher, as we can see on the daily chart of the SPDR Gold Shares (GLD), below. Last weekend I discussed the bottom-fishing pocket pivot of two Fridays ago and discussed the idea of buying the GLD using a 119 stop on the GLD. The first two days of this past week saw the GLD pull back and test that low without ever breaching it, giving one a good chance to buy it on weakness. On Thursday the GLD gapped up back through the 50-day moving average on another bottom-fishing pocket pivot, the second in the span of one week. As I wrote late weekend, we’ll see whether this current action leads to a more sustained upside move in gold, but so far it continues to move higher. If you are long the GLD then the 119 price level remains your downside stop.




During the first two to three weeks of the New Year the market made me look pretty smart, as a number of my long ideas were working very nicely, in some cases producing gains of 25-30% or more in just a few short days, such as with FireEye (FEYE), Canadian Solar (CSIQ), and YY, Inc. (YY), to name a couple. Over the last couple of days, however, the market has made me look rather stupid, as even the stocks which I cited as acting well and looking like they wanted to move higher, such as (AMZN), shown below on a daily chart, got creamed on Friday. AMZN fell back into its flag formation and actually closed just below the 50-day moving average on Friday as sellers swarmed the stock. In this regard AMZN resembles the action seen in a lot of leading stocks on Friday. In any case, when the market has been making me look smart and right for a period of time and then suddenly begins to make me look stupid and wrong, and harshly so I might add, that is useful market feedback telling me to back off on the long side.




Even a name like Cree (CREE) blew up in short order. I had discussed this in my report of this past Wednesday as looking like it wanted to jack higher following a huge-volume pocket pivot on Wednesday coming on the heels of its Tuesday after-hours earnings announcement. Being long the stock myself after Wednesday’s pocket pivot move, Thursday’s gap-down caused me to unload the stock immediately at the open, and in this case that was the smart thing to do. By Friday CREE was pushed right down through its 200-day moving average, as we can see on the daily chart as volume remained above average, proving that in the stock market there are only two types of investors – the quick and the dead.




The brutal reality for CREE is that on its weekly chart, below, the stock looks like a big, ugly short-sale set-up in what is basically a massive two-headed “Hydra-and-Shoulders” formation. Notice that the stock reversed hard this week on huge selling volume as it dips just below the 40-week moving average. The interesting thing here is that the 10-week line crossed below the 40-week line six weeks ago for a “Black Cross,” and while I thought the 10-week line might cross back to the upside based on Wednesday’s strong upside action, the ensuing reversal over the past two days makes the black cross more significant, in my view. While the stock looks potentially shortable here using a 5% stop on the upside up to around 64 on any sort of reaction bounce, such a bounce would be eminently shortable, in my view.




About the only thing acting well on Friday was Netflix (NFLX), which held tight on Friday following Thursday’s buyable gap-up, as we can see on its daily chart, below. NFLX didn’t move much on Friday as the market got slammed, which might speak in its favor. Right now the intra-day low of Thursday’s buyable gap-up move at 377.49 continues to hold as a downside selling guide for anyone who bought into Thursday’s BGU (buyable gap up). If the market is able to stabilize and turn back to the upside, as it has done during previous corrections throughout 2013, I would consider NFLX a good long idea with the idea that it will continue up through the $400 price level. Keep this on your buy watch list for now.




Twitter (TWTR) has also been showing a little relative strength over the past couple of days as it holds above its 10-day and 20-day moving averages, as we can see on its daily chart, below. Volume did pick up slightly on Friday, although it remained below average, as the stock pulled back a little over a dollar after holding positive on Thursday. However, this could change quickly if big volume selling takes the stock down through the 20-day moving average, but for now TWTR has been able to hold the two short moving averages as well as the 61.57 shakeout-plus-three buy point of seven days ago on the chart. Confirmation of strength in TWTR would likely come in the form of an extreme volume dry-up on a pullback to the 10-day/20-day moving average confluence or a pocket pivot off of the 10-day line. For now, however, I prefer to be out of the stock looking to possibly come back in, rather than in the stock wishing I was out should the market continue lower next week.




Meanwhile, there are some possible short-sale set-ups in the making here, such as LinkedIn (LNKD) which was not able to hold its 50-day moving average following Wednesday’s low-volume pullback to the line. It is now trading below this key moving average, as we see on the daily chart, below. Analysts are looking for LNKD to report 11% earnings growth on a hard number of 39 cents a share when it announces earnings in early February. This would be a sharp deceleration in earnings growth that in my view has to be bad for the stock unless they can pull a rabbit out of the hat and throw up some huge earnings surprise. In my view, the stock is worth a short here using Friday’s 221.50 high as a quick stop on the upside. The deep red “Kahuna” on the middle indicator bar at the top of the chart that showed up two Fridays ago when the stock reversed following its flawed pocket pivot is one clue that the balance here may be tipping to the downside.




Another one that might be in a shortable position is Michael Kors Holdings (KORS). KORS failed and broke below its 50-day moving average nearly three weeks, ago, as we can see on the daily chart below. This could represent the early stages of a late-stage, failed-base type of short-sale set-up. After breaking down through the 50-day line, KORS bounced off of what interestingly turned out to be its 150-day exponential moving average, the orange moving average on the chart. This has now resulted in a rally back up to the 50-day moving average where it becomes potentially shortable using a tight stop at Friday’s intra-day high of 81.10.




Lumber Liquidators (LL) is more of your classic head and shoulders short-sale set-up, as we can see on its daily chart, below. Notice how the rally that formed the right shoulder in the pattern pushed right up into the 50-day moving average before rolling over and busting through the 200-day moving average on Friday. Given that the stock has moved just below the 200-day line, a bounce might occur here that would be shortable, but I would not look for this bounce to carry much further than the 98.82 intra-day high seen on Friday. LL’s 10-week line at 100.15 is exactly 5% above where the stock closed on Friday, so one could use that as a stop if shorting into any bounce off of Friday’s close.

The action in leading stocks over the past two days constitutes a grisly change of character, and in my view the long side of this market now carries a high degree of risk. The Fed is expected to carry through with its first QE taper when it makes its policy announcement on Wednesday of this week, so it could be a volatile week. With the market short-term oversold, a bounce or rebound could coincide with the NASDAQ finding support at its 50-day moving average at 4081.98. Whether this creates an absolute low or just a quick bounce before the market heads lower remains to be seen, and by the time I write my Wednesday report we will probably have a clearer picture of where the market is at. The bottom line is that right now I don’t see any pullbacks in leading stocks that I see as buyable just yet. 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 positions in LNKD, though positions are subject to change at any time and without notice.


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