The Gilmo Report

July 15, 2012

July 15, 2012


The market looked like it was ready to blow apart on Thursday, but as it has done so many times before, just when it becomes obvious to everyone that things are looking ugly, it fools the crowd and snaps back in the opposite direction. As I discussed in my Wednesday report, the market simply looks to be moving within an uptrend channel as it ping-pongs its way back and forth. Volume picked up on Thursday but the NASDAQ Composite Index, shown below on a daily chart, closed near the peak of the intra-day trading range for a minor show of support. On Friday the index “melted” back up through the 50-day moving average on light volume, but after five-straight days of selling going into Thursday there weren’t any sellers left to knock it back down below the 50-day moving average. Breadth remains relatively unimpressive here, and for the most part the market looks to me to be locked in the summer doldrums. As I wrote on Wednesday, I’m not sure I’d want to be short this market, and while there are some stocks that look okay and in buyable positions, this is probably an environment where keeping one’s powder dry without getting overly aggressive one way or the other remains the wisest course.

NASDAQ Gilmo Report Stock Chart

As technology stocks flounder, medical and financial stocks have moved to the top of the industry group rankings, and I have to say that I have a hard time thinking the market is about to blow apart when financials are acting well. Some are even issuing buy signals, such as Wells Fargo & Company (WFC), shown below on a daily chart, which broke out Friday on a pocket pivot type of move that took the stock up and off of its 10-day moving average. WFC announced earnings on Friday and beat estimates by a penny, but its fundamentals are not going to knock anyone’s socks off. Nevertheless, it is expected to show a steady 17% earnings growth this year, selling at 10 times forward estimates at the same time that sales growth begins to turn positive again. Quarterly after-tax margins have also reached a peak of 20.4%, and so it appears that institutional money looking for a place to go is moving into financials like WFC. I’ve even noticed that REIT stocks like Simon Property Group (SPG), not shown, are acting very well. If the market has issues, it doesn’t appear to be in the financials as money appears to be rotating into the group.

Wells Fargo & Company (WFC) Gilmo Report Stock Chart

Nationstar Mortgage Holdings (NSM) also exemplifies some of the strength we are seeing in areas that we might not expect to see it as it continues to live in its own little roaring bull market. As we see on the daily chart below, NSM flashed some pocket pivot action on Friday as it moved to all-time price highs, although it was just a bit extended from the 10-day moving average on the pocket pivot. As I’ve discussed in previous reports (seethe June 17th report, for example), NSM is a recent IPO in the mortgage service industry, a line of business that may not elicit much excitement on the surface. But the stock’s upside price trajectory gives it the excitement of a small rocket and shows that the money in this market is being made in areas where the crowd may not be expecting it. Technology stocks, outside of Apple (AAPL), have gone into hibernation. This occurs as Medical-Biomed/Biotech and Financial – Mortgage and Related Services lead. The highest-ranked tech groups are, interestingly, Computer Software – Medical and Computer Software – Financial.

Nationstar Mortgage Holdings (NSM) Gilmo Report Stock Chart

Meanwhile a number of home-building stocks have been acting quite well. Even Eagle Materials (EXP), a building materials company, is showing strength with a buyable gap-up two weeks ago and then a pocket pivot buy point off the 10-day moving average on Thursday, as we see on its daily chart, below. EXP displayed some contrarian strength this week as it pulled back with the market without violating the intra-day low of the buyable gap-up day two weeks ago. The stock tried to break out to new highs on Friday on a pocket pivot volume signature, and in my view EXP is potentially buyable here on the basis of both the buyable gap-up and Thursday’s pocket pivot off the 10-day line. EXP is a turnaround story with earnings accelerating from -44% three quarters ago to 67% and 1900% in the most recent two quarters. Growth of 443% is expected when the stock announces earnings at the end of the month. Sales are also accelerating over the past three quarters at 2%, 19%, and 22%.

Eagle Materials (EXP) Gilmo Report Stock Chart

While NSM and EXP represent strength in the mortgage and building materials spaces, Zillow (Z), shown below on a daily chart, perhaps blends the two spaces into one. Z is as an online provider of real estate data that connects home buyers and renters with sellers and landlords as well as mortgage professionals. What makes it so interesting to me is the fact that it has 8.2 days of short interest. At 655,000 shares traded per day on average (outof a float of 10.3 million shares, according to Bloomberg), this means that a good deal of the stock’s float has been sold short. On Thursday, Z issued what I consider a pocket pivot buy point off the 50-day line and up through the 10-day moving average. As I’ve indicated on the chart, since the down-volume day of six days ago closed right near the peak of the daily trading range, in a sense this was really accumulation of the stock on a pullback rather than outright selling. Thus this day could be discounted, and Thursday’s action becomes a pocket pivot buy point, as I see it. Again, strength where you might not expect it and the potential for a massive short-squeeze make Z an interesting proposition, and I would look to buy any pullback towards the 40 price level.

Zillow (Z) Gilmo Report Stock Chart

While big bio-techs like Amgen (AMGN) and Biogen-Idec (BIIB), not shown, have been leading this market, drug stocks led by the biggest of the big drugs like Merck (MRK), also not shown, are exhibiting strength as well. I noted a pocket pivot buy point in Novo Nordisk (NVO) on Friday, but I don’t show that chart either given NVO’s 11% earnings growth. In the drug area I like Watson Pharmaceuticals (WPI), shown below on a daily chart, much better. WPI broke out from an 11-week base on Friday with a pocket pivot buy point that came on the heels of another pocket pivot on Thursday. While volume was not above average, WPI is potentially buyable on the basis of the pocket pivots. WPI also sports strong earnings and sales growth numbers as both have jumped up sharply in the most recent two quarters. WPI’s earnings growth has gone from 28% to 90% and 84% over the past three quarters while sales growth has accelerated from 23% to 62% and 74% during the same period. Notice also the small “ant” on the below chart seven days ago, indicating that the stock was up 12 out of 15 days or better at that point. It continues to exhibit contrarian strength as the market flops around.

Watson Pharmaceuticals (WPI) Gilmo Report Stock Chart

Seattle Genetics (SGEN) is still working its way through a short flag pattern as it came under pressure during the market’s sell-off earlier in the week but found some minor volume support off the 24 price level, as we see in its daily chart below. SGEN flashed a nice-looking pocket pivot eight days ago on the chart, but it was wedging ever-so-slightly just before that pocket pivot. So the pullback over the past few days might help serve to correct that tiny bit of wedging. On Friday SGEN’s CEO indicated that it was far too early to think about selling the company given that its pipeline and growth trajectory are looking so strong. In this market environment the stock may not be ready just yet to move to new highs, and so continues to spend time consolidating the big move it had in the first half of June. While disappointment that the company is not looking to be bought out sent the stock lower on Friday, it was not accompanied by any heavy selling volume. Selling volume overall in this four-week base that the stock has formed so far remains quite muted. Meanwhile just about 29 million shares of a 91 million-share float have been sold short. Watch for a pocket pivot coming up through the 10-day line as a potential buy signal for the stock.

Seattle Genetics (SGEN) Gilmo Report Stock Chart

A week ago, two of my strongest holdings were Mellanox Technologies (MLNX), not shown, and
CoinStar (CSTR), which I show on a daily chart below. In a sudden change of character, both stocks came down hard with the general market this past week and both tested their 50-day moving averages, so far successfully, at least based on the fact that they did not break down through these moving averages. MLNX was good for a two-day trade off the 50-day moving average, but heavy-volume selling keeps me away from that name for now. CSTR got hit on Friday morning after an analyst firm questioned the company’s growth potential. CSTR held the 50-day moving average, where one could try and buy the stock with the idea that it should hold the line given that Friday’s decline was based on news and so I would look for the stock to recover in a day or two. However, any failure to hold the 50-day moving average would be a clear signal to exit or stay away from the stock. I’m willing to test the stock here by taking a small position, but it would most definitely be kept on a very short leash. Meanwhile, CSTR merely adds up to another floundering leader that was looking good just a week ago but which has since turned tail.

CoinStar (CSTR) Gilmo Report Stock Chart

Social-networking stocks still remain somewhat viable here as LinkedIn (LNKD), not shown, was able to get back above its 50-day moving average after violating the line on Tuesday of this past week. The bounce back above the 50-day line has not been accompanied by any strong buying volume. So for now LNKD is still working on its base as it approaches earnings in early August. Meanwhile, Facebook (FB) bides its time in a little cup-with-handle formation as selling volume continues to dry up in the low 30’s within the handle. While a dry-up in selling volume is nice to see, it only becomes a profitable proposition if it is followed up by an increasing in upside buying volume, and for that we are still waiting to see whether FB can produce some type of pocket pivot buy point coming up through the 10-day moving average at 31.24 on volume that exceeds 19,526,800 shares, the highest down-volume in the pattern over the prior 10 days. It may be that FB’s formation is not resolved until earnings come out at the end of the month. Any strong upside action from current levels before then would likely be a clue of something constructive coming out of the earnings announcement.

Facebook (FB) Gilmo Report Stock Chart

Technically the market remains in a rally phase, although it has come under some pressure as the indexes so far swing from one end of the uptrend channel to the other. While some rotation into those stocks acting well as they either breakout or issue pocket pivots is evident, I still don’t see any reason to get overly aggressive one way or the other. If a stock is purchased and it continues to act well, then it can be held, but a strong-acting stock should continue to act constructively in this market. Anything that changes character in Jekyll & Hyde fashion from one week to the next should be backed away from. Thus, while MLNX and CSTR have pulled down to their 50-day moving averages, it is not clear that they will necessarily bounce with any vigor. But as long as something like AAPL or FB continues to go about the business of building a new base, it remains viable. And if I want to try and nibble on something like FB as it pulls down with volume drying up, then I must also be ready to unload it if selling volume picks up. Meanwhile, some of the constructive action in newer areas like the medicals, drugs, and housing-related stocks might be the first rumblings of nascent new leadership in any continuing market rally. Ultimately, the idea that significant progress can be made right away in this market remains somewhat sketchy, and it may take further movement through the summer before the market decides to embark on any consistent and meaningful trend.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC
Principal and Managing Director, MoKa Investors, LLC
Principal and Managing Director, Virtue of Selfish Investing, LLC

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