The Gilmo Report

July 5, 2008

July 5, 2011

To bounce or not to bounce, that is the question. Thursday’s rally was no surprise, given the light holiday trading on such a short market day. The market looks to be in a position where it could possibly try to stage a bounce type rally, but there is no way to know for sure. The “oversold” condition that so many were citing last weekend has not resulted in any kind of meaningful bounce in the major market indexes so far. On the other hand, it’s not as if the market has a right to rally. Currently, the NASDAQ index appears to be sitting on top of a short area of “congestion” around the March lows.

NASDAQ Gilmo Report Chart

If we look at a weekly chart of the NASDAQ Index we can see that the previous leg down in March of this year bottomed out at a point that was roughly in line with an area of congestion that occurred in mid-2006. However, given the extent of the last leg down, we might expect that the current leg down should extend further down at some point and take us through the March lows seen earlier this year. It is, however, possible that we could see a rally of a few days before rolling over again, but we are still only dealing in the realm of possibilities.

NASDAQ Gilmo Report Chart

If we look at the weakest index in this current market environment, the Dow Jones Industrials, we can see that it has currently, although admittedly briefly so far, found some support at a prior area of congestion that occurred in mid-2006, similar to what the NASDAQ did in March of this year.

Dow Jones Industrials Gilmo Report Chart

So while the market could bounce from here it is not necessarily clear that it will, so if you are short you have to play this market with some nimble feet if indeed it does start to rally because bear market bounces can often be violent to the upside. Keep this in mind, but don’t operate from a position of fear. Play your shorts as the market dictates, and remain focused on what the market is doing right now and do not allow yourself to be worked up into a fear state over a potential market rally.

Rallies and attempted bounces thus far have not been impressive given that market breadth, as measured by advancing vs. declining stocks, has continued to deteriorate in the face of any rally, including the “positive reversal that wasn’t” on Tuesday and the holiday levitation rally on Thursday. This is quite evident on the NYSE Advancing-Declining Issues daily chart, below, which has continued on a bee-line to ever lower lows:

NYSE Advancing-Declining Issues daily chart Gilmo Report Chart

The NASDAQ Advancing-Declining Issues daily chart has the same look to it, as you can see below, so it is clear that regardless of what the major market indexes have been doing over the past three weeks, a preponderance of declining stocks over advancing stocks remains the primary theme in this market.

NASDAQ Advancing-Declining Issues Gilmo Report Chart

One statistic worth noting is the percentage of investment advisers bullish vs. bearish, and as we saw at the March lows of this year, bearish investment advisers have now spiked to 44%, 13% higher than the percentage of bullish investment advisers which now stands at 31%. As well, the weakness of this market is easily seen on any number of overbought-oversold oscillators, and I note that this particular oscillator that I show below (image is stretched to make it easier to see) shows the market at extreme “oversold” levels. In addition, the number of news lows on both the NYSE and NASDAQ have reached levels that are in the neighborhood of those levels reached at the January and March lows.

So a rally would not surprise me here, and so you must simply be ready to act if necessary. Keep an eye on individual stocks that you are short or those that are the primary components of specific industry or general market index ETFs that you are short, either directly or through UltraShort ETFs.

Obviously, if you are short individual stocks you want to be aware of potential areas from which the stocks could logically rally, such as the tops of prior areas of support, undercuts below the lows of prior support, and key moving averages. For instance, if you’ve been playing Intuitive Surgical (ISRG) on the short side for the past few weeks you may have noticed that it has undercut my initial downside target on the stock at 254.37. This is a logical area from which the stock could rally, perhaps into the mid 260’s or higher, maybe into the 270 price area. The idea here is to cover on the undercut below 254.37 and look to re-short the stock on a rally into the 265-270 area, maybe even a little higher if the general market works itself up into a strong bounce/rally for a few days.

Intuitive Surgical (ISRG) Gilmo Report Chart

If, for example, you are short the QLD, the NASDAQ 100 Index ETF, then you have to keep in mind that the movement in this ETF will be dominated by the stocks that make up most of the index. The top ten stocks in the NASDAQ by market-cap are are Microsoft (MSFT) at 11.28%, Google (GOOG) at 7.86%, Apple (AAPL) at 6.99%, Cisco Systems (CSCO) at 6.37%, Intel (INTC) at 5.52%, Oracle (ORCL) at 4.98%, Qualcomm at 3.4%, Research in Motion (RIMM) at 3.03%, Amgen (AMGN) at 2.58%, and Comcast (CMCSA) at 2.53%. Therefore, if you are short the QLD then you want to monitor these stocks, as well as other components in the index to determine whether they, as a group, might be in a logical position from which to rally, since they have the potential to impact the index in a meaningful way.

Taking a look at MSFT, the largest stock in the NASDAQ 100 index by market-cap, we see that it is actually breaking down through the neckline of a head and shoulders type of formation, but looks like it could rally back into the neckline, say into the 27 price area or just above, even as high as 28. In general, this pattern looks quite weak to me, and whether the stock rallies temporarily from here if we get a bounce in the market doesn’t seem to detract from the fact that this thing looks like it is headed lower. I remember being short 500,000 shares of MSFT back in mid-2001 as the stock was coming down in the big bear market of 2000-2002, and, as a sideline, I might note that it epitomizes the type of liquidity you like to see in a stock you are selling short – you can certainly cover 500,000 shares pretty easily if you need to!

Microsoft (MSFT) Gilmo Report Chart

Looking for other stocks in “logical bounce areas,” I note that RIMM has found support at its 200-day moving average, and I would not be surprised to see some sort of rally out of this stock that could carry it as high as 130, possibly, but that would depend on the state of the general market and the sharpness of any general market rally.

RIMM Gilmo Report Chart

I also note that the fertilizer stocks, including Agrium (AGU), shown on the daily chart below, among others, found support right around their previous breakout points and, in similar fashion to AGU, at their 50-day (10-week) moving averages.

Agrium (AGU) Gilmo Report Chart

Potash Saskatchewan (POT), shown on the daily chart below, broke beneath its 50-day moving average on Thursday but was able to hold just above it by the end of the week. The 50-day moving average also roughly coincides with the top of its prior base. As I pointed out in my Wednesday report of this past week, I’m watching to see whether these stocks break down altogether and fail back down through their previous pivot points. For now they are holding, and could rally back up 5%, maybe 10% from current levels if the general market bounces from here.

Potash Saskatchewan (POT) Gilmo Report Chart

The most powerful solar-related stock in recent weeks has been Energy Conversion Devices (ENER), on the weekly chart below, which found support at its 10-week (50-day) moving average last week, a logical point from which it can bounce, and from which it did, at least for one day. Whether it holds this moving average line is another question, and will depend on the state of the general market. The big-volume “skyscrapers” on the chart, however, tend to make me think that this stock is an institutional favorite and one that will probably build a base throughout any bear market, should the bear trend continue, so it’s one I keep on my watch list. Of course, just because a stock holds its 10-week moving average once and bounces off of it doesn’t mean it cannot still break down through it if the bear trend continues.

Energy Conversion Devices (ENER) Gilmo Report Chart

So this is essentially what I see in the market right now: indexes that have come down a fair bit and which could be somewhat “stretched” and ready for a possible bounce here, bearishness among investment advisers reaching very high levels relative to bullish investment advisers, extreme “oversold” readings on any number of overbought-oversold oscillators, a Volatility Index (VIX) that isn’t registering any fear in the market as of yet, and new lows reaching extreme levels seen at the January and March lows of this year. So perhaps we are setting up for a bounce, but you simply cannot know for certain, and so you stay nimble on your feet, taking profits in short positions as they come into logical areas of support and remaining opportunistic on any rallies. After all, we know one thing for sure, and that is that the market still will need a few days before we can begin looking for a follow-through day that would signal a resumption of a market uptrend. However, if we did get a follow-through say within the next seven days, it is unclear where we would find leadership since many leading stocks have broken down off of their peaks and at best appear to need more time to form proper bases. In fact, if you look at a number of leadership areas, such as the coal and steel stocks, for example, some of the breaks off the peak look abnormal.

Perhaps, if we did get a follow-through, I might be inclined to look at some bio-tech stocks, a group which showed some unusual strength last week in the midst of all the market weakness. Among these, we saw some nice breakouts in Celgene (CELG) and United Therapeutics (UTHR), both on positive news, as well as Myriad Genetics (MYGN). CELG, which I had previously been monitoring as a possible head and shoulders formation, rallied above its 50-day moving average last week, at which point any short positions in this stock should have been covered immediately as I indicated. CELG benefited from news that a competitor’s product was doing poorly in its testing phase, leading to a big-volume breakout in the stock. CELG is a great example of how I like to say that “one man’s head and shoulder’s formation can be another man’s cup-with-hande” depending on underlying conditions, and that how one looks at a chart can change very quickly depending on the stock’s price/volume action. In CELG’s case, if we were in a rally phase following a market follow-through, I might be inclined to buy the stock here!

Here we see the weekly CELG chart as a possible head and shoulders, e.g., “one man’s head and shoulders…”

Celgene (CELG) Gilmo Report Chart

…which after last week’s breakout it becomes “another man’s cup-with-hande,” as the weekly chart below shows. Remember, there is absolutely nothing inherently determinant in a chart pattern – each stock chart pattern must always be considered within the context of underlying fundamental conditions. In the case of CELG, we see that the ensuing price/volume action following an announcement of troubles for a key competitor product changed the entire look of this formation from a potentially negative head and shoulders type of formation to a potentially positive cup-with-hande formation. This is why you must never maintain a rigid opinion and to accept new evidence and information as it presents itself in real-time.

United Therapeutics (UTHR) is another biotech breakout from a cup-with-hande formation shown on the weekly chart below. On Tuesday this past week the stock benefited from one analysts’ confidence in the approval of a new drug, Viveta, an inhaled version of Remodulin, a drug that is currently taken orally for the treatment of pulmonary arterial hypertension. An inhaled version is seen as “market expanding.” UTHR has not been a big earnings grower, but it did post 135% earnings growth in the last quarter, a big turnaround from the -89% posted in the previous quarter. Sales were also up 54% in the recent quarter, and forward earnings estimates look good. This is one for the watch list should we get some sort of meaningful bounce rally in the market. One characteristic to note is the big, “skyscraper” of volume on the original massive breakout back in late October of last year – often this is a clue of major institutional accumulation, after which the stock can build another base and then break out again as UTHR has. I tend to look at this in a positive light, but again, the state of the weak general market puts one in a tenuous position if you decided to go long something like this, despite the fact that it looks quite buyable.

United Therapeutics (UTHR) Gilmo Report Chart

Yet another biotech breakout this past week came from Myriad Genetics (MYGN), which, despite announcing disappointing test results for their Alzheimer’s drug, Flurizan, turned around on Tuesday after gapping down on Monday and rallied nearly 10% in the next two days, breaking out from a cup-with-hande type of formation on huge weekly volume. It is hoped by analysts that MYGN will shift focus from Flurizan onto their core business and benefit thereby. Apparently, the market agreed with this assessment. MYGN is still losing money, but estimates show some sizable increases in earnings going forward as the stock moves to profitability over the next couple of quarters.

Myriad Genetics (MYGN) Gilmo Report Chart

With all the focus on steels, metals, agriculture, oils, and other “crowded” areas of the market over recent months, it is interesting to see this sort of positive action in these three biotech names, CELG, UTHR, and MYGN since the biotech group is not one that has received much attention over the past few months. If we were to get a follow-through in the market and another rally, even if it were to end up as just another “bear market rally” and eventually fail, biotechs could provide a temporary area of leadership as money flows into the group during a short rally phase. In some markets, medical stocks can be seen as a “defensive” area, so there is this aspect to consider as well. Currently, strength in the medical sector is seen primarily in the genetics groups which has rapidly moved up to a #41 group ranking and the biomed/biotech group which has recently moved into the top 50 groups and is currently ranked #44. All in all, these represent two areas of positive action in the market that you should be aware of and keeping an eye on.

Gil Morales


Gil Morales & Company, LLC

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