The Gilmo Report

June 17, 2012

June 17, 2012

 

The market waved its “fat tail” on Thursday as the broader and hence more random distribution of potential outcomes along the probability curve, perhaps better described in simple terms as “anything can happen,” made itself known. This occurred when Reuters released a newswire indicating that central banks around the globe were preparing to flood the financial system with liquidity in the event of a less-than-desirable outcome to this Sunday’s Greek election or any other Euro-flare-up. This sent the market, which appeared to be floundering as the final hour of the trading day approached, rocketing to the upside and swinging around a bit before closing strongly near the peak of the day. On Friday the market extended its gains as the NASDAQ Composite Index led the charge with a 1.29% gain on heavier options-expiration-related volume as the NASDAQ daily chart below shows. At worst this is constructive action, and at best one might consider it a follow-through day. In general, I prefer to see a 1.5% or better move in the NASDAQ or S&P 500 to call a follow-through, but in the end a 0.21% “deficiency” is less important than what individual stocks have been doing. While I was prepared to come in on the short side as I waited in cash as of Wednesday’s close per my report of that day, Thursday’s action was enough for me to come back in on the long side, and Friday’s action confirmed this decision based on the immediate evidence at hand.

NASDAQ Gilmo Report Stock Chart

Some questioned the Thursday global QE headline from Reuters by asking “why isn’t gold rallying sharply in response?” My answer is simple, and if we look at the daily chart of gold’s proxy, the SPDR Gold Shares (GLD), below, we can see that gold has already been discounting “QE news” by moving sharply up off of its lows of late May. The big gap-up move on June 1st was the real reaction by gold, and despite coming back down to “fill the gap” the GLD has been able to climb right back up to the topside of its 50-day moving average and its highest close since May 5th. As I wrote in my report of this past Wednesday, if the GLD can hold tight sideways along the 50-day line here, and then issue some sort of pocket pivot buy point and/or a trendline breakout through the 1640 level, then a trend may develop. Pending this, in the meantime I am more inclined to want to play individual stocks on the basis of Friday’s “follow-through-like” action. Obviously, if the marginal follow-through on Friday turns out to be a failure, we will know soon enough. But for now, the handful of stocks on my buy watch list and which I’ve discussed in recent reports are sufficient initial long targets in which to take positions in order to participate in any further market upside from here as buy signals emerge.

SPDR Gold Shares (GLD) Gilmo Report Stock Chart

In my Wednesday report I discussed Apple (AAPL), shown below on a daily chart, as a potential short-sale target IF the general market rolled over and began a new leg to the downside. Obviously, that did not happen, and so with AAPL holding tight over the past two days as it underperformed the market on Thursday and Friday one cannot draw any conclusions on the stock either way. However, my view is that AAPL is a big-stock “market stock” and so whichever way the market moves is likely the direction that AAPL will move as well. While Monday’s higher-volume (but still about average volume) reversal at the 50-day moving average looks weak, it could still be a matter of the stock “correcting” the wedging rally off the mid-May lows, as I discussed in my report of exactly one week ago on June 10th. Again, I would look for a pocket pivot type of move up through the 50-day moving average as a buy signal in AAPL, with volume needing to come in higher than Monday’s volume to qualify as a pocket pivot volume signature.

Apple (AAPL) Gilmo Report Stock Chart

And while we want to see AAPL move up through its 50-day line on its daily chart we should note that on the weekly chart, shown below, AAPL has already closed two weeks in a row above the 10-week moving average – the weekly chart equivalent of the 50-day moving average on the daily chart. AAPL closed the week at roughly mid-range on slightly less volume, so one cannot say that AAPL is doing anything less or more than continuing to try and build a base, the duration of which is now at 10 weeks and counting. I see other big-stock NASDAQ names like Priceline.com (PCLN), Intuitive Surgical (ISRG), and Amazon.com (AMZN) as also trying to build potential bases, and my view is that if the market is going to continue higher then we will begin to see these big-stock names continue to come up the right side of potential new bases. We don’t have to see a mass of names breaking out right now to consider Friday’s action a possible follow-through as this can take a few days, sometimes even a few weeks, to develop in earnest. All I can tell you for certain is that right now there are a lot of “bases in the making” out there and the potential for the market to build upon Thursday and Friday’s constructive action is certainly real.

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In hindsight, the fact that I didn’t see anything all that actionable on the short side as of this past Wednesday, June 13th, outside of AAPL coming down with the market or CF Industries (CF) failing to hold its 200-day moving average, was likely one clue that the short-side was not really that ripe. As I’ve been writing in recent reports, almost all of my prior short-sale targets had already hit their downside price targets and profit objectives, and this is generally when the short-side gets fully played-out, at least in the short-term. Meanwhile, what had become a favorite short-sale target of stock market nabobs, Facebook (FB), has turned and crawled up the noses of short-sellers in the stock that swarmed it on the basis of a tidal wave of negative FB news. But, as I discussed in my report of June 6th as well as my appearance on Fox Business News this past Monday, FB has likely bottomed in the same manner as eBay (EBAY) in October of 1998, right after it came public in September of 1998 (see June 6th report for a more detailed discussion). As we see in FB’s daily chart, below, the stock issued a pocket pivot volume signature on Friday although it was slightly extended from the 10-day moving average. I still tend to see this as a short-term buy signal with the idea that FB will hold above the 10-day moving average at 27.30.

Facebook (FB) Gilmo Report Stock Chart

Facebook’s (FB) strength off the lows did not occur in a vacuum – other social-networking names have also been on the move over the past few days, not the least of which is LinkedIn (LNKD), shown below on a daily chart. LNKD is a good example of how a short-sale target can provide “visceral” evidence that perhaps the stock makes a better long. Having been short the stock off the 103 level myself in late May/early June, I noted that it just didn’t want to break the 90 price level, and in fact subtle signs of support on the daily trading ranges on May 21st and 31st, as I’ve annotated on the chart, were a clue of buying interest at the 91-92 price level. Add to that Friday’s pocket pivot volume signature that just missed clearing the 50-day moving average by 40 cents and the evidence for LNKD begins to tip to the long side, in my view. Institutional investors will have no choice but to have some weighting in social-networking names and, as I see it, the two “go to” names in the group are without question FB and LNKD. With LNKD pushing up to the 50-day line here, it will be interesting to see whether and how the stock is able to clear this key moving average on the upside. I thought the action on Thursday as the stock pulled back to test the 10-day moving average on light volume was constructive and buyable in small size, but I would not necessarily be buying the stock up here at 102 until I see further confirmation, preferably a pocket pivot move, from here.

LinkedIn (LNKD) Gilmo Report Stock Chart

If I had to pick three themes for a potential QE or “Romney Rally” they would be 1) social-networking 2) the “new cloud” and 3) medical/bio-tech. I’ve already covered #1, and two stocks that I’ve discussed in recent reports and which fit the bill for #2 are Mellanox Technologies (MLNX), shown below on a daily chart, and Equinix (EQIX). MLNX is an example of a stock that has strongly bucked the market’s correction over the past couple of months and tried to gap higher earlier in the week despite the market’s uneven action. MLNX gapped up on Monday on news that Intel (INTC) had selected the company’s InfiniBand adapter chips for use in their server motherboards and I/O expansion modules supporting the company’s Romley server CPU platform. That’s big news, and the stock has held that gap-up move despite running into a non-cooperative general market earlier in the week. If the general market continues to rally, then MLNX will likely break out to new all-time highs, but it remains potentially buyable on the basis of Monday’s buyable gap-up move using the 62.42 intra-day low of that day as your standard selling guide. MLNX wants to go higher but the market has kept a lid on it – if that weight lifts, the stock could move higher, faster.

Mellanox Technologies (MLNX) Gilmo Report Stock Chart


Equinix (EQIX), which I have discussed in recent reports, is another “new cloud” name that in fact staged a standard high-volume breakout from a short, six-week second-stage base, as we see on the daily chart below. Friday’s move also qualified as a pocket pivot breakout, adding some weight to the breakout. EQIX posted 34% earnings growth in the most recent quarter, and next quarter is expected to come in at -5%, so one might ask whether the fundamentals are deficient here. My view is that the market is looking forward, and generally what the crowd knows in terms of current earnings and sales is not always that relevant in extremely dynamic situations. More important, perhaps are the estimates for Q3 and Q4 of this year which are looking for 205% and 97% two and three quarters out. On an annual basis, we get a better picture of EQIX’s growth curve given that the company is expected to earn $2.60 a share in 2012, $3.72 in 2013, and $4.86 in 2014, all large year-over-year increases. This breakout is potentially buyable using a standard 6-7% downside stop for base-breakout buy points.

Equinix (EQIX) Gilmo Report Stock Chart

Medical and bio-tech names are the third leg of my three themes to focus on in a continued market rally. I’ve previously discussed SXC Health Solutions (SXCI) and Cerner (CERN), not shown, both of which appear to be revving up to break out of their current bases and thus should be monitored closely here as potential new leaders in any continuing market rally. Questcor Pharmaceuticals (QCOR), on the other hand, has already broken out of a 26-week cup-with-handle base and is quite buyable on this basis, in my view, using the standard 6-7% downside stop for a base breakout buy point. Interestingly, QCOR was essentially a non-participant in the market’s rally phase since early January of this year, and now that nobody is looking the stock is showing a lot of confirming strength on this breakout. The company continues to expand sales of its drug Acthar, and is ranked at the top of the Medical-Ethical drugs group. Anyone lamenting that there is a lack of leading names breaking out with the follow-through on Friday simply aren’t paying attention, as EQIX, MLNX, and QCOR have all issued buy points this past week. I like QCOR here as one of the first potential leaders in any potential continuation of the market’s current rally attempt, particularly since it appears to have awakened from its dormancy in 2012 and has done so in constructive fashion.

Questcor Pharmaceuticals (QCOR) Gilmo Report Stock Chart

The idea that the Fed will initiate any new round of QE by purchasing mortgage securities has given rise to a number of names in this area, such as Nationstar Mortgage Holdings (NSM), which is involved in mortgage servicing, a business where they are paid a small percentage, usually just a few basis points, to “service” mortgages, making sure the lender gets paid and that all is copacetic. NSM is a new issue which broke out through the 16 price level in early May in what has been a strong move. While this is a strongly-acting stock, it is a little thin for my blood. Nevertheless, I’ve had several questions come in on this one, so I think it is ripe for discussion. When it comes to these smaller more volatile stocks, I prefer to look at the weekly chart, below, to get a clearer picture of the action. We can see that the stock, despite swinging around wildly over the past couple of weeks, has managed to close tightly right around the 19 price level over the past three weeks, finding volume support at the lows of the weekly price range. Some might think the past two weeks look like “railroad tracks,” but this is way too early in the stock’s pattern and life-cycle to draw such a conclusion – I tend to view the action as more constructive. Right now there are no buy points in the stock, but I would have to say that the stock looks fine. If I owned it from lower down in the pattern, I would not see any reason to unload the stock just yet, so stay tuned on this one.

Nationstar Mortgage Holdings (NSM) Gilmo Report Stock Chart

The quasi-follow-through action on Friday has some basis for success in my view in that we have seen a handful of potential new leaders rise up in response to the improving general market tone. This of course makes the follow-through immediately playable in these key names, thus investors should be leaning to taking some initial positions without getting too carried away and letting the market and the stocks prove themselves as they potentially build on the end-of-the-week strength. The Greek election on Sunday has been cited as a critical event for global markets, but I am inclined to stick my neck out here and say that the market could just as likely yawn at the outcome, whatever that is.

I do believe that maintaining flexibility here is critical as one must respond to and act on the basis of objective market evidence which remains extremely fluid. This is the essence of successful investing, and it was brought home to me in October 1999, as I wrote in the book, “Trade like an O’Neil Disciple: How We Made 18,000% in the Stock Market” (Wiley, 2010). My personal trading diary from that period shows that on October 23rd, 1999 Bill O’Neil called me and told me that “this market is through,” and indeed it looked like it was at the time. Things were looking ugly, for sure, on October 23, 1999. Four days later the market followed through to the upside and we had one of the biggest upside rocket-rides in market history in the last two months of 1999, and Bill O’Neil along with all of his internal portfolio managers, including yours truly and my colleague and business partner Dr. Chris Kacher, set aside any prior market opinions or views and immediately got in sync with the new market evidence that was at hand to capitalize on one of the best bull moves ever. Both I and Dr. K led all the O’Neil portfolio managers in 1999 with gains well in excess of 500% by year-end, proving that what you thought about the market yesterday or last week goes right out the window when new evidence presents itself. So, focus on the evidence at hand and be prepared to move with the market, not your prior opinions, views, or feelings.

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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