The Gilmo Report

June 26, 2016

June 25, 2016

The odds-makers turned out to be very wrong when the United Kingdom surprised everyone by voting to exit the European Union on Thursday. The major market indexes were actually so confident of a “Remain” vote that the NASDAQ Composite Index posted a sixth-day follow-through day on Thursday.

Of course, as I blogged Thursday after the close, a follow-through day occurring within the context of an impending Brexit vote was probably not meaningful as an all-clear signal for the long side. As I’ve discussed in recent reports and blog posts, my decision was to stay in cash and let the vote play out as it may.

As I wrote on Wednesday, I was looking for a “Remain” vote to perhaps trigger a shortable rally. However, in the stock market we seldom get what we are looking or hoping for. The market will almost always do its best to throw you a big curve ball. Instead, what we got on Friday was a massive gap-down opening that briefly retraced about 40% back to the upside on an intraday basis before rolling over again in earnest. By the close the indexes all ended up near their lows for the day on huge selling volume.




The S&P 500 Index also split wide open, and like the NASDAQ broke for its May lows on massive selling volume. It is also approaching its 200-day moving average for the first time since pushing back above it in March. An undercut of the 200-day line on Monday could create a near-term low.

Basically, all we are seeing is the same thing we’ve seen since May/June of last year. The indexes move up off their extreme lows just when they look their ugliest. They then rally right back up to higher highs and the top of what is now a more-than-one-year price range. When they look their prettiest all hell then breaks loose.




Overall, the action on Friday was extremely weak and indicative of forced selling. Odds are that this will lead to more forced selling on Monday, which might bring about a short-term low. But the magnitude of the selling, whether event-related or not, had the feel of liquidation on a broad and deep scale. Thus it could be telling us that the market is in for a rough summer.

In response to the Brexit vote, the precious metals ETFs, the iShares Silver Trust (SLV) and the SPDR Gold Shares ETF (GLD), gapped furiously to the upside on Friday. As I’ve discussed in recent reports, these are not technical trades as much as they are thematic or quasi-fundamental trades.

If one is bullish on precious metals, then the best time to buy these is on weakness rather than seeking to buy on strength. Note that the last time the GLD had a big-volume gap-up to new highs back in February it led to a long period of sideways consolidation. Whether Friday’s gap-up move to higher highs on big volume meets with a different fate remains to be seen. Meanwhile, the SLV, not shown, merely rallied back to the highs of its eight-week cup-with-handle type of base.

From my perspective, the bottom line was that one had to buy these on Thursday when they were down along areas of support. If the market comes under more forced selling, precious metals could potentially get caught up in it as well.




The same goes for the precious metals stocks also mimicking the action in the metals themselves, something I’ve discussed almost ad nauseum in recent reports. Both Silver Wheaton (SLW) and Agnico Eagle Mines (AEM) jacked higher at the open, but SLW reversed off of its highs to close in the lower part of its daily trading range. Essentially Friday’s early upside move merely took the stock up into the highs of its current June price range. At that point it ran into resistance on an intraday basis and closed in the lower half of the trading range. Not too impressive, I must say.




AEM also pushed up into the highs of its June price range, but held up a little better as it closed in the upper half of its daily price range. Volume came in fairly heavy, but the stock still was unable to break out to new highs. Like the precious metals, and as I’ve discussed frequently in recent reports, continued forced selling in the general market could easily drag the metals and the metals stocks down with it. For that reason, particularly with the current state of the general market as it is, the long side of anything carries a higher degree of risk.




If one had not come into the day on Friday short already, it was difficult to jump on any shorts on the massive gap-down open. Just about everything on my short (and long, for that matter) watch list was decimated on Friday. Huge-volume selling in these names had the clear fingerprint of outright liquidation. However, the morning bounce did bring some stocks into shorting range if one was using the intraday five-minute 620 chart to monitor these bounces.

A good example is Facebook (FB) which opened the day at 111.01, hit a low of 111.00 even, and then rallied furiously back up toward its 10-day moving average. From there it rolled over again with the market and pushed lower to end the day at 112.08. You can see that the intraday price range just barely misses touching the magenta 10-day moving average before the stock turns back to the downside. By the end of the day FB posted a bear flag breakout to the downside on heavy selling volume.




FB’s 5-minute intraday 620 chart shows the precise mechanics of the stock’s intraday rally and secondary short-sale point. Remember that the 620 chart is a 5-minute chart using a 6-period (orange) and a 20-period (blue) exponential moving average. The MACD lines and histogram at the bottom of the chart is set to (6,20,9,C). The chart also includes after-hours and pre-market trading data.

We can see that FB pretty much held steady at the open and then launched higher in a rapid 15-minute burst back to the upside. It was action like this that was leading me to consider whether Friday’s market action was a wash-out that would send things rallying back to the upside. Obviously, that was not the case, and the 620 chart tells the story. By monitoring this not only for FB, but a large number of stocks on my watch lists, I can get a sense of what the market is likely to do.

When FB showed a MACD cross at around 7:30 a.m. my time here in California, that was one crack. The confirming sell signal when the moving averages cross occurred about two hours later. Notice, however, that the MACD lines engaged in a bit of a stretch, as I call it, just before the lines crossed.

That would have provided a nice intraday entry on the short side above 113 that was at least of a lower-risk nature than chasing the opening at 111. FB was one of the better bouncers on Friday. Most stocks I was watching didn’t see the light of day, or much of it, on their 620 charts at all on Friday.


GR062616-FB Intraday


Even where stocks looked like they were holding at potential support levels, the action looked far too volatile to buy into for anything but a quick intraday scalp. Silicon Motion (SIMO), for example, bounced nicely off of its 50-day moving average on above-average volume. That looks somewhat constructive, with the emphasis on “somewhat.” If the general market continues lower on Monday or next week it could easily retest the 50-day line. But if you bought it right at the line on Friday, you had a nice day-trade on your hands.

Friday’s move also took the stock down more or less to the top of its prior late-May base breakout, which perhaps provided additional support on the chart.




Another small, hot semiconductor name we’ve been following in recent reports, Maxlinear (MXL), was not so lucky. It gapped down to its 50-day moving average right at the open. This also coincided with a prior mid-May base breakout. That, however, wasn’t enough to support the stock as it blew through the 50-day moving average on heavy selling volume. Now I would consider this a bona fide base-failure type of short-sale set-up where any rally back up to the 50-day line would bring it into optimal shorting range.

This sort of action was typical for a number of stocks I’ve been following lately on both the long and short sides of the market. So in terms of what individual stocks are telling us, this market looks pretty bad right here, right now.


GR062616-MXL (CRM) was showing some cracks in its pattern earlier in the week, as I noted in my Wednesday report, but those cracks split wide open on Friday. CRM plummeted through its 50-day moving average on heavy volume as it also filled the “rising window” from its gap-up move of mid-May. While I suppose one could argue that the gap-fill might provide near-term support for a potential bounce next week, the bottom line is that this pattern is busted, plain and simple. Rallies back up into the 50-day line would now be considered potential short-sale entry points.




The same type of pattern where the stock has broken down through its 50-day line on heavy selling is also seen in other cloud wolf pack names like Adobe Systems (ADBE), Citrix Systems (CTXS), ServiceNow (NOW), and Workday (WDAY). Now all of these stocks are clear short-sale candidates with the idea of shorting any rallies back up towards their 50-day moving averages. I’ve been discussing the vulnerabilities in their chart patterns as v-shaped Ugly Duckling rallies off of the February lows, and now we see those vulnerabilities finally come to fruition.

Each of these stocks is shown on a weekly chart, below, and you can see the initial signs of failure from the right side peaks of these deep, v-shaped patterns. If the market is moving into a bearish phase, then these are likely headed lower in the same manner that we saw the airline stocks like Alaska Airlines (ALK) and Hawaiian Holdings (HA), blow up in back in April of this year.










As a quick aside, it might be helpful to look at where Alaska Airlines (ALK) is these days after its initial signs of failure from the right side of a deep, late-stage cup formation in April. Most of these cloud names are in a similar position to ALK’s position on its chart exactly ten weeks ago.




Splunk (SPLK) is the one outlier among these failing cloud names as it has not yet broken down through its 50-day moving average. On Friday the stock gapped down through the 20-day line on heavy selling volume, something I was looking for per my discussion of the stock in my Wednesday mid-week report.

It now looks set for a rendezvous with its 50-day moving average. However, I would now view any rallies up to the 20-day moving average at 57.04 as optimal short-sale opportunities. Also, if you study the weekly chart, not shown here, on your own, you will notice that SPLK has the same v-shaped characteristics as the other cloud names discussed above.


GR062616-SPLK (AMZN), which I consider to be perhaps the big-stock cloud name in this particular wolf pack, is also busting its 20-day moving average, the first sign of a potential late-stage base-failure. AMZN broke out of a big, late-stage cup formation with a tiny one-week handle back in early May, but has really gone nowhere since then.

As we know, the first sign of a late-stage failed-base (LSFB) short-sale set-up in-the-making is generally a high-volume breach of the 20-day line. That was achieved on Friday, and the stock did find support at its 50-day and 10-week moving averages on the daily and weekly charts, respectively. Therefore, AMZN can be viewed as a potential short-sale target on rallies up to the 20-day line at 711.83. AMZN closed Friday at 698.96, just below the $700 “Century Mark” and less than 2% away from its 20-day line.

While the breach of the 20-day line is the first clue of a potential LSFB set-up, a subsequent high-volume breach of the 50-day moving average would serve to confirm this. Depending on what the general market does next week, that may or may not take more time to develop.




Everything in this market that we’ve liked on the long side recently is pretty much a bust at this point. Even Activision (ATVI) has breached its 50-day moving average on heavy selling volume, and could now be considered a short here using the 50-day line at 37.18 as a guide for a tight upside stop. Across the board, formerly leading stocks that have accompanied the market to the upside since its February lows are coming unglued. And these failures only serve to push these from the long side of the market to the short side as new short-sale targets.

So, again, from the perspective of what individual stocks are telling us, this market appears set for further downside. That may occur over the next few days or weeks, but my best assessment is that it is an indication the market is likely in for a rough summer.




As they like to say on those cable TV infomercials, “But wait, that’s not all!” Here we see Priceline Group (PCLN) try to fake everyone out by actually breaking out to a marginal new high on slightly above-average volume Thursday. If you were trying to short this it might have forced you out, but the fact is it never got more than 2% past the breakout point at 1373.

Alas, the best way to have played this on the short side would have been to short it on Thursday right at the close in order to benefit from the big opening gap-down on Friday. However, barring that, one could have come after it right at the open as a shortable gap-down pushing below both the 20-day and 50-day moving averages.

Note that the stock had one intraday rally back up to the 20-day moving average and then rolled over. Thus one could have shorted it at the 20-day line near the 1313 price level. From there PCLN plummeted to a close of 1232.14, some 90 points lower! Now this becomes shortable on rallies up into the 200-day moving average at 1274.42. And right after the stock breaks out to a higher high on above-average volume. What a difference a day makes.




If I’m looking for stocks that might be further up in their patterns but still on the verge of outright failure, Panera Bread (PNRA) is one that might fit the bill. The stock failed from a late-stage base breakout attempt back in early June, and over the past 2-3 weeks has been living beneath its 20-day moving average.

As we know, a breach of the 20-day moving average is generally the first clue with respect to a potential late-stage failed-base short-sale set-up in the making. One thing to notice about PNRA over the past couple of months is that it has looked like it has been on the verge of a downside break several times. However, each time it has been able to recover and hold up within what is really just a big, choppy consolidation extending back to early March. But things are starting to get long in the tooth here, so to speak, and it may be time for PNRA to finally fall from the tree.

For that reason, I like the stock here as a short using the 50-day moving average at 214.06 or the Friday high at 215.61 as guides for a tight upside stop. You can choose either one you like, but both are less than 2% away from Friday’s closing price of 211.64.




If you want to get a sense of how ugly things look, just run through the charts of the Gilmo Short 50 Index list, below. The list shows each stock alongside the price levels for each of its major moving averages. This provides a nice reference list for short-sale points in the event that any of these stocks is able to bounce anywhere in its pattern.

But the most glaring thing about this list as you go through the charts is that everything, and I mean everything, was thoroughly decimated Friday on huge selling volume. To me this smacks of forced liquidation, and sets the stage for the possibility that more downside is yet to come.


GR062616-Gilmo Short 50 Index List


Everything on that list was reduced to a crispy critter on Friday. Most were hit on heavy scorched earth selling volume. In the meantime, I see absolutely nothing I would want to touch on the long side. We could see some undercut & rally set-ups show up in certain stocks that might present some trade-able moves in the event of a short-term market bounce. But I would view these as little more than short-term trades if not, in most cases, long side day trades.

One example of this, potentially, might be Tesla Motors (TSLA). The stock turned out to be a great short earlier in the week. As I discussed in my report of last week, the stock was shortable along the confluence of its 10-day, 20-day, and 200-day moving averages four and five days ago on the chart. It then gapped down on Wednesday after news of the stock potentially bidding for Elon Musk’s cousin’s company, SolarCity (SCTY). This took the stock below a number of prior lows in the pattern from August and October of 2015 and also May of this year.

Note that as the stock continues to come down over the past two trading days following the gap-down break, selling volume is starting to decline sharply. This could set up a reaction bounce back up toward the 10-day or 20-day moving averages in the 211-214 price area. If I’m looking for possible short-term long trades in the event of any kind of reaction rally in the general market, this is more or less the type of set-up I’m on the lookout for. This could just keep going lower if the general market does likewise, so it does depend on seeing a reaction low in the general market indexes.




We have clearly witnessed history-in-the-making this week, and I posted my “deep thoughts” regarding the implications of Thursday’s Brexit on the Gilmo blog page early Friday morning. For that reason, I don’t think I need to expand upon all that in this report. Just go back and read that blog post, titled “In Through the Out Door.” Ultimately, I tend to see the Brexit as a constructive development, but in the near-term the markets have proven that there will be hell to pay. And so all smart people who bought into the big upside action on Thursday paid through the nose on Friday.

Friday’s action would imply that this market is in serious trouble, however one wants to gauge the potential impact of the Brexit upon the global financial system. But for all we know, the Brexit was just an alibi for selling that is perhaps more related to the market coming to the realization that a global economic slump is upon us. In the meantime, central banks have very few bullets left to ride to the rescue with.

On Thursday I advised simply going to cash ahead of the Brexit vote results based on the fact that we were dealing with the most substantial known event-risk I believe I’ve ever seen in my 25-year-plus investment career. The reality is that things potentially could have gone either way. Since I don’t consider myself all that talented when it comes to calling coin flips, I chose to remain in cash and see how things played out. And indeed, those who believed a “Remain” vote was in the bag and went long in size on Thursday suffered badly for that decision on Friday.

And so, once again, after the indexes and leading stocks start to look quite good as everything pushes to higher highs, the breakout fails and the market heads in the other direction. The more this market tries to change, the more it remains the same. In summation, my focus, while already leaning to the short side per my report of last weekend, is broadening to short-sale set-ups that I’m starting to see in fresh breakdowns. Such breakdowns are observed in the cloud names, as well as with situations like ATVI, of which there are currently many in this market.

That alone is enough to raise a big red flag for this market. In the meantime, for those who don’t play the short side, cash is king.


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 FB, though positions are subject to change at any time and without notice.

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