The Gilmo Report

March 23, 2014

March 23, 2014

Despite the fact that the major market indexes remain within 1-2% of their highs I believe that the action this past week simply confirms my cautious stance towards the market. As we can see on the daily chart of the NASDAQ Composite Index, below, we now have six distribution days around the peak with Friday’s action representing a very ugly big-volume outside reversal to the downside. The S&P 500 Index, not shown, doesn’t look much different as it made an all-time high on an intraday basis Friday before reversing hard and closing down on the day on heavy volume.




In my view this market has become something of an “alibi” market. Negative news is cited as the cause of a particular sell-off which is then followed by a “relief rally” as the news turns out to be not as bad as originally thought. Walking through the past fifteen trading days on the NASDAQ chart, above, we can see how this has all played out. Fifteen days ago, the Ukrainian crisis was the alibi for the first sharp sell-off three weeks ago, but once Russian President Vladimir Putin ended military exercises along the Ukrainian-Russian border the market gapped up hard the next day, fourteen days ago on the chart, but made little to no further upside progress as the gap was sold into. As events in the Ukraine began escalating again, eleven days ago on the chart, the market came down for the next six days before finding an excuse to gap-up again this past Monday, five days ago on the chart, and continue rallying into Tuesday once events appeared to be limited to Russia only annexing the Crimean Peninsula. Two Ukrainian news-related and news-alibied sell-offs followed by two relief rallies that have seen no further progress to the upside. Thus the Ukrainian relief rallies have only served to keep the market temporarily afloat.

On Wednesday, three days ago on the chart,  the market sold off hard after the Fed policy announcement and new Fed Chair Janet Yellen’s (who I am convinced is the long lost sister of the Travelocity traveling gnome) press conference. On Thursday, the market bounced back after the sell-off was alibied by Yellen’s alleged “gaffe” during the press conference. In my view, there was no gaffe; Yellen was simply admitting that the Fed has no clue how to end QE now that they’ve decided to de-emphasize their 6.5% unemployment threshold for ending QE and raising interest rates in favor of using “broader measures” to gauge the correct time to end what is far and away the largest injection of easy money policy in the history of mankind. And so on Wednesday and Thursday we saw another alibied sell-off followed by another relief rally once the news was explained away. Meanwhile, leading stocks have been taking a beating in many cases, and Friday’s high-volume outside reversal and sell-off saw the negative action in leading stocks worsen. However, Friday’s action will likely find its own alibi as pundits blame “quadruple-witching” options expiration as the cause of both the heavy volume selling and the odd action where we saw the big-cap Dow Jones Industrials up big early in the day as the NASDAQ languished in negative territory.

In the past couple of days we’ve seen financials and semiconductors moving higher, and the chart of the PHLX Sox Semiconductor Sector iShares (SOXX) ETF, below, shows the “rotation” into chip stocks. The problem here is that this is not a rotation, as a number of semiconductor stocks have already been acting well for a while, and I’ve covered several in my reports such as MCHP, MU, NXPI, etc. However, a number of these names came under pressure on Friday and reversed on heavy volume. For all we know, given that semiconductors have been part of the market’s leadership since late January, they may simply be the next group to roll over. The idea that we are seeing some sort of constructive rotation in new leadership among semiconductors strikes me as simplistic on its face.




As far as financials go, the daily chart of the Financial Select Sector SPDR (XLF) shows that yes, financials did have a big-volume upside move on Thursday as a result of the Fed’s so-called “stress tests” where 29 of 30 big banks passed, sending financials of all stripes moving to the upside. This move, however, reversed on Friday on above-average volume. So are we on the verge of a glorious new upside leg in a continued bull market that will be led by semiconductors and financials. Somehow, I think not. What I see is movement into big-cap names with lower P/E’s that appears to be somewhat defensive in nature as institutions cycle out of high P/E names and into lower P/E, big-cap, stable names that would hold up relatively better in a market correction. Old-name, old-line stocks are not the kind of stuff that makes up the fertile soil of dynamic new leadership that bull market phases thrive in. In a severe market correction, P/E compression becomes a primary characteristic as high P/E high-flyers are sold off.

The dynamic, “new-merchandise” leadership that led the market higher in the first two months of the year has been getting hit hard as of late, and unless I were to see some stabilization in these names followed by a slew of new buy points (most likely in the form of “bottom-fishing” pocket  pivots) as the stocks turned out of their current corrections, I’m not an aggressive or even a timid buyer of stocks at this point in time, end of story.




Gold was poised to have its best first quarter performance in 20 years before this week but the last five days have put the kibosh on this, as we can see on the daily chart of the SPDR Gold Shares (GLD), below. Now gold is only looking at its best first quarter since 2006, but there are still another six trading days left in the first quarter, so it could get worse. In my report of this past Wednesday I advised taking profits in the GLD, and that view stands for now. As I see it, Friday’s action was merely a short pause in a move that looks to me like it wants to test the 200-day moving average down around 125-126.




My general view is that if stocks start to sell off even further here, assets of all stripes will sell off as well, and this includes gold. While you will run across many deceitful advertisements on TV telling you to “protect” yourself from financial carnage like we saw during the so-called 2008 Financial Crisis by “investing” in gold, the truth is that gold is not a hedge against a severe correction or bear market in stocks. Frankly, I have to wonder where the SEC is when these types of commercials are aired, some of which even show an actor who claims to have “peace of mind” because he has a “gold-backed IRA.” A gold-backed IRA is nothing more than an IRA with a position in gold and that position can drop in value quite a bit under bear market conditions.

If we look at the last quarter of 2008 on the GLD weekly chart, below, we can see that gold sold off hard with the market in 2008 and in fact began to roll over from above the $1000 price level before stocks started to break down hard in September. Gold’s action was a clue that a deflation-driven asset sell-off was coming, and it hit with full force as we moved into the final quarter of 2008. As I measure it, that sell-off in gold was about 35% from peak to trough, and if that sort of downside movement is what gives you “peace of mind” through the alleged virtues of owning a “gold-backed” IRA, I’ll pass, thank you very much. Notice, however, that gold bottomed before stocks did, and recovered back up to its highs just as the market was bottoming in April of 2009. Thus, ultimately, a sell-off in stocks that drags gold and other assets down with it could present a buying opportunity in the yellow metal, but I would prefer to visit that possibility if and when we see the signs. Notice that gold had three sharp waves of selling in the weekly chart during 2008, with each wave of selling getting sharper and deeper than the prior one.




The only thing looking like it’s in a bull market on my buy watch list is Finisar (FNSR) which has continued to move higher on strong, above-average volume following Wednesday’s breakout from a ladle-with-handle base formation. My view here is that if the market starts to correct further next week, taking profits by selling into this breakout might be prudent. There has also been talk of Cisco Systems (CSCO) buying FNSR, and some of that may be helping to propel the stock higher. If one bought the stock within the base per my discussion of FNSR’s very constructive weekly base in my report of one week ago, March 16th, then one could give it some room to see how it plays out. Otherwise, if you sell into this move you take a quick 15-20% profit, which in this market is nothing to sneeze at.




Tesla Motors (TSLA) is symptomatic of some of the better-acting leaders as it continues to drift lower in its pattern and move below the 20-day exponential moving average, the green moving average, with volume picking up on Friday, as we can see on the daily chart, below. TSLA is losing momentum here, and as I discussed in my Wednesday report of this past week, one could have sold the stock after it violated the 10-day moving average based on the Seven-Week Rule, which is explained in detail in the book I wrote with my colleague Dr. Chris Kacher, “Trade Like an O’Neil Disciple: How We Made 18,000% in the Stock Market.” Outside of that, depending on one’s profit cushion in the stock, one can use the 228.45 intraday low of the late February buyable gap-up move as a final stop for the stock. My view, which I outlined this past Wednesday, is that a continued market pullback would likely drag the stock down to fill its gap down around the 218-219 price level at the very least, with the 50-day moving average just above 204 providing the last stand for the stock on  any further pullback. As with any strongly-performing leader, my choice has always been to sell into strength, even if sometimes I sell a little bit too early. Buying strength in this market is generally not a smart way to operate, as I have discussed numerous times in previous reports.




My approach on the long side has been focused on the idea of selling into strong upside moves after buying the stock within a “quiet” position in its base. For example, I first discussed buying FireEye (FEYE) at around the 42 price level while the stock was still within its base back in early January following a pocket pivot buy point within the base, as we can see on the daily chart, below. Refer to my December 29, 2013 report for my discussion of the stock’s action at that time. FEYE gapped up hard and ran up sharply before pulling back and flashing a continuation pocket pivot off of its 10-day moving average, leading to another price run-up. If you bought the stock at around 42 as I advised in late December, at that point you were up nearly 100% in a mere two weeks.

The stock then started to build its first real base, but notice how two breakout attempts from a short flag formation failed, so we see how standard-issue breakouts are not necessarily the time to be buying leading stocks. Finally, FEYE stabilized around its 10-day moving average as the price action became very tight and volume dried up in the extreme. This was your last buy point in the stock before it launched over 20% higher, finally topping on a climactic sort of move up to 97.35. This was followed by an immediate reversal and then a huge-volume gap-down move off the peak, at which point it is screaming to be sold. Now FEYE’s breakdown is complete as it violated its 50-day moving average on Thursday in the face of an up market. Meanwhile, we see other hot, young, leading stocks breaking down in names like Tableau Software (DATA), which broke down through its 50-day moving average on heavy volume this past Friday, and Workday (WDAY), which is now testing its 50-day moving average on heavy selling volume.




Other areas of prior leadership that are showing mass breakdowns include the bio-techs, which I illustrate with a daily chart of the Market Vectors Biotech (BBH) ETF, below. The breakdown in the group on Friday was attributed to news that some members of Congress are concerned about the high price of Gilead Science’s (GILD) new hepatitis C drug, Sovaldi. The problem with ascribing the weakness in the bio-tech sector to Friday’s news event is that the sell-off in bio-techs was gathering momentum long before Friday’s big-volume breakdown through the 50-day moving average by the BBH.




The daily chart of Gilead Sciences (GILD), below, shows that the stock failed on a late-stage, base-breakout attempt two weeks ago. This was long before Friday’s negative news regarding its new flagship drug. I even wrote in my report of this past Wednesday that I had traded the stock on the short side for a couple of days as it broke down through its 50-day moving average six and seven days ago on the chart. I should have re-shorted the stock on the bounce back up into the 65-day exponential moving average, given that it rolled over and broke down even further from there. I have to admit I was busy shorting other names and thought the rally might carry further up into the 50-day moving average. At this point GILD looks like it is headed for its 200-day moving average.




Another big-stock biotech name that was flashing warning signs for the group was Celgene (CELG), shown below on a daily chart. In fact, CELG has now completed a head and shoulders topping formation and on Friday broke out to the downside through the neckline of this H&S formation. Thus my view is that the stock should be shorted on any rallies back to the neckline which also coincides with the 200-day moving average at the 249-250 price level. Since CELG and GILD began to break down off of their peaks earlier in the year I have from time to time shorted the stocks on what I refer to as a “tactical” basis. However, once a stock forms a clear topping pattern such as an H&S top, the breakdown and downside breakout through the neckline is generally where the short-side approach shifts from tactical to “strategic” as we look for the stock to embark on a sustained downside move following a neckline breakout to the downside.




Three-D Systems (DDD) illustrates a textbook head and shoulders topping pattern. I haven’t spent time discussing the stock in recent reports primarily because the stock is so widely shorted at this point that one cannot borrow shares. Of course, this does not preclude using put options if one is so inclined. In this case, I’ve chosen to draw the neckline along the weekly closing lows given the deep break and mid-range close seven weeks ago on the weekly chart, below. DDD broke out to the downside and through the neckline of this H&S formation last week, had one brief rally back up into the 40-week (200-day on the daily chart), and then rolled over again. Whether we see more jerks to the upside and into the 40-week moving average remains to be seen, but this thing looks cooked to me.




3-D printing stocks as a group are also busting in synchrony, as we can see on the weekly chart of another big-stock 3-D printer, Stratasys (SSYS), below. Drawing the neckline along the weekly closes, something I will do when I can also see that putting the neckline in this position also coincides with where the 40-week moving average is at, shows SSYS breaking out to the downside and through both the 40-week line and the neckline of what is clearly an H&S formation. There is also a great deal of high-volume selling in the pattern over the past few months, and you can also see how four weeks ago the stock reached the peak of a right shoulder and stalled as volume picked up that week. I think any bounce in SSYS back up into its 40-week moving average is potentially shortable. SSYS’s relative strength had dropped to 58, making a lower low ahead of the price, which I see as a bearish indication. SSYS’ 200-day moving average is at 108.32 while the corresponding 40-week moving average on the weekly chart is at 109.73, giving us a nice short-sale “zone” between those two price points, but one could also simply consider the stock shortable at Friday’s close of 106.45, using a 3-5% upside stop from there.




LinkedIn (LNKD) remains one of my favorite short-sale targets, and I have to say it has been very obliging on a tactical basis as each rally up into or around the 50-day moving average over the past month has been quite shortable, as we can see on the daily chart, below. I wrote in my report of this past Wednesday that I considered the stock shortable within 1-2% of its 50-day moving average, and the stock obliged on Thursday by rallying to 206.43, about ¼ of a percent away from its 50-day line at 207.19. Notice also that my indicator bars at the top of the chart are going, as I like to say, “Code Red.” My best guess is that the stock is ultimately set to test its February lows at around 185, and that is where I would look for the first undercut & rally type of reaction bounce.

Short-term that is my downside target on the stock. LNKD has seen earnings growth decelerate sharply over the past four quarters, declining in sequence at 200%, 138%, 77% and 11%. Next quarter’s estimates call for negative 22% earnings growth. Sales growth has also been on a steady decline since peaking at 126% in the September 2011 quarter. LNKD currently sells for 125 times forward earnings, and it certainly isn’t clear what makes a stock growing earnings at 11% in the most recent quarter worth 125 times its forward earnings stream. And with 1,111 mutual funds owning 54.4 million shares of the stock, a little over half of the float, my view is that the only direction for institutional money to go at this point is out of the stock, intermittent reaction rallies notwithstanding.




If we study the weekly chart of LNKD, below, we can also pick up a number of clues that the pattern is slowly and steadily deteriorating. The basic underlying reality that we can glean from the chart is that the stock has been in a prolonged downside trend channel since September of last year. Since then we’ve seen two big-volume breaks off the peak, forming the right side of two “heads” in the pattern which I view as a single head, followed by a series of right shoulders over the past four months or so. In January LNKD attempted to push above its 10-week moving average but stalled out on above-average weekly volume. This happened again in late February as the stock stalled out at the 10-week line on big weekly volume. I’m looking for LNKD to eventually break down to the prior 185.03 low from early February and then beyond that as the pattern shifts from a tactical short to a strategic short.


GR032314-LNKD Weekly


Pandora Media (P) remains an “early stage” short-sale target of mine, and on Friday it dipped just below the prior week’s low at 33.30 before staging a minor but typical “undercut & rally” movement that closed at 34.01 on Friday. This is normal sloshing action as the stock starts to lose traction on the upside, as I see it. We can see the high-volume gap-down off the peak over two weeks ago, which in my view might turn out to be the peak of the “head” in a nascent, potential head and shoulders formation. We can already see what could be a left shoulder and the head in the pattern, and the action over the past week or so serves to begin “construction” of a potential right shoulder in the pattern. You might notice that the stock is also finding support at its 65-day exponential moving average as well as that prior 33.30 low, but I view any rally between Friday’s close and the 50-day moving average, currently at 35.59, as shortable, using the 50-day line as your guide for an upside stop depending on where your short-sale entry point is.




Cree (CREE), the stock that can’t make up its mind as to which way it wants to resolve what is now a two-month sideways range, may finally be starting to come unglued. As we can see on the daily chart, the stock reversed back down through both its 200-day and 50-day moving average on Friday with selling volume picking up sharply. The pattern has been quite noisy over the past couple of months, but I do note that the indicator bars at the top of my chart went “Code Red” on Friday.




The noise on the daily chart is perhaps clarified a bit by taking a look at CREE’s weekly chart, below, which has the looks of this two-headed “Hydra-and-Shoulders” topping formation. I’ve been quite generous to the stock in recent reports by not taking a firm stand on the stock one way or another, and keeping an open mind about its future direction. On the weekly chart, however, I see a pattern that is slowly deteriorating. We can obviously see the two massive-volume breaks on the right sides of the two heads in the pattern, and the action over the past four months or so has the look of a couple of right shoulders in the formation process. More recently we can see heavy volume stalling around the 40-week moving average in January followed by more subtle stalling at the 10-week moving average in February. CREE closed at 60.03 on Friday, and the 50-day moving average closed at 61.21, about 2% above Friday’s close. In my view, based on Friday’s heavy-volume downside move coming on the heels of the heavy-volume stalling action at the 50-day line seven days ago on the daily chart, above, the stock is shortable using a 3-5% upside stop.


GR032314-CREE Weekly


What I find most interesting about the current market environment is the complacent view taken by financial TV talking heads and pundits who fall back on the mindless idea that there is plenty of money out there to support a rally and that the retail investor is now starting to come back into the market. Perhaps it hasn’t occurred to anyone that retail investors falling in love with what is now a five-year bull market might be a contrarian bearish sign. And with the indexes within a percent or two of their recent highs, the danger being flashed by the action in a broad swath of leading stocks and sectors does not appear to be all that obvious to those who want to wish for new, dynamic leadership in old-line, mature, financial and semiconductor stocks. I think this market has some problems, and the first element of “proof-in-the-pudding” was that I was making big money on the short side Friday even in the face of a Dow that was up over 100 points on an intraday basis.

As I see it, there is no reason to be bullish on the market. I prefer to let the market prove to me why I need to be buying stocks, and that will come in the form of proper set-ups in leading stocks For now, as Sargent Schultz from the old “Hogan’s Heroes” TV sit-com used to say, “I see nothing!!!” In the meantime, I see set-ups on the short side which could offer decent downside plays if and as the general market continues to deteriorate, and that is where my efforts are focused pending further market evidence to the contrary.


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 a position in LNKD, though positions are subject to change at any time and without notice.

Gil Morales & Company, LLC (“GMC”), 8033 Sunset Boulevard, Suite 830, Los Angeles, California, 90046. GMC is a Registered Investment Adviser. This information is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to GMC, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Gil Morales & Company, LLC. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2008-2019 Gil Morales & Company, LLC. All rights reserved.