The Gilmo Report

March 30, 2014

March 29, 2014

With so many leading stocks, or rather formerly leading stocks, selling off deep down into their patterns, I would expect that at least some sort of short-term reaction bounce would be forthcoming from such extremely oversold positions. That almost looked like what was going to happen on Friday, but the market simply ended up showing us just how weak it is as the major market indexes stalled and gave up most of their earlier gains. The NASDAQ Composite Index, shown below on a daily candlestick chart, stalled to close roughly flat after rallying over 1% earlier in the trading day, making for a big “shooting star” formation on Friday. Volume came in lighter on Friday, indicating that the initial morning gap-up and rally just didn’t have enough buying demand to sustain it and investors simply took the opportunity to sell more stock into the bounce. While I still think the extreme oversold condition gives the market some chance at a reaction bounce, the extreme oversold condition may also be telling us just how weak this market actually is. During prior sell-offs, such as in January of this year, leading stocks held up much better as the indexes sold off, but this time around the situation has reversed as leading stocks are getting pounded far more than the indexes.




In fact, despite the carnage in the NASDAQ, the S&P 500 Index, shown below on a daily candlestick chart, is still holding above its 50-day moving average and within 1-2% of its recent price highs in a very stark divergence. Distribution around the highs, however, is picking up, and Friday’s action saw the index stall and close in the lower half of its daily trading range as weak volume failed to provide the buying boost necessary to sustain a rally. I still look for the S&P 500 to play catch up with the NASDAQ on the downside and at least head for its 50-day moving average at some point. If that were to occur, and the S&P 500 were to find support at the line, this could then trigger a more significant reaction rally. For now, however, that is all speculation, and we need only observe what the market is doing in real-time, particularly when it comes to the action in formerly leading stocks, which has been at best abysmal.




Underscoring the defensive flavor of the market’s action, the best-performing sector in the market during the month of March has been the Utilities, with Basic Materials (read: oil stocks) and Consumer Goods, another defensive area, coming in second and third. As money has shifted away from high-P/E highflyers to low-P/E, stable, old-line big-cap names and defensive stocks, a comparison between the NASDAQ Advance-Decline line ($NAAD) and the NYSE Advance-Decline ($NYAD) line, both shown below, starkly illustrates the divergence between the often more speculative NASDAQ-listed issues and the mostly less speculative NYSE-listed issues, including “defensive” stocks.






The urgency with which leading stocks like Facebook (FB) have been sold off over the past couple of weeks is quite striking as well. Most leading stocks are in this type of position, underneath their 50-day moving averages and in some cases having cleanly violated them. Logically, as FB pulls down to its late-January, post-earnings buyable gap-up, giving up all of those gains, one would expect some sort of reaction bounce, perhaps up into the 50-day moving average where I would expect resistance at the line. FB also illustrates what is different this time around compared to the market correction in January. Back then, FB was defying the market’s short correction by gapping up and moving higher in the midst of that correction.

Today we see FB leading the breakdown in leading stocks as it goes fully “Code Red” this past week. And while Thursday’s action shows a volume signature that would qualify as a pocket pivot volume signature, it is not even close to any position where it would qualify as a bona fide pocket pivot buy signal. And this, too, illustrates the problem with leading stocks right now, which is that almost none of them are in any kind of constructive position where we might see a pocket pivot or some other buy point emerge as they try to recover from a short-term correction. Having violated its 50-day moving average earlier in the week, FB is a sell, in sharp contrast to the late January market correction when FB was a buy based on its buyable gap-up move back then.




Another big-stock NASDAQ leader that defied the market correction in January, Netflix (NFLX) has been pounded throughout March, as we can see on its daily chart, below. Like FB, NFLX ignored the market correction in January and staged a big buyable gap-up after its earnings report and then proceeded to move steadily higher from there. This all changed in March as the stock began to quietly fade off of its highs as the selling in the stock slowly gained momentum. It reached a crescendo of sorts this past week as NFLX burst through and violated its 50-day moving average on very heavy selling volume. We can see on the chart that NFLX actually went “Code Red” the day before it smashed through the 50-day line on the news that Apple (AAPL) was in talks with Comcast (CMCSA) on a possible streaming content collaboration. On Monday, NFLX’s chart was showing the gray vertical bar that indicates an oversold condition on my charts, but that oversold condition has simply led to more selling as the stock made lower lows.




The formerly hot area of leadership in the bio-tech sector continues to get no respect, and despite hard sell-offs in the group across the board, most of these stocks just continue to move lower as the group gets ground into fine dust. What had been the strongest-acting, big-stock bio-tech, Biogen Idec (BIIB), illustrates quite nicely just how bad things have become for bio-techs. After violating its 50-day moving average in rapid order over the past six trading days and within just a few days of actually having made a new all-time price high two weeks ago, BIIB simply moved lower with selling volume picking up sharply on Friday. In recent reports I discussed the weakness in the other two members of what I once dubbed the “Three Caballeros,” Celgene (CELG) and Gilead Sciences (GILD), not shown here on charts. Both of these stocks made lower lows on Friday as well. GILD, at least, is now at its 200-day moving average, and it will be interesting to see if it can hold this final line of support. In all three of these examples, FB, NFLX, and BIIB, we can see how bad of a beating former leaders have taken, and why the NASDAQ is down 5% while the NYSE-based S&P 500 isn’t even down 2%.




There is talk of how financials and semiconductors have provided a potential area of leadership as the market allegedly rotates into these areas. But this is not clear to me either as both of these areas of the market have been in uptrends since early February, and their action over the past week has been somewhat sluggish. Where we have been seeing some rotational strength has been in the oil patch, and the daily chart of the Energy Select Sector SPDR (XLE) shows this quite clearly with a breakout to new highs on Friday. The move looks quite interesting, but I have to wonder just how much leadership the oil sector can provide during a continued market correction. To me this smacks more of a defensive move into these names than anything else.




Among individual oil names, we can see that one of the names in the group that I’ve discussed in recent reports, Diamondback Energy (FANG), flashed a pocket pivot buy point on Thursday and then moved higher on Friday on stronger upside volume, as we can see on the daily chart below. This is actually constructive action, and if the general market were not so weak I might be more interested in going after something like this on the long side, but for now I consider the long side of this market to be a low probability situation as far as sustainable upside is concerned.




Continental Resources (CLR), which is also a fracking play like FANG, also flashed a pocket pivot buy point on Thursday and moved higher again on Friday with strong buying volume coming into the stock, as we can see on its daily chart, below. Like FANG this looks very good, but the general market situation makes the idea of jumping into anything on the long side, even constructively acting oil names like these, less appealing to me. The bottom line is that despite the alleged rotation into names like financials, semiconductors, and oils, the more profitable side of this market for at least the last 2-3 weeks has been the short side, end of story. As I see it, why harvest sprouts on the long side when you can chop down big trees on the short side?




Antero Resources Corp. (AR) is another fracking-related oil name that has acted strongly during the current market correction with a buyable gap-up two weeks ago, as we can see on the daily chart, below. After a brief run-up following the BGU, AR has pulled back down towards the gap as it holds above both its 10-day and 20-day moving averages. I think if I were going to buy an oil name, I would not chase the strength in FANG or CLR but might consider buying AR on this pullback with the idea that it will continue to hold the 20-day moving average on any further pullback. In this manner one can mitigate the risk given that the stock is only 2% above its 20-day line and less than 3% from the 62.32 intraday low of the BGU day. From the long side of the market, FANG, CLR, and AR are about the only potential opportunities that I can find, which tells you just how grim things are for the long side of this market. Sprouts vs. trees, you decide.




Cree (CREE) was first discussed as a short-sale target last weekend, and it has rewarded us with some decent downside this past week, as we can see on the daily chart, below. In my Wednesday report I wrote that “My thinking here is that the stock is headed for the early February low at 55.76, so I’m using that as my short-term downside price objective, although I believe the stock can get down to 52 in the event of some very weak general market action over the next few days.” CREE busted through that 55.76 low on Thursday on a big-volume downside break that saw the stock down around 3 bucks before rallying a few cents off of its intraday lows.

Since this was my short-term downside target, I decided to take profits on Thursday and see where it goes from here. With the move below the prior 55.76 low, a potential “undercut & rally” situation is set up, but I would simply view this as a shortable rally up to 57-58. CREE tried to rally up to the 56 level on Friday, but reversed course and stalled, closing at 55.02 on above-average volume. Ultimately, I see CREE heading for the 52 price level in a continued market correction. Notice that we are getting a vertical gray oversold bar on the chart here, but like NFLX this might just be indicating that CREE is very weak here and will eventually move lower.




Pandora Media (P) is forming what appears to be a short bear flag en route to possible new lows as it also shows a vertical gray oversold bar on the daily chart, below. P decisively undercut the 30.93 low of early February on Wednesday, which can be considered a short-term downside price objective. But with the stock unable to rally on Friday as buying volume failed to come into the stock, my guess is that a move down to the 200-day line down at around 26.50 is more likely. P has tried to rally on an intraday basis over the past two trading days, and volume on Thursday was actually above average, but the stock stalled on both days, closing roughly flat on Thursday and down a little less than 1% on Friday. Right now I consider the stock potentially shortable using the 31 price level as an upside stop just in case the stock is able to stage an upside jerk which I assume would most likely occur if the general market can get any kind of short upside reaction rally going from its current position.




Stratasys (SSYS) is also showing vertical gray oversold bars on its daily chart, below, but for now I would simply use any rally up into the 200-day moving average at 108.93 as a shorting opportunity. In the past we’ve seen how these gray oversold bars have often indicated a low for leading stocks on pullbacks, but I would also point out that such an oversold condition can also indicate just how weak things are as oversold becomes even more oversold. Within the context of a market that is finding a low, stabilizing, and turning back to the upside, these gray oversold bars might have a more positive meaning for the stock. But within the context of a market that continues to weaken and is unable to sustain any type of reaction bounce and rally, their meaning could be negative.

I never view indicators as absolutes, as their interpretation is always and at all times dependent on the context of what is going on in the general market and the stock itself. If SSYS is roughly holding along the neckline of a big head and shoulders formation, which is self-evident on the chart without my having to draw curved “hats” above the head and the shoulders in the formation, then the oversold indicators could be telling us that a break to the downside is imminent. We can also see that on Thursday SSYS undercut the 102.21 low from early February, where it has found temporary support, but with the stock now underneath the 200-day moving average, I have to view this as upside resistance and hence a shortable point if the stock were to rally up into the line.




Among my short-sale targets, LinkedIn (LNKD) looks to be giving us another potential entry point on the short side as it rallies up into resistance around the 189-190 price level and the 10-day moving average, currently at 193.03. I wrote in my report of this past Wednesday that the stock looked like it wanted to move lower after forming a two-day bear flag, and the stock did just that, decisively undercutting the 185.04 low from early February before turning and rallying back up into resistance.

While there is always potential for LNKD to rally back into the 50-day moving average again, my feeling is that it is likely too weak to do so at this point and at most would rally up to the 20-day moving average at around 106, max. However, I viewed the rally on Friday into the 10-day line and right up to and just past the 193.03 price point as a shorting opportunity, using the 20-day line, less than 2% higher, as a quick upside stop. Ultimately, in a continued market correction, I believe LNKD can get down to 160, undercutting the 160.20 low of the base it formed between April and July of last year. With over a thousand funds owning 54 million shares of a 103 million share float, and earnings growth slowing to 11% in the most recently reported quarter while estimates look for negative -22% earnings growth in the next quarter, it is time for institutional money to start a methodical and persistent movement OUT of the stock, not in.




Based on the price/volume action of the major market indexes and formerly leading stocks, combined with what I view as an institutional shift from high-P/E highflyers to low-P/E, stable, old-line, big-cap names, there is no way I can consider the long side of this market, outside of trying to play short-term bounces in oversold stocks for a day or two. Otherwise, this correction is much uglier “under the hood” than the one we saw back in January, and that one carried the indexes down 7-8%. So far this correction, while uglier as far as individual stocks go, has only taken the S&P 500 down a little less than 2% while the NASDAQ has come down 5%. In my view, this implies that further downside is the more likely probability, regardless of what happens between now and then.

If the market is going to come out of this, my guess is that we will start to see some constructive action among individual stocks somewhere in the market (besides oil stocks), and at that point I can reassess things on a stock-by-stock basis. For now, the message of the market is clear – stay out or stay short until further notice while remaining flexible and avoiding getting locked into a bullish or bearish frame of mind. Going with the flow was the hallmark of my success last year and so far the story has been the same in 2014, and it is in this “happy space” that I intend to remain. Stay tuned!


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

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