The Gilmo Report

May 12, 2013

May 12, 2013

Simply stated, the market continues to grind higher, as we see in the daily chart of the NASDAQ Composite Index, below. The NASDAQ was able to shrug off higher-volume stalling on Thursday as it moved to a higher high on Friday, despite lighter volume on the day.




The Dow Jones Utilities Index, which had been trending steeply and smoothly to the upside until May arrived, has now corrected about 4% off of its peak. Treasury bonds also took a hit this week, which might be signaling a shift in the market.




Headlines that the Fed is mulling over how to end QE in a manner that is not disruptive to the markets may have had a hand in this week’s dive in Treasury bonds, which was first broadcast by the breakdown in the peak by the Dow Jones Utility Index. Gold also took a hit, as we see in the daily chart of the SPDR Gold Shares (GLD) chart, below, but the yellow metal was able to recover off of its lows and close near the peak of the daily trading range. The GLD has done this twice before, and each time has recovered back up towards the highs of its bounce off of the mid-April lows.




Despite the allegedly “strong” jobs gains, there remains a great deal under the hood of the economy that does not confirm the rosy view that the economy is now ready to take the baton from QE and keep things chugging along. A front-page story in this weekend’s Investor’s Business Daily indicated that while jobs growth appears healthy, total hours worked is actually declining, such that growth in private payrolls in 2013 has exceeded total hours worked by75%. That is a fairly large disconnect, and likely indicates a shift towards part-time employment. According to the article, had payrolls been more in line with total hours worked, private non-farm jobs would have risen by a total 463,000 jobs compared to the reported 813,000. Meanwhile, tepid GDP growth remains overstated given that the government understates inflation, with expectations of a slowdown in the second quarter. Thus, in my view, the Fed will not find itself in a position to takes its foot off of the QE accelerator any time soon. When the end finally does come, the market will likely tell us before the Fed does.


Three D Systems (DDD) remains strong despite two tests of its 10-day moving average this week. The first came on Wednesday when the company announced a $250 million secondary offering that included 1.3 million shares from selling shareholders, also known as “insiders.” The stock recovered after bouncing off of its 10-day moving average to log a pocket pivot buy point on Wednesday. On Friday, the 7.5 million share secondary offering was completed and priced at $40-a-share, leading to a quick drop towards the 40 price level at the open from which the stock fully recovered, closing up 1.98% on the day. This resulted in a second pocket pivot buy point as the stock bounced off of the 10-day moving average again on very strong volume. This was due in part to the completion of the secondary offering as DDD continues to round out a 41.9% deep cup formation and approaches its 52-week high. What is fascinating here is that even as DDD continues to rally, short interest has increased from 5.8 days of short interest as reported on April 15 to 6.6 days of short interest by the end of April. This makes for a total of 28.2 million shares sold short against a float of 81 million shares, and in my view this makes DDD ripe for a short squeeze.




Netflix (NFLX), which had faltered after its buyable gap-up following earnings in the latter part of April, recovered on Thursday to issue a pocket pivot buy point as it came up through its 10-day moving average. This puts the stock back in play after failing on the buyable gap-up.




Sinclair Broadcasting Group (SBGI), which I discussed in my Wednesday report of May 8th as tracking very tightly along its 10-day moving average, followed through with a pocket pivot buy point on Thursday. The big downside volume spike in the pattern is not counted, as it was due to a completed secondary offering so was in fact constructive.




Nationstar Mortgage Holdings (NSM), also discussed in my mid-week report of this past Wednesday as a buyable gap-up move, has continued higher and led to a subsequent breakout to all-time highs.




Illumina (ILMN), which had issued a buyable gap-up back on April 23rd as I reported in my April 24th report, has steadily tracked higher. On Friday, rumors of a buyout sent the stock streaking higher, but as is the case with most such rumors (remember MNST last January?) the spike up above 75 could have been sold into with the idea of buying back once the rumor was not confirmed. Either way, ILMN remains in a healthy uptrend.




Lumber Liquidators (LL), which had issued a buyable gap-up move following earnings on April 24th, has also followed through on this BGU by remaining in a healthy uptrend as it continues to make all-time highs.




Qihu 360 Technology (QIHU) continues to follow through on its breakout after I identified its tight, constructive action in my report of exactly one week ago. Overall, the tone of recent breakouts and buyable gap-ups remains rather healthy, which I believe is a good sign for the market.




In my mid-week report of this past Wednesday I considered Workday (WDAY) to be buyable as it pulled down into its 10-day moving average. This led to a subsequent “re-breakout” to all-time highs, although again on weak volume that is technically insufficient for a valid breakout. Thus WDAY, in my view, is best bought on pullbacks to logical areas of support.




Valeant Pharmaceuticals (VRX) has been sputtering around recently after some legal wrangling regarding the acquisition of another company, but Friday saw the stock issue a pocket pivot buy point off of the 50-day moving average, which provides a low-risk entry point for the stock.




The last time Acadia Pharmaceuticals (ACAD) launched off the 12 price level following its early April buyable gap-up, I saw that one coming (see April 21st report), but I only viewed that as a 10% trade. The stock has since come back in to test the $12 level and undercut the April lows, which could set the stock up for another move to its recent highs. Consider buying here using Wednesday’s low as a quick stop.




Santarus (SNTS) failed on Tuesday’s buyable gap-up, thanks to announcing a secondary offering. But this may set up another buy point here as the stock bounced off the 10-day moving average on volume that qualifies as a pocket pivot volume signature following the quick pricing of the 4.25 million share secondary offering at 18.25.




Telecom infrastructure play Mastec (MTZ) popped higher on a buyable gap-up move this past Monday, but a little overhead resistance from the left side of the pattern has caused the stock to pause here as volume dries up. Thus it remains in a buyable position using the 28.75 gap-up day intra-day low as your stop. This is the first real base the stock has formed since breaking out to all-time highs last December.




Fleetcor Technologies (FLT), which staged a buyable gap-up move after earnings from a base-on-base type formation, also remains in a buyable position following last Friday’s buyable gap-up move, using the intra-day low of the gap-up day at 78.88 as your selling guide. FLT has been a strong leader in the 2013 market rally, and this is the closest it has come to forming a new base since breaking out in August of last year.




This theme of leading stocks which have corrected and which are now rounding out the lows of potentially new bases (e.g., DDD, SSYS, NSM, etc.) appears to be expanding into names like Goldman Sachs (GS), which flashed a bottom-fishing pocket pivot as it came up through its 50-day moving average on Monday of this past week. The stock gently drifted back into the 50-day line on Friday, providing a low-risk entry point




Cloud software leader (CRM) is engaging in similar action to GS as it flashed a bottom-fishing pocket pivot on a move up through its 50-day line on Thursday. This resulted in further upside on Friday, leaving the stock slightly extended from the 50-day line, thus I would only venture to initiate a position on a pullback to the line from here.




Buyable gap-ups seem to have been the rule of the day in this market as “earnings roulette” season has progressed. Fortunately, the buyable gap-up method that was first discussed publicly in the book that my colleague Dr. Chris Kacher and I wrote back in 2010, “Trade Like an O’Neil Disciple,” provides a concrete solution to dealing with what otherwise look like “crazy” and altogether unbuyable price moves. The truth is that the BGU is in fact one of the easiest set-ups to buy into given the concrete risk-control using the intra-day low of the BGU day as a selling guide. In the case of what is often referred to as the “ of Latin America,” Mercadolibre (MELI), we see another huge buyable gap-up occurring after earnings this past Tuesday. MELI, as of the end of April, had 15.6 days of short interest, equivalent to 8.7 million shares sold short on a 31 million share float. The stock closed about 9-10% above the 111.25 intra-day low of the BGU day, but is holding tight on either side of the 119-120 price level. The tight action here as volume dries up implies to me that the stock should try and immediately move higher from here, thus I would use Wednesday’s 116.18 low as a quick downside stop. Over the next four years, MELI is expected to see annual earnings progress in sequence to $2.81, $3.48, $4.80 and $5.00 per share, so strong growth still remains ahead of the stock.




I have to admit while I have loved the story behind Splunk (SPLK), the stock’s action has driven me nuts as I have been in and out of the stock several times as it slowly progresses higher within this shallow uptrend channel it has formed since a strong upside move on earnings in early March. This past week the stock made new all-time highs on volume that was either average or below-average, in many ways not unlike WDAY over the past week as well. SPLK’s action, however, reminds me of when I played Apple (AAPL) back in 2004, moving in and out of the stock as it moved in a shallow uptrend channel from late August to mid-October 2004. Eventually, a strong earnings announcement on October 13th sent AAPL gapping higher on a massive run, and so the current action in SPLK leads me to think a similar scenario could unfold when it announces earnings on May 30th. In the meantime, it appears that SPLK should be bought on any weakness, such as Thursday’s pullback that held the 10-day moving average. Tough to hold within this shallow uptrend channel for now, SPLK may however see a real move start after earnings in the event that a strong announcement generates a BGU type move up and out of this current trend channel.




Tesla Motors (TSLA) was a big story this week after gapping up hugely on Thursday following the posting of its first profit ever. Notice that TSLA was flying around within an upside trend channel over the prior four weeks. Thursday’s move was in fact a buyable gap-up move, and no doubt was aided by the fact that as of the end of April TSLA had 10 days of short interest, the equivalent of 39 million shares sold short against a float of 80 million shares! TSLA is estimated to earn $1.07 in 2014 after turning a profit of six cents in 2013, although it already exceeded this in the first quarter with a 12 cent profit as reported this past week. I played the stock on this move, but I think at this stage one might look for a well-formed, tight flag formation to ensue and present a secondary entry point over the next few days or weeks. It is possible that all the short interest in the stock has scrambled to cover given that 53,691,300 shares traded on Thursday and Friday alone, but this does not negate the longer-term potential of the stock’s growth story as I see it. TSLA’s roadster has twice the energy efficiency of a Toyota Prius, and the company plans to build a family of cars that are more family- friendly and affordable, thus the move in TSLA may just be starting, so we will follow the stock as we await a secondary entry point at some point in the, hopefully, near future.




Another aspect of TSLA that I find interesting, and which might be applicable to the first stock I discussed in this report, DDD, is that both stocks had huge short interest numbers in the most recent reports date April 30th. This is one reason why I believe DDD’s short interest could fuel a breakout from its current cup formation.


In general, and as this report illustrates, a number of stocks are moving into actionable buy points, whether those are buyable gap-ups or clean base breakouts. This appears constructive for the underlying foundations of the current rally phase. Despite the indexes looking somewhat precarious and extended on the upside, the fact that so many quality stocks are showing actionable buy signals/points seems to argue that the rally may continue to accelerate to the upside. The NASDAQ’s trend in 2013 has been relatively shallow, but it has now begun to accelerate and outperform the S&P 500, which might indicate that this rally is moving into a phase where mid- to smaller-sized growth stocks dominate. Small-cap growth has lagged large-cap growth since April, but if that situation begins to reverse it can help to sow the seeds of an accelerated upside move in the market. Otherwise, the market doesn’t top until the market tops, and if a slew of stocks that fits our methodology is suddenly rising to the top of pile, the rally becomes even more playable, whether the indexes are seen as extended to the upside or not.


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 DDD, SBGI, TSLA, and VRX, though positions are subject to change at any time and without notice.


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