The Gilmo Report

May 16, 2012

May 16, 2012


The market has now broken near-term support at the 2900 level as illustrated by the NASDAQ Composite Index, below. Both yesterday and then again today the indexes posted downside reversals after opening up on “good” news each day with volume increasing each day. Thus the market picks up two more distribution days as leading stocks continue to buckle and break under the steady selling pressure. The market remains in an unstable state of affairs, but I would note that with the indexes breaking support which the crowd clearly sees, we are set up perhaps for some sort of reaction bounce back up to what was prior support at 2900 on the NASDAQ but which now may serve as near-term resistance. Most of my short-sale target stocks have come down a ways. Given these extended moves to the downside, such as with CF Industries (CF), they are probably due for a bounce. So as the breach of support in the major market indexes is obvious to the crowd, it could produce an “undercut & rally” situation for a couple of days. I can see the timing of the wildly hyped Facebook (FB) IPO providing just enough enthusiasm at the right time to drive such an “undercut & rally” maneuver, Of course, that is not set in stone, but in my view if you were not shorting the ideas I have discussed in recent reports last week, then at this juncture you may be a little bit late, for the most part.

NASDAQ Gilmo Report Stock Chart

However, a nice news-oriented or Facebook-ebullience rally in the market that were to push up into logical resistance might also correlate to some of our short-sale ideas also rallying into logical resistance where they could become quite shortable. The bottom line right now, however, is that I’m tending to look at some of these situations, such as F5 Networks (FFIV), as being at logical points at which to take profits. FFIV’s daily chart, below, shows the stock undercutting the prior lows in the pattern around the 120 price level. From here I would only be interested in shorting the stock again on some sort of lame bounce back up above the 120 price level. With another one of our cloud-related short-sale ideas, (CRM), announcing earnings tomorrow after the close, there is always the outside chance that an earnings-related bounce in CRM leads to a sympathy bounce in FFIV, although we won’t know for certain if that is going to happen until it actually does. Meanwhile, I view the undercut of the prior lows in the pattern as a decent enough reason to take short-term profits, particularly if one takes huge positions in short-sale target stocks as I do. Longer-term, my view is there is very good potential for FFIV to continue moving lower.

F5 Networks (FFIV) Gilmo Report Stock Chart

Valeant Pharmaceuticals (VRX) is also panning out as a successful short-sale set-up as it drifted up towards the 50-day moving average where it became very shortable, as I discussed in my report of last Wednesday, March 9th. If you shorted this into the dead-cat bounce as it approached the 50-day line, the past three days have yielded decent downside progress as the stock has made a lower low, undercutting the intra-day low of the massive-volume reversal the stock had on what was an ugly breakout failure. At this point you want to use the 200-day moving average at 46.37 line as your downside price target to take profits. Certainly, any upside blip from here into the 51-52 might be feasible to short into, using the 50-day moving average at 53.87 as a reasonable upside stop. When a stock blows apart like VRX did two weeks ago on volume that is as massive as it was on that day, the probability that it is going lower is generally pretty strong, and so far that has turned out to be the case as VRX makes lower lows.

Valeant Pharmaceuticals (VRX) Gilmo Report Stock Chart

In a similar vein to VRX is Rackspace Holdings (RAX), which I discussed in my report of this past weekend. RAX did not engage in any reversal-type action to “seal the deal” on its disastrous breakout failure, but rather pulled a spectacular massive-volume downside gap following its earnings announcement. Thus we are faced with a situation where extreme selling likely indicates institutional investors running for the exits, leading to a six-day dead-cat bounce that appears to be stalling at the 65-day exponential moving average. In my view this is initially shortable here with the idea that the 65-day exponential moving average will hold as upside resistance. Should RAX continue its dead-cat bounce and get through the 65-day line then I would look for the 50-day moving average at 56.02 as the next logical short-sale point. As always, use a maximum 3-5% upside stop in short positions in order to keep yourself from getting into trouble.

Rackspace Holdings (RAX) Gilmo Report Stock Chart

CF Industries (CF), which I mentioned at the outset of this report, has also been a successful short-sale target as a late-stage failed-base (LSFB) short-sale set-up, as we see on the daily chart below. The stock blew through its 50-day moving average last week where we initially set out to short the stock, and then Friday’s move to the 200-day moving average offered a logical place to cover and take short-term profits. However, that bounce came on extremely weak volume, and when the stock retested the 200-day moving average and failed right then and there it was potentially re-shortable at that point. However, note the steep descent of CF since failing on the breakout attempt at the end of April. And with the stock finally busting the 200-day moving average, its weakness becomes a bit obvious to the crowd. So I would certainly be looking for some sort of reaction rally from these levels given the extent of the downside move off the peak. CF has been exceptionally weak as an LSFB set-up, since most will break down sharply to the 200-day line and then rally back up to the 50-day line one to three or more times before finally blowing apart again. I would prefer to be shorting this one again into a rally, and so will sit and wait for the next shortable rally to show up.

CF Industries (CF) Gilmo Report Stock Chart

Underlying the market’s weakness is the action of its biggest big-stock leaders, such as (PCLN) which has issued several sell signals recently as I discussed in my report of this past weekend, and of course Apple (AAPL). As you may recall, my strong view was that AAPL was destined to breach the 555 low of its current “base” formation (ifthat’s what we can call it), and it achieved that yesterday, as we see on the daily chart, below. What I find ominous about AAPL’s chart is the unusually low-volume selling in the stock since its earnings-related gap-up move at the end of April, which failed right away. In spite of the low-volume selling, the stock has not found any buying interest whatsoever as it has continued to drift lower today. This leads me to believe that the crowd is all loaded up on AAPL, and everybody who is going to own AAPL is already in the stock. With AAPL undercutting the 555 low, of course, this sets up the possibility of a short-term “undercut & rally,” but at this point the stock is broken and its steady erosion since violating its 10-day moving average in mid-April has been a strong barometer of the general market weakness that continues to unfold.

Apple (AAPL) Gilmo Report Stock Chart

As a former big-stock leader in the bull rally which started off the lows of March 2009, Chipotle Mexican Grill (CMG) has had what we might consider a startling change of character over the past month since violating its 10-day moving average in mid-April, as we see in its daily chart below. You might even notice the short head and shoulders type of formation on the daily chart as the stock has now violated its 50-day moving average in May. Remember that H&S formations on weekly charts are what I rely on in assessing a potential short-sale target stock, but I think the way this pattern is unfolding tells you that CMG deserves to go on your short-sale watch list, if it isn’t outright shortable right here as it wedges back above the 65-day moving average. Throughout this recent upside leg and rally phase in the market so far in 2012, CMG has held up in stellar fashion as it has tracked higher in an excruciatingly tight uptrend channel that obeyed the 10-day moving average all the way until mid-April. Now it has completely changed character and my best guess is that it will steadily form a larger topping formation. I would, however, be eager to short any weak rally up into the 50-day moving average at 414 and change, so keep an eye out for this.

Chipotle Mexican Grill (CMG) Gilmo Report Stock Chart

While the market stinks so bad that one could smell it all the way from Las Vegas where I spent the first three days of this week speaking at the 2012 MoneyShow at Caesar’s Palace, the breach of support in the major market averages sets up the possibility of an “undercut & rally” as the action gets a bit obvious to the crowd. However, I would tend to view such an undercut & rally from here as a rally to short into. Meanwhile, I want to emphasize that members who choose to engage this market on the short side should remain nimble and alert to areas within the charts of our chosen short-sale target stocks where profits should be taken as illustrated, for example, by my discussion of FFIV, above. Otherwise, cash is not a bad place to be at all, and so members who do not feel that their psychology meshes well with short-selling should be more than satisfied to be in cash, side-stepping the persistent weakness in the general market indexes and leading stocks.

Over the past couple of weeks, I have discussed some short-sale ideas that have panned out very nicely so far, such as CRM, FFIV, VRX, and CF.

When it comes to short-selling, one should focus on quality, not quantity, and so I am trying to draw a bead on those situations that I believe offer the best potential for short-sale profits. So far so good, and for now the only stock among those I’ve discussed in recent reports that I consider in a reasonable short-sale position is RAX. As the big-stock “Power Trio of cloud stocks like CRM, FFIV, and VMW continue to come loose and break down, RAX’s position as a cloud cousin to these stocks makes it vulnerable, particularly when viewed in context with its recent extreme and ugly price/volume action. We shall see whether the market can muster a dead-cat bounce over the next couple of days, and whether anything new in the way of short-sale targets pops up by the time I write this weekend’s report. Stay tuned!

Gil Morales

CEO & Principal, Gil Morales & Company, LLC
Principal and Managing Director, MoKa Investors, LLC
Principal and Managing Director, Virtue of Selfish Investing, LLC


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.