The Gilmo Report

May 16, 2021

May 15, 2021 9:11 pm ET

The market took a beating early in the week and the rebound over the past two days keeps the indexes in no-man’s land. For those of you following me on the Live Blog, and for those of you attuned to the short side in general, it was a very good week for the shorts. By Wednesday things were looking oversold, and the S&P 500 Index was testing its 50-day moving average, which set up a logical bounce on Thursday and Friday that came on successively lighter volume.

 

 

Percentage-wise, the NASDAQ Composite bounced a little harder, rallying a total of 3.04% on Thursday and Friday vs. the S&P’s 2.71% and the Dow’s 2.35%. That’s not too surprising, since, for the most part, it has been in the high-PE-expansion area of the market that calls the NASDAQ Composite Index home where the most brutal selling has occurred. It is now rallying back up toward its 50-day line on lighter volume as it remains in a downtrend.

 

 

From the perspective of the S&P, it’s more or less right back at its prior highs, since despite all the tumultuous price action this past week, stuff stocks have held their ground. Thus, the S&P looks like it is making a quick recovery from a shakeout. The NASDAQ Composite, on the other hand, has much ground to make up, and looks more like a reaction bounce off oversold lows. The two-day bounce was helped by some good news later in the week after the Wednesday disaster when the Consumer Price Index posted a 4.2% 12-month increase, the highest since 2008. On Thursday, the Producer Price Index came in with a 6.2% 12-month increase, the highest ever, but the market shrugged it off.

From a chart perspective, once the S&P had met up with its 50-day line the day before, a logical area of support, some positive news then helped change the oversold mood of the market. The restart of the Colonial Fuel Pipeline and the CDC’s announcement that fully-vaccinated citizens may now dispense with the ignominy of wearing a face diaper whether indoors or outdoors were both causes for cheer. Very weak retail sales numbers on Friday also helped defray some of the inflation fears that resulted from the CPI and PPI numbers earlier in the week.

Unless we see the NASDAQ Composite continue to recover, it appears that the market still expects more inflation, higher interest rates, and therefore PE-compression in high-PE-expansion names. The 10-Year Treasury Yield didn’t rally to new highs on the inflation numbers early in the week but that doesn’t strike me as any surprise. The current consolidation remains intact, and it is likely that the prior, very steep rise in the $TNX had already discounted the CPI and PPI prints we got this past week, so that any breakout would likely be a reaction to market-perceived inflation coming down the pike.

 

 

If the market is going to sell off further, then at this stage we should keep a close eye on the stuff stocks where the current leaders reside. Not that they haven’t also come under pressure this past week, but for the most part they have held up despite taking a beating on certain days of this past week. If these start to break near-term support, then this may constitute a new area of the market where early short-sale targets will appear.

If not, and the market is able to find its feet, then the stuff stock rally could easily resume. I assume nothing. We might also see some of the beaten-down tech and growth names rally as well. How far the rallies would carry in these names, however, would remain an open question in a rising interest rate environment.

Rising interest rates are the stuff of rising inflation, and if this week’s inflation data was a harbinger of things to come, then the market may be on edge until we get next month’s data. And that could become the story of this market. Anything that confirms rising inflation keeps the rising interest rate scenario in play, which may put pressure on the high-PE areas of the market, or the entire market.

Big-stock industrial metals names are correlating strongly, and we can see the fight put up by Alcoa (AA) throughout the week after getting smacked on heavy selling into a move to new highs on Monday. Rally attempts on Wednesday and Thursday were sold into, and the stock ended the week with a low-volume move up into its 10-dma.

It is possible that AA needs more time to base up here as the market begins to anticipate the next round of inflation data. At the same time, we want to be aware of any signals of failure along the 10-dma and 20-dema which could turn this into a failed-base, short-sale situation. For now, the 20-dema offers buyable support with the proviso that a breach of the line could trigger the stock as a short-sale target if it occurs.

 

 

U.S. Steel (X) correlates closely to AA with a reversal from new highs on Monday followed by two rallies on Wednesday and Thursday that were sold into. The Wednesday rally sealed the deal on a failed breakout, but X has so far been able to hold support along the 20-dema where it is technically buyable using the line as a selling guide. Objectively, it is also in a failed-base type of position, where a breach of the 20-dema would trigger it as a short-sale target at that point.

 

 

With soaring copper prices taking a bit of a break this past week, Freeport-McMoRan (FCX) has pulled back as well, but note that it, too, correlated closely to AA and X this past week. A move to new highs on Monday was sold into and this was followed by sell-offs on Wednesday and Thursday. By Friday FCX was holding support along the 10-dma as volume declined, which puts it in a lower-risk long entry spot for now, pending any potential reaches of near-term support at the 10-dma and 20-dema.

 

 

Iron ore producer Cleveland-Cliffs (CLF) also correlates strongly to the action in other industrials metals names with a move to new highs on Monday getting sold into and then rally attempts on Wednesday and Thursday that were also sold into. It then spent Friday pulling into its 20-dema as volume expanded, which can be interpreted as support along the line.

One can therefore test this as a long here using the 20-dema as a tight selling guide. Like X, however, CLF is also a failed-base situation after Monday’s failed breakout attempt, so that a break below the 20-dema could trigger this as a possible, failed-base, short-sale target if it occurs, similar to X.

 

 

Uranium producer Cameco (CCJ) is another metals/resource name that is having difficulty with a recent breakout attempt. The breakout of two Fridays ago has gone nowhere, but the stock has been able to hold support at the 20-dema. My own view, based on real-time research, is that buying breakouts is an ineffective, outdated way of buying stocks as most breakouts either fail outright or will come back in to test the 10-dma or 20-dema before pulling the classic QE market re-breakout.

It appears that CCJ is best bought on pullbacks to the 20-dema with the idea that a breach of the 20-dema would trigger this as a short-sale target if it occurs, based on the breakout-failure set-up. Otherwise, it is certainly putting up a fight and holding its ground despite the past week of market mayhem.

 

 

Teck Resources (TECK) is the strongest of the bunch as it holds above a recent breakout point and its 10-dma. I suppose one could therefore look at this as a buyable situation along the 10-dma which of course then becomes your selling guide.

 

 

For most of this past week we were working tactical short-sale set-ups in the metals names as I posted ideas to watch on my Live Blog in names like X and AA, for example, when they reversed on Monday, Wednesday, and Thursday. Those were good for some decent short-sale profits, but the situation remains fluid with all of these names for now, so assume nothing.

An interesting twist to the whole inflation story is that agricultural commodities got hit with selling this past week despite the strong CPI and PPI prints. We can see on the group chart of the Teucrium Corn ETF (CORN), the Teucrium Soybean ETF (SOYB), the Teucrium Wheat ETF (WEAT), and the iPath Coffee ETF (JO) that all four of these mainstream food commodities were hit.

 

 

This has had a mixed effect on agricultural names as we’ve seen names like Agco (AGCO) and Corteva (CTCA) get hit recently, but fertilizer names continue to hold up. CF Industries (CF) remains above a prior breakout point and its 10-dma after posting earnings last week and pulling a big upside reversal and breakout. This is buyable here along the 10-dma, which the usual proviso that a breakout failure could have bearish implications, particularly if it results in an eventual breach of the 20-dema.

 

 

Nutrien (NTR) correlates very closely to CF as it holds up following a breakout two Fridays ago. The 10-dma has served as near-term support, as is the case with CF, putting it in a buyable position here. Again, be alert to any breakout failures that could have bearish implications if we start to see breaches of the 10-dma and 20-dema. So far, however, CF and NTR have held up during a difficult market week.

 

 

Mosaic (MOS) is struggling a bit but still holding up with its fertilizer buddies CF and NTR. It broke out at the end of April and failed, then pulled a re-breakout maneuver two Fridays ago that also failed. It then held support along the 20-dema throughout the past week before breaking out for the third time on Friday, albeit on light volume.

While it is buyable here based on the second re-breakout and support at the 10-dma, we can also watch this closely like the others since any further breakout failures may not result in such a happy ending. MOS illustrates nicely how the whole breakout-buying concept can be a source of frustration if one is not open to using alternative, more opportunistic methods of buying on weakness at key near-term moving averages like the 10-dma or 20-dema, when then serve as tight selling guides.

 

 

With agricultural machinery names like Agco (AGCO) and Deere (DE) struggling, if one wants to on a machinery stock why not just go with the big-stock name that operates in both the agricultural and metals space? If I’m interested in this area of the market, then I tend to prefer the company that makes machinery that moves and digs up stuff in both the agricultural and metals spaces, Caterpillar (CAT).

Of course, CAT is another one of these stocks that can’t make up its mind what to do after an initial breakout. The stock popped to new highs on Monday but couldn’t hold that rally and has been more buyable along the 20-dema, which remains the case for now. Again, any break below the 20-dema could bring CAT into play as a possible short-sale target, and I would watch other agricultural and metals names for a possible confirming correlation.

 

 

While agricultural commodities languish, gold is now at its highest levels since February as the Sprott Physical Gold Trust (PHYS) cleared the 200-day moving average Friday on strong volume. The yellow metal has been leading the way for its white metal cousin, silver, but the Sprott Physical Silver Trust (PSLV) continues to hold its own. A low-volume pullback into the 10-day line on Thursday offered a lower-risk add point for those playing the white metal since the late-March undercut & rally (U&R) along the lows at that time.

 

 

Gold miners and related stocks remain in their own little bull market, trending higher right along with the yellow metal ever since the March lows.  So far, the best way to buy these has been on pullbacks to the 10-dma as they become ever more extended in their uptrends. Agnico Eagle Mines (AEM), Franco-Nevada (FNV), Kirkland Lakes Gold (KL) and Newmont Corp. (NEM) kissed their 10-day lines on Thursday before moving to higher highs with NEM leading the way by pushing sharply higher on Friday.

 

 

Admittedly, silver has been slightly less robust than gold recently, but the white metal has continued to trend higher off the March lows. In a seeming paradox, however, silver miners continue to diverge starkly as most of the names in the space that I follow break down. Of the six I show below, First Majestic (AG), Coeur Mining (CDE), Fortuna Silver Mines (FSM), Gatos Silver (GATOS), MAG Silver (MAG) and Pan-American Silver (PAAS), only GATO and MAG are acting even half-way constructively.

MAG is in an uptrend with support along its 20-dema, where it shook out on Thursday, while GATO has regained its 50-day moving average where it pulled back to post a voodoo volume signature at the 50-day line on Friday. If silver keeps moving higher, the wild card here is that these silver miners all suddenly rise out of the Ugly Duckling Swamp in which they are currently mired, so while I consider them worth watching, I have preferred the gold names or, as I’ve said before, just outright ownership of silver itself.

 

 

I tend to view oil names as similar to the airlines a month or so ago when they were rallying on re-opening hopes. Those eventually turned into shorts and have been looking ugly ever since. Meanwhile, oil names have recently perked up, but the action is erratic at best. If oil prices continue to rise, then perhaps oil stocks will catch a stronger bid, but the situation strikes me as uncertain.

One of the best-acting names in the group that has been discussed in recent reports, Bonanza Creek Energy (BCEI), is now trying to break out but stalled a bit on the move Friday after failing to clear to new highs on Wednesday. In my view, the new-high breakout is fool’s bait, since the proper buy point occurred on the pocket pivot and trendline breakout in early May.

Given the halting action over the past few days as BCEI tries to clear to new highs, I would also be alert to any changes that could trigger this as a possible base-failure short-sale situation, starting with any possible break below the 10-dma. Play it as it lies.

 

 

A couple of weeks ago the “leading stocks breaking out” crowd was hailing the homebuilders as an area of new market leadership, but as I noted at the time, I was skeptical of the action in this group as rising interest rates are not a positive for the housing sector. My instincts on this were correct, and the group split wide open this past week.

Most of these names are now late-stage, failed-base (LSFB), short-sale set-ups in process, and the rallies over the past two days could end up bringing these into secondary short-sale positions along their 20-demas, as would be the case with D.R. Horton (DHI), Hovnanian (HOV), Pulte Home (PHM), and Toll Brothers (TOL).

 

 

Semiconductors have had such severe downtrends over the past month that if one were just looking at the charts of Applied Materials (AMAT), Advanced Micro Devices (AMD), KLA Corp. (KLAC), Micron Technology (MU), Qorvo (QRVO), and Western Digital (WDC) one would likely be surprised that the NASDAQ Composite had been rallying to all-time highs. The semis were instead the first chinks in the market rally’s armor well ahead of the near-term peak two weeks ago.

However, after extended downtrends leading into the Wednesday lows, I would consider the possibility that they may simply consolidate their declines after the first leg down. Either that or they all start setting up in Ugly Duckling long configurations that see them trudge back up to their highs. In the group below I can see that MU and QRVO are in U&R Land, while WDC posted a U&R on Thursday and then shot higher on Friday. These are certainly playable as tactical long swing-trades, but only when risk can be kept to a minimum by buying as close to the prior reference low as possible.

 

 

U&R attempts earlier in the week by beaten-down cloud names haven’t produced any significant upside. In the group below, consisting of Avalara (AVLR), CrowdStrike (CRWD), DocuSign (DOCU), Okta (OKTA), Twilio (TWLO) and ZScaler (ZS), we can see that U&R moves by DOCU, TWLO and ZS earlier in the week have gone nowhere.

 

 

Big-Stock NASDAQ names Apple (AAPL), Amazon.com (AMZN), Facebook (FB), Alphabet (GOOG), Microsoft (MSFT) and Tesla (TSLA) all rallied off their intraday lows, with AAPL bouncing right off the 200-day line. However, all of these names got a bit near-term oversold, so the bounces don’t strike me as all that surprising and I don’t see anything all that appetizing on the long side of these at least for now.

Most of these moves look a bit extended after two days of upside, so the situation with the big-stock Naz names remains fluid. Keep a close eye on this group since where they go from here will likely determine where the markets go from here, at least with respect to the NASDAQ Composite.

 

 

We remain in one of the most bizarre periods in economic and market history. Despite the fact that retail sales are now 15% above trend after a sharp break and equally sharp recovery last year, courtesy of helicopter-money stimulus checks from the government, the Fed remains in emergency mode. Interest rates are still at 0%.

 

 

Friday’s weak retail sales number makes complete sense within this context since retail sales are literally off the chart. There is no economic boom coming, it already came! Yet the Fed is still in emergency mode, and we should also remember that the Fed continues to purchase upwards of $120 billion of bonds every month, including mortgage-backed securities, despite the fact that we are in a housing boom.

 

 

In my view, what the Fed has done was never intended to address the pandemic alone, but rather to continue to prop up and inflate a bubble that it cannot afford to stop inflating. That is why Fedheads continue to coo that the current spikes in inflation are transitory. But if inflation persists, and the Fed continues to keep Fed Funds at 0%, negative real interest rates will become more negative, which should be a positive for precious metals.

Meanwhile, the Fed may realize that they cannot reverse current policy, because once it does, the bubble will pop, with unknown but likely extremely deleterious consequences. This is one wild card to consider when participating in this current market environment, but so far, the Fed has been quite deft in side-stepping the time when the proverbial piper will have to be paid.

In my view, we are witnessing a massive economic, monetary, and fiscal stimulus paradox. We have massive QE stimulus and massive deficit-spending stimulus that now tallies an astounding $6 trillion in new proposed spending by the Biden administration even as the economic data shows an economy that is already well beyond where it was pre-pandemic. On the surface, any sensible person would say that this cannot end well. A lot of people have been saying it, in fact. Maybe too many.

In the meantime, it may simply mean that we are likely to see a lot more WTF action on the economic and market front going forward, and as we know, this market climbs not the proverbial Wall of Worry but the newly proverbial Wall of WTF. Therefore, focus on the set-ups in an objective manner, as they and they alone will push you in the proper direction at the proper time, so pay ‘em as they lie. I’ll see you Monday on the Live Blog.

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

 

Notes on Terminology

Note #1 – Moving Averages: When I use the term “20-day moving average,” “20-day line,” or “20-dema” I am referring to the 20-day exponential moving average. I use four primary moving averages on my daily charts: a 10-day simple (the magenta line), 20-day exponential (the green line), 50-day simple (the blue line) and 200-day simple moving average (the red line). On rare occasions, I will also employ a 65-day exponential moving average (black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

Note #2 – U&R Set-ups: A U&R, or undercut & rally, is a long entry signal that occurs when a stock undercuts (moves below) a prior meaningful low in its chart pattern and rallies back above that low. The precise entry occurs at the prior low, which then becomes your selling guide. There are no other special requirements for a U&R other than the price action. It is similar to Wyckoff’s Spring. A MAU&R, or a moving average undercut & rally, is essentially a shakeout at a moving average where your entry point occurs at the moving average as the stock is coming up through the line. This then becomes your selling guide. You can run things tight by using the actual price levels as stops or allow for 1-3% of further downside (otherwise known as downside porosity) before being stopped out.

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