The Gilmo Report

May 21, 2014

May 21, 2014

Objectively the market remains in a big sideways range as we can see on the daily chart of the S&P 500 Index, below. The action so far this week has exhibited choppy movement as the indexes sold off yesterday on heavier volume in a clear distribution day, only to rally back sharply today on lighter volume. As we can see on the chart, however, volume remains below average and the index continues to maintain support at the 50-day moving average. At most, the action is inconclusive, but I have to say that trying to short into possible right shoulder rallies is not being rewarded as stocks have in most cases broken down briefly only to rally back again. This is just fine with me, as I’ve already discussed the fact that the “fat” part of the short-sale game occurred primarily in March and early April. At this stage of the game, with stocks having broken down and now engaging in potential right-shoulder-rallies, it is a matter of seeing whether this RSR action resolves to the downside or the market is able to resume its rally. For now the one thing I’m looking for as some sort of confirmation that the shorting game might come back into full swing is a breakdown below the 50-day moving average by the S&P 500 that might coincide with the NASDAQ Composite Index heading for its 200-day moving average. Until I see this, I am not willing to take on aggressive short positions, if any, at this time.




We can see the triangular “pennant” formation that the NASDAQ is forming on the daily chart, below, and it is simply a matter of waiting to see how this resolves itself. Yesterday’s distribution day came on below-average volume as was the case with the S&P 500, and the daily trading range held within the range of the prior day, so things were not as ugly as they might have seemed. The NASDAQ is now at the 65-day exponential moving average with the 50-day simple moving average just above that. We might consider this a critical juncture IF the index can rally above both of these indexes, which is a clear possibility. The critical thing here is that one must absolutely maintain an even keel in terms of their psychology. From my own perspective, I am flush with profits from a nice short-selling campaign that began at the beginning of March, and as I test these potential right-shoulder-rallies I can get a sense that the market just keeps wanting to push higher. So I back away and reconsider things with a clear mind and with no preconceived bias. If the NASDAQ fails here at the 65-day line, then I would look for confirmation of the weakness by a break through the 50-day line by the S&P 500. If that doesn’t happen, then we are presented with the problem of what to go long here if the general market does begin a new rally phase. Let’s take a look at what some of the stocks are doing.




We can begin by looking at some of my previous short-sale targets, starting with Netflix (NFLX), shown below on a daily chart. NFLX has been mimicking the NASDAQ as it has continued to work on its RSR phase, but yesterday the stock flashed a bottom-fishing pocket pivot buy point as it popped up and off of the 50-day moving average. I’ve been watching the stock and testing small short positions into the rally, but the stock just keeps pushing right past my tight stops. Today it continued higher on heavy, above-average volume as it cruised right past the prior mid-April peak in the pattern. Notice also that the little black triangles or “ants” that are showing up on the daily bars that indicate the stock is up 12 out of 15 days in a row or better, a sign of strength. In addition, NFLX has moved above 383.96, the peak of the right shoulder in the pattern. In my view, if this is going to remain a short-sale target, it should fail relatively quickly, but that isn’t happening, and I’m not dumb enough to stand in the way of the stock here as it is now well above all potential resistance areas, end of story.




Facebook (FB) looks interesting on its daily chart, shown below, mainly because it looks pretty much exactly like the NASDAQ. FB has been forming a pennant for the past month just as the NASDAQ has, and it too has run into resistance along the 65-day exponential moving average. I was short some FB coming into the day today and decided to cover and go long instead since the stock feels like it wants to push higher. That turned out to be the case today as the stock closed just above the 65-day line on increased volume. If FB is going to turn here, then I would expect to see some sort of pocket pivot action coming up through the 50-day moving average very shortly.

The other minor detail here to take note of is that FB just cleared the top of its month-long pennant formation on a five-day pocket pivot. Pocket pivots where the stock moves up and off a moving average, in this case the 10-day line for FB, on volume that is higher than any down-volume over the past five days instead of ten, can occur in big stock leaders, so I’m willing to give this a shot here using the 10-day line at 58.70 as a quick downside stop. There is not much to go long here if the market continues to rally, so some creativity will have to be exercised in terms of looking for big stocks that could be building new bases in the form of “roundabout” patterns where the stock is rounding out the lows of a potential new base.




Here we can see Baidu (BIDU) on its daily chart pushing right up through its 50-day moving average on increased volume that is still below average. If one were trying to short the stock at around the 50-day line, then one has clearly been stopped out. BIDU is a good example of the type of “pushy” action in prior short-sale target stocks. The stock had a short breakdown from the 50-day line last week, but the selling did not come on heavy volume. Thus a small increase in buying interest is enough to propel the stock back above its 50-day moving average. That is not how a weak stock should act. Price-wise, BIDU is up at the 164 price area which has represented resistance on prior rallies since early April, but it closed at the peak of its daily range today and feels like it wants to move higher.




Celgene (CELG) is an example of a weaker situation as it stalls out along its 65-day exponential moving average, as we can see on the daily chart, below. CELG did find resistance last week at the 200-day line which sent it right back down to the 50-day line, but so far we might simply consider it to be lost in “no-man’s land” here between the 50-day and 200-day moving averages. I would keep this on my short-sale watch list, but again, remember that I only want to come back after short-sale target stocks IF we see the S&P 500 breakdown below its 50-day moving average. Otherwise, we have to be cognizant of the market’s potential to move higher from here, which likely would result in a stock like CELG pushing back up to the 200-day line. Biogen Idec (BIIB), not shown, is in a similar but opposite position, trapped below its 50-day line but above its 200-day line. In essence, I observe that most of my short-sale target stocks are sitting in either non-descript positions within their chart patterns where it is difficult to ascertain which way they will move next, or they are crashing through resistance levels such as is the case with NFLX and BIDU.




Another example of a short-sale target stock that is starting to show more constructive behavior is Goldman Sachs (GS), shown below on a daily chart.  They say that Cinderella only comes once, and GS has given us several tactical short-sale opportunities each time it has rallied up to the 160 price area, more or less, over the past month. Without fail, each of these rallies turned tail and sent the stock back down to the lows of the sideways range it has been locked in for the past month. Today, however, GS flashed a big-volume bottom-fishing pocket pivot buy point, which in my view takes it off the table as a short-sale target. Notice also that selling volume appeared to dry up yesterday, and with today’s well above-average move off the 10-day moving average, the stock is telling us that it likely wants to move higher from here.




While I see very little that I consider to be in an optimal buying position, what I am keeping an eye out for are “roundabout” formations where a bottom-fishing pocket pivot shows up, such as we see with Illumina (ILMN) on its daily chart, below. ILMN grew earnings at a whopping 15% in the latest quarter, but that hasn’t kept the stock from rounding out the lows of a potential new base and flashing a bottom-fishing pocket pivot as it came up through the 50-day moving average on Monday. ILMN pulled back towards the 50-day line yesterday before turning and making a higher high today. I would expect that if ILMN is to remain viable, the 50-day moving average provides a reasonable selling guide. This is a good “model” for what we want to be looking for in terms of possible buy set-ups in a market environment where all of the prior big leaders have been knocked down pretty severely.




The one factor that might work in favor of the market here is the fact that many former NASDAQ big-stock leaders have been crushed and lie deep down in the dungeons of their chart patterns. I haven’t seen such oversold action in such a broad number of former leaders in a long time, and given how oversold many of them are, logical and normal reaction rallies off the lows which can often be quite sharp would give the NASDAQ the impetus it needs to move higher and play catch-up to the S&P 500. Basically, an extreme oversold condition in so many former leaders makes this a possible scenario for further upside.

If the NASDAQ is able to clear its 50-day moving average on strong volume, and this occurs in tandem with a strong-volume breakout by the S&P 500 to new highs, then I would consider the market to be back in rally mode. The real question is what to buy in such a situation, and right now that is not very clear at all. My tendency is to favor former big-stock leaders that are not as far down in their patterns and which could be engaged in “roundabout” formations where they are rounding out the lows of a potential new base and the roundabout is confirmed by the appearance of a bottom-fishing pocket pivot buy point, such as we see with ILMN, for example. Among the big-stock leaders I tend to favor FB in this regard, and I am anticipating some sort of confirmation occurring in the next few days. The other type of buy set-up is the venerable “shakeout-plus-N” buy point, but this is not necessarily a common buy set-up. I would prefer to see roundabout formations that are confirmed by bottom-fishing pocket pivots – that would be my favored buy set-up in this environment.

In the meantime, if one is testing the short side of the market as short-sale target stocks rally into areas of resistance but these same stocks just keep going right on higher, let them force you out naturally and get out of the way. It is not clear to me that the short side is the place to be at this precise point in time, and that is okay as I am sensing a shift here. While I could be wrong, I know what I’m looking for to confirm that the short side is back in play. In the meantime, I believe it is prudent to keep an open mind here and see how things play out – there is no need to take an aggressive stance one way or another.


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 FB, though positions are subject to change at any time and without notice.

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