The Gilmo Report

May 22, 2011

May 22, 2011

While the market may indeed be in the midst of a “correction,” the bottom line is that as a result of this “correction” the NASDAQ Composite Index is little more than 2% off of its early May peak of 2887. The index, like the S&P 500, looked poised to bust through its 50-day moving average to the downside on Tuesday before finding its feet and reversing back to the upside, setting off a three-day wedging rally where volume declined on each day of the short rally. Friday’s action took the NASDAQ and the S&P 500 down on heavier, options expiration day volume, adding another distribution day to the mix. Sentiment has also declined from its recent bullish bias, and the AAII Investor Sentiment poll currently shows 41% bears to only 27% bulls among individual investors, while the Investors Intelligence Advisor Sentiment survey has seen the percentage of bulls drop from the high 50% range to a current 46.5% bulls vs. 19.6% bears, helping to bring the previously spiking bull/bear ratio down to 2.33 from its lofty 3.5 or higher ratio seen earlier in May. While the long side of this market isn’t providing all that much excitement, it doesn’t look to me like the short side is producing much in the way of profit opportunities either, and so I believe investors should simply take an even-handed stance here and let the market prove itself out, one way or the other.

NASDAQ Composite Index Gilmo Report Chart

Until the major market indexes are able to decisively break down through their 50-day moving averages, I am not inclined to get ragingly bearish here, as the continuing wrangling over how the U.S. will solve its looming budget deficit and borrowing limit issues keeps the situation fuzzy, at best. Should the U.S. Congress come to some breath-taking agreement to cut spending and address the budget deficits in a meaningful way, then I would venture to guess that the dollar would rally sharply, and that this could be trouble for stocks and commodities. However, if the options of “deflate or devalue” remain the only viable solutions given the inability of politicians to make difficult choices, then the dollar could easily resume its downward spiral. Perhaps a clue in this regard is offered by the action in gold, the less-extended of the two precious metals, given silver’s recent climactic run towards the $50 price level where we sold out of our SLV and AGQ holdings. As I have noted in both of my reports last weekend and this past Wednesday, gold appeared to offer the lower-risk re-entry point of the two metals given its ability to hold the 50-day moving average. Lo and behold, the SPDR Gold Trust (GLD) flashed a pocket pivot buy point on Friday as we see in its daily chart below.

SPDR Gold Trust (GLD) Gilmo Report Chart

On Friday it was interesting to see stocks selling off while gold and the dollar both moved higher. With Greece suffering another downgrade to “B+” (somehow I would think a “D+” is more appropriate), perhaps this was evidence of a fear bid in gold and the U.S. dollar. In any case, I like the pocket pivot buy point in the GLD, and if I’m going to play either of the precious metals then gold gets my vote first on the basis of Friday’s action as well as its ability to hold the 50-day moving average quite well. Silver, on the other hand, as shown in the daily chart of the iShares Silver Trust (SLV), is still probing along its lows, and I would have to say that at this point the worst the white metal could see on the downside would be a test of its 200-day moving average down around 28-29 on the SLV. Unlike gold, silver remains well below its 50-day moving average and so is in a less constructive position to flash a meaningful pocket pivot “bottom-fishing” buy signal or something similar, although it could be very close to a bottom here in the low 30’s. We can see in the chart below that both buying and selling interest in the SLV have diminished sharply in recent days, which I see as setting up some sort of resolution one way or the other. However, with gold flashing a pocket pivot buy point on Friday the implication then is that an upside move in gold from here will likely drag silver along with it.

iShares Silver Trust (SLV) Gilmo Report Chart

I’ve discussed a scant few short-sale set-ups in recent reports, and a couple of these like Finisar, Inc. (FNSR) and Las Vegas Sands (LVS) have yielded some small downside moves, but not much more. And of course this is to be expected since the short side of the market will not reach full-bloom until the market has established a bona fide downtrend, whether short-term or otherwise. Meanwhile, strength is seen in a few long-side plays that I continue to monitor as I build a watch list in case the market is able to find its feet and move higher from here. (CRM) flashed a buyable gap-up move on Friday after announcing earnings on Thursday afternoon, right as I was discussing the stock on Fox Business News after the close that day. While this looks buyable, Friday’s move in CRM only got up to resistance at around 150 and the left side of this base it has been working on since early December of last year. CRM recently bought Radian6, which offers products that help businesses integrate social media into their activities, and to me represents a more viable play on the social media frenzy seen in Thursday’s LinkedIn (LNKD) IPO. I would look for CRM to hold above the 142 level on this latest move if I’m a buyer. (CRM) Gilmo Report Chart

My own view of the LNKD IPO is that it is most definitely NOT a buy right here, right now. Like other big IPOs in the past, such as Google, Inc. (GOOG) in 2004, the best strategy is to simply lay back and let the stock build its first base. Back in August/September of 2004 GOOG built a short 3-week flag formation and then broke out after its IPO, and I recall buying the stock right at about the $111 price level back then. LNKD needs to build a base, whether a short flag formation or something longer, and in the meantime I think investors might consider looking at some other, more established plays that incorporate the social media phenomenon into their currently profitable and growing business models, such as CRM. Tibco Software (TIBX), which I last discussed in my report of March 30th when I talked about the emergence of social media as an investment theme for investors to keep a close eye on, is another one. TIBX has shown decent earnings and sales growth, and its future success will depend largely on how well its newest product, Tibbr®, does. In the meantime, I note that TIBX flashed a pocket pivot buy point on Friday, as we see on its daily chart below. I would use the 50-day moving average as my ultimate selling guide for the stock on this pocket pivot buy point.

Tibco Software (TIBX) Gilmo Report Chart

To me, the whole social media thing simply represents another offshoot in the way businesses and consumers are making use of the “cloud,” or what we used to call the “internet.” The use of the term “cloud,” however, seems to update the utility of the internet in that it refers to the new paradigm through which business and individuals communicate, collaborate, and engage in commerce with each other by making highly efficient use of the capabilities offered by the internet. Thus I think that the software end of the cloud-computing space could start to come to life IF the general market gets going again, and of course I still like VMware, Inc. (VMW), which I have discussed repeatedly in recent reports. VMW is still working on a cup-with-hande formation, as we see in its daily chart below, and even showed a sympathetic pocket pivot volume signature on Friday even though this was not a bona fide pocket pivot buy point since the stock was extended from its 10-day moving average. Like CRM, VMW gapped up on earnings but ran into some resistance from the left side of its pattern, causing it to back up and consolidate a bit further. Notice that volume was drying up sharply until Friday’s action showed up, and it looks to me that VMW could easily break out if the general market starts to rev up again.

VMware, Inc. (VMW) Gilmo Report Chart

Indeed, the increased focus on the social media phenomenon as a result of the LNKD IPO frenzy could lead to a general move by cloud-computing software players as I’ve noticed many of the stocks in this area have been either building bases or holding up well after recent breakouts, such as Fortinet, Inc. (FTNT), the #1 global provider of Unified Threat Management solutions, shown below on a daily chart. I’ve discussed FTNT’s fundamental story in greater detail in previous reports, such as my March 30th and January 9th reports, and currently I’m more focused on the stock’s strong technical action in the fact of a choppy market “correction” in May. FTNT gapped up and broke out in late April after announcing earnings, and since then the stock has been able to hold its 10-day moving average, even flashing a pocket pivot buy point on Thursday of this past week, as we see in the chart. Friday saw a small pullback in the stock, but this looks buyable to me in this position, using the 10-day line as a guide for a very tight and quick downside stop.

Fortinet, Inc. (FTNT) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

A lot of the hype surrounding the “rare-earth metals” shortage thanks to restrictions that China is placing on its own rare-earth miners has dissipated in recent weeks, and we can see this deflation of rare-earth hype in the daily chart of Molycorp, Inc. (MCP), below. One thing to keep in mind about MCP is that the stock came public in late July of last year at $14 and hit a peak of $79.16 in early May, a move of about 465%. The stock needs some time to digest this huge price run, as I see it, and so I view its current pullback and correction with the stock currently down 25% off its recent high as potentially healthy for the stock as it technically rebuilds and sets up again. MCP earnings are expected to jump 196% in the next quarter, and 546% in the quarter after, according to the earnings estimates we see on the chart below. In addition, by 2013 MCP is expected to earn $9.44 a share, putting the stock at six times forward estimates at current prices. This recent pullback has taken the stock right back to the true top of its prior base formation at around 55-56, and so I would keep an eye on this as being potentially buyable off the 55-56 support level.

Molycorp, Inc. (MCP) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

When many stocks are conducting themselves in a decidedly unimpressive manner those stocks that do act well tend to stick out like a not-so-sore thumb. Thus the market helps investors clear away the chaff and see where some of the better opportunities might lie if the market is able to continue higher. I have to admit I am quite impressed with the action of Green Mountain Coffee Roasters (GMCR) since it gapped up in early May after announcing earnings. While GMCR pulled in just a bit following the buyable gap-up move for a couple of days, since then it has held in very tight, building a little three-weeks-tight (3WT) flag formation here with weekly volume drying up in the extreme on its weekly chart, below. If we were in a strong bull trend I would say that this stock is without a doubt going higher given this impressive technical action. GMCR has an outstanding long-term earnings and sales record, and its forward estimates remain quite strong. Depending on how the general market acts this coming week, I would not be averse to taking a small starter position in GMCR right here with the idea that the stock should flash a pocket pivot buy point or an outright new-high breakout from this 3WT pattern.

Green Mountain Coffee Roasters (GMCR) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

Higher-end retailers have fared much better than some of their lower-end brethren, and it is interesting to me that even stocks like Lululemon Athletica (LULU) continue to hold up well in a slushy general market environment. Just because we’re in a weak economy doesn’t mean that rich people don’t still need their over-priced yoga wear! LULU has remained a favorite of the wrong-way shorts who fancy themselves as being smarter than the market, such as hedge fund manager Whitney Tilson who saw fit to mouth off about his NFLX short for so long before he was forced to cover and admit he was way off on that one. Technically, LULU shows no signs of deterioration on its weekly chart as it has simply built what is so far a four-week flat base with the past three weeks closing very tightly along the lows as the stock has held its 10-week (50-day) moving average. Keep an eye on LULU, because it would not surprise me to see this stock break out again if the market decides to resume its uptrend. Right now I would look for a possible pocket pivot buy point to show up here. Watch for a move up off the 10-day moving average on volume that exceeds 1,293,900 shares, the highest down-volume in the stock over the past 10 trading days.

Lululemon Athletica (LULU) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

Adding some weight to the theory that higher-end retailers continue to act well is Fossil, Inc. (FOSL), shown below on a daily chart. This despite the fact that earnings growth is expected to slow going forward, as we see in the data portion of the FOSL daily chart, below. FOSL staged a buyable gap-up move nine days ago when it announced earnings and since then has held above the intra-day low of the gap-up day as volume has dried up. So far the stock has only one week down in this formation that is discernible as a short flag on the daily chart. With the stock holding along the 10-day moving average and closing at 102.94 on Friday, the easy thing to do here is to either wait for the stock to flash a pocket pivot buy point off the 10-day line or to buy the stock on the basis of the buyable gap-up move nine days ago using the 100.03 low of the gap-up day as your selling guide. This presents risk of less than 3% to the downside, more or less, thus FOSL presents a reasonable risk-reward here if one is looking for something to go long in the event the market is able to find its feet here.

Fossil, Inc. (FOSL) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

I seem to get fewer and fewer questions about Apple, Inc. (AAPL) these days as the stock has probably lost the interest of most investors. If we look at the data portion of the daily chart below we can see that AAPL retains its impressive earnings and sales prowess as both sales and earnings growth re-accelerated in the most recent quarter while forward estimates over the next two quarters indicate decently robust earnings growth for a company selling at 14 times forward earnings. From a value perspective AAPL is “cheap,” but for investors who are more technically oriented as we are the daily chart, below, doesn’t seem to offer much in the way of constructive action other than the fact that AAPL simply keeps plugging away in this big sideways consolidation and base. AAPL wedged up into its 50-day moving average in the middle part of this past week only to drop off to the downside on heavier, albeit below-average volume, on Friday. My view of AAPL currently is that there is nothing for us to get excited about the stock currently, either as a long or a short. Volume in general has diminished in recent weeks, so perhaps some resolution to this sideways movement will occur soon, but it doesn’t happen until it happens.

Apple, Inc. (AAPL) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

Netflix, Inc. (NFLX) is still popular among short-sellers who believe the company’s business model is on the verge of collapse, and the stock still has 18.7% of its stock sold short against a float of 48 million shares. Fundamentally NFLX is still showing strong earnings and sales growth with five quarters of accelerating sales and two quarters of accelerating earnings while the next two quarter’s estimates show a slow-down to 39% earnings growth which is then expected to re-accelerate to 59% in the following quarter. Meanwhile, NFLX refuses to break its 50-day moving average as it builds what looks to me like a “ladle-with-handle” type of formation as the handle keeps getting longer and longer. Notice how selling volume diminished noticeably on the last test of the 50-day line four days ago. With so many becoming skeptical about NFLX’s future prospects, it would not surprise me to see the stock break out of this ladle-with-handle formation and go higher. At the very least, I’m not going to get negative on NFLX until I see it breach the 50-day line on heavy volume, something it has not done yet. Another one for the buy watch list, as I see it.

Netflix, Inc. (NFLX) Gilmo Report Chart

Chart courtesy of HighGrowthStock Investors ( ©2011, used by permission.

For the most part the market strikes me as just “spinning” about as stocks move back and forth, some leaders break down, and other leaders hold up well. A lot of stuff stocks have broken down along with the recent pullback in commodities, such as agricultural stocks like Mosaic (MOS) and metals like Freeport-McMoran Copper & Gold (FCX), but we have seen some tech names remain resurgent such as Cypress Semiconductor (CY) and Citrix Systems (CTXS), and a number of cloud-related software names, for example. Does this current market “correction,” which I tongue-in-cheekily put between quotation marks since it so far has resulted in nothing more than a 2% pullback in the NASDAQ Composite and S&P 500 Indexes, result in further downside, or does it result in some sort of rotational shift in leadership that fosters another upside move? Right now this is not 100% clear, and I believe investors should be ready for anything. My previous reports over the past two weeks have discussed a very few short-sale ideas which members can keep in their quivers if needed, but this report focuses more on the constructive things I am seeing develop currently in the market. With bullish sentiment backing off somewhat, there is still potential for the market to try and move higher, and remember that QE2 is still in force through the end of June, so anything can happen. Thus we can sit back, take things slowly and let them develop as we look to get not necessarily on the bull or bear side of the market, but on the right side as the correct window of opportunity opens wide.

Gil Morales

CEO & Principal, Gil Morales & Company, LLC

Principal and Managing Director, MoKa Investors, LLC

At the time of this writing, of the stocks mentioned in this report, Gil Morales, MoKa Investors, LLC, and/or Gil Morales & Company, LLC held a position in DGP, though positions are subject to change at any time and without notice.

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