Market Comment

A Normal Correction

May 6, 2012

“I would rather have good money management and a mediocre strategy than mediocre money management and a good strategy. That’s your defense and tells you how much you’re going to make.”

–Mark Boucher

Shares, fresh from a fortnight of repair to their tainted chart patterns, came under a renewed assault Thursday and Friday, as institutions, not caring to distinguish between good and bad news, sold on any news.

The two days of distribution brought to five the number over the past three weeks in the Nasdaq.


The backdrop worsens. Market participants see less likelihood of European countries being able to right their fiscal ships when citizens are voting for politicians who seek to relax austerity measures. A showdown looms between European citizenry, their debt-strapped governments, Germany, bond market vigilantes, etc. We suspect Germany may be the one to leave the Eurozone.

Either way, shares feel the brunt of the selling, which has little to do with concerns over US economic growth. If that was the real worry, consumer discretionary, retail, and building segments would not be in outperformance mode.

Technically, last week’s report noted our concern as being the lack of volume, real volume, on up days. There has not been real conviction to the buying since early February. This has a way of catching up to a market eventually. Then Thursday and Friday’s 1%+ down days in the Naz on increasing turnover cast the die.

If a speculator is holding some of the glamours that are holding up, e.g. Dollar Tree (DLTR), Sally Beauty Holdings (SBH), Whole Foods Market (WFM), Petsmart (PETM), Cerner (CERN), et alia, there is no need to sell them.

Otherwise, a generous cash position, or roughly 80%-100%, is warranted. The main challenge is not to get too focused on the day-to-day developments as they relate to Europe.

If one zooms out and takes the 50,000-foot view, one sees a Nasdaq that moved up 24% from the Dec. 19 low to the Mar. 27 high. Yet the largest decline during this 3-plus month move was all of a 3.3% reaction. It makes sense, then, to expect an intermediate-term, 8%-12% correction at some point.

Thus, the current pullback in the averages is quite normal. The Nasdaq has come off as much as 6%. The probabilities favor a return to new highs and much more deterioration in the advance’s breadth, i.e. the average stock, before a primary top is put in and a bear market begins.

With that said, one should neither operate on this premise nor any other besides a focus on the averages and leaders. With this in mind, the glamours that are in the midst of basing patterns are the ones that should merit attention in case the market firms up and puts this decline behind it. It is better to be proactive than reactive.

Among the names, Petsmart (PETM) is typical of the best actors, in that it is a steady-eddy earnings grower in the retail sector. Earnings estimates are 23%/12% for January ’13/’14 and earnings stability over the past several years is very high. A potential entry would be a takeout of the May 2 high of 59.36.

Petsmart (PETM) Gilmo Report Stock Chart

Rackspace Holdings (RAX) is expected to
report earnings either Monday or Tuesday. Estimated earnings growth is big and industry group relative strength is high. This issue is listed here not so much as something to play in the next day or two but more as a “worth watching” type of name. The earnings report, of course, could result in a gap that would materially change the chart.

Rackspace Holdings (RAX) Gilmo Report Stock Chart

Linkedin (LNKD) has been one of a few glamours that we have believed had the most potential to become a big leader in this bull market. Unfortunately, its timing has not been right, as it was faced with a mountain of overhead supply of shares right when this market move took shape in January. The view here has been that if it was too late to really break clear of all the resistance, the next round of markups in the glamours would allow it to assert itself at last.

The stock was mentioned as being attractive when it was in the mid-90s and again around 107, though the pullback to 96.32 on Apr. 24 may have resulted in a stop-out of the latter position. In light of the general market position, and after Friday’s gap up move on earnings, LNKD does not offer attractive entry at present. Those who hold it from lower levels should hold.

Linkedin (LNKD) Gilmo Report Stock Chart (PCLN), another favored horse here, is expected to announce earnings this week. The view here is that the stock, like AAPL, needs some weeks to put in a base and rid itself of the speculative attention in which it is bathed. Stocks generally do not break out and begin a meaningful advance from a period of heightened volatility, e.g. the current situation with AAPL.

In PCLN’s case, price moved up by greater than two-thirds since December. To expect it to adequately work off its excesses, i.e. to take speculators’ attention away from it, in just the four weeks in which it has been consolidating, and then embark on a new leg up, may not be reasonable.

In any case, it holds up, and therefore deserves a spot on our watch list. (PCLN) Gilmo Report Stock Chart

Chipotle Mexican Grill (CMG) is worth watching. It may not be buyable here, but in a few weeks, or whenever this decline in the averages is over, it might. There is plenty of time to watch this one before it gives a signal that upward revaluation is imminent. Very high earnings stability w/ earnings estimates of 30%/25% for ’12/’13. Very liquid, just what institutions want.

Chipotle Mexican Grill (CMG) Gilmo Report Stock Chart

Michael Kors Holdings (KORS) builds a nice-looking eight-week base, one of the better ones in the glamour complex, and could be considered above the May 2 high of 49.50. The next earnings release is not expected until June. Earnings for the March ’13 fiscal year are expected to be 40% higher than that of the ’12 year. Definitely speculative compared with, say, Chipotle, but also very liquid, and a big winner since it came public in December. We like titles that have already been there before.

Michael Kors Holdings (KORS) Gilmo Report Stock Chart

Elsewhere, Pharmacyclics (PCYC), Intuitive Surgical (ISRG), Tractor Supply (TSCO), and Under Armour (UA) hold up and should be on a watch list of potential leaders for the next advance in the averages.

As noted last week, it would be a plus if the averages went sideways for a while longer, or even corrected some more. This would enable more of the leaders to build sturdier bases that would, in turn, be expected to generate more explosive breakouts, better follow-throughs, and ultimately larger gains.

In summation, unless a speculator is holding leadership names that have held up well, a generous cash position is suggested until institutions show more resolve in buying back into this market. Europe may be important, but more important is what the market is actually doing in terms of price/volume. At some point the market will look over the valley and a new intermediate-term advance will emerge. The leaders of that advance are likely to be the titles that are holding up best now. The list above is intended to comprise part of a watch list for when things firm up. Some may break out even before the averages firm up.

Kevin Marder

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.