The Gilmo Report

November 20, 2011

November 20, 2011

The market’s inability to get through resistance at the 200-day moving average on the NASDAQ Composite Index daily chart below is starting to have the look of a “three and out” rejection at this key area. Each move above the 200-day moving average by the NASDAQ over the past four weeks has been met with rejection, and the “Rule of Three” is now becoming a possible “three and out.” We can see the “Rule of Three” in action back in September and early October when the NASDAQ finally made it up through its 50-day moving average, the blue moving average on the chart, on its third attempt to clear that line. In this case, at the 50-day moving average, the “Rule of Three” worked quite well, but the NASDAQ’s third attempt to clear the 200-day moving average this past week was met with two increased days of selling as the index peeled away from the 200-day line to the downside, resulting in two big distribution days. Friday’s action saw light volume as investors refused to step in and buy the index at the 50-day moving average. Simply put, there wasn’t enough buying demand on Friday to retake and hold the 50-day moving average. Meanwhile, the on-again-off-again news flow out of Europe and the market’s jerky reactions thereto give one the feel of walking on eggshells regardless of whether one is trying to go long or short.

NASDAQ Composite Index Gilmo Report Chart

My view over the past week has been that it is quite uncomfortable, if not outright dangerous to try and hold positions overnight as news-related gaps up and down at the opening seem to be the order of the day. But the only thing that can prevent further downside from here, given the deterioration we see in a number of former leaders, would be more QE in the form of an announcement of MBS purchases by the Fed or a massive Euro-printing scheme coming out of Europe. On the other hand, yet another debt-ceiling crisis is approaching for the U.S. as we get within about $200 billion of the new debt ceiling agreed to a couple of months ago. That certainly didn’t take long, and with the so-called “super-committee,” which I would be more inclined to call a “stupor-committee,” unable to come to an agreement on how to implement $1.2 trillion in spending cuts, Now, that didn’t take long did it? Meanwhile, gold doesn’t seem to be arguing for more QE coming down the pike as it has pulled back with the market over the past three days but is still clinging to its 50-day moving average, as we see on the daily chart of the SPDR Gold Shares (GLD), below. A violation of the 50-day line would be a reason to sell gold ETF positions, in my view.

SPDR Gold Shares (GLD) Gilmo Report Chart

As I have theorized numerous times in my reports ove the past month, a breakdown in the general market will likely be accompanied by a breakdown in big NASDAQ stocks like Apple, Inc. (AAPL), which, as we already have observed, issued a potential topping signal back in late September and early October with its two-weeks-down-and-one-week move to new highs (See November 2nd and 9th reports). The sell signal was confirmed when AAPL gapped down after earnings, and further confimation came last Friday when AAPL broke down through its 50-day moving average on heavy selling volume, as we see in the daily chart below. Thursday and Friday saw AAPL make lower lows but this was not accompanied by increased selling volume. On the other hand, it was not like anyone was stepping up to buy AAPL on the undercut of Monday’s lows at around the 380 level, so I would not be surprised to see the stock eventually test the 200-day moving average at around 363-364. In the meantime, I would short any rallies/bounces in AAPL using Thursday’s high at 384.58 as my upside guide for a stop.

Apple, Inc. (AAPL) Gilmo Report Chart

As I’ve also discussed in my November reports, Amazon.com (AMZN) flashed a topping signal that is almost identical to AAPL’s, save for the fact that it took an extra week to go back up to new highs in a slightly different 2-down-and-2-up sell signal at the same exact time. AMZN’s technical sell signal, like AAPL’s, was then confirmed when the stock gapped down on to its 200-day moving average on massive volume the day after earnings were announced in late October. This resulted in a logical bounce and wedging rally back up towards the the 50-day moving average, as we see on the daily chart below. Over the past two days AMZN has rolled over with the market, but this time it failed to find support at the 200-day line, closing beneath the line on Friday. Since AMZN already staged an undercut & rally from the early October low it may simply remain under the 200-day line and continue lower. I would view any rallies up to the 210 level as very shortable, should that occur, but from here this could be shorted using the 200-day moving average or Friday’s high at around 205 as a much tighter stop.

Amazon.com (AMZN) Gilmo Report Chart

Earnings roulette season continues to take its toll on former big leaders,and Salesforce.com (CRM) has become its latest victim, as we see on the daily chart below. CRM had been trying to clear its 200-day moving average over the past three weeeks as it almost looked to be coming up the right side of a potential new base formation, but that was all cut short by Thursday of this past week as selling began to pick up and the stock fell away from the 200-day line as volume increased sharply going into Thursday’s after-hours earnings announcement. This is quite a massive-volume gap-down move from what could now be the right shoulder in a “slow death” type of head and shoulders formation. Generally such gap-down breaks, when they occur with this kind of overwhelming volume as a stock rolls over to complete a right shoulder in an H&S formation, are certain harbingers of further downside to come. CRM may undercut its prior 110 lows and try to rally from there, but the gap-down move looks shortable using the intra-day high of Friday’s gap-down move at 120 as a stop.

Salesforce.com (CRM) Gilmo Report Chart

CRM’s weekly chart reveals this sort of “slow death” head and shoulders formation I’m talking about, where it takes two or more right shoulders before it finally breaks down in earnest. CRM tried to break out of a rolling base in mid-May of this year, as can be seen on the chart below, but that breakout has so far turned out to be the start of the left shoulder in the formation, with the big-volume break in August 2011 forming the right side of the head. Two right shoulders have formed since then, and interestingly CRM was starting to show some relatively more constructive price/volume action on the weekly chart when it moved up through its 10-week and 40-week moving averages four weeks ago on robust upside volume. This was followed by two weeks pulling back with volume drying up, normally constructive action. There is one subtlety, however, in that the stock found resistance at the 40-week line on these two small pullback weeks as it remained trapped between the 10-week and 40-week lines. This past week changed the picture drastically as the highest weekly downside volume in almost a year zapped the stock. This looks like a significant top in CRM that likely will lead to further downside for the stock, in my view.

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Two-thousand eleven has been a very challenging year for many investors. Choppy markets are always characterized by whipsaw moves in the market that look alternately constructive and then destructive, but the net result is a big sideways chop zone. However there is a clear market context for all of this, and this is the massive tug of war going on between a deteriorating reality and the potential for QE to prop up that deteriorating reality. As I’ve writen before, you can only kick the can down the road for so long, and eventually a new wave of QE becomes the “big bid to hit.” This gives the market a certain instability that is quite evident in the daily charts of the major market indexes. Does the mass-printing of paper money rule the markets ad infinitum, or does reality finally catch up because, to roughly paraphrase PIMCO’s Bill Gross, the idea of creating economic growth with debt is a fundamentally flawed business model that, left uncorrected, must fail at some point. QE has been successful for the past three years, and the tug-of-war between reality and QE has had its moments of intensity. The weekly chart of the NASDAQ, below, shows wide weekly ranges that give this “base” that the market is trying to build a wide, loose, late-stage look to it. Closes in the upper part of the weekly ranges over the prior two weeks still closed under the 40-week/200-day moving average, but these may turn out to be as phony as CRM’s action prior to this past week.

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If you linger on the long side here, you risk the chance of the market embarking on a new downleg in a continuing bear market, and if you play the short side you will likely endure some news-related gaps to the upside. But the breakdowns in AAPL and AMZN do not bode well for the market, in my view, and when I see stocks like CRM breaking down in patterns that “mimick” the general market, my tendency is to lean towards the short side here, understanding that increased risk and reward will go hand-in-hand in such an environment as this. If one can catch a new downleg in a bear market as it starts, it can be a very profitable affair, but one must be prepared to cut and run quickly if QE ends up winning this tug-of-war as it won the tug-of-war last summer in 2010. While we have a shortened holiday trading week ahead of us, I would not assume that the action will necessarily be “quiet holiday trade.” Recall, if you will, the news-related, gap-down action that occurred the day before Thanksgiving in 2009 for just such a negation of this concept of “quiet holiday trade.” With the news flow in this market being what it is, it may not be possible to have such quiet this week. For this reason this coming week’s mid-week Gilmo Report will be published on Tuesday instead of the usual Wednesday, so 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

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 held a position in AGQ and DGP, though positions are subject to change at any time and without notice.

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