The Gilmo Report

October 10, 2018

October 10, 2018

The indexes certainly appeared as if they might be in position for some kind of reaction rally as of last Friday’s close. But, despite the oversold condition of the indexes and many leading stocks, oversold simply became more oversold. Most of these price breaks are something to behold, to be sure. Leading stocks in most cases haven’t even been able to hold undercut & rally moves as they have trended lower this week.

The NASDAQ Composite Index was in position for an undercut & rally move after undercutting the mid-August low last Friday, but that fell short with a lower closing low on Monday. A brief rally yesterday ended with a full reversal back to the opening levels and the bottom of the daily price range. In my Tuesday video report, I noted the bearish tone of this action.

That quickly came to fruition today as the index sliced through its 200-dma on heavy selling volume. It is now testing the 7419.56 low of June 28th . While things are really starting to get oversold, it’s difficult to say that the indexes have reached a potential low point. At the very least I’d need to see an undercut & rally move back up through that late-June low, and that hasn’t happened yet.




The S&P 500 Index held along its 50-dma on Monday and yesterday, but it, too, churned and stalled on an attempt to move higher. As I noted in yesterday’s video, that also looked bearish. And, lo and behold, today the index split wide open as it busted the 50-dma and made a run for its 200-dma.

It is now undercutting several lows from late July and early August. As with the NASDAQ, I’d need to see an undercut & rally along these lows before calling any potential near-term low for the index. Barring this, things could simply get a lot uglier.




Meanwhile, the Dow Jones Industrials Index did its best to hold support at its own 50-dma most of the day today, but its grip finally slipped, and the Dow plummeted -831.83 points on the day. Volume was, of course, heavy. The index also undercut two prior lows from early September and late August.

All I can say is that I was putting out short ideas as early as two Mondays ago, so I was dead on the mark, and at the exact right time. Keep in mind as well that two Mondays ago the market opened up big on news the prior Sunday evening that the U.S. and Canada had settled their trade differences. But that was just a “selling opportunity” (and a short-selling opportunity), something that you will never hear anyone say on financial cable TV, although every big sell-off is always a “buying opportunity.”




Interest rates have continued to rise, and the hubris of the Fed as they pursue their faith in being able to “manage” economic growth does not bold well for the market. In my view, what the Fed is doing currently, or at least trying to do, is to see how far they can push a pin against the very taut skin of a massively over-inflated balloon without popping the balloon. Meanwhile, the 10-Year Treasury Yield ($TNX) is pushing up against the 3.25% level, closing today at 3.225% after hitting an intraday high of 3.242%.




With so many stocks already busted, it was difficult to come in with some new short-sale ideas this week. But, I managed to do just that with a handful of ideas, which is really all you need when the market splits this wide open. First up was Netflix (NFLX). In my weekend reported I noted that, “…from here, any small rally up to the 50-dma would put it in another short-sale position, but with the idea of using the 50-dma as a guide for a tight upside stop.”

The stock rallied up into the 50-dma yesterday and closed right at the line. This morning it broke just a hair below the 50-dma at the open, triggering a short-sale at that point. It then broke down -8.38% for the day before finally meeting up with its 200-dma. This would be a logical cover point looking for a bounce to short into. Alternatively, one could use the prior low of early September at 335.83 as a trailing stop.




Square (SQ) was also a fantastically cooperative short-sale target this week, although I was already calling it a short at the $100 Century Mark last week based on Jesse Livermore’s Century Mark Rule in Reverse. given its inability to convincingly clear 100. After coming off a bit from the $100 price level, the stock found support last Friday at the 20-dema.

Over the weekend I wrote, “The 20-dema now becomes a critical level of support for the stock, such that a breach of the line would trigger SQ as a short-sale at that point, looking for a test of the 50-dma.” That is precisely what happened on Monday, and the stock headed straight for its 50-dma. A small bounce yesterday briefly opened higher this morning before SQ promptly turned tail and smashed through the 200-dma.

At the risk of tooting my own horn even more, recall that I assessed SQ’s situation in conjunction with a general breakdown in its cousin payments’ stocks. To this end, I wrote over the weekend, “But with its cousin, PYPL, wavering as a nice short-sale play this past week, it may be throwing up a cautionary flare for SQ as well.”

At this point, SQ has been beaten to a pulp and may be set for a reaction rally back up toward the 50-dma. That might present a lower-risk short-sale entry at that point.




In yesterday’s video report I went through my theory that the Price-Earnings Ratios of all stocks have been wildly inflated because of the Fed’s rate-cutting campaign and the abundance of free money looking for a place to go. I discussed the idea that not only were tech stocks guilty of this, but so were industrials, citing examples of historical P/E ranges for railroads, machinery, big semiconductors, etc.

This was while I was looking at a chart of Norfolk Southern (NSC), which was holding up well as of yesterday. But as I noted in yesterday’s video report, these nicely-acting rails would likely just become the next stocks to sell-off. And so, they did. NSC split wide open today as it broke below the 20-dema, triggering an LSA-type short-sale entry at that point, and then sliced through its 50-dma on an ugly, high-volume day.




NSC’s railroading cousin, CSX Corp. (CSX), acted similarly. It was also holding up reasonably well as of yesterday, but all hell broke loose today when the stock breached its 20-dema and then sliced right through its 50-dma on an ugly, high-volume price break. There’s no other way to put it except to say that it was a brutal sell-off.




In yesterday’s video report I also pointed out the short-sale trigger in Caterpillar (CAT) after it breached the 20-dema and the 200-dma yesterday on above-average volume. That led to a small gap-down open that then sliced right through the 50-dma. CAT, as a big machinery stock and industrial name, fit the bill as far as my theory regarding P/E contractions in QE-inflated stocks among the industrials went.




So, the reality is that despite the downside extension in the indexes and many leading stocks as of this past weekend and yesterday, I was hopefully able to provide members with some actionable short-sale ideas this week. It was, however, dependent on my theory that P/E’s are wildly inflated in this market, and we have reached a tipping point where these P/E’s will begin to contract and normalize, for lack of a better term.

You know things are bad when Apple (AAPL) is busting its 50-dma on heavy volume. But, as a big-stock index name in the Dow and the NASDAQ, it’s no surprise that AAPL starts to split wide open as the market itself does. Now, rallies up into the 50-dma might provide lower-risk short-sale entries if this market continues moving lower.


GR101018-AAPL (AMZN) is another big-stock NASDAQ name getting read its last rites. The stock had already been in a six-day down-trend after failing at the second Millennial Mark (that would be the $2,000 price level). I suppose we can now come up with a corollary to Livermore’s Century Mark Rule and call it the Millennium Mark Rule in Reverse!

Today’s price break was much deeper than the prior daily price ranges coming down from 2,000, so it may be getting a little bit climactic. As the stock approaches the late July low at 1739.32, it may be setting up for some kind of U&R move, but we won’t know for sure until we get there. If this market is in full-on crash mode, things, as I intimated earlier in this report, could get a lot uglier.




Nvidia (NVDA) also split wide open today after selling off from its highs over the prior week-and-a-half. Today’s move was the longest price range of the decline and took the stock just below its 50-dma on huge selling volume. It is now approaching the prior August lows, which could set up an undercut & rally attempt from there.




Virtually nothing was spared from today’s brutal sell-off as market breadth readily shows. NYSE advancers paled in the face of decliners, 328 up to 2648 down. Things were no better on the NASDAQ, as decliners swamped advances 2635 to 381, according to data available from eSignal®.

Among stocks I’ve discussed as shorts in recent reports, J.P. Morgan (JPM), Facebook (FB), Tesla (TSLA), PayPal (PYPL), Canada Goose Holdings (GOOS), Palo Alto Networks (PANW), Planet Fitness (PLNT), Okta (OKTA), and ZScaler (ZS), among others, have all split wide open. In many cases, as with Etsy (ETSY), the stocks are in free-fall with only prior lows standing between them and their much lower 200-dmas.




In the past few days, we’ve also seen high-flying leaders like Fortinet (FTNT) and Roku (ROKU) trigger as LSA-type shorts when they broke their 20-demas last week.  As I’ve discussed in recent reports and video reports, LSA stands for Late-Stage Assumption in a stock that is a) extremely extended to the upside in a long price run, b) potentially vulnerable to a sharp P/E contraction, and c) busting its 20-dema.

It is the breach of the 20-dema that triggers these things as actionable short-sale targets. As I wrote over the weekend, this type of set-up can often result in strong downside price velocity, hence the trades can have high time-value as shorts. Many of these, as with SQ, have been very successful, high time-value shorts over the past few days, but also understand that they are dependent on my general market view being correct, which it has.




For newer members: Please note that 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 (thin black line). In all cases I will mostly use the shorthand version of “10-dma,” “50-dma,” etc.

The bottom line with this market is that it all started two Mondays ago when I began to sense a faint odor in the underlying market action, even as the indexes were rocketing higher following the U.S.-Canada trade reconciliation. So, I was on it at the right time, and since then the short side has worked famously.

Things are now wildly extended to the downside, and I don’t see any more short-sale set-ups that are still in lower-risk positions. The best new set-ups were the railroads this morning, which then split wide open. As I discussed in last night’s video report, these stocks were vulnerable to a sudden P/E contraction based on their hugely inflated-P/E’s relative to historical norms.

Now it’s a matter of seeing how far things go to the downside, and when we begin to see reaction rallies. These reaction rallies, where they occur as undercut & rally long set-ups, may provide some swing-trading opportunities on the long side. At least until they reach logical resistance levels at major moving averages or areas of overhead price congestion. At that point, they may again offer potential lower-risk short-sale entry points if this market is headed for a deeper, longer correction than the pundits seem to think is possible.

All I know is, my timing on the short side was near perfect as of two Mondays ago, and I believe that I provided more than enough ammo to members in the form of short-sale ideas over the past couple of weeks. Hopefully, these have enabled them to participate and profit handsomely on the short side during that time. Now we’ll see where the next set-ups show up, either as long swing-trades or fresher short-sale entries.

In the meantime, I feel as if I’ve done my job, and now it’s time for a celebratory martini, shaken, not stirred. Cheers!

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 held no positions, though positions are subject to change at any time and without notice.

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