The Gilmo Report

October 19, 2011

October 19, 2011

The window looked to be opening wider with bulls celebrating “Finally a Follow-through Day” on Tuesday, a legitimate index follow-through day coming on the 11th day of this rally off the lows of early October. But the opening window was more like a trap door today as the NYSE-based indexes reversed hard on lighter volume, while the NASDAQ, already underwater on the opening thanks to Apple, Inc.’s (AAPL) earnings gap-down, moved even lower into the close with volume picking up, a distribution day. Even with yesterday’s follow-through, the key ingredient that has and continues to be missing from this rally off the early October lows has been any serious leadership. Thus my position remains the same as it was over the weekend, which was to concentrate my activities to stalking the short-side in the short list of short-sale target names I discussed in my report of this past weekend, October 16th. At this stage, it is not necessary to have a large number of short-sale targets, as we use the market rally to help us sift out the weaker names to short in the event of a failed rally. Perhaps with the Investor’s Intelligence survey of investment advisors showing far more bears than bulls, what has been needed is a nice bear market rally to wring out the bearishness while lathering up the bulls.

NASDAQ Gilmo Report Chart

Perhaps we are seeing some of that now as the American Association of Individual Investors (AAII) sentiment survey shows that bullish individual investors now exceed bearish individual investors by a margin of 39.8% bulls to 36.4% bears. So the “retail public” is buying into this rally. Meanwhile the National Association of Active Investment Managers (NAAIM) survey, shown below (©, used by permission) shows that this group of 40 active managers is now net short into this rally. The NAAIM has also shown that they have not gotten much past 20-30% invested on any rallies since the early August lows in the market, and one must wonder if they will turn out to be the steady, smart money, particularly after today’s sharp reversal.

National Association of Active Investment Managers (NAAIM) Gilmo Report Chart

A new study using raw data from the same unemployment survey used by the Bureau of Labor Statistics shows that monthly median household income continues to collapse, and that the collapse accelerated after June 2009, when the “recession” was declared to be over by economists using their usual massaged data. At least going by household incomes, the gritty inner side of people’s wallet, which is where people feel a bad economy the most, never improved, arguing for the strong possibility that the recession never ended. Thus, the “douple-dip” argument is moot since there was never a first dip, just a continued slide, and perhaps the market’s message harkens a deeper recession. The next few days will be critical, and while I could be wrong I’m willing to bet that this rally is over.

The short side of the market, particularly with respect to the stock that had moved to the top of my short-sale target list as I discussed over the weekend, Green Mountain Coffee Roasters (GMCR), shown below on a daily candlestick chart, has been very profitable over the past three days. GMCR broke down hard off the peak of the right shoulder in its overall head and shoulders topping formation and undercut its 82.40 low from October 4th before trying to bounce to the upside on a typical “undercut & rally” attempt on Monday and Tuesday. When it could not muster up much of a rally on the undercut today, it headed for the 200-day moving average, which was my downside price objective. If you shorted GMCR per my discussion a week ago near the 94-95 price level, you have a fat 25.8% profit, and since I did short GMCR at that level, I decided to take profits on the position today, with the idea of shorting again into a rally back up towards the 200-day line at 74.34. If you are still short GMCR, you can try and be a “pig” here, holding the stock for more possible gains, by using the 200-day moving average at 74.34 + 3% as your trailng stop. Even in the face of a rallying market, GMCR has been a model short-sale stock.

Green Mountain Coffee Roasters (GMCR) Gilmo Report Chart

Moving up on the list of my short-sale candidates today is Apple, Inc. (AAPL) which, as the daily candlestick chart below illustrates quite nicely, cratered on its 22 cent earnings miss. As I wrote over the weekend in my October 16th report, I advised avoiding the urge to buy AAPL into earnings on Tuesday. Giiven that the crowd was about as certain as it could be that AAPL would blow out earnings again and continue its wild v-shaped rally to all-time highs it seemed like a sheep’s trade, actually. Sure enough, AAPL issued a rare earnings miss and the stock gapped down hard this morning on huge volume. Today’s action on the candles below looks like an ominous “shooting star.” Add some flames with the massive selling volume and you get a “plummeting meteorite.” I hate to be a party-pooper, but I think AAPL is done here and has probably put in a top. I consider the stock potentially shortable on this breach of the key $400 price level to the downside and the massive-volume gap-down off the peak, using today’s high at 408.41 as a guide for a quick stop. Obviously, if one wanted to use a 5% stop instead at current prices, you are talking using the 420 level as your stop in that case. My thinking is that if this is going to fail, it is going to do so in fairly rapid order here given the huge selling and gap-down move.

Apple, Inc. (AAPL) Gilmo Report Chart

In this report I’m sticking with the short-sale target stocks I discussed over the weekend, with the sole addition of AAPL, above, as I think that they all remain in play here with the exception of GMCR which already hit my downside price objective. Fossil, Inc. (FOSL), another short-sale target, is bumping around at what looks like the peak of a second right shoulder within an overall head and shoulders topping formation. As we see on the daily candlestick chart below, the stock gapped down yesterday on heavy, above-average volume in the face of a very strong market rally and general market follow-through. Today the stock pushed up into its 200-day moving average and reversed with the market as buying volume failed to come in. This remains potentially shortable, using the 94.68 price level at the 200-day moving average as your guide for an upside stop. The downside price objective would be the 73.01 low of early October. Keep in mind that FOSL announces earnings on November 8th, and keep an eye on other upscale retailers like LULU or TIF as weakness in those stocks will likely confirm FOSL’s weakness here around the 50-day moving average.

Fossil, Inc. (FOSL) Gilmo Report Chart

I discussed Baidu, Inc. (BIDU) over the weekend as well, and it has pushed back below its 50-day moving average with volume picking up yesterday, as we see on the daily candlestick chart below. BIDU found resistance again today at the 50-day line before closing below the 200-day moving average. If you are not already short the stock around the 50-day moving average and the mid-130’s, then look for some sort of bounce up into the 200-day moving average at 132.05 to possibly short into. Meanwhile, the 50-day moving average average at 133.83 makes for a reasonable spot to use as a maximum stop-out level on the upside. My tendency is to think that if this is going to work, however, then it should not have enough in it to rally past the 200-day moving average. The weekly chart of BIDU, not shown here, reveals a big head and shoulders top formation (see October 9th report) with this latest rally perhaps forming the top of the right shoulder in the formation. Keep in mind that BIDU announces earnings on October 27th, next Thursday.

Baidu, Inc. (BIDU) Gilmo Report Chart

Sina Corp. (SINA) saw selling volume pick up today as it reversed in rather ugly fashion, conversely forming a very pretty “shooting star” type of reversal on the daily candlestick chart, below. SINA made a heartened attempt today to get to its 50-day moving average today after failing at that key line on Monday, but selling pressure turned the stock upside down by the close. I would only look to short the stock in or around the 50-day moving average, so for now it is out of range. If you are short the stock from somewhere around the 50-day line, then that remains your upside trailing stop. SINA announces earnings on November 15th, and not much is expected as analysts are looking for more negative earnings growth of -53%, as I pointed out over the weekend. This gives the stock plenty of time to continue to weaken before one has to face “earnings roulette” in November. Currently we are looking at a potential downside price objective of 64.82, the low of early October.

Sina Corp. (SINA) Gilmo Report Chart

Big-stock NASDAQ name (PCLN) has been unable to hold the 50-day moving average per my discussion over the weekend, and that pattern has continued so far this week as the stock is starting to get into trouble underneath its 200-day moving average. While PCLN has rallied with the market since undercutting its own August lows in early October, it has run into resistance along with the market and so its fate will likely be closely tied to what the general market does. You can see that for the most part, all of the stocks I’m looking at as potential short-sale targets in this report have all more or less mimicked the market’s action on this recent rally off the early October lows. GMCR was also rallying with the market, but when the indexes hit resistance four days ago it did more than just back down a bit from resistance – it blew up. I’m interested in finding the next blow up, and most likely it will be found in the former leaders that have shown the weakest rallies within their overall chart patterns. For me, that brings into focus PCLN, BIDU, SINA, and FOSL, with AAPL starting to come into play as a more evolved, potential late-stage
base-failure. (PCLN) Gilmo Report Chart

Follow-through day or not yesterday, today’s action did not speak well of the market’s attempt at a bold new bull rally. As well, from an objective, results-oriented perspective the short side has remained very profitable over the past three days of this week, particularly with the action in GMCR. All of my other short-sale target stocks discussed in my October 16th weekend report have moved lower over the past three days, some more than others, but all have been profitable trades if they were shorted, hypothetically speaking, even on Monday morning. Thus this begs the question, if the market is so strong why does the short side of the market remain the most profitable side, even in the face of Tuesday’s big index rally and follow-through day? Thus the market indexes create a perceived market rally while individual stocks provide the objective reality in the form of short-sale profits. That may be a clue worth considering. In the meantime, until further evidence presents itself, you know where I stand.

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, and/or Gil Morales & Company, LLC held a position in AAPL, BIDU, and FOSL, though positions are subject to change at any time and without notice.

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