The Gilmo Report

October 21, 2018

October 20, 2018

The NASDAQ Composite Index is the weakest-performing of the major large-cap indexes by virtue of its -10.56% peak-to-trough decline that hit a near-term low last week. This contrasts with the peak-to-trough declines of over -7.83% and -7.61% in the S&P 500 and Dow Jones Industrials Indexes, respectively. After a natural reaction rally early in the week, the NASDAQ ended its third-straight down week Friday on a reversal back below the 200-dma on roughly even volume.

 

GR102118-$COMPQ

 

Even weaker, however, has been the small-cap Russell 2000 Index, which logged its lowest closing low since topping on the last day of August. It is also sporting a peak-to-trough decline of -12.12%, leading all comers. The relatively weaker performance in the NASDAQ and the Russell makes perfect sense within the context of my contracting P/E theory as the driver behind the current market correction.

Given that most of the huge P/E expansions we’ve seen have been most egregious in the tech and growth areas of the market, those indexes with the greatest concentration of these stocks have suffered the most. No surprise there.

And with market participants moving rapidly to a decidedly risk-off posture, the small-caps take it on the chin. Thus, the extreme downside cascade we are seeing in the Russell as it plumbs lower lows with no signs of a solid low just yet.

 

GR102118-$RUT

 

The S&P 500 Index is also back below its 200-dma by a margin of 46 cents, ending the day there Friday on higher volume. This came after an initial upside rally that reversed by the close as the index just barely crossed into the red. From here, the index is now retesting its prior lows and we can only wait to see whether fresher lows are in the offing.

 

GR102118-$SPX

 

The Dow Jones Industrials Index is the last major or even minor index still holding above its 200-dma. An early rally ran into resistance along the 10-dma and reversed, but the Dow still held a marginal gain on the day of 0.26%. We’ll see whether the index soon joins its brethren underneath the 200-dma.

 

GR102118-$INDU

 

To really get a sense of how bad things are for the broader market, take a look at a daily chart of the very broad NYSE Composite Index. It slashed through its 200-dma over a week ago and has managed little more than a whimper of a reflex rally over the past week. Unlike the other indexes, it never got all that close to is all-time highs of late January.

It is now moving toward the lows of early February, late March, and early April of this year. At this point it wouldn’t take much for the index to reach those lows. But its primary message remains clear. The broader market has remained sluggish throughout 2018 even as the major indexes made all-time highs during the summer into early fall.

 

GR102118-$NYA

 

Even as the Ten-Year Treasury Yield starts to kiss 3.20% again and the U.S. Dollar holds up near its recent highs, gold is holding its ground after gapping through its 50-dma over a week ago. Volume on that bottom-fishing, buyable gap-up move through the 50-dma was huge, and the SPDR Gold Shares (GLD) has held tight sideways since then as volume has steadily declined.

If the general market selling starts to get even uglier, my expectation is that gold, along with other fungible sources of liquidity, including gold mining stocks, would likely sell off. That’s usually the case, and it will be interesting to see whether gold holds its ground as stocks continue to move lower, assuming that is going to happen.

You have to wonder where all that volume in the GLD came from. I have noted, however, that China continues to sell their holdings of U.S. Treasuries, and this past week it was revealed that Russia has liquidated all its U.S. Treasury holdings. Is there an allocation shift by these countries out of sovereign debt and into gold? Who knows, but the correlation between the continued selling of U.S. Treasuries with the recent big-volume move in the GLD is intriguing.

 

GR102118-GLD

 

The weed patch is starting to go up in smoke, but this is no surprise given the general market weakness. These stocks were good for some very profitable swing-trades earlier in the week after I blogged about these as long ideas two Thursdays ago. Cronos (CRON) posted a 40%-plus rally earlier in the week, but overhead supply has come into play, driving the stock below its 10-dma, 20-dema and 50-dma on increased selling volume.

It looks like after the big upside move earlier in the week that Cinderella has left the ball and isn’t coming back any time soon. Thus, CRON was good for a very nice swing trade, but anyone who stayed too piggy for too long ended up with a handful of dirt. That’s why I tweeted and blogged on Tuesday morning that selling into the rise and putting it in the bank at that point was the smart thing to do, based simply on the Piggy Principle.

 

GR102118-CRON

 

The same thing applied to Canopy Growth (CGC). The stock has gone from a nice swing trade earlier in the week to an outright late-stage breakout-failure type of short-sale set-up. Monday’s strong breakout ran into trouble quickly on Tuesday after an opening gap-up, but I had already tweeted and blogged earlier in the day that the Piggy Principle was in full force with these cannabis stocks, and that was the time to put at least half, if not all of it, in the bank.

CGC decisively reversed back below its 20-dema on Friday on heavy volume but held support at the line on an intraday basis. However, in my view, the stock was a short Friday morning once it breached the 20-dema, per my video report of Thursday evening. The stock is hard to borrow, but those familiar with the use of options could consider buying puts here, assuming such puts are reasonably priced.

 

GR102118-CGC

 

Tilray (TLRY) is still hanging on as it pulled into its 20-dema on Friday with volume remaining extremely light and dry. However, with the group weakening fast, and even morphing into short-sale targets, TLRY may simply become the next one to fall. The trade off the 20-dema from two Thursdays ago into this past Tuesday’s open was very nice, but as with the others, the Cinderella Principle (she only comes to the ball once!) now applies.

 

GR102118-TLRY

 

Netflix (NFLX) didn’t last long after Wednesday’s feeble gap-up attempt. While this could have been treated as a buyable gap-up set-up using the 356.50 intraday low of Wednesday as a tight selling guide, I didn’t give it much hope of holding up. That certainly turned out to be the case on Thursday when it briefly rallied and then reversed to bust through the 356.50 intraday low from Wednesday and dove below the 50-dma on Thursday.

In my Thursday video report, I noted that the stocks populating the list of ticker symbols I put out as a starting point for a short-sale watch list, along with other names discussed in my Wednesday report, had mostly come apart on Thursday. I noted also that if I had not shorted these names on Thursday, I would only look to short into any rallies from there.

The market cooperated nicely in this regard, much to my surprise, by sending all of these stocks back to the upside on Friday morning. I wasn’t expecting that, but it provided a good re-entry opportunity on the short side of most of these names. NFLX was one of them. A brief rally on Friday morning that carried just a hair above the 50-dma quickly reversed, and the stock broke hard as it streaked down to its 200-dma.

I would expect the 200-dma to provide some near-term support as we move into the new trading week, but that’s not necessarily clear at this point. The stock already tested and bounced off the 200-dma the week before this past week. The stock broke some 20 points below the 50-dma on Friday, which certainly made for a good short-sale play that day. Now I’d watch to see what kind of bounce, if any, develops that might offer a new short-sale entry point.

 

GR102118-NFLX

 

While I didn’t consider Nvidia (NVDA) to be the most optimal short in my Wednesday report, it was still shortable on any rallies into the 200-dma. We got one of those on Thursday and the stock promptly reversed back to the downside but remained within the confines of the short bear flag it has formed since initially breaking below the 200-dma.

On Friday, the stock finally broke out to the downside of this short bear flag to post lower lows. The stock strikes me as a victim of a normal P/E contraction as the market corrects. After all, it is still just a semiconductor name, and after a period of strong growth over the last 2-3 years, earnings are expected to slow to a crawl of 9% earnings growth in 2020. In this position, the stock is extended to the downside, but was last shortable at the 200-dma.

 

GR102118-NVDA

 

In my Wednesday report I discussed the idea of using earnings-related gap-ups as potential short-sale opportunities. As we move into earnings season, this has worked quite well with names like NFLX and railroader CSX Corp. (CSX) as they both gapped up after earnings this past week and promptly reversed and broke to the downside.

This remains a primary earnings season strategy for the short side, and so I believe short-sellers should keep a close eye on any busted former leader that has a cathartic gap-up move following an allegedly strong earnings report. One example from Friday would be PayPal (PYPL). The stock blew apart with the rest of the tech sector in the early part of October before bottoming with the market the week before this past week.

That oversold condition set up what I see as mostly a reaction move that was helped along by a decent earnings report. The gap-up move reminds me of NFLX’s gap-up move since PYPL stalled but still closed up on the day on very heavy volume. Note that intraday resistance came in near the 50-dma while intraday support was found near the 200-dma, such that the daily price bar extends from the 200-dma up to the 50-dma.

In this position, it appears that the best place to try and short the stock would be on any continued rally up toward the 50-dma. If we saw that, then the stock would become shortable as close to the line as possible. The other nuance in the chart is that the stock has posted a U&R move back up through the prior 84.22 low of mid-August and closed only 56 cents above that low. Therefore, an alternative short entry could come on a break below 84.22 that is then confirmed by a new breach of the 200-dma.

There are obviously several ways in which this could play out over the coming days. However, if the general market remains weak, and continues lower to test the lows of over a week ago or even break below those lows, then PYPL likely gets dragged back below the 200-dma. So, we’ll see how this plays out as we move forward from Friday’s post-earnings gap-up move.

 

GR102118-PYPL

 

With this idea of looking to short gap-up moves after earnings in beaten-down, busted former leaders, we can look forward to several big-stock names reporting earnings this coming week. One of these, and perhaps the biggest of the big-stocks reporting this coming week, is Amazon.com (AMZN).

Whether it gaps up or gaps down after it reports on Thursday is anyone’s guess. But what we are looking for is a gap-up move to short into. For now, AMZN is rolling over after a brief undercut & rally move that started up when the stock undercut the prior 1739.32 low of July 31st . This is one to keep an eye on as we approach Thursday’s expected earnings report.

 

GR102118-AMZN

 

Below is my current short-sale watch list and includes all the names I discussed and listed in Wednesday’s report as well as in Thursday’s video report, with some additions. This list could be a lot larger, to be frank, because everything got ugly when the market broke off the highs over a week ago. Some have gotten even uglier as the market has rolled over during the past 2-3 days.

I’ve sorted the list by Earnings Due Date, with the earliest earnings dates first. This provides a handy reference for upcoming earnings announcements among my short-sale target stocks. I would, however, double-check these expected earnings report dates by looking up the stocks on Briefing.com or going to the company websites to confirm the precise earnings date.

You will also notice that following the Earnings Due Date column the table shows the price at which each moving average, from the 10-dma to the 200-dma, is. This is helpful in quickly determining where potential areas of overhead resistance, or downside triggers, might be, and facilitates the setting of price alerts.

 

GR102118-ActionableShortList

 

I am also posting a larger version of this list on the blog page. Clicking on the image here or the image on the blog page will make it larger and quite readable. Note that many of these names, which were discussed in my Wednesday and Thursday reports, have rolled over in the past two days. Thus, most are not in a shortable position after Friday’s close.

Going down the list we can see that MSFT, NOW, and V are expected to report on October 24th, which would be this coming Wednesday. After that, we have DDD, FEYE, and MA expected to report the following week on October 30th, and then AAPL, FTNT, and LITE on November 1st. So, all these stocks will be ones I’ll be watching closely for potentially shortable gap-up moves.

Microsoft (MSFT) is a big, lumbering NASDAQ leader that is now living below its 50-dma. I would look for any kind of rally up into the 50-dma following earnings as a possible short-sale entry. It’s possible it could gap up further, or even gap down, so we won’t know for sure until Wednesday.

 

GR102118-MSFT

 

Fortinet (FTNT) won’t be reporting until November 1st, but it has given short-sellers two opportunities over the past three days to short it at the 50-dma. On Wednesday, the first such opportunity showed up, and the stock promptly reversed to the downside. On Friday, the second opportunity showed up and the stock again promptly reversed to the downside. Whether we get a third opportunity remains to be seen.

Note that FTNT appears to be forming the right shoulder in a fractal head and shoulders formation. A lot of stocks in this market are showing this exact type of formation, and you can see this by flipping through the charts of the watch list I showed up above.

 

GR102118-FTNT

 

Lumentum (LITE) is a little different since it has moved above its 50-dma rather than run into resistance and reverse at the line. It was recently pumped by an analyst from J.P. Morgan (JPM), who raised his rating on the stock from neutral to overweight. In this position, the 50-dma has served as near-term support while the prior late-September highs just below 64 have served as near-term resistance.

The simple trigger here is to set an alert at the 50-dma, and then look to short the stock as it breaches the line. One can then set their stop near the 50-dma or near the highs of the past three trading days. Another way to work this is to short moves up to the three-day highs, anticipating a possible breach of the 50-dma.

 

GR102118-LITE

 

Short-selling in this market requires a highly nimble and opportunistic approach. I generally do not hold heavy short positions overnight, instead seeking to pick up where I left off the prior day by taking back my short position at or around the opening the following day. Usually this may occur at the same price, maybe a little higher. Sometimes, however, one gets lucky and another optimal short-sale opportunity shows up the next day.

A good example of this is Intuitive Surgical (ISRG), which was on my short-sale watch list in Wednesday’s report and which I also discussed in my Thursday video report. On Thursday, the stock was quite shortable right at the 50-dma, and it promptly broke to the downside on heavy selling volume. The next day, on Friday, it gapped up with the market and gave short-sellers a second opportunity to hit it on the short side right at the 20-dema.

From there the stock blew apart and posted a lower low as it closed in on the $500 price level. That made for a very profitable two-day short-sale expedition that could have been played as a short on Thursday which was then covered near the close, followed by another re-entry on Friday at the 20-dema. ISRG is now getting blasted on huge selling volume, which looks very bearish. Whether it gaps up again, perhaps up to the 10-dma or the 20-dema, is likely a low probability event at this point.

 

GR102118-ISRG

 

ISRG does, however, illustrate quite well why I don’t generally hold short positions overnight, and how I try to use the wild volatility of this market to my advantage. If I catch a nice downside move on one day, I find that quite often I will be presented with another entry opportunity above my cover point the very next day. This is what I mean when I tweet that short-sellers should try to use the market volatility to their advantage.

Roku (ROKU) is a different example of how I can work stocks on the short side without holding a position overnight. On Wednesday the stock rallied up into the 50-dma, presenting short-sellers with an optimal entry at that point. It then reversed hard to the downside as selling volume came in. On Thursday, it opened down slightly, then edged slightly back into positive territory.

This offered a re-entry point for the position taken the prior day on Wednesday at the 50-dma, and the stock then reversed back to the downside. After covering at the close, one could then re-enter their short position the very next day on Friday when the stock gapped up with the market and then reversed to lower lows. A three-day short-sale campaign on the same stock as it moved steadily lower in what is starting to look like a fractal head and shoulders formation, but without holding a position overnight!

Not all stocks are as cooperative as FTNT, ROKU, and ISRG, but by keeping a watch list of 15-20 stocks as actionable short-sale targets, I can scan for opportunities within this small universe every day as they break and bounce, break and bounce. I find this is a lower-risk, albeit far more nimble and active, approach for the short side in a market where nutty overnight gaps are not uncommon.

 

GR102118-ROKU

 

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 reality of this market is that most broken-down, former leaders are starting to roll over with the indexes after getting quite oversold over a week ago. At that point, a logical oversold reaction rally occurred in these stocks and the general market, but that appears to be failing as we now head for a retest of the prior lows.

With the weed patch going up in smoke, there is nothing I see setting on the long side. This includes any undercut & rally (U&R) set-ups, even those that occurred in conjunction with the near-term lows of Wednesday, October 11th. The reaction rally, as I saw it, lacked thrust, which looks bearish, and in my view increases the probability of a move to lower lows.

For now, short-sellers have our current watch list for potentially actionable short-sale targets, while those not oriented toward short-selling should be sitting in cash, or at least mostly in cash. As I wrote on Wednesday, I will do my best to offer guidance in the form of timely blog posts and video reports as the short side ebbs and flows during any continued market correction.

As we progress through earnings season, one major component of our current short-sale strategy will be to look for post-earnings gap-up moves in busted former leaders as possible short-sale entry opportunities. Keep in mind that these may or may not materialize on the day of any gap-up. CSX is a good example of one that did cooperate and reverse badly after an earnings-related gap-up, while NFLX took a little more time (one day) to develop.

Thus, with these examples in mind, we can see how PYPL plays out from here. As well, we can see how any other earnings-related gap-ups over the next 2-3 weeks play out and whether they offer some prime short-selling opportunities. That’s how things stand for now, and once I see how the futures are opening up on Sunday afternoon I may post a video report covering my strategy for Monday morning.

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.

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.