The Gilmo Report

October 22, 2014

October 22, 2014

The NASDAQ Composite Index and the S&P 500 Index both posted fifth-day follow-throughs yesterday, as the daily chart of the NASDAQ shows below, after news that the European Central Bank would be buying corporate bonds in December. As the Europeans pick up the QE baton, the question of a sustainable market rally from here presents us with an interesting problem. In prior QE market bottoms, I have always seen a swath of leading stocks begin to flash buy signals, mostly in the form of bottom-fishing or roundabout pocket pivots.

This time around, we saw a small handful of these, but most occurred in synch with yesterday’s follow-through day. Usually the stocks would tell you what was happening before the indexes, and this time around it is the indexes that are signaling a potential rally phase. This is why I tend to think that yesterday’s follow-through day will fail, as I tweeted earlier this morning. Today we got a reversal off the highs on slightly lighter to even volume, but for the most part I remained unimpressed with the lack of “juicy” buy set-ups here.




Most leading stocks are in deep V-shaped positions, which in most cases makes their “buyability” somewhat problematic. The second issue is that we are currently right smack in the thick of earnings season, and taking new positions in stocks that are set to announce earnings in the next 2-3 weeks brings the earnings roulette question into play. After such a steep rally off the lows, all of which was quite logical and the reason why I remained in cash over the weekend (as I discussed in my weekend report), a pullback is likely here. I think investors can lay back and see how any such pullback plays out.

There is no need to rush into the market based on the follow-through alone – we need to see stocks setting up properly first and foremost before we can plunge headlong into this market on the long side. If that doesn’t happen, and short-sale target stocks fail at logical areas of resistance should the follow-through day fails as well, then another down leg might be in the cards.

If we keep getting more earnings reactions like that seen in Netflix (NFLX) and Yelp (YELP), then this follow-through day could unravel quickly. After-hours, YELP announced earnings and the stock is cratering as I write on this fine Wednesday afternoon. Looking at the weekly chart of YELP, below, I figured this was setting up to bust so I shorted a modest position of YELP into earnings, essentially playing earnings roulette. However, given how much I am up year-to-date, I have plenty of cushion to play in this manner if I think the set-up warrants it and the position size is reasonable.

In this case we can see YELP’s big, primary head and shoulders formation that extends back to September of last year. Over recent months it has formed two more right shoulders, and based on where the stock is likely to open up tomorrow morning given that it is trading down to around 60 so far as I write this afternoon, it looks like it has now completed a third right shoulder. Interestingly, the three right shoulders in the pattern themselves also form a smaller, fractal H&S formation. The neckline of this fractal formation is higher than the primary neckline. If YELP opens around the 60 level it is right at the fractal neckline, which may serve as temporary support, however I might treat this as a shortable gap-down IF I can establish a strong intraday high tomorrow. If so, I will probably add to my short position in YELP.




Perhaps the most coherent looking stock out there is Apple (AAPL) which is struggling to break out of its current seven-week base, as we can see on the daily chart, below. AAPL announced another blowout quarter Monday after the close, but I have to say that the ensuing reaction wasn’t really commensurate with all the fantastically wonderful and great news emanating from the earnings report. You couldn’t turn on a single financial cable TV channel without seeing a panel of “expert” investors all praising AAPL as the ultimate bullet-proof investment and “sure thing” for the New Millennium.  But even with this, and good ol’ Carl Icahn pitching the stock to his best ability, it just can’t clear the highs. Frankly, if it’s that hot, it should be at 110, at least, and particularly with yesterday’s massive follow-through.

Today the stock stalled at the highs of the range as volume dropped to just about average, which tells me that buyers must not be THAT interested in the “hot” story that is AAPL. Perhaps the only problem with AAPL’s hot story is that the crowd is by now quite familiar with that story, and so we might inquire, who is left to buy the stock?” I shorted AAPL at the highs of the range, and I am short it again. My view is that if the general market and yesterday’s follow-through fail, AAPL will be a big cause of that. A new high would be my first guide for an upside stop.




There really is very little to nothing that I am interested in buying. AAPL is one of the better-looking names and I’m more inclined to short it than buy it! I do find Alibaba (BABA) somewhat interesting here as it tries to build a flag formation after its much-hyped IPO a few weeks ago. Yesterday the stock had a decent pocket pivot off the 20-day moving average and came up through the highs of a low-base structure it has formed since coming public in late September. If I’m going to try and buy something like this I might be interested if the stock were to come back into the 20-day line on lighter volume if and as the general market acts in a similar manner.




Even in the face of a strong rally off the lows over the past five trading days, Tesla Motors (TSLA) still hasn’t been able to get back above the October 1st low, which also coincides with a fractal H&S neckline, as we can see on the daily chart, below. That October low and the fractal neckline have served as stiff near-term resistance following the logical bounce off of the 200-day moving average last week that occurred in synch with the general market bounce. I still think this thing is shortable in the 235-236 price area, using that as your upside guide for a stop.




LinkedIn (LNKD) also ran into resistance at what is perhaps a far more subtle fractal H&S neckline and its 20-day moving average, as we can see on the daily chart, below. LNKD reversed around the 20-day line for a complete give-back of yesterday’s gains and a little more for good measure. LNKD is expected to come in with their earnings announcement two Thursdays from now. So unless one is interested in playing earnings roulette, shorting into these rallies into the fractal neckline and the 20-day line means you are looking for a reasonably quick give-up before earnings late next week.


GR102214-LNKD (AMZN) also staged a shortable rally today, running right into the neckline of its own fractal neckline, as we can see on the daily chart, below. Are we starting to see a theme developing here? I think so! AMZN is expected to announce earnings tomorrow after the close, and objectively it is in a position to fail and get to that 285 low I’ve been looking for. My guess is it will have to happen on earnings, assuming the stock has a bad report and gaps down tomorrow after hours.




When the market rallies as it has over the past five days, I still keep an eye on broken-down stocks that are rallying and which could materialize as potential short-sale targets. Remember, I try not to maintain a bullish or bearish bias, but simply keep an eye on all of the individual stock set-ups, long or short, occurring in real-time and focus on that alone. Recently we’ve seen the oil groups get decimated, and the sharp decline in crude oil, currently around $82 a barrel, is likely behind this breakdown. If oil continues down to the $60 price level, as it looks like it wants to, more downside may be in store for these names.

Oil-related fracking sand names like U.S. Silica Holdings (SLCA) have also been pummeled, and I would characterize the breakdown off the peak as the likely initial formation of a head within an overall head and shoulders formation. This is merely speculation, and needs confirmation. But when it comes to the short side, keeping an eye out for right shoulder rallies, or RSRs as I like to refer to them, is one of my daily screening activities. This is what SLCA looks like on the weekly chart:


GR102214-SLCA Weekly


The break off of the peak has been brutal as it forms the right side of a possible head in an overall H&S formation. The last two weeks have closed up on a standard reflex rally, in my view, and both weeks are currently showing stalling action around the 40-week line. If we move to a more granular level on the daily chart, we can see that the current rally has taken the stock right up into the 20-day moving average, which is usually my first upside reference point for a short-sale entry into such a logical RSR move. The stock reversed today on heavy volume, the first clue that this latest rally back up through the 200-day moving average is indeed a likely RSR.


GR102214-SLCA Daily


Biogen Idec (BIIB) has now confirmed as a late-stage failed-base (LSFB) short-sale set-up after blowing up on earnings this morning, as we can see on the daily chart, below. BIIB is a big-stock bio-tech, and so I am not surprised that it found support off the lows. The fact is that the stock failed on a breakout attempt from a late-stage cup-with-handle back in late September and has simply deteriorated from there. I would look to short this if it comes further up towards the 200-day moving average, currently at 316.78, using that as my nearby guide for a stop. Notice also that the 200-day line also coincides with the 20-day moving average, which is a key moving average that I watch as stocks begin to break down from LSFB type formations.




Perhaps my main issue with this market and yesterday’s follow-through is that I still see a lot of stocks that appear to be in topping formations. Let’s look at a stock I’ve actually favored on the long side since the lows near the 30 price level, Twitter (TWTR). First, the weekly chart below shows the stock has formed a big cup formation after falling 60.5% off of its late December 2013 highs. Some might see this as a giant cup-with-handle, but I can also see it as a Punchbowl of Death (POD) topping formation as well. The depth certainly qualifies, and the duration of 30 weeks is fairly typical for a POD. But wait, there’s more! Last week and the prior week both show heavy-volume selling volume. More clues exist on the daily chart as well.


GR102214-TWTR Weekly


The daily chart of TWTR, below, reveals a flag breakout failure about two weeks ago that also forms the head of a small, fractal H&S at the right side peak of the overall POD. Fractal H&S formations are commonly seen at the right side peaks of PODs, and so we can put this evidence together with what we’re seeing on the weekly chart to come up with a somewhat bearish conclusion. Today TWTR staged an outside reversal to the downside on heavy selling volume after attempting both yesterday and today to get back up to the prior flag breakout point. It is actually quite common for a stock to have one or two moves back up to a failed breakout point before breaking lower, and so there is more bearish evidence on TWTR. I consider the stock a short, using the 20-day line as a guide for an upside stop, but remember that earnings are due out late next week,


GR102214-TWTR Daily


Some notes from my trading diary concerning other stocks I’ve discussed in recent reports:

Netflix (NFLX) – stock has rallied past the 366.12 intraday high of the post-earnings gap-down day. This, however, makes perfect sense given the oversold nature of the stock within the context of a massive oversold rally in the major market indexes.

Palo Alto Networks (PANW) – stock is back above the $100 price level, and it acts more like a leader than most stocks after yesterday’s follow-through day (FTD). However, if the general market and the FTD fail, a break back below the $100 level would be shortable…again.

Pandora Media (P) – stock has rallied right up to its 20-day moving average again, pushing just past it this morning. The company is expected to announce earnings tomorrow after the close, so I’m not keen on playing earnings roulette here. See how it acts after the earnings, as a post-earnings rally could present a decent short-sale opportunity depending on how it plays out.

Two days ago we saw Chipotle Mexican Grill (CMG), not shown, fail from a late-stage base after a weak earnings report. The stock is somewhat in “mid-air,” and it’s not clear to me if it can be considered a shortable gap-down using yesterday’s intraday high at 62.50 as an upside guide for a stop. Illumina (ILMN), not shown, is also being touted as a new leader, but yesterday’s breakout after a positive earnings breakout is coming out of a big cup-with-handle formation and on a rally over the past six days that has come straight up from the bottom. This could very well be failure-prone, and I would not be interested in buying a standard base breakout in an “old-merchandise” leader.

I’ve also noticed GrubHub (GRUB), shown below on a daily chart, flashing a bunch of pocket pivots along its 10-day and 20-day moving averages over the past few days. It also appears to be trying to round out a new base after getting buried underneath a 10-million-share secondary offering in late August. There have been four pocket pivots over the past seven days, all from a position underneath the 50-day moving average and some overhead on the left side of the pattern extending from late August to late September. As well, GRUB is expected to announce earnings next week, so you have to ask yourself if you want to buy something going into earnings in this market.




As I scan through the market on the day after a big follow-through day, I see little that I find buyable. There are plenty of deep, v-shaped rallies, but nothing really sets up in an optimal position. As well, the pattern of leading stocks showing buy signals at a QE market correction low, before an FTD materializes, has been broken. In the meantime, with an allegedly powerful FTD, not much is showing up on my buy screens. This makes me very suspicious of the FTD, and shorting into the move this morning yielded positive feedback in the form of initial short-sale profits, adding to my at-least-short-term negative outlook here.

This could change, of course, but I would have to see more leading stocks setting up constructively rather than the type of action we are seeing in stocks like AAPL, TWTR, TSLA, and BIIB, for example. In other words, I am reading what individual stocks are telling me and giving it far more weight than what the indexes’ might be showing. Until the market proves me wrong, my view is that yesterday’s FTD has a strong chance of being failure-prone. Take it from there.


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 positions in AAPL, SLCA, TSLA, TWTR, and YELP, though positions are subject to change at any time and without notice.

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