The Gilmo Report

October 23, 2011

October 23, 2011


The market was looking like it was going into roll-over mode on Thursday morning as an early rally fizzled and the indexes began to turn red. Then the leading “Euro Zone” countries announced that they will consider leveraging up the so-called European Financial Stability Fund or “EFSF,” and unleash 960 billion Euros ($1.3 trillion U.S.) worth of QE to prop up Eurobanks. Thus, as the Fed continues with “Operation Twist,” which we can refer to as QE3, the Europeans are now looking to come in with “Euro-QE,” or QE4. Add to the fact that Fed heads on Thursday and Friday began to raise the possibility of another round of QE from the Fed in the form of mortgage-backed securities purchases, and you get QE5. So as the global sovereign debt crisis continues to spin out of control, government officials can only continue to kick the can down the road by expanding the QE Zoo, all of which amounts to only so much money-printing. Massive QE on all fronts certainly has the potential to spark a rally in stocks, particularly if stocks begin to be viewed as stores of wealth. Why own devaluing dollars and euros when you can own a company? And so the markets responded by rallying back up to their highs, as we see on the NASDAQ chart below.

NASDAQ Gilmo Report Chart

The S&P 500, along with the broader market indexes such as the NYSE Composite Index, made higher highs on Friday with volume picking up as a result of options expiration. As we see on the daily chart of the S&P 500 Index, below, Friday’s move took the index up and out of the range it has been in since the early August lows, and on the surface this looks very strong. The bizarre thing about Friday, from my own perspective, is that I was fully short all day on Friday and was up about 7-8% on the day, despite the indexes rocketing to the upside. It was, as I said on CNN Radio Friday afternoon, a bit like a Dali painting where all is not what it seems. As well, only one (PCLN) of the focused number of short-sale targets I was working with was up on Friday. Meanwhile, my long screens are turning up only a small handful of stocks that even come close to being buyable, which I will discuss a little later in this report. But the bottom line is that I cannot recall being up as much as I was on Friday while exclusively playing the short-side in a market that saw the Dow up 267.01 points! Go figure.

S&P 500 Index Gilmo Report Chart

I suppose the practical side of Friday’s action on a stock-by-stock basis confirms that this is a market where one can approach the market not as a stock market, but as a market of stocks. On Friday, it helped to be short Green Mountain Coffee Roasters (GMCR), shown below on a daily chart, as the stock tried to rally up towards its 200-day moving average but could not catch a ride on the general market’s upward-flowing tide. By the close the stock got hammered back into the red on very heavy selling volume, even after a Suntrust analyst came out and made a pathetic attempt to defend the stock. Near-term resistance for GMCR looks to be in the 72-73 area as the 200-day moving average at around 74.68 did not come into play at all on Friday despite the torrid upside move in the general market. If we use stocks like NFLX from this year or CROX from 2007-2008 as precedents we might project a longer-term downside target for GMCR in the low 40 range. This also coincides with potential support on top of the base from which GMCR broke out in February of this year. For now, I’m using the 200-day moving average as a trailing stop for the position.

Green Mountain Coffee Roasters (GMCR) Gilmo Report Chart

It was also surprising, or maybe it wasn’t, that big-stock NASDAQ leader and consumer technology juggernaut Apple, Inc. (AAPL) was held down on increasing selling volume Friday in the midst of a very strong market rally that saw the NASDAQ Composite Index move up 1.49%. AAPL is now flirting with its 50-day moving average, and a high-volume breach of this key moving average would confirm continued weakness in the stock, regardless of what the general market does. However, if the general market continues to rally, AAPL may simply bounce around and above the 50-day line. Meanwhile, the fundamental picture for AAPL indicates that all the good news is in the stock as I see it, and anyone and everyone who is going to own the stock on this basis probably already does. Tablet device market share numbers for Q3 2011 were released this past week, and Android-based tablets took 27% market share while AAPL’s share dropped from 96% to 67%. These numbers prove that the iPad is not bullet-proof, and investors in AAPL should not become too complacent here. For now, we are using a $400 trailing stop on any AAPL short position.

Apple, Inc. (AAPL) Gilmo Report Chart

Another big-stock NASDAQ name that was down while the index itself was up 1.49% on Friday was Baidu, Inc. (BIDU), shown below on a daily chart. BIDU is one of the stocks I’ve had on my short list of short-sale targets, and since failing at the 50-day moving average four days ago BIDU has not been able to rally once over that time period. On Friday, the stock was up early in the day but finally reversed to close lower and right on top of its 20-day moving average. Selling volume, however, has not been very heavy, but then the fact that absolutely no buying interest came into the stock on Friday to bolster the upside opening even as the general market was rallying sharply does not speak well for the stock. The bottom line here is that if you are short BIDU from the 50-day or 200-day moving averages, you haven’t been stopped out and the stock hasn’t given you a reason to cover and take profits, unless you prefer to before next Thursday’s earnings announcement and don’t want to play “earnings roulette.” I would use Friday’s intra-day high at 126.29 as a trailing stop for any BIDU short position or take profits in advance of Thursday’s earnings.

Baidu, Inc. (BIDU) Gilmo Report Chart

Sina Corp. (SINA), another of the Chinese internets that we have stalked on the short side, did somewhat better than BIDU on Thursday and Friday as it did rally up off of its 20-day moving average, as we see on the daily chart below. However, the two-day rally has seen very little buying interest come into the stock and so this has the look of a little two-day wedging rally. While BIDU announces earnings next Thursday, which might alter one’s strategy regarding any short-sale position in that stock, SINA doesn’t announce until November 15th, so the stock could easily continue lower as that date approaches. It will, however, likely react to any BIDU numbers, so that should be considered as well. But if one is short SINA from around the 50-day moving average at around 97-98, you’ve got about 10-15% of upside cushion before the stock starts squeezing you on any potential rally from here. Thus one could take profits here and see how things pan out for Chinese internets following the BIDU earnings announcement this Thursday, or those more brave can stick it out, using the 50-day line as a trailing upside stop for any SINA short position.

Sina Corp. (SINA) Gilmo Report Chart

Friday saw mixed action in retail stocks, which as a group show pockets of strength and weakness. For example, on Friday, Tiffany & Co. (TIF) was rallying sharply while Lululemon Athletica (LULU) could not hold early gains and closed in the red. The high-end retailer we’ve been stalking on the short side, Fossil Inc. (FOSL), was somewhere in between as it stalled and closed mid-range on weak volume, as we see in its daily chart below. FOSL also ran into key resistance at its 50-day moving average at around the 91.30 price level. FOSL comes out with earnings on November 8th, about two weeks away, and so there is still time to see how this one pans out in the interim. Analysts are looking for FOSL earnings growth to come skidding to a near halt as they project 3% earnings growth on $1.03 per share in earnings. That said, FOSL is still just working on the peak of what may be a second right shoulder in an overall head and shoulders topping formation and it has not come off all that much since finding resistance at the 200-day moving average at 94.86, which remains the upside stop for any FOSL short position.

Fossil Inc. (FOSL) Gilmo Report Chart (PCLN) was one big NASDAQ stock that did rally on Friday as it was able to get back above its 200-day moving average en route to potential resistance at the 50-day line, currently running through the 499.21 price point. Sellers have come after PCLN in three very distinct waves since the peak seen at the April/March monthly cusp. This is very much a “three waves down” situation where three very sharp sell-offs in this deep, ranging 5½-month base may serve to wash out sellers. Thus if one is short PCLN here off the 50-day or 200-day moving averages, the 50-day line is your clear upside stop. Given that PCLN’s action over the past two days is materially stronger than the other stocks on my short list of short-sale targets, it moves to the bottom of the list if not completely off for now, pending its upcoming earnings announcement on November 8th. Remember that market rallies provide useful feedback for short-sellers as they reveal which of your short-sale target stocks are weakest. This information can be used to whittle down your list, and this is exactly what got us to placing GMCR at the top of our list in my report of last weekend, October 16th, just in time for this past week’s bust. (PCLN) Gilmo Report Chart

So with the market posting a follow-through day on Tuesday and the NYSE-based market indexes (S&P 500, Dow 30, and NYSE Composite Indexes) making higher highs in this rally that has continued to move up off the early October market lows, doesn’t it make sense to be looking at the long side of this market? Despite the fact that very few stocks are showing up on my long screens, there are some stocks working and in potentially buyable positions as of the end of the week, such as the irrepressible Chipotle Mexican Grill (CMG). CMG flashed a big pocket pivot buy point on Friday after announcing earnings after the close on Thursday, as we see on the daily chart, below. This is quite buyable with the idea that the stock should hold the 320 level. While CMG could always fail from this late-stage formation, it could also continue to push higher if the general market goes into a renewed QE rally mode. I also like the fact that CMG is showing a technically buyable formation and entry point here AFTER announcing earnings, which saves one from playing “earnings roulette.”

Chipotle Mexican Grill (CMG) Gilmo Report Chart

Intuitive Surgical, Inc. (ISRG) also put its earnings announcement behind it this week and gapped up out of a long-term pattern on Wednesday to make an all-time price high, as we see on the daily chart below. ISRG’s buyable gap-up also took it out of a big, 18-month cup-with-hande type formation that extends all the way back to April of 2010. I like the fact that it is just emerging from a long-term consolidation, setting up the possibility of a fresh move higher. As a medical stock, it also has a slightly defensive flavor to it, and its relative strength line is confirming this fresh breakout. ISRG is not insulated from general market action, however, since we can see on the chart that the stock had another buyable gap-up move in late August that died on the vine. That, however, might bring out more skeptics regarding this past Wednesday’s gap-up move which may give it a better chance of working from a contrarian standpoint. Bottom line on ISRG is that this gap-up is potentially buyable using a violation of the 410 intra-day low of this past Wednesday as your guide for a stop, or the 400 breakout level, which is only 3-4% away from the stock’s close on Friday.

Intuitive Surgical, Inc. (ISRG) Gilmo Report Chart

In my view, if the market sets off on a continued QE rally, big stocks like CMG and ISRG will continue higher and validate these current breakouts. If the market rally fails, then the out points are fairly clear and thus make the trades low-risk propositions as initial entries on the long side. I note positive action in other stocks like LinkedIn, Inc. (LNKD), which I discussed in my report of last weekend, October 16th, Questcor Pharamaceuticals (QCOR) which has broken out of a base with a buy point at 32.78, and Hansen’s Natural Corp. (HANS), which I do show below on a daily chart. HANS flashed a very subtle pocket pivot buy point as it moved just slightly up off the 10-day moving average on volume that was higher than any down-day in the pattern over the prior 10 trading days. The only issue with all of these stocks as long ideas is that they will be announcing earnings in the next couple of weeks. I frankly prefer not to play “earnings roulette” with my stocks, whether on the long side OR the short side. Thus for now I limit my buy list to two stocks: CMG and ISRG, with ISRG providing potential “new merchandise” given its only-very-recent emergence from a long-term consolidation.

Hansen's Natural Corp. (HANS) Gilmo Report Chart

To me the market has always been about the material evidence. What actually happens rather than what one thinks should happen is what is important, and surprisingly enough this past week was another very profitable week for me on the SHORT side, despite the NYSE-based market indexes moving to higher highs. But while I was playing up to 300-400% short on an intra-day basis during the week quite regularly, on a net basis I ended the week off of margin on the short side but still with short positions that continue to work. Meanwhile it was also possible to buy CMG on the gap-up open Friday around the 320 level and watch it move up to 333.49 by the close. Thus the objective evidence and real-time market feedback is telling me, at least for right now, that the market is a market of stocks where opportunities have to be evaluated on a stock-by-stock basis on the long or short side.

That may change in the coming days as the Europeans decide how much ink to put into their fiat money printing presses, and whether or not the Fed formally begins QE5 by buying up mortgage-backed securities. On Wednesday of this past week, I bet that the market would continue lower. Ironically I was wrong, only with respect to the direction of the general market indexes since my bets, my short positions, made me some strong profits. Thus this market is like a painting where images of stairs that seemingly are moving upward suddenly and seamlessly turn into stairs moving downward, and images of doors simultaneously open inward and outward – a true “Salvatore Dali market.”

Despite the market’s confusion, my plan is relatively clear as short positions like GMCR continue to work while I focus on the possibility of playing two big stocks, CMG and/or ISRG, on the upside. Where some may see a stock market, I see a market of stocks, and that perspective has made me money, even on the short side, over the past week. As we move forward, we can gauge opportunities on the long or short side by that same standard of material results, and shift accordingly, if necessary. QE4 and QE5, should they come to pass, could easily power another nominal rally in the markets, and could bring into focus the need for investors to consider broader hedges against devaluing fiat currencies. This always sets up the possibility that stocks will begin to be seen as potential stores of value, particularly among the most high-quality companies. That is one scenario that has always lurked in the back of my mind as the world becomes flooded with worthless paper currencies and investors start to wonder where they can hide in addition to the obvious places like hard assets such as commodities and precious metals. Food for thought, perhaps, but a possible driver for further upside in the market, even if it is not as coherent as we might like it to be. Expect the next few days to be highly news-related as the Eurocrats deliberate, and be ready to shift with the action in individual stocks. 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, and/or Gil Morales & Company, LLC held a position in AAPL, CMG, and GMCR, though positions are subject to change at any time and without notice.

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