The Gilmo Report

October 27, 2013

October 26, 2013

The NASDAQ Composite and S&P 500 indexes both made new closing highs on Friday, but the action in leading stocks as a whole did not confirm the index move, despite some strong moves in a handful of individual names, such as (AMZN). The general go-nowhere malaise of most leading stocks is reflected in the daily chart of the NASDAQ Composite Index, below, which reveals that despite the index closing at a new 13-year high it did so on a big churning day as it closed below the mid-point of its daily trading range on very heavy volume. As well, the NASDAQ Advance-Decline line saw a divergence on Friday as declining stocks led advancing stocks 1349 to 1201 despite the NASDAQ being up on the day. With the index making a new high and big-stock NASDAQ names like AMZN moving higher, one might expect more robust breadth, but this divergence strikes me as a potentially subtle warning signal. Meanwhile, three out of the past four trading days have seen the index log distribution or churning, and this adds to my sense of caution.




The S&P 500, shown below on a daily chart, moved to a new high but on lighter volume. We can see that since May the S&P 500 has had three sharp corrections. The last two v-shaped recoveries coming out of these corrections that bottomed in late June and late August, respectively, all moved to marginal new highs before rolling over again. In October 2013 we have the index making another marginal new high following a v-shaped correction and recovery. With most leading stocks in extended positions we have to consider the fact that the sharp rally off of the early October lows could be running out of gas. Obviously, one should focus on their stocks and their trailing stops and selling guides, but I get the sense that the market is setting up for at least some sort of “cleansing” pullback. Thus, with few leading stocks at sound buy points, it is best to lay back and let things develop without looking to make any major new commitments at the present time. In other words, exercise caution and patience.




Something that I think is significant but which the media and most investors seem to be ignoring is the fact that last week’s “solution” to the budget and debt-ceiling impasse included the Default Prevention Act of 2013 which essentially gives the President the authority to raise the debt-ceiling at will, unless Congress disapproves by a 2/3rds majority. Thus the debt-ceiling can now be raised by the President without the a priori approval of Congress as was previously required. In a nutshell, this puts the debt-issuance and money-printing machine on full tilt. The U.S. dollar promptly responded by gapping down, with the UUP moving to a new two-year low ahead of the dollar as we can see on the weekly chart of the PowerShares Db US Dollar Bullish ETF (UUP), below. This puts the dollar in a position to break near-term support where it would not be that far away, about 10% or so, from a multi-decade low. So we are left wondering when and where all of this debt-issuance ends, because if it doesn’t, the only logical outcome is a more pronounced collapse of the dollar at some point in the future.




A breakdown in the dollar has to be good for precious metals, in my view, and we are seeing the metals form what could be a “Wyckoffian low” where they successfully pull back and retest the lows of late June before turning higher. Gold, as represented by the SPDR Gold Shares ETF (GLD), shown below on a daily chart, pulled back during September and October to retest its June lows. In the process, the yellow metal held well above those lows and over the past week or so has gapped up three times on the heels of the passage of the Default Prevention Act last week. The GLD is now back above its 50-day moving average, which puts it in position for a possible pocket pivot move off the line over the next few days.




The iShares Silver Trust (SLV), shown below on a daily chart, closed Friday right at its 50-day moving average, currently at 21.71, where it has been moving sideways over the past four days. This also sets up the possibility for the SLV to flash a pocket pivot buy point if it comes up and off of its 50-day moving average on volume that exceeds 7,511,378 shares, the highest down-volume in the pattern over the prior 10 trading days. Thus both gold and silver are in positions where a concrete buy signal in the form of a “bottom-fishing” type of pocket pivot might be seen, and this is something for which members should be on the lookout.




The sluggish feel of the market is mirrored in the action of the “Four Horsemen.” Facebook (FB) has pulled back over the past five days since gapping up and churning six days ago on the daily chart below. So far the stock has been able to hold above that range breakout and gap-up move of six days ago and its 10-day moving average as it approaches its earnings announcement at the end of the month. Meanwhile, no sell signals in the stock have occurred as it remains within its overall uptrend and above all the major moving averages that we follow.




LinkedIn (LNKD) is expected to announce earnings Tuesday after the close, and fortunately the stock is nowhere near any kind of actionable buy or short-selling point which saves us all the trouble of attempting to play earnings roulette with the stock going into Tuesday’s report. LNKD does, however, look a bit weak here as it closed below the 50-day moving average on a small outside reversal type of day with volume picking up on Friday. The ultimate resolution to the stock’s current action probably will not come until after earnings are announced, and I am not willing to bet either way, long or short.




Netflix (NFLX) has managed to hold up for the past three days after its huge-volume reversal day on Tuesday following its Monday after-hours earnings announcement. My guess is that shorts swarmed the stock following Tuesday’s reversal with the idea that a major downside break and follow-through was imminent, but instead the stock drifted higher on declining volume in a small wedging rally back up towards the 340 price level. From here I could see the stock breaking down towards its 50-day moving average, currently at 304.22 before finding significant support, but so far the stock has yet to move below the pocket pivot buy point of ten days ago on the daily chart below.




Tesla Motors (TSLA) continues to bounce and roll off of its 50-day moving average, as we can see in the daily chart below. Downside volume has been much higher than upside volume since the high-volume sell-off from the peak of not-quite four weeks ago, and the preponderance of larger red volume spikes is easy to discern on the chart. A move below Wednesday’s 160.15 intra-day low would constitute a 50-day moving average violation and a sell signal, but it is also likely that TSLA’s current pattern, which might simply be the formation of a new base or indicative of a sort of rolling top, will not be resolved until it announces earnings during the first week of November. Meanwhile, the stock is starting to “live” under its 50-day line which is a near-term change of character in the stock compared to its action all the way up from its May buyable gap-up move.




Last weekend I discussed the buyable gap-up move in (AMZN), but going into earnings on Thursday after the close it was not clear as to whether one would want to play “earnings roulette” with the stock. AMZN came in with a smaller loss than expected at 9 cents a share, and sales growth ticked up to 24% compared to 22% over the prior three quarters. Next quarter AMZN’s earnings growth really starts to kick in with 273% growth expected on an impressive hard number of 72 cents, the largest quarterly earnings growth for AMZN for at least the last several years. Interestingly, AMZN is expected to post at least mid-triple-digit earnings growth for the next nine quarters, with an even larger 2,200% increase expected three quarters from now and a 500% increase expected four quarters from now. AMZN closed Friday about 3% above its intra-day low of 352.62. If one wanted to take a shot at this latest buyable gap-up, risk is reasonably well-contained using that 352.62 low as your selling guide.




In my report of this past Wednesday I suggested that we might look to see if any support shows up for Netqin Mobile (NQ) on this latest pullback following a breakout to new highs last week. Interestingly, the inverse of support is what actually occurred as the stock blew apart following a report from a group called “Muddy Waters” that essentially claimed the company is a fraud and that they consider the stock a “zero,” meaning that’s what the stock price would eventually be worth. Pretty heady stuff and it had the effect of cutting NQ down by more than 47% as investors swarmed for the exits. What made it all even more interesting is that I owned the stock which was purchased right off the 50-day moving average at 20.09, as I discussed in my report of exactly one week ago. Fortunately, I keep tight stops on my positions, and when it could not hold a three-day pullback on Thursday I sold at 22.48, for an 11%-plus profit. A stark illustration of why stops are so important. I’ve often discussed the fact that if I am looking for a stock to find support at a particular price level or moving average, and it doesn’t hold that level, I do not waste time cutting it. In NQ’s case my quick action, based entirely on adhering to my trailing stop and expectations for the stock’s action, ended up saving my neck. It also illustrates O’Neil’s axiom that there are only two types of investors in the stock market: the quick, and the dead.




The past couple of days have seen the demise of two of my favored stocks, Ciena (CIEN) and Finisar (FNSR), both of which were acting quite well as of Wednesday of this past week while they were holding up right near 52-week highs. On Thursday, a disappointing earnings announcement from a much smaller player in the Telecom – Fiber Optic group, Infinera (INFN), not shown, was cited as the reason for the sell-off in CIEN and FNSR. Whatever the excuse, in my view the fact that neither stock was able to hold its prior breakout points, as I’ve highlighted on the daily charts of each, below, made them clear sells. On Friday, another smaller player in the Fiber Optic group, Allied Fiber Optic (AFOP), ran up over 15% following its earnings announcement and CIEN and FNSR both responded by moving even lower, with CIEN breaking down and closing below its 50-day line. I had previously felt that these stocks had decent upside potential, but in the stock market feelings and opinions are utterly irrelevant. The stocks’ price and volume action has spoken, and they will need to heal this current damage and set up again in proper fashion before I will become interested in them again.






FNSR and CIEN don’t have a monopoly on failed breakouts in the current environment, however. Qihoo 360 Technology (QIHU), which has been a big leader since I first discussed it in my reports way back in May of this year, looked like it was breaking out of a five-week base last Friday, as we can see on the daily chart, below. That breakout was short-lived as the stock almost instantaneously reversed to close back down at its 50-day moving average this past Friday, exactly one week after the breakout attempt. Some cite QIHU’s weakness as being part of the general sell-off in Chinese stocks as a result of the NQ controversy. But the reality is that QIHU was already selling off during the first three days of the week and closed slightly up on Thursday, the day that the NQ news broke. Thus QIHU’s weakness cannot be attributed to NQ. QIHU announces earnings sometime in mid-November, and it is likely that its current pattern won’t be resolved until then. However, I would use the 50-day moving average as a selling guide in the meantime if the stock weakens further before earnings. QIHU has had a nice price run since May and there is always the possibility of an intermediate top taking hold after such a move.




On a more constructive note, NXP Semiconductor (NXPI) gapped up on Thursday after beating on earnings Wednesday after the close. I discussed the stock in my mid-week report of this past Wednesday after the stock gapped down on very heavy volume, closing below its 50-day moving average, as we can see on the daily chart below. This, however, morphed into a “shakeout & breakout,” as the stock staged a buyable gap-up move on Thursday that remains within buyable range using the 38.75 intra-day low of the gap-up day as your selling guide. NXPI surprised with 85 cents a share in its more recent quarter on decelerating sales growth of 7% which has dropped steadily from 20% four quarters ago to 11% and 9% in the last two quarters, sequentially. Earnings growth is also decelerating from 213% and 45% over the past two quarters, sequentially, but is expected to jump back up 66% next quarter on a hard number of 93 cents. With the stock closing at 39.90 on Friday and your selling guide at 38.75, risk is relatively low in testing out a long position here.




Align Technology (ALGN), the maker of clear, invisible aligners used to treat malocclusion, otherwise known as braces for straightening out crooked teeth, handily beat estimates of 30 cents a share by coming in with earnings of 40 cents a year two Fridays ago when it announced earnings. Sales growth jumped to 21% from 12% last quarter while earnings over the past four quarters have gone from -7% to 0%, 6%, and then 62% in the most recent quarter with next quarter’s estimates looking for 65% growth on a hard number of 43 cents a share. I did not discuss the stock in my report of last weekend because it was extended from the buyable gap-up day intra-day low of 53.13. Over the past week, however, no upside follow-through from the buyable gap-up has been forthcoming as the stock has drifted back down towards that 53.13 low, closing at 56 this past Friday. As we can see on the daily chart, below, volume has been drying up on the pullback, and if BGU is going to remain viable the stock needs to turn back to the upside over the next 2-3 days, in my view. Thus one could take a long position here with a time stop rather than a price stop, giving the stock 2-3 days to get going but still using the 53.13 level as your downside stop with no porosity, which means give it 2-3 days but if it breaks down through 53.13 before then it should be sold immediately without giving it another 2-3% of downside leeway.




Last weekend I discussed the tight action in Lumber Liquidators (LL) as it tracked along its 10-day moving average. LL announced earnings on Wednesday before the open and earned 73 cents a share, seven cents more than expected, which resulted in 59% earnings growth on accelerating sales growth of 24%. Not bad for a company that has just been raided by the government for allegedly illegal Siberian wood supplies. In any case, the strong earnings announcement resulted in a buyable gap-up move on Wednesday with an intra-day low of 111.76, which serves as a nearby downside selling guide given the stock’s Friday close of 114.04.




Alexion Pharmaceuticals (ALXN) violated its 50-day moving average back in early October, which resulted in a sell signal for the stock, but over the past four days the stock has rebounded sharply off of its 200-day moving average, which it kissed on Tuesday of this past week as it morphed from an ugly duckling to a beautiful swan. ALXN announced earnings on Thursday and beat estimates by 4 cents with 83 cents a share representing earnings growth of 38%. This sent the stock up through its 50-day moving average, as we can see on the daily chart, and on Friday it followed through by making an all-time closing high. ALXN’s Relative Strength rating is still lagging at 74, and the RS line has not confirmed the stock’s new highs. This might imply that a pullback to the trendline that I’ve drawn on the chart would be the best opportunity to pick up shares of the stock, using that level as a tight stop, rather than chasing it up here. In this market, chasing strength is not the best strategy, in my view. Over the past quarter, sponsorship in ALXN has picked up with a number of Fidelity funds taking new positions and several Fidelity funds with existing positions materially adding to those positions. However, there were 455 funds, including a number of A- and A+-rated funds that reduced their positions in the stock over the past quarter. Bottom line is that I consider ALXN extended from the trendline breakout and would only consider buying the stock on a pullback to or near that trendline, using the trendline as a quick downside stop should the stock fail.




Celgene (CELG) came out with earnings this past week on Thursday, but the stock responded by selling off a bit on above-average volume, as we can see on the daily chart below. This tepid response to the earnings report was likely due to the fact that there was nothing spectacular about it. CELG’s earnings growth continues a three-quarter deceleration at 21% in the most recent quarter and estimates of 17% growth in the next quarter. If CELG cannot hold the 150 breakout level from its last base breakout and “re-breakout,” I would be a seller.




The Fed meets this week and will issue its usual policy announcement on Wednesday at 11:00 a.m. Pacific time. I doubt if any change in the current QE policy will be forthcoming as the Fed remains “taperless.” As we move through earnings roulette season I see very little that is actionable outside of a handful of buyable gap-up moves in stocks that have already announced earnings. To the extent that risk can be controlled, it might be worthwhile to take some shorts in these select few names that I’ve discussed in this report. But I still find the overall action in the market to be indicative of a slowing of the trend, which might be presaging a pullback given the extremely sharp rally that we’ve seen off of the early October lows. Stay tuned.

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.