The Gilmo Report

October 30, 2011

October 30, 2011

The whiff of QE-anticipation that I was picking up on Wednesday turned into a full-blown cloud of fumes that ignited on Thursday when the deliberating Eurocrats announced that they had agreed to leverage up the European Financial Stability Fund (EFSF) to the tune of a trillion Euros. While there were no announcements of specific terms for how this would be achieved, it did not keep the markets from blasting to the upside in an “all-in” rally on Thursday that took the NASDAQ Composite Index on a sling-shot move up through and well beyond its 200-day moving average as we see on the daily chart below. Thursday’s massive gains were held quite nicely as the indexes all pulled back slightly and held tightly on Friday as volume receded and they all remained above their 200-day moving averages save for the NYSE Composite, which has yet to get above its 200-day line. The leadership situation is also improving, albeit slowly, but more stocks are starting to filter through my screens as this rally continues to develop. One notable development has been the shift in sentiment from profoundly bearish just a couple of weeks ago to a broad front of nascent bullishness. Even the Investors Intelligence survey of investment advisors has flipped back to bulls outnumbering bears again, and this is confirmed by all other sentiment surveys

NASDAQ Composite Index Gilmo Report Chart

Even on Thursday’s rally I noted a number of commentators lamenting the fact that nothing has “in reality” been settled in Europe, and I would tend to agree with this fact. And of course the extensive rally off the early October lows brings into play the pat (and simplistic) assessment that the market is “severely overbought.” In our view, of course, we don’t subscribe to “reversion to the mean” type theories that say that which is “overbought” must swing back to “underbought” or “bought just right” like some over-simplified investment pendulum. When a market becomes “overbought” sometimes it may be simply telling you that there is more power behind the rally than most want to admit. Frankly, I would welcome a new upleg in the market as making money on the long side is a lot less stressful than the short side, although I must admit the short side has been very rewarding over the past few weeks. But for now that party may be over.

Despite its rallying ways, we can see over the past two weeks on the NASDAQ chart that the ride has not been an even one as news-related pullbacks have hit the indexes from time to time, and this pattern is likely to continue. So, if we look to play the long side of this market, we might expect a less than smooth ride. While there are some stocks worth taking a shot at, my focus is in trying to work through a basic problem on the long side, and that is: If we are on the verge of a strong upleg and move to new highs by the major market indexes, where will the biggest leaders with the biggest moves come from? I have liked Intuitive Surgical (ISRG), which I discussed in my report of this past Wednesday, October 26th as just starting to emerge from an 18-month, long-term consolidaton, and Chipotle Mexican Grill (CMG), which continues to confound the shorts who just can’t see the growth potential in cheap food yet the company continues to pound out steady earnings growth. To me ISRG represents potential “new merchandise” while CMG is simply an old leader reasserting itself. One could have taken starter positions in either of these stocks when I first discussed them over a week ago and by now one would see some progress to the upside, which is always the proof in the pudding when it comes to taking a stand in the market, whether long or short. Regardless of which direction one chooses to play the market, the defining question is always, “How much progress is being made?” If no progress is being made, then you may not be on the right side of the market. The rub in this market is that it has been entirely possible to make progress on BOTH the long and short side of the market. But this week, outside of the final break in GMCR, the short side appears to have been played out, as I see it, for now.

So where do we go? Well, let’s start with the precious metals.There are more than a few skeptics when it comes to gold and silver, but the bottom line is that the SPDR Gold Shares (GLD), shown below on a daily chart, flashed a pocket pivot buy point four days ago as it cleared the top of the sideways range it’s been in since the late September lows following a sharp sell-off from the peak. On Thursday the GLD cleared its 50-day moving average and held the line tightly on Friday as volume dried up. Sentiment on gold, and silver for that matter, has been quite muted, and as most of you know it is usually best to buy the precious metals when nobody loves them. As I like to say, “Buy it when it’s quiet.” And likewise, the pocket pivot buy point of four days ago provides a very “quiet” but still easily determinable entry point for gold that gives one a shot at starting to build and pyramid a potential longer-term position in gold if this bottom-fishing pocket pivot holds up. For now I would continue to use the 65-day exponential moving average, the black moving average on the chart, as my ultimate downside selling guide. Now that the GLD has moved back above the 50-day moving average, one might get a little more picky and insist that the GLD hold above the 50-day line, although that is cutting it quite close.

SPDR Gold Shares (GLD) Gilmo Report Chart

I’ve received a few questions about the GLD chart pattern as some think they are looking at a head and shoulders topping formation. I show a weekly chart of the GLD below and have outlined what some see as a left shoulder, head, and right shoulder in a head and shoulders formation. My view is that this is more like a head and shoulders hallucination. First, the right shoulder is way above the left shoulder which would serve to create a wildly ascending neckline if I were to draw it on the chart. This alone would make the pattern suspect as a bona fide H&S top formation. And even if it were, we can clearly see that this past week’s price/volume action has negated the right shoulder mirage as the GLD has moved above the 10-week/50-day moving average on volume that is the highest upside weekly volume since the lows were put in. Note also that following the steep pullback in late September the weekly bars over the last five weeks have shown three weeks of supporting action with the GLD closing well up off the weekly lows and roughly at the mid-point of the weekly range on decent volume spikes. The GLD trade doesn’t have to work, but the evidence is sufficient to indicate that a possible bottom has been put in and the GLD will now start to work its way up the right side of a possible cup formation, and for now that is all we know for sure.

GLD Gilmo Report Chart

In my report of this past Wednesday, October 26th, I indicated that the “heart of the watermelon” was out of Green Mountain Coffee Roasters, Inc. (GMCR) on the short side as it undercut the 63.05 April low to set up a logical “undercut & rally.” GMCR has given me great joy on the short side over the past two weeks, and hopefully it has done the same for more than a few Gilmo members, but as we see on the daily chart below the stock is making a hard run for its 200-day moving average. Selling in GMCR exhausted itself three days ago and this latest rally is occurring on volume that is still above-average but declining in magnitude as GMCR bounces off the lows in the high-50’s. The time to short GMCR was off the peak of the right shoulder, and if one is trying to short the stock here it is something of an exercise in the obvious. Wait for some sign that the stock is running out of gas on the upside, preferably as it approaches the 200-day moving average which is currently in the 175-176 price area. A move into the 200-day moving average would also take it up into the neckline area of its head and shoulders to formation, which coincides with the 200-day lne, roughly, so keep an eye out for this.

Green Mountain Coffee Roasters, Inc. (GMCR) Gilmo Report Chart

In my October 16th report I discussed the first pocket pivot buy point, a “bottom-fishing” pocket pivot, in fact, that I picked up in social networker LinkedIn, Inc. (LNKD), shown below on a daily chart. LNKD to me represents the type of situation that could turn into a big leader, despite the skepticism that the company encounters from those who believe Google, Inc. (GOOG) will take market share from them with their new social networking jobs site. But the bottom line is that social networking and social media have a good shot at providing strong themes for big market leaders in that space, and for now LNKD remains the only “pure play” in the room. Another sign of the nascent rise of social networking/media as an investment theme is the fact that it is one of the biggest areas of focus for venture capital which is flowing into social networking/media start-ups. As I’ve discussed before, investors or “jonesing” for social networking/media investment opportunities, and for now LNKD is their only fix. And the stock’s technical characteristics are likewise improving, as LNKD has flashed three pocket pivot buy points over the past three weeks, the most recent occurring on Friday. Despite earnings coming out Thursday, I think one can take a starter position in LNKD based on the positive technicals, using Friday’s low at 86.66 as a downside sellng guide.

LinkedIn, Inc. (LNKD) Gilmo Report Chart

Surprisingly, retail stocks have really started to perk up over the past week or so, and this week saw stocks like Deckers Outdoor, Inc. (DECK) launch to all-time highs, while former short-sale targets like FOSL and TIF were also pitching sharply higher as well. With the group moving, I think investors might consider taking a position in other higher-end retailers like Lululemon Athletica (LULU), shown below on a daily chart. LULU flashed a pocket pivot type of gap-up move on Thursday of this past week that I see as quite buyable using the 50-day moving average at 53.44 as a downside guide for a stop. Looking at the daily chart we can see that LULU had three waves of selling in the pattern after the July peak that took the stock to lower lows each time, with the most recent selling wave taking the stock below the 200-day moving average for a final washout that coincided with the market’s undercut of the August lows in early October. On the weekly chart, which I don’t show here, LULU is coming up the right side of a possible double-bottom formation with a classic buy point at around 60 and change, but I think Thursday’s pocket pivot allows one to get a little bit of a head start, looking to add more aggressively if the stock can clear the 60-and-change price level on heavy volume.

Lululemon Athletica (LULU) Gilmo Report Chart

Adding weight to the theme of strong higher-end retail stocks is Under Armour, Inc. (UA), a stock that is in many ways becoming the next Nike, Inc. (NKE) when it was a big leader way back in the 1980’s and 1990’s, for those of you who’ve been around long enough to remember those bygone days. UA, shown on a weekly chart below, is not the tightest-looking base I’ve ever seen, but we should also perhaps keep in mind that many weekly patterns may simply be mimicking the general market’s volatility. Hence there may be a general market “context” for the volatility seen in some of the weekly patterns, such as we see in UA’s. The key here is that while the general market was testing its August lows, UA was counter-trending by moving to higher highs, pulling back with the market in early October only enough to build the lows of a handle within an overall cup-with-hande formation. Last week’s volume was fairly dry as the stock pulled back one more week within the handle before breaking out to all-time highs on massive weekly buying volume as is quite evident in the chart. A pullback into the 82 price area might be your best shot at buying the stock on this breakout.

Under Armour, Inc. (UA) Gilmo Report Chart

Another stock that has bucked the market’s trend since early August as it has also tried to make higher highs as it counter-trends the general market is “big stock” Visa, Inc. (V), shown below on a daily chart, I discussed V and its sibling, MasterCard, Inc. (MA) in my September 16th report. V didn’t quite make it back then, as it then failed on a breakout attempt as the general market rolled over to test its August lows. But note that V did not test its own August low; instead it held well above that low to form a higher low, and this week’s pocket pivot buy point on Thursday has expanded the pattern into a short series of higher highs and higher lows. With financial stocks making a comeback on the heels of the Eurocrats’ and the Fed’s stated williingness to “print, baby print,” V is also likely to continue higher. Certainly I would expect the stock to hold the 90 price level as it has done twice before over the past two weeks. V also has a characteristic of “new merchandise,” in that it is, like ISRG, just emerging from a giant, long-term, 18-month, cup-with-hande consolidation. Note also that those tiny black triangles, “ants” as we call them, showing up on the chart indicate that the stock has been up 12 out of 15 days in a row or better. MA comes out with earnings this week, and with V announcing positive earnings results this past week we might look for MA to do the same.

Visa, Inc. (V) Gilmo Report Chart

If there is truly going to be a sustainable upside move in this market, and I would define “sustainable” as anything that produces a reasonably material upleg that carries the indexes to new highs in the overall trend off the early 2009 lows, then I want to try and find those stocks that have the potential to achieve significant upside price moves. Even a market rally that lasts 1-3 months can produce some strong upside moves in individual market leaders, and we are moving into a seasonally favorable period going into year-end. In addition, there is always the potential for the market to find fresh wind in its sails that comes from a true finalization of Euro-QE and perhaps another round of QE coming from the Fed. While such actions may not do much for the economies of the U.S. and Europe, as has already been proven with previous rounds of QE, they will certainly spark rallies in commodities, precious metals, and stocks. And with massive fiat money-printing there is also the potential for stocks to begin taking on the perception that they too are forms of “alternative currency” or stores of wealth. It may be a simple question of how one likes their paper: dollars, euros, or stock certificates? Ask yourself, would you rather own devaluing paper currencies or the paper stock certificates of leading companies?

However one chooses to intellectualize over the current market environment the bottom line is that I simply do not see any optimal short-sale set-ups at the current time while I am simultaneously picking up more stocks at decent, actionable buy points. Thus, based on the objective evidence, the long side presents the best profit opportunities in the here and now, subject to change if and only as new evidence presents itself.

For my latest month-end video review, Gilmo members can go to:

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 AGQ, DGP, GLD and LNKD, 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. ©2008-2018 Gil Morales & Company, LLC. All rights reserved.