The Gilmo Report

October 30, 2013

October 30, 2013

The Fed released its latest policy announcement today and there were no surprises – QEternity remains the order of the day. However, the market was already selling off prior to the Fed’s announcement at 11:00 a.m. my time here on the West Coast, so after some brief spinning about it set about resuming the sell-off. Volume was slightly higher on the NASDAQ Composite Index as it staged an outside reversal to go along with the one distribution day and two churning days over the past six trading days, as we can see on the daily chart below. As I wrote over the weekend, my sense of caution is increasing here, and with more leaders showing wider cracks, that caution continues to grow to the point where I am no longer long stocks as I test the short-side waters here.




The S&P 500 Index, shown below on a daily chart, has acted better than the NASDAQ, but today it also had an outside reversal day on slightly higher volume. While the index action is necessarily downright ugly, it is flashing some warning signs, and the action of leading stocks is also providing a supporting clue in this regard. Therefore, I will emphasize the point I made over the weekend, which is that it is not necessary to make any aggressive long commitments here as one keeps a close eye on their stocks and adheres to stops and/or trailing stops.




Despite the Fed announcing what was already obvious – essentially that there would be no tapering for now as their monthly bond purchases continue unabated for now, it was interesting to note that the precious metals actually sold off in reaction to the announcement, and the dollar rallied. With the Fed releasing a statement to the effect that they are “encouraged” by the economy’s alleged progress, perhaps the market was interpreting this as a time to begin discounting a potential taper further down the line. Since the market tends to discount the future anywhere from six to nine months in advance, this would make sense. My own view is that the economy is only getting worse, and with the Default Prevention Act being passed two weeks ago, the need for more debt issuance and money-printing is the higher probability. In any case, the SPDR Gold Shares (GLD), shown below on a daily chart, sold off following the Fed announcement as volume increased but remained below average. It did, however, manage to hold above the 50-day moving average.




But while the GLD closed down on the day, the iShares Silver Trust (SLV) managed to close up on the day, as we see on its daily chart, below. In fact, the SLV flashed a pocket pivot buy point off the 50-day moving average. This may be an indication that the metals are in fact okay here, and we could see the GLD produce a pocket pivot of its own in the coming days given that it is resting right at its 50-day moving average as of today’s close.




I’ve previously discussed the changing character of the market’s strongest leadership as The “Four Horsemen” have continued to deteriorate. LinkedIn (LNKD) is now a busted chart as it became the latest “earnings roulette” victim following yesterday’s after-hours earnings report, as we can see on the daily chart below. LNKD beat estimates for the quarter, but issued weak forward guidance, resulting in first a sell-off, then a rally, and then another sell-off in after-hours trade yesterday. This morning LNKD opened up back above the $240 price level, giving short-sellers a prime opportunity to nail the stock right at the 50-day moving average. From there it blew apart as the morning progressed, reaching an intra-day low of 222.22 before closing at 224.11.

After-hours as I write, LNKD had rallied to 227.05 as a result of Facebook (FB) earnings this afternoon, but I simply used it as an opportunity to add to my LNKD short position at that price level in after-hours trade. The idea with a LNKD short position is that the stock is headed for the 213.50 low of early October, when it sold off earlier in the month and/or its 200-day moving average, currently at 193.67. The fact that LNKD offered weak guidance was no surprise given that analysts were already looking for paltry earnings growth of 14% in the next quarter. 235 as an upside stop for a LNKD short position seems reasonable from current levels as it represent about 5% of upside.




The other big social-networking name among the Four Horsemen, Facebook (FB), came out with a strong earnings announcement this afternoon, sending the stock up above the 56 price level. FB had been selling off on above-average volume over the past four days, as we can see on its daily chart. As I write this afternoon, FB is now trading back around where it closed today at 49.01 after peaking at 57.44 in after-hours trade. That’s a pretty ugly reversal on an intra-day basis, and it will be interesting to see how FB opens up tomorrow morning. If the stock should continue to reverse and go very negative tomorrow, that would be the final nail in the coffin for the so-called “Four Horsemen” as they would become the “Four Headless Horsemen” just in time for Halloween tomorrow.




Netflix (NFLX) continues to bounce around after last week’s wild high-volume reversal, as we can see on the daily chart below. As I wrote over the weekend, I can see the stock heading for the 50-day moving average, currently at 307.57, and after rallying back up to its 10-day moving average today, I tend to see the stock as potentially shortable, using the 10-day moving average at 329 as a reasonably quick upside stop about 3% or so from where the stock closed today. If I squint real hard, I can see a left shoulder and a “pinhead” type of head in a possible ultra-short head and shoulders formation with the last few days of bouncing action starting to form a little right shoulder.

I may be all wet on this as it is still very soon after NFLX’s top last week, but a breakdown through the 50-day moving average would confirm my theory that it is forming a “Pinhead & Shoulders” type of formation. One of the things that has bothered me about NFLX is that at this point 980 mutual funds own 35 million shares of the stock, roughly 63% of the stock’s float. I recall doing a study back when I was a broker at PaineWebber in the early 1990’s where I determined that the point at which a stock’s mutual fund ownership becomes somewhat “saturated” and prone to a top is 63%. That was about 20 years ago, and it might be time to update that study, but intuitively one can see that 63% mutual fund ownership of the stock’s float is a fairly large percentage.




Tesla Motors (TSLA) violated its 50-day moving average yesterday, but as is so often the case in this QE market, the “Ugly Duckling Theory” came into force as TSLA reversed and closed up on the day. However, the violation held as the stock reversed again today, to the downside, to close at its lowest level since early September as it confirmed the 50-day moving average violation. TSLA is expected to announce earnings next week, but I’ve considered the stock a sell for a while now, at least since it violated its 10-day moving average in early October. I do not advocate long or short positions in TSLA going into next week’s earnings announcement, and I can only surmise that the ugly price/volume action in the stock is likely an initial warning and shot across the bow.




With the so-called “Four Horsemen” losing their heads, we might look to other big-stock NASDAQ names to take up the slack. Apple (AAPL), which announced earnings after the close on Monday, might be abdicating that potential role as it reversed to the downside yesterday on very heavy selling volume, as we see in its daily chart below.




I suppose the market’s best hopes for new “big-stock” leadership lie in (PCLN), Google (GOOG), and (AMZN), all of which continue to hold up well after recent strong price/volume action. I don’t show PCLN or GOOG here on charts, choosing instead to show AMZN which is holding up in a short three-day flag following last Friday’s buyable gap-up move. With the general market acting weak, AMZN might be expected to continue to build a flag formation here, assuming that it can weather any market downturn, should that occur. One big issue I have with AMZN’s currently three-day flat is that volume is not drying up as I would like to see with any flag formation as it moves tight sideways or drifts slightly downward. Instead, AMZN’s flag is drifting slightly upwards as selling volume picked up and came in above average today. This is not what I would consider constructive action within such a short flag formation following the buyable gap-up move. Should AMZN break down through the 352.62 intra-day low of last Friday’s buyable gap-up, I would be selling the stock in a hurry if I were long the thing, which I am not currently.




Currently I see nothing actionable on the long side of the market, consistent with my view that one does not need to be taking aggressive new long positions here. Recent buyable gap-ups in NXP Semiconductors (NXPI), shown below on a daily chart, as well as Align Technology (ALGN) and Lumber Liquidators (LL), both not shown, have held up so far, but again, if you take new positions in these, pay close attention to your selling guides, which in all three cases would be the intra-day low price of each stock’s respective buyable gap-up day.




Throughout the past few weeks I’ve advocated bagging profits in Yelp (YELP). YELP came out with earnings yesterday after the close and took some heat, moving down as low as 61 in after-hours trade. This morning the stock opened up at 62.98 and fought its way higher as it moved above and found support off of its 50-day moving average. I don’t really see this as buyable action given that the stock missed on earnings, coming in with a loss of four cents vs. expectations of a whopping one cent profit. It would not surprise me to see the stock roll over again and retest that 50-day moving average, currently at 64.37.




Earlier this month in my report of October 9th I discussed Trulia (TRLA) as a potential late-stage failed-base (LSFB) type of short-sale set-up that could be shorted on rallies up to and just beyond the 50-day moving average. As you can see on TRLA’s daily chart, below, this is exactly what the stock did, pushing up through its 50-day moving average two times before doing it one more time today after announcing earnings yesterday after the close. However, that move above the 50-day line did not hold up either, as the stock reversed and closed down on the day on very heavy selling volume. This looks like death to me, and I think any rally from here up towards the 50-day line at 45.18 would be quite shortable, although I might consider a breach of the neckline, which I’ve highlighted in yellow on the chart, as more likely in the near-term, particularly if the general market pulls down.




I’m also keeping an eye on one of AAPL’s main suppliers, Arm Holdings (ARMH), which recently failed on a cup-with-handle breakout last week after coming in with an earnings number that beat estimates but failed to impress investors. Thus we have a possible late-stage failed-base (LSFB) set-up here that would be confirmed if ARMH busts through the 50-day moving average, currently at 46.22, something I’m looking for here given that it has bounced off the line twice already and today found resistance at the 10-day moving average, as we can see on the daily chart below. One could test this by taking a short position here and using the 10-day line as a hyper-stop on the upside, with the idea that the third encounter with the 50-day moving average will invoke the Rule of Three and send the stock crashing through the line on the downside.




As I started off saying in this report, the current environment has pushed me from the long side to the short side, although it is not clear to me just yet how long I will remain on the short side. Rallies in leading stocks have been sold into as a number of leaders have taken heat in recent days as we progress through “earnings roulette” season. FB’s action as it drops below the 49 level following a supposedly strong earnings report this afternoon cannot be a good sign for the market, to be sure.

The question then becomes whether we will see old leaders drop off while new leadership steps up to take its place in healthy, rotational action. But that does not seem to be happening with any vigor, and so I am left in a very cautious and, I suppose, based on my current short positions, somewhat bearish frame of mind. From there, you can draw your own conclusions.

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 LNKD and TRLA, though positions are subject to change at any time and without notice.

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