The Gilmo Report

October 9, 2013

October 9, 2013

About a week ago I wondered out loud in one of my reports whether it would be the lagging S&P 500 Index that would play catch-up on the upside to the outperforming NASDAQ Composite Index or whether it would be NASDAQ playing catch-up on the downside to the underperforming S&P 500. The charts below provide us with the answer, and it is clear that the latter scenario has played out, thanks to the prolonged budget log jam which is now spilling over into a broader argument over the debt-ceiling. This has spooked markets in a big way. While the major market indexes did try to find their feet today, closing mid-range on heavy volume, the market was obviously in a very oversold position as it broke to lower lows this morning, and a bounce, even a weak one, was not surprising to see.




The S&P 500 Index managed to close up on the day on heavy volume, giving it the look of supporting action off the lows. The S&P is now down about 4.2% from its September peak, while the NASDAQ is down about 3.7% from its own September peak. Thus this can be defined as a short-term correction, but given the action of the leaders I would be looking to lighten up into any rallies, assuming I haven’t sold off positions as they’ve gone crashing through near-term support levels.




Tuesday was one of the ugliest days we’ve seen in the market in a long time with respect to how the leaders were creamed. In many ways it was like the proverbial bull in a china shop, the main difference being that instead of a bull it was a bear, and an angry one at that. Virtually no leading stocks were immune as they all got smashed to smithereens on Tuesday. The carnage was incredibly brutal in some cases, including, but certainly not limited to, names like LinkedIn (LNKD), down -6.10%, Yelp (YELP), down -7.62%, Trulia (TRLA), down -8.42%, YY, Inc. (YY), down a whopping -15.03%, and Acadia Pharmaceuticals (ACAD), burned to a crisp at down -15.46%.

Today’s opening saw more downside in leading stocks, but a scant few were able to finish well off of their lows. Hopefully members understand the difference between seeking to buy stocks on constructive pullbacks and trying to catch falling knives, because none of these leading stocks that I’ve been discussing in recent reports has had anything even closely resembling a “constructive” pullback over the past couple of days, as we’ll see in a second here. Using constructive pullbacks to buy leading stocks was certainly the strategy I was looking to employ on the long side of this market as I avoided buying into strength, but trying to step in the way of a Mac truck is quite another, and most of these sell-offs have had amazingly dangerous velocity to the downside for anyone lingering in their path too long.

If the health of the so-called “Four Horsemen” tells us anything about the health of the general market, then it is not a stretch to conclude that the market is busted here and will need some time to heal. It is possible that a sudden resolution to the budget and debt-ceiling logjam will spark a rally, and in fact I would say that it most certainly will, but the quality of any such rally will have to be monitored closely.

Facebook (FB) broke sharply below its 10-day moving average on Tuesday and violated the 10-day line today. If one was using the 10-day line as a trailing stop, then this action would push you out of the position. If one is using a deeper trailing stop, such as the 50-day moving average, then the stock remains well above that price level, currently at 42.99, but it is possible that any further downside in the general market could see the stock test the 50-day line. Of course, that would be the first test of the 50-day line for FB since its buyable gap-up breakout move of late July, so one might keep that in the back of their minds as a potential re-entry or initial entry point should that occur.




LinkedIn (LNKD), which I haven’t cared much for per my discussions in recent reports, blew through its 50-day moving average, violating the line on Tuesday, as we can see on its daily chart below. The stock has undercut its prior low of August 16th, and has now more or less filled the gap from its prior buyable gap-up after announcing earnings in early August. In my view, this is now a late-stage base-failure, and I would be looking to short rallies back up towards the 50-day moving average, currently at 239.72.




Netflix (NFLX) has also come unglued from its prior coherent price action, slashing to the downside over the past two days as it finds some support at its 50-day moving average. This is not the stock’s first pullback to the 50-day or 10-week moving averages since breaking out in early July, so it is not clear to me that the stock can be bought here on this basis. My tendency would be to use any bounce off the 50-day line to sell into, frankly.




Tesla Motors (TSLA) has also pulled into its 50-day moving average, as we can see on its daily chart below. But as I wrote over the weekend, if the stock cannot quickly recover from last week’s news-related (or should we say video-related?) sell-off then it must be considered suspect. With more heavy volume selling in the stock this week, I would not be interested in holding the stock going into earnings at the beginning of November. The two-day wedging rally back up into the 10-day moving average that ended on Monday was obviously an opportunity to sell into, and the stalling action on Monday as volume diminished was somewhat prophetic given the action over the past two days.




Acadia Pharmaceuticals (ACAD) offers the most brutal example of a massive price breakdown as it gave up a month’s worth of gains in essentially two days, as we can see on its daily chart below. In my report of September 8th I discussed the pocket pivot buy point of September 6th, as we can see on the daily chart below, and ACAD had roughly a 39% move to the intra-day peak on October 3rd. ACAD also offers a stark lesson in why one should consider taking profits when a stock yields a 20-25% upside gain after a valid buy point, and that is one policy that I myself have abided by in this nutty QE market environment. Looking at the chart and that amazing three-day price break, I can only say, “Wow.”




In recent reports I’ve discussed taking profits in Yelp (YELP) given that it has had a very nice price run from its initial pocket pivot buy points along the 10-day moving average in late August, as we can see on the daily chart below. Over the past three days the stock has broken down to retest the top of its prior base and prior support at around the 59 price level, as I’ve highlighted on the chart. If one did sell the stock near the peak as I discussed, then I would not necessarily be looking to buy back into this price break going into earnings at the end of the month. YELP did kiss its 10-week moving average on its weekly chart, not shown, today, and this is the stock’s first pullback to the 10-week line. The question is whether one wants to buy into this ahead of earnings and in the current general market environment. Obviously, if one did choose to buy into this pullback into the 10-week line, then that should also be used as a reasonably nearby downside stop.




Over the weekend I discussed my skepticism regarding Splunk (SPLK) and its attempted breakout on Friday of last week, which we can see on the daily chart below. The breakout came from a two-week flag, way too short in my view, and volume was also not sufficient for pocket pivot volume signature. And so SPLK came crashing down with the market over the past three days, finally finding support at its 50-day moving average today. When the stock could not hold the 10-day line on Monday, that was my signal to exit the stock, and this was fortuitous given the sharp breakdown over the next two days.




I owned a little Trulia (TRLA) over the weekend, having purchased it along the 20-day moving average per my discussion of the stock in my weekend report, and on Monday the stock was not able to hold the line, as we can see on the daily chart below. Despite attempting to rally back into the black a couple of times during the day on Monday, TRLA wavered and that was enough for me. In all cases, if I’m buying a stock off the 20-day line with the idea that it should bounce off of that moving average and it doesn’t, I sell quickly. In this case reacting quickly was again fortuitous, as the stock proceeded to bust through its 50-day moving average yesterday. TRLA violated the 50-day moving average on an intra-day basis today, but it was able to bounce off prior support in the 40 price area, as I’ve highlighted on the chart.

However, as far as I’m concerned, this chart is busted, and we may be looking at a late-stage failed-base situation. Thus rallies back up into the 50-day moving average may become shortable, but much of this will depend on how the general market acts in the coming days. Any stock that breaks down from a prior base and blows through its 50-day line like LNKD and TRLA, for example, becomes a potential LSFB short-sale set-up.




Most leading stocks look like garbage here, although some are finding support at their 50-day moving averages in some cases, such as bio-techs Celgene (CELG) and Regeneron Pharmaceuticals (REGN), for example. But when stocks cannot hold recent breakouts, that is enough of a reason to sell them, in my view. CELG, shown below on a daily chart, provides an example of this as it broke out from a short cup-with-handle formation about two weeks ago. It did manage to hold this breakout last week when it pulled down towards the 150 price level and held. However, yesterday, CELG broke down through the breakout point which in my view was a reason to sell the stock. Now the stock is trying to hold the 50-day moving average, and it remains to be seen whether it can make a “re-breakout” attempt.




If the market is able to find its feet in the coming days, I would probably keep a close eye on the stronger Telecom – Fiber Optic names, Ciena (CIEN), and Finisar (FNSR). While both gave up on breakouts over the past couple of days they have also both been able to hold above their 20-day moving averages, which is somewhat more constructive than the action we’ve seen in most other leading stocks. Both have dropped back into their bases, and while both did fail on recent breakouts, if they can hold up along their 20-day moving averages they will likely remain viable, in my view. If the general market continues to deteriorate, then of course all bets in any stocks are off the table, but these are two names I am watching closely here.






In general I believe the action of leading stocks over the past two to three days is bearish for the market. If I’m still long stocks here I would be using any rallies or bounces as opportunities to lighten up until and unless the general market can find its feet. What disturbs me most is the sudden, violent downside action we have seen over the past two days. I have to admit to being quite amazed by the sudden change in the character of so many leading stocks, something that reminds me of March 2000 at the top of the dot-com bubble. Perhaps the initial clues to this week’s ugly action came in the form of weak action by LNKD and TSLA, two of the alleged “Four Horsemen” of this market, last week as they began to falter. With NFLX and FB coming under pressure this week, the market has lost its stability, and in my view, things will need to settle down considerably before I am interested in jumping in on the long side of this market.

In the meantime, should a budget and debt-ceiling resolution be reached, any market rally that ensues should be monitored carefully, as the current action strikes me as indicative of something more ominous. If such a rally were to occur and then fail in short order, this would confirm my suspicions, in my view. 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.


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