The Gilmo Report

September 11, 2011

September 11, 2011


The market’s situation cleared up significantly in the last two days of this past week as an early morning rally coming on the heels of Wednesday’s big gap-up completed the upside “dope of hope” head fake going into President Obama’s “jobs speech” on Thursday night, and the market reversed sharply to the downside on heavy volume. Friday featured a gap-down open that gathered momentum into the end of the day, capping the week with two solid distribution days that appear to be trying to send the market back towards its August lows. As the daily candlestick chart of the NASDAQ Composite Index shows below, the index never came close to testing resistance at the 2600 level. If you are long any inverse NASDAQ 100 ETFs such as the SQQQ or QID, as I suggested a week ago, the upside stop at NASDAQ 2611 never came close to being taken out. Thursday and Friday constituted the two heaviest days of selling in the general market seen since the August lows, and the odds appear to favor a retest of those lows. With Obama speeches, Bernanke speeches, and the ongoing Greek tragedy, the news is thick, but I would simply stay focused on the price/volume action of the market and (former) leading stocks. The past two days have put the market in a precarious position.

NASDAQ Composite Index Gilmo Report Chart


In my report of this past weekend, I noted that the action in the market currently is quite normal at this stage following the sharp break off the peak that is evident on the daily candlestick chart of the S&P 500 Index, below. As I see it, all the market is doing currently is consolidating the initial break off the peak in late July and early August. And while some want to believe that the market is in a “confirmed uptrend” the preponderance of market evidence as embodied by the action of (former) leading stocks indicates that this “rally” is little more than the normal formation of a bearish reverse flag type of formation that will eventally resolve itself to the downside. It is just a matter of how long this shallow rally will continue as it sucks in dumb money. For now I see resistance for the S&P 500 at the 50-day line around 1240 while 2611 remains as upside resistance for the NASDAQ.

S&P 500 Gilmo Report Chart

The U.S. dollar provides a ready clue to what it is that is bothering the market. Some might point to Obama’s speech, or Bernanke failing to uncork the QE3 spigot, but it appears that forced selling as institutions seek to raise liquidiity in reaction to the ongoing European debt crisis is the main driver here. This, in my view, is confirmed by the world’s tallest midget, the U.S. dollar, going into launch phase as it gapped higher twice this past week, taking the PowerShares U.S. Dollar Index (UUP) up through its 200-day moving average for the first time since August of last year. Meanwhile, Treasury bonds are finding a strong bid and the iShares Barclay 20+ Year Treasury ETF (TLT) closed at its highest level in over two years as it mimicks the dollar in its recent upside streak. Money is looking for a place to hide, and as I wrote a week ago, foreign reserve accounts at the Fed are brimming as central banks and other foreign institutions frantically seek a safe haven. That search for a safe haven has propelled the dollar and Treasuries higher.

PowerShares U.S. Dollar Index (UUP) Gilmo Report Chart

The odd anomaly here is that normally we might expect the dollar’s big gap-up action this past week to the upside to have a negative effect on gold and silver, but both of the precious metals held up within their current consolidations, largely ignoring the dollar’s move. This adds weight to the safe haven argument, as gold and silver benefit from their roles as alternative currencies, even in the face of a sharp dollar rally this past week. The SPDR Gold Shares ETF (GLD), shown below on a daily chart, finished the week only 2% off of its all-time high, so the yellow metal continues to hold up well as it finds some volume support along its 10-day moving average. Meanwhile, the iShares Silver Trust (SLV), not shown, is tracking tight sideways just above the $40 price level as it continues to consolidate normally. There is not much to think about here as the GLD and SLV remain stable, and investors holding positions in these or related ETFs should simply remain sitting for now.

SPDR Gold Shares ETF (GLD) Gilmo Report Chart

Over the past few reports I have found things to love about Apple, Inc. (AAPL) and things to hate about it. One of the most puzzling aspects of AAPL to me is the fact that it sells at 12 times forward earnings, an astounding “valuation” for what is clearly one of the most successful and innovative consumer technology companies in market history. And I would have to say that this is what troubles me most about AAPL – it clearly indicates that the market places a low value on the future earnings stream of AAPL’s business. It’s not as if AAPL represents some hidden “value” play waiting to be uncovered by a shrewd, pencil-sharpening value-oriented money manager. Everybody knows about AAPL, and everybody in the market knows that it sells for 12 times forward earnings. Is there an answer for this? Is it the “Steve Jobs discount,” is the fact that every institutional investor on the planet is up to their eyeballs in AAPL stock, or is it a sign of future slowing in their business? Ultimately, the answer will be forthcoming when AAPL resolves this current, jagged consolidation it has been forming since it failed to clear the $400 “Century Mark” in late July. Incidentally, one could have theoretically instituted Livermore’s “Century Mark” rule to short AAPL for a 10% profit when it failed to hold the 400
price level.

Apple, Inc. (AAPL)  Gilmo Report Chart

Other negatives in AAPL’s current chart are the weak-volume gap-ups over the past two weeks where the stock has gapped up on pathetic volume and then failed to hold those gap-up moves, a sign of smart money selling into the gaps. AAPL’s action at the $400 “Century Mark” hasn’t been as bad as its action when it first failed at the $200 price level in late 2007, after the general market had topped in October of that year.

On the following page you can see a daily chart of AAPL placed on top of and lined up with a daily chart of the NASDAQ Composite from the 2007-2008 market period. This gives you a sense of how AAPL’s action around that market top synched up with the general market action as represented by the NASDAQ. Note that the market itself had topped in late October 2007 and then had one quick leg to the downside after which it moved sideways in a bearish reverse flag formation, similar to what we are seeing right now in the general market. While the market was working through the reverse flag AAPL was actually continuing higher and by late December was making a run at the $200 price level. Based on Livermore’s “Century Mark” rule (see the October 17, 2010 report for a detailed explanation of this rule) AAPL was shortable once it failed at the $200 level, and when it did in late December that coincided with the general market starting a new leg to the downside, as we can see in the two charts on the next page.

In addition to AAPL in late 2007, other big leaders from that time like Baidu, Inc. (BIDU) and (AMZN) were holding up close to their highs, much as they are today. They also broke in late December 2007 as the market started a new leg down from the bearish reverse flag it formed in November through December of 2007. Thus, I am looking for a possible breakdown in AAPL, as well as other big NASDAQ leaders like AMZN and BIDU, to break down sharply from here if and when the general market begins a new leg down.

With AAPL failing to hold the $400 price level in late July, similar to the way it could not hold the $200 price level in late December 2007, the stage is set for history repeating itself, although the comparison between AAPL of today and AAPL of late 2000 is not necessarily “apples to apples,” if I might employ a bad pun. It is close enough, however, to tell me that the next leg down in the market, if it is going to happen, is going to take down the big NASDAQ stocks with it, and this is my rationale for liking the SQQQ or the QID as a reasonable way to play for such a break.



When it comes to shorting individual stocks, most stocks have been chopping back and forth along with the market without really splitting wide open. However, my guess is that if the market embarks on a new leg to the downside, some of these choppy sideways patterns will break to new lows. Thus I am on the lookout for the weakest set-ups here, and particularly stocks that have broken down from short-sale patterns and which may be “ledging” as they consolidate within a firmly entrenched, overall downtrend.. OpenTable, Inc. (OPEN) is one such situation that has recently “broken out” to the downside and through the neckline of a head and shoulders topping formation, as I’ve outlined on the weekly chart below. OPEN fits the bill as a hot, former leader building a “ledge” (yellow highlighted area) as it consolidates the prior down move and breakout through the neckline. This past week was only four days long, but OPEN sold off on extremely heavy weekly volume as it closed at a lower low right around the 55 support level. While this would be very shortable on any rally up towards the 60 level, as it was on Friday, this appears to be on the verge of a downside “breakout,” so it could be shorted on this basis, using a 5% upside stop, or at least the 59.20 intra-day high on Friday.

OpenTable, Inc. (OPEN) Gilmo Report Chart

In my last two reports I have focused on (SOHU) as the most shortable of the Chinese internets, and it did not disappoint on Thursday and Friday as it broke down through all five of the moving averages I show on the daily chart below, most notably its 50-day and 200-day moving averages. SOHU’s chart typifies the choppy action in the stock since the market hit its lows five weeks ago. Despite the choppiness, one could still be holding a short position in the stock taken last week when it rallied up to prior resistance at the 83-84 price area, as I suggested in my report of August 31st, since the stock has never moved above the intra-day high of that day. Now with the stock breaking down through the 50-day line on increasing downside volume which contrasts with the waning upside volume on each of the past two upside bounces in the stock, the stage may be set for a breakdown through the lower trendline I’ve drawn along the series of rising lows over the past three weeks, so I would certainly look to short into any rally up towards the 50-day line at 78.28. (SOHU)  Gilmo Report Chart

This past Wednesday and in my August 31st report I suggested that one could take short positions in retailers like TIF, JWN, LTD, EL, UA and Deckers Outdoor Corp. (DECK), shown below on a daily chart. While all of these have moved somewhat lower than where they were trading Thursday morning they have still not displayed any wholesale breakdowns. Among these TIF, EL, UA, and JWN appear to be in the weakest positions as they drop down towards their 200-day moving averages, while LTD is still hovering just below its 50-day moving average. The only one I show on a chart here is DECK, which is also hovering just below its 50-day moving average where it closed on Friday on expanding downside volume. In my view, if DECK is going to work as a late-stage failed-base type of short-sale set-up it is going to have to fail outright right here along the 50-day line given that it has now rallied just above that key moving average three times since failing on late-stage
breakout attempt. I would therefore use the Friday high at 92.59 as a stop if I want to test this on the short side. DECK lost 19 cents a share last quarter, something it hasn’t done in at least six years, so the growth story here may be at risk.

Deckers Outdoor Corp. (DECK) Gilmo Report Chart

Among all the retailers I’ve been watching as potential short-sale targets, the H&S type set-ups in TIF and UA are certainly compelling, but I’d have to say that none is as classic as the H&S top we see in former big leading retailer Fossil, Inc. (FOSL), shown below on a weekly chart. The massive price break off the peak defines the right side of the “head” in the H&S formation, and the right shoulder is formed by the ensuing rally that retraces roughly 50% of the prior downside break off the peak. The right shoulder also seems to find resistance within the congestion area defined by the short base that forms the left shoulder in the pattern. This is textbook stuff, as far as I’m concerned, and the only trick here is how to enter a short positoin without getting stopped out on any upside jerk that carries above the $100 price area. Thus one could wait for either a rally up to $100 or higher to short into, or a high-volume break of the 40-week (200-day) moving average, the red moving average on the chart using a 5% stop.

Fossil, Inc. (FOSL) Gilmo Report Chart

Given the volatility of the market, the SQQQ or QID is a much simpler way to play the possibility of a new leg down in the market coming into play soon. Using the 2611 high of last week on the NASDAQ Composite as your selling guide for the SQQQ or the QID has so far kept you in the game and should continue to if the market remains in the “chop zone” for a few more weeks. The point here is that we want to be in position for any eventual downside breakout and a new potential down leg in the market extending from its current bearish reverse flag formation. The action of the last two days has helped to clarify the situation that I found a bit uncertain in my mid-week report of this past Wednesday, and if one looks at the charts of big European financials like UBS Ag (UBS) or Credit Suisse (CS) you can see what the catalyst for a new leg down in the markets is likely to be. September is likely to be a very interesting month for the markets, and my main objective here is centered around the task of getting properly positioned for another leg down using a combination of the SQQQ, QID, and individual short-sale target stocks.

On an administrative note, some members may notice that despite the date on the cover page of this report is exactly 10 years after the terrorist attacks of September 11, 2001, I have not offered any platitudes or commentary in reference to this very important date in history. In my view, there is enough of that in the media this weekend, so I won’t add to it. Suffice it to say that if you want to read about my thoughts and experiences on that hectic day just turn to Chapter 9 and pages 313-316 of “Trade Like an O’Neil Disciple” (John Wiley & Sons, 2010).”

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 positions in AGQ, DGP, OPEN, and SQQQ, though positions are subject to change at any time and without notice.

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