The Gilmo Report

September 25, 2011

September 25, 2011

The major market indexes, as represented by the NASDAQ Composite Index daily chart, below, gapped down Thursday on what can only be called a wave of massive liquidation that took stocks and commodities to the proverbial “woodshed.” This sent the NASDAQ below its rising-lows trendline which may now serve as upside resistance as it did on Friday’s weak-volume attempt at stabilization following the Thursday massacre. By Wednesday’s close it was clear that the market does care for “Operation Twist,” and this latest break to the downside greatly increases the odds that we will break below the August lows. For now, at least on the NASDAQ, the lows are still a little ways away from being penetrated to the downside, but if we have another couple of days like we had on Wednesday and Thursday the market may soon find itself floundering in deeper waters. It isn’t clear whether the market will spend a few days noodling around before attempting a more decisive move, one way or the other, but I would not be surprised if some news event coming out of Europe serves as the catalyst for such a move, one way or the other. Taking this week’s action at face value, my current trading orientation is towards the short side as I anticipate the possible start to a new leg down for the market within an overall bear phase.

NASDAQ Composite Index Gilmo Report Chart

The S&P 500 Index has lagged the NASDAQ given its weightings in oil, machinery, transportation, and financial stocks, among others, which have performed far more weakly than the big-stock NASDAQ leaders. The daily chart of the S&P 500 shows the index bouncing along the August lows after it too busted its rising-lows uptrend line. Technically we would consider this nothing more than a test of the August lows, with the final resolution still to be determined. Given the severity of this past week’s drop, the market is in a logical point, at least on the S&P 500 chart, to try and bounce and shuffle along these lows, but I would watch for any further rally to run into resistance at the underside of the rising-lows trendline. This applies to the NASDAQ as well. Unless the Fed steps in with a massive new, direct form of QE in order to prop up the markets, I don’t see that money flows are going to suddenly reverse direction from out of the market back into it. In my view, the market is presaging further economic weakness, and with Europe tottering while China begins to feel the effects of a debt bubble of its own, a global “double-dip” is likely in the offing.

S&P 500 Index Gilmo Report Chart

The week before last on Fox Business News I answered anchor Sandra Smith’s question regarding what could derail the precious metals story. My direct response was simple: a sharp and continued sell-off in stocks could set off liquidation and margin calls that lead money managers and investors of all stripes to dump assets in order to raise liquidity, and that this would no doubt affect gold and silver. This is what I often refer to as “forced selling,” and when it occurs it leaves nothing standing in its wake. That is what we are seeing in gold and silver currently, and a chart of the SPDR Gold Shares (GLD), shown below, illustrates the carnage in the precious metals. But as I pointed out in my report of this past Wednesday, it was time to unload precious metals as I had dumped ½ of my precious metals positions on Wednesday in anticipation of dumping the rest on further weakness, which occurred on Thursday. Thus currently I believe there is absolutely no reason to be holding gold or silver, much less stocks, on the long side, unless one is holding an inverse index ETF like my beloved TZA.

SPDR Gold Shares (GLD) Gilmo Report Chart

The NASDAQ Composite has held up better mostly thanks to big NASDAQ 100 stocks like Apple, Inc. (AAPL), shown below on a daily chart, but that may not continue for long. As I wrote in my mid-week report of this past Wednesday, however, I shifted from long AAPL to short AAPL after it had run its course on the Livermore Century Mark trade, launching 22 points beyond the $400 “Century Mark” price level just as Livermore’s rule prescribes. The short trade ran its course back down to below the $400 price level, and my test short position was successful in confirming the resistance in AAPL around the 420 level. Volume was very heavy on Thursday as AAPL tested the $400 level, but the gap-down move places some questions on this recent breakout. In my view, institutions are piling into AAPL as a safe haven, given its low P/E ratio. Even if the stock tanks from here in any continued bear market, institutional money managers can keep their jobs since they can easily justify hiding in AAPL based on its low P/E and continued strong earnings and sales growth. If AAPL fails on this recent breakout attempt, however, it would be the final nail in the market’s coffin. Currently the NASDAQ is down 14% off its 2011 peak while the S&P 500 is down 17%, so the NASDAQ may soon start to play “catch up” on the downside on the backs of declining NASDAQ 100 leaders.

Apple, Inc. (AAPL) Gilmo Report Chart

Among the big-stock NASDAQ leaders AAPL continues to just barely hold its recent breakout, AMZN has fallen beneath its new high breakout from a flawed v-shaped cup formation, BIDU is a late-stage failed-base short-sale set-up, GOOG far below its 200-day moving average, and (PCLN), shown below on a daily chart, looks to be failing on a breakout attempt it made four days ago. Thursday’s heavy selling took the stock below its 50-day moving average, and on Friday a lower-volume reflex bounce took the stock right up into and just below its 50-day moving average. PCLN looked like it was going to fail outright in August, as we see on the chart, but it has helped do heavy lifting duty for the NASDAQ in late August into September as it rallied sharply back up off the lows it saw underneath its 200-day line in August. This latest technical action puts the late-stage failure question to PCLN again, and if one intends to be persistent in seeking out short-sale targets, PCLN has to be considered as potentially shortable here in order to test a possible “second-stage” breakout failure right here along the 50-day line. If I do end up testing this on the short side myself, I would use a very tight stop at Thursday’s 521.49 intra-day high or the 20-day moving average at 527.05. (PCLN) Gilmo Report Chart

In my Wednesday mid-week report I noted that Baidu, Inc. (BIDU) was in a very shortable position as a potential late-stage failed-base short-sale set-up which was also confirmed by the very weak action in all the other big Chinese internet stocks. BIDU gapped down on Thursday, and this gap-down could have been shorted right on the open at 134.37 as the stock then plummeted down to the 120 level. When a stock in a short-sale set-up formation gaps down as it initially breaks down from the formation, that gap-up is often shortable right off the open. You do not want to short gap-downs in short-sale target stocks that are extended to the downside, but when they first start to breakdown from the pattern, such as the way Netflix, Inc. (NFLX) initially broke out to the downside through the neckline of its H&S top formation last week, they can be jumped on right there as if one were buying a powerful upside gap-up. In this case, however, one is buying a powerful gap-down. I would look to add to or even initiate a BIDU short on any rally up into or towards the 200-day moving average at 130.14.

Baidu, Inc. (BIDU) Gilmo Report Chart

Sina Corp. (SINA), another busted Chinese internet that I discussed in my Wedneday report, also gapped down on Thursday and moved down through the prior 82 low from early August, as we see in its daily chart, below. That provided a short-term cover point on the “undercut & rally.” It sets up re-entry on the short side on this bounce back up towards resistance at the top of Thursday’s gap-down move and the 90 price area. This is where we find some overhead congestion from the latter part of August, as I’ve highlighted on the chart. This looks like a normal undercut and rally reflex bounce, and I would look to use this bounce as an opportunity to enter SINA again, or even for the first time, using the 90 area as a quick upside stop. If one is stopped out at the 90 level then the 200-day moving average at 98.80 would be your next short-sale target price, although I am not so sure that SINA is strong enough to rally that far. Thus this current move up towards 90 resistance looks potentially shortable, even at Friday’s close of 86.91, which is not quite 4% away.

Sina Corp. (SINA) Gilmo Report Chart

Retail stocks have been a stubborn group on the short side, but even in the face of persistent rallies in some of these we can get a sense of which might be the weaker situations. For example, Fossil, Inc. (FOSL) remains a strong short-sale candidate on the basis of its status as 1) a huge retail leader during the prior bull phase and 2) its clear massive-volume breakdown head and shoulders short-sale set-up formation, as we see in the daily chart below. When a big leader drops from about 130 to 70, no doubt many late-to-the-party investors will see it as extremely “cheap,” and their buying can prop up the stock for a period of time as it works its way through a possible right shoulder in the formation. On FOSL’s weekly chart, not shown, three of the last four weeks have shown tight closes at around the 94 price level, but I would tend to view this as a sign of steady distribution and selling of the stock at this price area. FOSL has not been able to rise above its 50-day moving average, and so it has been weaker than other retailers like DECK or LTD. From here, I would look to short the stock using a stop at the 20-day moving average at 96.97 with the idea that the stock will soon roll over through the 200-day line.

Fossil, Inc. (FOSL) Gilmo Report Chart

Tiffany & Co. (TIF) has been another retail stock we’ve had on our short-sale target list, and while it was able to rally well past its 50-day moving average on the upside it also broke down a severe 15% in just three days before finding support at the 200-day moving average. Like FOSL, TIF is in a head and shoulders type of formation, and Friday’s bounce off the 200-day line took the stock right back up into its 50-day moving average where it stalled out, as we see on the daily chart below. My guess, or rather my bet, would be that TIF is not able to get back above the 50-day moving average this time and so I would consider it potentially shortable here using the 50-day line as a quick upside stop. TIF is also somewhat similar to FOSL in that on its weekly chart, not shown, it shows some tight closes around the 70 price level on three of the past four weeks with wide weekly price ranges, which I see as clues of systematic distribution on the rally. The selling volume on the Thursday gap-down is also heavier than any volume seen on the rally back above the 50-day line, so on balance this looks far more negative than the rally back above the 50-day would lead you to believe.

Tiffany & Co. (TIF) Gilmo Report Chart

When I flip through the charts of my short-sale target stocks they all have big-volume gap-downs in the patterns that in most cases took the stocks to logical areas of support such as a moving average or a rising-lows trendline, such that seen on Rackspace Holdings, Inc.’s (RAX) daily chart, below. I’ve drawn this trendline on the chart, and it apparently served as short-term support for the stock on Thursday, but I note that Friday’s bounce was non-existent and occurred on an extreme dry-up in volume. While RAX was able to turn positive for part of the day on Friday, it never got above Thursday’s intra-day high. If I am not already short this from the 50-day/200-day moving average “black cross” around the 37-38 level, then I would look to either add or initiate here using the 20-day moving average at 36 as my quick upside stop, more or less. Depending on one’s own risk tolerance and shorting style, one could give it a little more room past the 20-day line depending on your entry price. In any case shorting the stock here comes with the idea that next week will see it break down through the rising-lows trendline.

Rackspace Holdings, Inc.'s (RAX) Gilmo Report Chart

For anyone who was bold enough to short Netflix, Inc. (NFLX) on Monday after I had discussed the stock in my report of last weekend, September 18th, you were well-rewarded as the stock continued to blow apart over the next three days. Now I see NFLX engaging in a little bit of “dead cat splat” action on its daily chart, below, as you will notice it is quite unable to stage any kind of “dead cat bounce.” With volume drying up it doesn’t look like buyers are stepping up to the plate, which is what is going to need to happen if the stock is able to muster a rally even up to its 10-day moving average at 161.21. On Friday, NFLX tried to rally above its recent three-day price range, getting up over 134 intra-day, but it could not hold the 130 price level and closed at 129.36. If you are bold, you could try shorting NFLX here with the idea that this “dead cat splat” is nothing more than a low-volume consolidation of the prior sharp move down and will result in a continuation to the downside next week from here, using the 134.19 price level as a guide for an upside stop. My bold longer-term prediction is that at some point you will see NFLX trading at closer to $40 – at some point – but I do see a tactical trade opportunity here using the proper risk controls.

Netflix, Inc. (NFLX) Gilmo Report Chart

Some notes from my trading diary regarding other short-sale target stocks that I still consider to be “in play:”

ACOM – has broken down through the neckline of a head and shoulders top formation but staged a huge-volume rally back up into the neckline, roughly running through the 23-25 price area. Look for the rally to potentially carry up into the 25 price area where the stock could potentially be shorted using the standard 3-5% stop-loss for short-sales.

OPEN – as I discussed in my Wednesday report, members should have watched for the “44-45 level as a potential area of support from which the stock could bounce,” and the stock did in fact bounce off a low of 43.25, finding support at the top of the base it formed between June and August of last year, 2010.

SODA – gapped down hard on Thursday with weak-volume buying on Friday. The stock is potentially shortable at current levels using the 20-day moving average as a quick stop guide at around the 38.70 price level.

SOHU – the stock has never stopped us out on the short side since I discussed shorting the rally up into 84 resistance in my August 31st report. As I have written frequently regarding SOHU, it has been the weakest of the Chinese internets and so has remained as “the most shortable of the Chinese internet stocks.” Of course, now we see all the Chinese internets getting slaughtered, but SOHU has led the way on the downside all the way down since late August.

If the short side of this market scares you, then cash is the “preferred venue,” particularly as we see the U.S. dollar rally in mirror fashion to the Euro as Euro holders apparently dump one fiat currency for the “tallest midget” among the fiat currencies, the dollar. Meanwhile, margin calls cannot be met in precious metals, so they get destroyed as investors sell them off to raise liquidity, and those seeking safe-haven go to the dollar given that the U.S. dollar market is highly liquid. As well, news of numerous hedge funds, such as Geoge Soros’ funds and others, closing up shop due to the mindless constrictions of Dodd-Frank implies that there are likely a number of hedge fund liquidations going on out there, and these liquidations do not readily turn into sources of funds to be re-deployed back into stocks – once they are out they are likely out for a period of time, at least.

Meanwhile, this past week has been one of my best weeks on the short side since May of 2010, when I got close to doubling my shorting account. As well, being long inverse ETFs like the 3-times leverage inverse Russell 2000 ETF (TZA) as I discussed in my report of last weekend, September 18th, has been quite profitable for those of who went in that direction. Making money on the short side requires a lot more courage than the long side, in my view, but some might say you just have to be “nuts.” In any case, the only way to make serious money in this market has been on the short side, despite brief breakouts from big-stock NASDAQ names like AAPL or AMZN, and that is likely to be the case going forward from here. Stay tuned.

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

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