The Gilmo Report

June 11, 2008

June 11, 2011

As I wrote over the weekend, and in no uncertain terms, the market rally failed on Friday, June 6th. The marginal “follow-through” failed, and so the broadly positive action of stocks in trading last Thursday, June 5,th that created an impression of broad strength in the market, immediately changed character the very next day. This occurred despite the oversold bounce we saw on Monday and to a much lesser extent Tuesday, which has now given way to further downside. The past two days were weak rally attempts by the various indexes, and today the NASDAQ Index broke right through its 50-day moving average. Instead of showing strength by rebounding off of the 50-day moving average, the “NAZ” rolled right over and is now starting to emulate the ugliness of the Dow and S&P 500 Indexes.

All that you know for certain right now is that the market is in a correction with a downside duration and magnitude that is currently unknown, and that’s good enough. I would not, however, be surprised to see the market test or even break through its March and January lows. As I wrote over the weekend, continued deterioration in the financial stocks as a result of revelations regarding the amount of “toxic” mortgage securities they have on their balance sheets could lead to “forced selling” as financial institutions have to sell stock, among other assets, in order to raise liquidity. This is my theory, but the bottom line, in my view, is that the market has, at the very least, the distinct odor of determined distribution about it. I see no reason to own stocks, to be quite frank, since I don’t consider the risk/reward equation to be all that attractive. If you have profit cushions in certain stocks that you are comfortable holding through a market correction, I wish you luck. But I am certainly not going to tell anyone that they have to own stocks here, since it is at least going to be several days from now, or more, before we have any ideas about whether this market is again buyable or not.

Two major research/brokerage firms put out back-to-back upgrades on various solar stocks on Monday and Tuesday, respectively, and of course some of these stocks have also rallied over the past two days, including First Solar (FSLR), which we have identified as a potentially failed, late-stage, punchbowl short-sale set up. You can see that FSLR has rallied into resistance at around the 260 price level three times now, and today stalled out at that level after rallying sharply on a recommendation by a major brokerage firm. Note that the stock also bounced off of a logical support zone at the 225-235 area and for the past five days has essentially been consolidating its recent downside move. The stock again looks like a possible short here with a stop at the 260 resistance level, more or less. This may be able to move down into the 220 level or a little lower in a continued weak general market.

First Solar (FSLR) Gilmo Report Chart

As the FSLR example shows, look for logical areas of support from which the stock might bounce to take some profits in your short position, and then look to re-short on logical bounces into potential resistance areas. It’s possible that FSLR could rally up into and just beyond its 50-day moving average, taking the stock up into the 180 price area. That is why I’d be inclined to cover a short position at the 160 level or sooner if the general market began to stage a sharp, bouncing rally, which is possible at any time and is what makes short-selling difficult, so you have to be somewhat anticipatory in this regard and, above-all, quick on your feet. You want to be covering into sharp downside moves, and not vice versa, and then shorting into short, sharp, weak-volume or stalling rallies, and not vice versa. Keep that one clear!

All of the short positions we’ve discussed recently appear to be working, and so consider taking 20% profits on positions when you have them, and of course at the time looking to cover on downward moves into logical areas from which the stock might bounce. Of course, you can, if you have shorted a stock at the most optimal point, sit through any and all bounces as long as you are not stopped out of your overall position. This is for the tougher among you who might want to play an extended potential downside move in a former leader.

Here’s an idea of how I might handle Intuitive Surgical (ISRG) from here. If you shorted it somewhere around 280 or higher, the stock is now in a downtrend that could potentially carry it through the March low at 254.37, at which point I might look for the stock to undercut that low and then attempt a rally. So you would look to cover at least part of your position when the stock undercuts the 254.37 low, particularly if the market is screaming to the downside, fear is rampant, and blood is on The Street, all at the same time. When this happens, you get a rush of liquidity in a stock as sellers panic, and it is the perfect opportunity to easily cover a short.

Intuitive Surgical (ISRG) Gilmo Report Chart

As the market weakens, keep on the lookout for Late-stage Failed-Base short-sale setups, or LSFBs. These sorts of set-ups occur when a stock fails and breaks back down through a buy point in a faulty, late-stage base, and usually after the initial downside price break the stock will attempt to rally back up into an area around the former buy point and into the 50-day moving average, as ISRG did when it failed (see above). Take a look at Icici Bank Ltd. (IBN), on the weekly chart below, when it failed from a breakout attempt in early January 2008. This is essentially how they happen, and IBN is a good example to study. In most of these types of set-ups the stock fails on a breakout attempt as volume picks up, and then it will generally try and rally back up towards the original breakout point, often near or at the 10-week (50-day) moving average, and then eventually rolls over.

Icici Bank Ltd. (IBN) Gilmo Report Chart

What is interesting about IBN is that the stock started out as a Late-stage Failed-Base short-sale set-up and has now evolved into a “big head” Head and shoulders Top formation. Note how the stock is just starting to pierce through the neckline on the pattern, but I wouldn’t be trying to short the stock aggressively here since it could turn and rally back up through the low on the left side of this right shoulder and fake out premature short-sellers moving in on the obvious initial break of the neckline.

AGCO Corp. (AG) offers another example as it recently failed on its breakout attempt through the 70 price level, and then broke back down through the buy point with volume picking up sharply, as shown on its weekly chart below. The stock then bumped up into the 10-week (50-day) moving average before starting to roll over again. This stock is starting to undercut some support levels, so it might try to turn and rally as it fakes out short-sellers who see the obvious breaches of support at short-sale signals. Therefore, I’d wait for this thing to rally before I’d try and short it.

AGCO Corp. (AG) Gilmo Report Chart

Dryships (DRYS) was a previous “Punchbowl of Death” short-sale suggestion back around the 100 price area, and notice that the stock continues to move lower after it failed to hold the 20-day moving average as it bounced around in the 90-95 price area for several days before breaking down again.

Dryships (DRYS) Gilmo Report Chart

The next two days will be interesting to see whether today was just the beginning of further carnage as we move into the end of the week. I believe this to be the case. Leaders outside of the fertilizer stocks have broken down sharply, and it may just be a matter of time before the fertilizer stocks break down as well. In any case, I have favored some of the Ultra-short index and sector ETFs as well as shorting certain sector ETFs as vehicles to play the downside in the market. Keep in mind that if you are trying to jump in on the short side after the market has already started to break, you risk being whipsawed on any sharp upside bounce. I prefer the ETFs because they tend to be less volatile in most cases, and when stocks start to break down they tend to do so in groups, so an ETF is generally an effective way to play such downside. Of course, you can do quite well simply buying an Ultra-short Index ETF or even shorting an Ultra-long ETF like the Pro-Shares NASDAQ 100 Ultra-long ETF (QLD) if the market is likely to test its March and January lows.

Again, if you are long and are trying to hold onto certain stocks in which you have a profit cushion, I wish you luck. Otherwise, I’m looking to play the other side of this market or to stay in cash.

Gil Morales


Gil Morales & Company, LLC

At the time of this writing, Gil Morales & Company, LLC held a short position in FSLR. Positions mentioned are subject to change at any time.

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. ©2008-2019 Gil Morales & Company, LLC. All rights reserved.