Several Theories To Explain Apple's Nosedive

Jan.30.13 | About: Apple Inc. (AAPL)

While I have been a bear on Apple (NASDAQ:AAPL) forever, and have told you many times to sell the stock (starting off with this article when the stock was at $700 - Apple: Take The Money And Run), nevertheless I never thought it was an expensive stock. That's the reason why I never told you to short it. It's one thing to sell a stock because you think it won't do anything, and it's another to short it because you think it will tank.

To be honest, I didn't think it would tank the way it did. I just thought it would simply bounce up and down and be dead money for those invested in it. Well it turned out to be more than dead money, it turned out to be toxic. And to be totally honest, Apple's nosedive below the $450 mark surprised even me. And believe me, I don't get easily surprised.

So the question is, if Apple's stock is not expensive, why was it below $450 recently? Here are several theories as I see things that mostly don't have to do with Apple itself.

Theory 1 - Global margin call

I remember a conversation with a hedge fund manager a while ago, telling me he is getting killed in Apple. At the same time he was, he also told me he doubled up on the stock on the way down. By "On the way down" I mean when the stock reached $600. I don't know if he still has his position, but if he hasn't sold, he is bleeding very bad.

But bleeding is not the worst that can happen. Bleeding simply means that your margin positions are still intact and your broker hasn't forced you to sell to cover margin.

Since Apple is the most over-bought stock on margin in the world and in more hedge fund portfolios than meets the eye, is it possible that the stock's nosedive is simply a matter of a global margin call?

Theory 2 - Portfolio re-balancing

A good point raised by a comment in my recent article The 'Too Big Of A Market Cap Stock' Theory:

You may also want to consider that at some point investors have as much of APPL as they desire (say 5% of portfolio) and once almost everyone has done this then the stock can only go down since there aren't enough buyers left regardless of underlying metrics. However, as it falls and looks attractive those same people may buy more to get back to their desired allocation. APPL too will go sideways; whether at 300 or 500 is hard to tell but it will happen sooner than later outside of an AAPL takeover of the rest of the home electronic market (TV, radios, etc).

I totally agree with this comment. As such, there might be limits as to how high Apple's stock can go (or any stock for that matter), irrespective of how good earnings are or how bullish forward guidance from management might be.

Theory 3 - The market has it right

Markets are forward looking. Price action today reflects what the market thinks the company will be worth in the future, not today. So while Apple has done great in the past, the market is probably telling us that the future is a little cloudy.

With this in mind, the market probably thinks Apple will command lower margins in the future and have more competition from the likes of Research In Motion (RIMM) and Nokia (NYSE:NOK) - not to mention the armada of Chinese Google (NASDAQ:GOOG) Android makers that are invading world markets with lower priced alternatives.

Many analysts have said that the high end smartphone segment is saturated and will provide no growth after 2014. If that's the case, then the Nokia Lumia 920 and RIMM's new Z10 devices will only add to that competition in the high end smartphone segment.

Theory 4 - Long Apple and short everything else?

One of the tactics that hedge funds use is to go short one stock and long another. Now in this video here, the guest Jim Doak claims that there is a trade going on with U.S. hedge funds, where they are long Apple and Short RIMM.

If this is true, it explains the run up in RIMM short interests. In other words, as RIMM was going up hedge funds would sell more and more RIMM shares short and would buy more and more Apple shares on the way down.

Now RIMM is very small in market capitalization to be able to even scratch Apple. No matter how many shares of RIMM hedge funds sell and buy Apple with that money, they would not be able to affect Apple in any way. The money from RIMM is not a whole lot.

However, suppose that several hundred hedge funds were all going long Apple but shorting a wide variety of stocks at the same time. Imagine while they were all long, suddenly, on the first big Apple pull back, their broker calls them up and says they need to unwind positions.

See, when you are long Apple and short something else, when you unwind positions, you will sell Apple and buy that something else you were short in. If this was done on a massive scale, it explains the never-ending drop in Apple, because on every down-tick, brokers would be calling hedge funds to unwind.

That also partially explains the run-up in RIMM itself. As Apple's stock was falling, hedge funds were forced to sell Apple and buy RIMM to unwind the position.

Now if the above scenario has any merit, it also probably means that the leverage in Apple has been washed out and there is probably not going to be any more forced unwinding pressure on Apple anymore.

For RIMM, it might also mean that hedge funds will not be forced to buy back any more RIMM shares to unwind any positions, because they have probably covered all there is to cover. This also explains the big fall in RIMM's stock the past couple of days. If this scenario makes any sense, logically we will see a very big drop in RIMM short open interests in the next Nasdaq report.

Bottom line

My conclusion is that the fall of Apple's stock has to do with all of the above, especially theory 4, and much less to do with valuations or even future prospects.

In other words, the nosedive in Apple's stock is probably a case of overexposure, too much leverage and too many people wanting to become rich very fast, thinking Apple was such a sure trade.

And if my theory that most of the forced selling in Apple shares has ended is correct, then there is probably not much technical selling pressure on Apple anymore and it probably deserves at least a healthy bounce.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.