Where's Apple In The Public's Appraisal Of Market Sentiment?

| About: Apple Inc. (AAPL)


We’ll get to Apple, but first what is the public sense (sentiment) of how high (or low) the market is now?

Does this differ from the perceptions of the every-day-present market-making professionals? If so, in what way?

Is there a way to identify the difference, to use it to make money, to be ahead of the crowd?

Why the substantial variance in price change expectations for one market index, compared to all the others?

What is the current expectation of market pros for Apple?

How come Market-Makers [MMs] behave so optimistically now at record market index levels?

It's not just now. They usually behave that way.

Take a look at what their hedging of the market index for SPX, the S&P 500, has implied on a once a week basis over the past 2 years for likely coming ranges of price for that index.

(used with permission)

First, for those new to a Block Trader Forecast [btf] picture like this, the vertical lines are price range forecasts of likely coming prices, not historical records of past prices so common to most stock "charts." The forecasts are implied from the self-protective hedging actions taken by the market-makers as they must expose firm capital to market risk in order to "fill" orders by their big-money portfolio-manager fund clients.

Each of those price range forecast bars are separated into implied upside and downside price change prospects by a heavy dot of the end-of-day market quote at the date of the forecast. The separation has a measurement label we call a Range Index [RI] that tells what proportion of the whole range lies below the current quote. The smaller the RI, the larger is its upside prospect.

Now contrast that above history to exactly parallel implied forecasts by the same MM community, but for the SPDR S&P 500 (NYSEARCA:SPY).

The heavy-dot prices of SPY are 1/10th of the SPX index, and they track very closely to one another, thanks to index-basket arbitrage seagulls constantly patrolling that beach for any squibs of opportunity.

But if the MM community is looking at two such closely-locked price series, and they come up with these differences (top of range for SPY 205.34, top of SPX 2103.29, converted to 210.33 in SPY prices) why does that happen? What does it mean?

The same model is used to convert hedging actions into forecast price ranges for both SPY and SPX. But the hedging is being done in different markets - options in SPY in one, and options on SPX in the other. SPX index option traffic is dominated by MMs, SPY ETF options are influenced, perhaps significantly, by public, and non-professional investors.

The resulting appearance is that the public is more fearful (lower forecast price ranges) than the far better-informed market pros. The pros also have skills not shared with the public to protect against possible problems, and their continual market presence provides arbitrage opportunities to profit from market-participants' errors in perception.

Perception is the key notion here. All players in this very serious game act on the basis of their perceptions. Some are bound to benefit, others are bound to be hurt in the process; that's what makes markets functional, differences of perception, of opinion.

So in the SPX~SPY situation, who is winning, who is losing? In the two years pictured, it seems most likely that those with the more optimistic outlook probably benefited at the opportunity-foregone losses of the more fearful.

But is this some peculiarity of SPX and SPY, evidenced just in the past two years?

No, it is not. Here is a picture of today's (7/9/2014) MM appraisals of upside price change prospects for the S&P 500 and the other three major market indexes (DJIA, Nasdaq 100, and Russell 2000) and their index-tracking ETFs, SPDR Dow Jones Industrial Average (NYSEARCA:DIA), PowerShares QQQ (NASDAQ:QQQ), and iShares Russell 2000 (NYSEARCA:IWM).

Their current upside prospects are indicated by the horizontal scale down in the green area. Of perhaps more interest is the actually experienced average worst-case price drawdowns in each subject following all prior forecasts of the last 5 years with upside-to-downside balances like those of today. That negative side of the coin is measured by the vertical scale at left in the red area.

Continuing with the SPX~SPY comparison, SPY at [ 1 ] shows the smallest upside prospect of any, and also the least-risk-exposed (historically) alternative. But SPX at [ 2 ] offers an upside of +6%, compared to SPY's +3%. Same downside experience of -3%.

Now let's consider the others. DIA ETF [ 1 ] vs. DJIA Index [7] has the same reward~risk balance (+3,-3) vs. (+6,-6) but no proportional bonus for the added risk. IWM ETF [3] vs. RUT index [5] favors the index experience with more current upside prospect at lower prior price drawdown involvements. QQQ ETF [6] vs. NDX index [4] . . .whoa! What goes on here?

Why is the NDX index offering an +11% upside, far above any of the others, while having a Range Index that in the past has had average worst-case price drawdowns over 5 years better (smaller) than any of the other major indexes? What makes the NDX so different?

Apple, Inc. (NASDAQ:AAPL) is the difference. It is only 1 stock in a 100-member index, but the index is cap-weighted, and AAPL is the single biggest capitalization in the market, $575 billion, compared to Exxon Mobil's (XOM) second-place (not in the NDX) $440 billion. So AAPL can be a big influence if its outlook by the market pros is much different from the rest of the NDX.

When we bring AAPL into the prior picture, here is where it locates, now at [ 1 ]:

AAPL has more drawdown in its history at today's level of Range Index than does the NDX index now shown at [8], but it also has more upside prospect. And that upside is far bigger than any of the other things in the picture.

There are now some additional subjects now being shown beside AAPL. They are the 3x leveraged versions of the index-tracking ETFs, included because they have provided some very useful clues to interim market moves. Added are ProShares UltraPro S&P 500 (NYSEARCA:UPRO) at [4], ProShares UltraPro DOW 30 (NYSEARCA:UDOW) at [9], ProShares UltraPro Russell 2000 (NYSEARCA:URTY) at [11] and ProShares UltraPro QQQ (NASDAQ:TQQQ) at [5].

In the tradeoff between historical risk exposure to worst-case price drawdowns, and return prospects of current forecasts, adding a 3x leveraging to price change prospects for major stock market indexes and their tracking ETFs, at this stage of the market appears to be a bad idea. In every case, it has moved them further to the left and above the dotted diagonal where risk and return are of equal size.

That movement in the past has usually been followed by temporary market retreats, often of a scale large enough to wish to be avoided. The typical experience of attempting to gain advantage by employing inverse (short) market-tracking ETFs has proved disappointing for many. It seems to be advisable as a general rule, as one commenter observed, "don't try this at home, not yours or anyone else's."


So, if the investor is concerned (as he/she might well be) about near-term significant market weakness, how best to seek some advantage? The obvious answer is to move portfolio emphasis into AAPL. Here is how its current btf picture looks, with its prior market experiences subsequent to today's level of Range Index.

Key data points to consider here are AAPL's Range Index of 24 means that MMs see prospects of 3 times as much price change upside as down; 83 of every 100 such forecasts (150 of them) in the past 5 years have produced gains, and including the other 17 incurring losses, the net result has been wealth-building at an average annual rate of +45%.

With MM expectations trending higher, there does not at present appear to be sufficient concern either present or building to create concern for interim downside experiences larger than the -5% seen from time to time in the past. In contrast, some have expressed the concern: "Is it too big to succeed?"

A concern many are willing to embrace.

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