Apple's (AAPL) shares have been quite hot lately. Apple shares closed at $542.44 on 2/29/2012, after reaching an intraday record high price of $547.61. Given its current market capitalization of over half a trillion dollars at $505.75 billion, it is quite impressive that Apple has appreciated by as much as 33.93% year-to-date from its 12/30/2011 close of $405.
Apple Stock Price y-Year chart
Source: Yahoo Finance
It seems there is very little that can stop Apple. Less than 2 weeks ago, when Apple shares suffered a technically bearish "key reversal day", many analysts, investors and traders sounded the warning alarms, claiming that Apple has established its 2/15/2012 intraday high price of $526.29, and will continue trading lower in the near future.
We actually dismissed such predictions in our article of 2/21/2012, "3 Indications Apple Shares Haven't peaked Yet". We provided many factors supportive of additional gains in Apple shares, including the prevailing interest rate environment where the Federal Reserve has maintained near zero interest rates and has indicated it would continue to do so through 2014.
On 2/29/2012, as Apple was establishing its most recent record intraday high of $547.61, U.S. Federal Reserve Bank chairman Ben Bernanke, in a testimony to lawmakers in Washington, dampened the prospects for additional monetary easing. Stock markets immediately started retreating. Apple shares initially maintained their gains, but at around 3:15 P.M., they came under tremendous selling pressure, dropping as low as $535.86 by 3:37 P.M. before bouncing to close at $542.44. Before the 3:37 P.M. bounce, it almost seemed as a possible repeat of the price action of 2/15/2012.
Apple Stock Price Intraday Chart for 2/29/2012
Source: Yahoo Finance
Although Apple shares continue to look quite impressive, investors need to beware Mr. Bernanke for 3 good reasons, as was evident on an intraday basis on 2/29/2012. Naturally, such warning is not about Apple on its own, but a risk to the entire market, as it would be challenging for Apple to avoid a market wide sell-off.
1. Effect of No Monetary Easing
It does seem at this time that the economy is doing well, with the latest GDP growth rate recording a 3% gain. As long as the economy continues to do well, then lack of monetary easing by the Federal Reserve should not cause a major setback for the market. As a matter of a fact, as long as inflation remains in check, and the economy continues growing, lack of monetary easing may even be interpreted as a positive sign for the market for lowering future inflationary pressures.
However, if lack of monetary easing causes the economy to retrench, and consumer demand to drop, then such drop in consumption will undoubtedly affect potential sales for consumer technology producers such as Apple.
In addition, if lack of monetary easing causes additional pressures on financial stocks, then a market sell-off, led by financial stocks, could also take Apple down with it, although such drop may once again prove to be temporary.
2. Effect of Possible Higher Interest Rates
Although the Federal Reserve at its January 24-25 Federal Open Market Committee meeting has given indication that it would maintain its current low interest rate policy through 2014, it is unlikely they would do so in case inflation creeps higher.
In his latest testimony, Mr. Bernanke spoke of the latest inflationary impact of higher gasoline prices, claiming such impact is likely to be temporary. The keyword here is "likely". What if such impact does not prove to be temporary? In such case, if inflation creeps above the Federal Reserve's target of 2%, there is no question that the Federal Reserve would be forced to increase interest rates sooner rather than later.
By taking the historic step of setting an inflation target at its last meeting, the Federal Reserve in a sense has placed itself in a possible future credibility doubt "fait accompli"; if inflation creeps higher than the established target sometime in the next two years, then if the Federal Reserve leaves interest rates unchanged, it would lose credibility for not doing what is necessary to maintain its own target. On the other hand, if it raises interest rates to maintain its inflation target, then the Federal Reserve will lose credibility for having said it would maintain current low interest rates through 2014, and yet not being able to follow through on such promise.
The Federal Reserve could possibly have quite a dilemma on its hands....
However, in both scenarios, whether in a higher inflationary environment, or a higher interest rate environment, or both, market valuations, and PE ratios will come under pressure. Although Apple still maintains a favorable low PE ratio, in a higher inflation/higher interest rate environment, Apple's share price would still come under pressure due to comparative alternatives.
On the plus side, due to higher interest rates, Apple would start earning higher revenues on its massive cash of almost $100 billion (assuming they have not already locked themselves into long term low yielding fixed income instruments, in which case they would actually lose money due to a potential principal loss on the market value of such instruments) . However, in any case, it is unlikely such possible increase in interest rate earnings would offset a lower calibration of PE ratios.
3. Effect of Market Volatility
In an article we published on 8/29/2011, "The Bernanke Effect on Widely Held Stoicks", we discussed how in general, the stock market had done well following FOMC meetings. However, given Mr. Bernanke's latest testimony, the resulting bearish market reaction, inflation uncertainty, the cloud that has been cast about prospects for any further monetary easing, and the questioning of the FOMC's future ability to maintain low interest rates through 2014 (and related prospects for Federal Reserve credibility), there is now more uncertainty about the possible positive effect of Mr. Bernanke on the stock market.
Uncertainty results in volatility. Volatility results in risk. Higher risk results in possible lower stock valuations, in order to compensate for the increased risk. Hence, if such volatility ultimately leads to recalibration of risk adjusted returns, then at the least, the stock market will face headwinds, including Apple shares.
Does this mean that Apple shares will no longer move higher? Not necessarily. As a matter of a fact, Apple is still our favorite stock to own. However, investors need to beware Mr. Bernanke. Going forward, investors could possibly face increased volatility in Apple's stock price. Such phenomena, if it comes to fruition, will be experienced by the entire market, and Apple may actually feel it less than other stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
