This is a follow-up to my previous posts on Apple (AAPL). The first noted a bubble in formation, while the second noted the flash crashes and what they were signaling. In this post we'll review the fundamentals of the situation and offer some hypotheses as to how price may behave.
First let's start with a chart, to give us some context.
Now, let's review some of the fundamental developments that will help push price lower:
1. The U.S. Department of Justice has filed an antitrust lawsuit against Apple, one which Apple wishes to fight back against. I usually side with the company being sued in antitrust legislation, and I do think Apple is operating legitimately here. With that said, though, I do think the lawsuit runs the risk of tarnishing the company, and will provide investors sitting on huge profits with some extra incentive to begin taking them. That is what many Apple shareholders who grow enraged when Apple is critically assessed do not realize; when a stock rises significantly, those who have been in it for a while have incentive to get out and book enormous gains on even the slightest of bad news. This is why parabolic moves are unsustainable regardless of the asset in question.
2. In addition to the attack from the DOJ, Apple is also under a potential attack from carriers that are showing less interest in subsidizing Apple's mobile products. For instance, Verizon Wireless (VZ) recently announced it will begin charging customers $30 to upgrade to a new phone. At the same time, Apple will continue to be attacked on price and margins by cheaper products from Google (GOOG) and Amazon (AMZN). Apple's trick has always been to sustain a first mover advantage by inventing or re-inventing computing devices. For this reason, I believe success with an Apple TV set is vital to the company's share price. The Apple TV set is expected Q4 of 2012.
These company-specific events are compounded by Apple's ownership issues; hedge funds are significantly invested in Apple. In our current environment, hedge funds employing high frequency trading contribute to a more volatile market with more flash crashes.
Moreover, in our current monetary system, whenever money supply is expanded (as it continues to be), new money that is created flows from the banks down. This means corresponding inflation hits what banks and funds (the distinction between the two being largely erased thanks to the repeal of Glass Steagall) buy first - i.e. Apple shares - before it trickles down to consumers paying $4.50 for a gallon of gas. Now, it is certainly possible that money supply will continue to expand - in fact this is what I'm expecting - although I'm skeptical that hedge funds will continue pouring money into Apple.
Rather, based on the parabolic move that has occurred, the DOJ lawsuit, and the threat of losing market share in existing products as second movers (i.e. Amazon, Google, Samsung (SSNLF.PK), etc) move in ... all this will lead the funds to look elsewhere. Being a gold bug who focuses primarily on energy and precious metals, I consider it quite likely that the funds will find their way there, as precious metals and energy stocks are significantly undervalued.
The good news for passionate Apple shareholders is that hedge fund unloading could result in a market that is oversold, thus providing value investors with bargain prices. That is one of the problems (or opportunities, depending on your perspective) that hedge funds and their high frequency trading systems bring. They create a market that is more volatile and more irrational in both directions. A move back to $425 or lower could constitute an excellent buying opportunity, in my opinion, as that would essentially erase the parabolic blow off we've had thus far and allow Apple to progress upwards at a more natural rate.
Opposing Arguments to Consider
In the interests of creating a balanced piece, there are two points I want to note that I think could help Apple's share price continue to rise without much of a pullback:
1. If the Fed continues to expand the money supply via QE3 or whatever they want to call the process that sends MZM higher, I think it will be tough for any stock to fall very much and stay there. The Fed's actions can push the market as a whole higher, simply because newly created liquidity from the Fed will go first to banks who will likely use them, at least in part, to prop up equities. For this reason I personally don't enter short positions in equities in an environment where the central bank is aggressively participating. And if I do think something is ripe for being shorted, I often recommend coupling it with a long position in something else.
Although I agree that Amazon's P/E ratio is a bit much and that the company is not undervalued, I do not think it is overvalued either. As such, for those who want to couple a short position in Apple with a long position in another technology company so as to remain neutral to macroeconomic events, Amazon remains my favorite choice. For more on this line of thinking, see my previous piece, "Vertical Integration is Why Amazon Will Be Worth So Much More." Indeed, the gap between Amazon and Apple has narrowed since Apple began its decline on April 10, so early signs suggest this strategy could work.
2. The Apple TV set has enormous potential. If Apple can nail this, it will be potentially huge - bigger than the iPad and the iPhone. It could be another market Apple can re-invent and pave the way for Android as a lower priced offering. So, the more positive news there is surrounding the forthcoming Apple TV set, the more bearishness becomes tough to justify fundamentally. As we are still at least six months away from a product launch, though, I think it may be a bit early to start forecasting higher share prices now based on this forthcoming product.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.