"I'm not smart. I try to observe. Millions saw the apple fall but Newton was the one who asked 'why.' " - Bernard Baruch, legendary investor
While Sir Isaac Newton was able to achieve a moment of scientific insight regarding the phenomenon of gravity through his visceral observation of the behavior of apples falling from a tree, these days one seeks slightly different insight into the state of today's stock market by observing the role of Apple, Inc. (AAPL) in the current environment. What is observable in this instance is that the direction of Apple stock, which reported earnings on April 24, has had an increasingly greater correlation to the Nasdaq 100 and by inference, the Nasdaq Composite Index. Today, Apple represents about 17% of the Nasdaq 100 but its effect on the markets seems to have an even greater impact on the direction of the Nasdaq 100. Since major market indices correlate to a high degree, the "Apple effect" in turn has a significant influence on the other major market indices and begs the question, "Has Apple become the market?"
Exactly how big is Apple, and how has its popularity as a mainstay of institutional portfolios affected its influence on the overall market? Consider that today Apple turns over its float every 50 days, while a mere three months ago the trading velocity of Apple was only half that as it turned its float over every 100 days.
When we speak of velocity we mean the number of shares traded relative to the stock's float. Apple has a float of 923 million shares and trades 26,086,000 shares a day on average as measured by the 50-day moving average of daily trading volume. This adds up to 1,304,300,000 shares traded over the last 50 days, well in excess of Apple's 932,000,000 share float. That is an astounding number of shares, even for Apple, and a tremendous amount in terms of dollar value. When you talk about Apple you are talking about a true "big stock," and this much money moving into and out of AAPL, mainly as a result of the activity of institutional investors which includes mutual funds, hedge funds, and pensions fund, etc., increases the correlative nature of Apple to the overall markets, and thus the overall risk in being exposed to such an environment.
Apple has been the key leading stock in the current market environment with mutual funds alone owning about 37% of the stock - over 366 million shares. When funds start to pile out of an over-owned stock, it can create a landslide effect, though it could be argued that 37% is not at extreme levels. However, according to the most recent data, big funds like Fidelity Contrafund or the T. Rowe Price Growth Stock Fund now own positions in Apple that exceeds 10% of their respective funds' total portfolio values. This is something to take note of, since this implies that Apple has grown to become a truly "over-sized" position within institutional portfolios. This in turn makes the stock susceptible to institutional investors like these starting to take profits in the stock on the basis of its huge size as a component in their portfolios. The fate of Apple, given its huge influence on the current market environment, has an exacerbated effect, and any tilting of institutional portfolios away from Apple as it becomes perhaps too large of a component in their respective portfolios will have a correlated effect on the general market.
Perhaps the greater risk is in markets that are more highly correlative than ever, and this current "one-stock" market is something that is a new circumstance. Thus Apple's fate is to a large extent representative of the fate of the market, and its ability to please or disappoint investors with new products and new growth can on its own be a catalyst for a new market up leg if viewed positively or a catalyst for a market correction should it be viewed negatively. As well, Apple's action can be used as a "mask" for institutional distribution given its correlation to the major market indexes.
Another twist to Apple's huge influence on the Nasdaq-based indexes and the market as a whole is that by holding up or supporting Apple stock, institutional investors can stabilize the general market indexes during any correction as they sell off other holdings and reduce their exposure to the current market environment. This provides some cover, as institutional investors can count on late-comers to Apple stock seeking to get in on any significant pullback to help provide support for the stock and hence the general market. Thus we find it useful to consider Apple's action on any given day relative to the general market in order to glean clues about what is going on under the surface.
In our view the main aspects of Apple's influence are twofold, and that is that if the stock is now a huge influence in a "one stock market" and institutional investors are loaded up on the stock, how then can we anticipate the direction of the general market based on Apple's behavior, and what clues is it offering in terms of helping us decipher what institutional investors, the true drivers of any market trend, are doing with their portfolios? For now, our conclusion is that as Apple goes, so goes the market, and investors would be wise to consider Apple as a ready barometer for this current market environment as we move into the third year of a bull market that started off the March 2009 lows. Indeed, two apples that changed the world- Newton's apple and Steve's apple.
Gil Morales and Dr. Chris Kacher are both principals and managing directors of MoKa Investors LLC and Virtue of Selfish Investing, LLC, cofounders of www.selfishinvesting.com and co-authors of "Trade Like An O'Neil Disciple: How We Made 18,000% in the Stock Market" (Wiley, August, 2010). Both are former internal portfolio managers for William O'Neil + Co., Inc., where Mr. Morales also served as Chief Market Strategist and co-authored with William J. O'Neil a book on short-selling, "How to Make Money Selling Stocks Short" (Wiley, 2004).
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in AAPL over the next 72 hours.