Apple And The Fed: The Keys To The Next Market Move

Sep. 28, 2022 4:40 PM ETApple Inc. (AAPL)11 Comments
Matthew Smith profile picture
Matthew Smith
4.96K Followers

Summary

  • While the U.S. Federal Reserve has embarked on a mission to deflate asset prices across various asset classes, AAPL shares have defied logic and headed higher.
  • While peers are trading at fresh 52-week lows, AAPL is nearly 15% above its 52-week low established back in mid-June.
  • With many retail investors, hedge funds, and ETFs having overweight holdings, AAPL shares could see any sharp pullback lead to a major sell-off in the shares.
  • For the overall market to capitulate, Apple will have to set new 52-week lows; we believe the question is not IF, rather it is when.

Apple Store At Catalonia Square (Plaza Catalunya) in Barcelona in a neoclassic architecture building

Lobro78

Let me start off by saying that I have written five versions of this article in various formats, one with a deep dive into portfolio management, another focusing on the history of bear markets, a short version discussing market sentiment and then a few more which were in some shape or form a variant or derivative of the others. None of them seemed to hit the nail on the head of what I needed to convey when the topic set to be covered will turn many permabulls into trolls in the comments. However, with the news breaking tonight on Apple (NASDAQ:AAPL) it does seem like it is finally time for me to organize everything to lay out the argument for how investors will know if the bear market is near an end.

Over the course of our investing career we have experienced a few recessions and are always taken aback by the chorus of talking heads and various segments on financial news shows trying to espouse on why things are different this time. We started feeling uneasy about the market when certain lawmakers began to discuss how monetary policy had advanced and we could avoid depressions, and quite possibly recessions, by implementing modern monetary theory, or MMT. In our experience, when people start to get "cocky" about the central bankers' abilities, a peak has either been reached or will in the near future. The arguments to support the "this time it is different" talk rarely age well, and corrections generally play out the same way - just as a bathtub drains one way; down and out.

Which brings us to the current market. Man, has it been ugly, especially in the technology space. Within technology, speculative names have been crushed, the social media names have fallen across the board, and even Big Tech has been unable to avoid the sell-off (although many of those names have held up better than their smaller tech brethren). Alphabet (GOOG) (GOOGL), Amazon (AMZN), Meta Platforms (META), Microsoft (MSFT), Netflix (NFLX) Salesforce (CRM), Snap (SNAP), and others have seen their shares come under serious pressure for a myriad of reasons, but one name that has recently been able to hold on to its recent gains is Apple.

So What Is The Story?

Every single major recession we have invested in (and an argument can also be made that this held true to some extent during the COVID induced sell-off) saw capitulation. Every single one of the stock market's generals has to get taken to the wood shed so that there is no safe harbor for investors and max pain is felt. Depending on the recession, length of downturn, erosion of financial metrics and a few other items, one can expect that eventually investors throw in the towel in order to move on to asset classes deemed "safer". It happens every time.

But the question is, has this already occurred in the market and are we seeing the beginning of green shoots? That is pretty hard for us to believe because although capital can move much more quickly today than in the past, via liquidity in the equity markets and ETFs, it defies logic that a true market pullback and bottom would have occurred over the last 10-11 months with most people not realizing something was happening until the last 8 months max. Plus the U.S. Federal Reserve continues to raise rates, with plans for more rate hikes moving forward. While we do not see 'blood in the streets' when analyzing equities, there is an argument to be made that it is quite possible that the excessive bubbles were elsewhere in the market, such as cryptocurrencies and fixed income securities, and when looking in those areas we do see a lot of pain. As it pertains to the fixed income world, while we see a lot of investment grade bonds trading at prices below $0.85 on the dollar and Treasury bonds also trading below par, thus far this price action is a result of the Fed raising rates aggressively and is in no way related to credit issues. So maybe the Federal Reserve has ended the greatest bull run in history, the 40-year run that bonds have been on since the 1980s, by introducing interest rate risk fears that far outweigh credit default fears today.

Why have we discussed all of this? Well, if you accept the thinking that this recession might be short-lived once energy prices retreat, and recognize that at this point most of the pain felt by the general investor class center around the fixed income and cryptocurrency asset classes, then it is not crazy to think that investors might be trying to insulate their portfolios by moving out of the worst performing asset classes and reallocating funds into the equity space, or just maintaining stable dollar values in their equity exposure. This could explain why Apple is a bit of an outlier.

What Does Apple Have To Do With This?

Apple is the aircraft carrier in the market. With a $2.44 trillion market capitalization, Apple generally is the largest component of any fund or index that it is included in. Due to this, its influence on the general market's direction is outsized, which ordinarily would not be that big of a headline, but due to Apple's large retail following and inclusion in many funds it is possible for the stock to outperform based on money flows and those who utilize active management. But the important takeaway here is that Apple makes up a huge portion of the S&P 500 by weighting, which trickles down to the largest ETFs such as the SPDR S&P 500 ETF (SPY) where it is 7.101% of the fund and Vanguard S&P 500 ETF where it makes up an even larger 7.201% of that fund. Microsoft is the next largest weighting in the S&P 500 and makes up about 5.50% and 5.80% of those respective ETFs, which is still extremely large, but is smaller than Apple by the equivalent of a Berkshire Hathaway (BRK.B) or UnitedHealth Group (UNH) which are the 7th and 8th largest constituents in the S&P 500.

So size matters in this case, but so too does the direction of the stock and lately we have been using Apple to help us make decisions on directional investing in both the equity and derivative (options) markets. Right now, we are hesitant to put on any directional trade (in any stock or option) if at the time Apple's stock price is moving in the opposite direction of our trade. If we see Apple building momentum in a direction that is opposite some of our trades in the technology space, again we are closing that position and moving back to cash. Why? Quite simply the tail is wagging the dog on certain trading days and on any sign of strong moves (up or down) it seems that the quants just pile in.

Chart
Data by YCharts

Back on September 16th, which was a Friday, the move at the end of the day was led by Apple's stock catching a bid which in turn led to other names like Alphabet and Microsoft seeing buying interest emerge. The following Monday's (September 19th) rally saw Apple stock gaining strength over the course of the day with investors finally buying the rest of the market and the broad market finishing green. When doing short-term trading Apple is a good last check before placing the trade, but might this be indicative of something bigger? Such as Apple actually indicating that equities have already bottomed and are the better option of where to weather the current storm?

We Think Not

While there are some out there who think that Apple is the place to camp out during a storm we would make the argument that it actually might be one of the riskier places to park capital at this time. The stock looks overpriced relative to peers on various metrics, and while a number of companies such as Alphabet and Microsoft have been hitting new 52-week lows on what seems like a daily basis over the last few weeks, if one looks at Apple it is not anywhere close to its 52-week low which was set all the way back on June 16, 2022! To put this in perspective, while nearly all of Apple's peers are hitting fresh 52-week lows which are below the previous lows set back in June (many of the indices and ETFs which track the tech sector are weaker, and that is even with Apple being a large component in many of them), we have Apple sitting almost 15% above the lows it set back in June! Quite possibly even more mind boggling is that Apple was less than 10% away from a new 52-week high in the last six weeks. This leaves one to ask whether the stock has been overbought recently or just not sold aggressively enough.

Chart
Data by YCharts

Our belief is that too many people are of the mindset that Apple is going to provide a safe harbor for their capital, or protect it better than the alternatives. While we admit that right now the move has paid off, we would argue that it has been a fluke and only worked because of the U.S. Federal Reserve's scorched earth policy as it pertains to raising interest rates to fight inflation. By laying waste to the fixed income market as quickly as they did, the Fed trapped investors in certain places and luckily for those who were invested in Apple it has generally worked out.

Chart
Data by YCharts

It does seem like the last shoe to fall has to center around Apple and its share price. Everywhere else in the economy you are seeing price pullbacks; real estate, equities, vehicles, most fixed income securities - and in all cases it is due to higher interest rates which have negatively impacted asset prices. Through all of this, Apple shares have defied the gravitational pull of the correction, but with no major dividend increase, huge share buyback program or a new product line in a new market, we see little reason to be excited about the stock, let alone for it to continue to trade at such rich levels. Yes, revenues and EPS are estimated to increase this year and next, but even that fails to get us interested because we think that the American consumer might be set to tighten the purse strings over the next 12-18 months, and by our estimation that would impact Apple (because it is consumer facing) far more than some of its other peers.

Last night's news, which is that Apple is telling suppliers to not plan on a production increase for its new phones, is the first sign of a weaker U.S. consumer, with the second being that the higher priced phones are seeing strong demand while the lower-priced phones are seeing weaker demand. Those are cracks in the story, maybe the thesis for those who were banking on a strong product rollout, and should continue to play out and impact shares.

How We See This Playing Out

Apple has a big retail following and many fund managers who own outsized positions relative to their benchmarks. We think that a pullback is coming and that eventually this overallocation will shrink as everyone moves closer to their benchmark and an equal weight on Apple. Being the last general standing at this time leads us to believe that when the stock breaks that it will fall sharply and quickly. It might take a while for the pain to build and become enough to force people away, but capitulation for the market cannot happen so long as you have the dog, or the tail of the dog, preventing massive pain and the beginning of capitulation. Children can spend a lot of time trying to get Band-Aids off slowly, but eventually they grow impatient or find that even slowly taking a Band-Aid off can be painful and will undoubtedly give up (read capitulate) and do what they should have done from the beginning: rip the Band-Aid off.

Chart
Data by YCharts

Investors who think that the Federal Reserve is going to hurt the economy via their aggressive rate hikes should probably check their portfolio's holdings (particularly the passive holdings such as ETFs and mutual funds) to figure out their exposure to Apple. While it has been an outperforming holding for many, aided by many owning overweight positions, we think it is prudent to take some profits and focus on areas within the market that should continue to hold up well; money market funds, ultra short duration bond funds (we actually provided an update on one recently), floating rate bond funds and 1-year or shorter CDs from banks that are fully insured by the FDIC and yielding 3.5% to 4.5%. We suspect that these may hold up better than Apple over the next few months as you can protect capital by structuring maturities to allow the weighted average maturity, or WAM, and weighted average life, or WAL, to remain short enough to not allow rising rates to destroy capital. Apple looks at least 10% overvalued at current prices, so trimming allocations to equal weight with the indices seems like the logical play here. One still has exposure, but not so much that on a major pullback your portfolio's returns could be trashed by the overallocated portion.

This article was written by

Matthew Smith profile picture
4.96K Followers
Follow us on Twitter here: @theinvestar Previously a Trader/Portfolio Manager for a Treasury Office managing anywhere from $10-20 billion (treasury assets, retirement benefits, endowment related funds), currently part of a team that oversees an outside investment manager managing almost $30 billion. Previously the founder of theinvestar.com, LLC. theinvestar.com, LLC was a leading news provider on the potash and uranium mining industries supplying data services, commentary, interviews, investment news, newsletters and quarterly industry publications.

Disclosure: I/we have a beneficial long position in the shares of AAPL either through stock ownership, options, or other derivatives. 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.

Additional disclosure: AAPL is held directly and indirectly (via ETFs for example) in client portfolios.

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