Like many, I closed-out my long position in AAPL during the recent Japan-related volatility (it actually hit my stop at $338 (I figured this was at the very bottom of the medium-term up-trend in place since September ’10 and a likely pivot either to (a) bounce, or (b) gap lower). Apple had tested this support line a number of times recently and bounced strongly. However this time the stock fell through and quickly hit a low of $326.
All the (rather sensationalist) media coverage of the nuclear crisis and fallout from the tsunami was compounded by a flood of negative AAPL stories all breaking at the same time. AAPL’s tsunami hit with new photos of Steve Jobs looking thin, the infamous JMP Securities analyst downgrade, supply constraints from Japan, and survey data showing Android gaining momentum. It would have been a brave trader to go long in those few days, especially as all the chartists were telling us Apple's uptrend had been broken and was set for a prolonged bear phase. However Primostocks, in his Seeking Alpha article “Japan Crisis an Opportunity in Disguise, Especially for Apple Stock”, suggested doing exactly that.
Like Primostocks, I missed the immediate bounce and did not re-open my Long as AAPL re-took $340. With such extreme volatility I was happy to sit out the market. You have to think that if one of the many negative Apple stories had persisted or gained traction, or the nuclear crisis had taken a turn for the worse (e.g. major explosion or radiation leak, which WAS a high risk probability at the time) we could easily have seen even lower panic-induced prices. Maybe even down towards $300.
In my opinion the stock was never likely to breach $300 but who knows (just remember the Flash Crash last year). My question is how anyone could have realistically timed the market to get back in at $330 as suggested by Primostocks, when Apple spent less than a day at this level before bouncing in two straight sessions back over $340? Even with this bounce, it could conceivably have capitulated back, based on the strong breach in the up-trend. Perhaps even now with the stock at $350 this is possible - history (and chartists) would suggest once a trend has been breached in this way beware.
The point is, would such a strategy of immediately getting back in on the bounce, work in a repeat scenario? Market moves in a panic-situation are so exaggerated it is highly risky to bet which direction the market may move. Timing such moves is a reckless gamble, not sound option/spread trading. Of course, in saying that, I can’t profess not to have been frustrated as I watched Apple climb back to $350 and beyond. Annoying, yes, but we must ask ourselves: is this latest cycle well and truly over? Is Apple going to break all time highs yet again or will it falter as we approach $360?
The trouble is, Black Swans have a nasty habit of occurring when you least expect them. Who’d have thought of a 9.0 earthquake with global implications just as we hit highs on the market? Think of the announcement of Steve Jobs latest medical leave just the day before record-breaking Q1 results. The Flash Crash of May 2010.
Despite stock-outs of iPad 2 and a seeming return to form for Apple stock, there are other Black Swans which lurk in the background for Apple. Supply chain concerns leading to very low Q3 guidance would shock the market in a big way. But there is another, potentially more serious Black Swan, that we can have a reasonable stab at prediction.
So what is this Black Swan?
It may be obvious, but in my opinion, Steve Jobs himself is the Black Swan. It could easily be announced in the next month or so that he is not coming back. Think about it - Steve has never been away for longer than 6 months. Come early summer, Apple will have to announce that either (a) he is ready to come back; (b) they are extending his medical leave; or (c) that he is stepping down and handing over the reins to Tim Cook. Whilst we only have tabloid speculation, the rumour mill, and an appearance at the iPad 2 launch to go on, it is the brave investor who bets on him returning at this stage.
However just imagine a worst-case where something awful happens to Steve leaving no time for an orderly CEO transition. Despite a mute initial reaction to the medical leave announcement, I still think the stock will react very badly to such news in the short term.
So what value can we apportion to such a Black Swan scenario?
Back in 2008, Barron’s estimated that out of AAPL’s then $84 billon market cap, Steve Jobs was ‘worth’ close to $20 billion. This figure was approximated based on market cap versus the intrinsic value of Apple’s various business lines at the time. They argued the difference was the ‘Jobs Premium’.
Fast forward to 2011 and many have speculated that this ‘Jobs Premium’ has long left the stock since AAPL, at 19X current PE and approximately 15X forward PE, is trading at the very bottom of its long-term PE range. However if we examine the impact of January’s announcement of Steve’s medical leave, we saw an immediate drop in AAPL of around 6%. At a January 2011 market cap of $320 billion, up from $84 billion, this equates to $19.2 billion – a remarkably similar sum to that projected by Barron’s. After all, it could be argued that although market cap has risen dramatically, the value one individual brings to the company as CEO should remain fairly constant.
On the day of the January announcement, AAPL recovered almost the entire initial drop as investors digested the news, and has continued to hold those gains on strong results. The market has arguably had time to price in the worst case scenario due to the open-ended nature of the announcement, which offered little optimism of a speedy return. However if Steve did retire from Apple, can we expect to see a similar 6% decline as an immediate reaction? In reality this may be the base case scenario, as AAPL’s growth rate has exploded since 2008, in part due to the launch of the iPad – a product that was primarily Steve’s pet project.
Just how much the market has discounted Steve’s genius in the context of current exploding revenue growth versus a current static stock price is an unknown. But what we do know is that at some point a successor will be announced, and when one is, the stock will drop. With Apple’s product roadmap likely set for the next 3-5 years, this could well be the real buying opportunity investors have been waiting for. But you would need to be quick, as it probably wouldn’t last for long.
Looking back at AAPL during 2010 we see a similar pattern to now, with the stock trading in a $30 range while it builds a base to break out higher. Hopefully all being well history will repeat and we will see that breakout during 2011, perhaps within a month or so after a reassuring earnings announcement. However new negative chatter around Amazon beating AAPL to a cloud-based data store and launching their competing App Store, Android’s continuing ascendancy, plus some analysts trimming 2011 numbers due to the possibility of a delayed iPhone 5, is currently denting its momentum once again.
There will come a day when, sadly, Steve WILL retire. That could be this summer, next year, or maybe even in a few years time. However if a shock announcement is made the next few months, the market could still interpret this as a Black Swan event and we may well see an even better buying opportunity than the recent weakness. To understand why, I suggest reading Jason Schwarz’s article ‘Hedge Funds, Bloggers and the Origin of Apple Rumors’.
We have not seen such nervousness about AAPL stock in recent times. Even some analysts and bloggers are beginning to question their bullish views. Just read Rocco Pendola’s excellent article ‘Why I’m selling Apple’ for one example. In such times I am top-slicing my holdings in AAPL and will maintain a smaller holding going into earnings. I am certainly sitting out short-term plays until such time as we re-take all time highs on strong volume, or we get some clarity on the CEO position.
Disclosure: I am Long AAPL through ordinary shares but currently do not have any further positions and do not intend to open any within the next 48 hours.