A microcosm is a way to illustrate how a large environment behaves using the traits of a similar small environment.  In this case, Apple’s (AAPL) rise and fall this year provides an excellent illustration of how broader markets often work. 

Over the past year, Apple is up roughly 40%.  Since the company released its first iPhone in June, 2007, the stock has more than quadrupled from about $120 per share.   On September 21, the company released the iPhone 5 and the stock peaked at an all-time high of $705.07 per share.  Today, with its products more popular than ever, the stock is down 25% from the peak closing at $533.25 on Friday. 

Not only is Apple a microcosm of the broader market, it represents a significant portion of the broader market.  It is 4% of the S&P 500 and almost 12% of the Nasdaq.  Possibly the most asked question last week is why is AAPL trading down.  Before we take a shot at answering the question, the stock behavior of Apple is typical of the broader market during secular bear times. 

  • On Wednesday, Apple’s stock fell 6.4%, the biggest one-day drop in more than four years.  Roughly two and a half weeks ago, the stock surged 7.2% in its largest one-day gain in three years.  Volatility is a bearish indicator.  It usually is associated with rising risk premiums.  Rising risk premiums mean lower stock prices as incremental stock buyers demand higher expected returns to own the stock.  The largest one-day advances in stocks are often paired with large one-day declines during a bear market trend.  During the bear market decline of 2008, it was quite common to see huge one-day advances surrounded by repeated losses punctuated with severe one-day declines. 
  • The valuation seems reasonable but the stock keeps going down.  Apple is trading at price earnings of roughly 12x, in-line with the broader market.  However, Apple is one of the best positioned and fastest growing companies in the market and should reasonably be expected to carry a premium P/E multiple.  Buyers often buy on the basis of valuation only to be surprised and disappointed by the stock’s continued decline.  In the broader market and with Apple, valuation almost never marks a bottom.  Bottoms are reached when there is selling exhaustion. 
  • Right now, there are more sellers than buyers of Apple stock.  Until the sellers are done selling, stay clear.  Markets and Apple stock generally are trend following and until there is strong evidence that the sellers are exhausted, step into Apple lightly.  You may want to consider selling puts at lower prices to collect premium and possibly take ownership of the stock at a lower price if the bearish trend continues.  Be cautioned, however, that selling puts in Apple or the market when it is in a bearish trend is a dangerous game as stock valuations often overshoot what most investors would consider to be reasonable. 
  • There is no consensus on what is causing the stock to decline.  We are entering the holiday season when Apple products are expected to experience record sales.  The iPhone 5 is more popular than ever and the company owns 56% market share in the tablet market which is taking share from PCs.  At some point, Apple is expected to launch the iTV and enter one of the largest consumer electronic markets of all time.  The invisible hand of the market is saying there is a problem that has yet to become fully evident.  This was also true of tech stocks in 2000 and all stocks in late 2007 and 2008. 

Securities pricing carries a substantial amount of information.  The stock trading pattern of Apple involving increasing volatility, a bearish trend even at attractive valuation levels and a general disbelief by many investors that the stock keeps going lower is not a healthy sign.  With markets and Apple, it usually pays to decrease exposure during such times and allow the trend to reverse before committing new capital. 

We are not Apple analysts.  But for those who have an interest, the following are some of the leading reasons why Apple may be trading down: 

  • There is a continuing wave of increasingly better competitive products coming to the market.  While Apple has sold approximately 271 million iPhones since its 2007 release, there are more than 500 million devices running on free Android software made by Google.  Google maps work while the Apple maps need some work.  Nokia is making a resurrection in China running a Windows 8 system.  Last week, it signed an operating agreement with China’s second largest wireless carrier, China Mobile, to launch the Lumia 920T.  The iPad Mini was launched as a result of competitive offerings with 7-inch screens.  Analysts fear that the iPad Mini will lead to declining average selling prices (ASPs) in Apple’s tablet business. 
  • Without Steve Jobs, analysts fear that Apple’s pace of innovation will slow.  Without new products, their existing products will be increasingly commoditized.  Over time, almost all consumer electronics follow this path. 
  • Long-time shareholders are selling as a result of potential changes in the capital gains tax rate.  Even if this is true, it suggests long-time shareholders are not all that bullish about continued rapid appreciation of the stock over the next few years. 
  • Apple has not announced a special dividend as have over 120 companies in the past several weeks who are returning to shareholders excess capital before year end and before dividend tax rates change.  Investors who bought the stock in hopes of catching a special dividend may be part of the selling pressure. 

It is likely that Apple’s decline is a combination of the above.  In any event, the invisible hand of the market will let us know if this pull-back is the beginning of an important secular trend change or an incredible buying opportunity.  The trick to trading it is to be patient and allow the market to show you its cards. 


New Positions

Facebook (FB) – On Dec. 5, recommended to buy to open the FB Dec 27 puts (FB1222P00027000) for $1.10 or less. As of Friday’s close, this position was trading at $0.85. We continue to like this trade below our limit. Given the near month expiration, you have to keep a close eye on this trade and be ready to close on short notice. 

Closed Positions

Helmerich & Payne (HP) – On Nov. 27, we recommended to buy to open the HP Mar 55 calls (HP130316C00055000) for $1.90 or less. On Dec. 4, we recommending to close this trade for $3.50 or more, The stock and options appreciated into the close on news that the company hiked their dividend. 

Open Positions

Our Top Trades — the trades that we recommend you enter now if you haven’t already — are marked below with an asterisk.

Alcatel Lucent (ALU) – On Oct. 17, we recommended to buy to open the ALU Jan 1 calls (ALU120119C00001000) for $0.25 or less.  As of Friday’s close, this position was trading at $025. We continue to like this trade. 

Arch Coal International (ACI– On Aug. 9, we recommended to buy to open the ACI Jan (2013) 8 calls (ACI130119C00008000) for $1.38 or less (our entry price was $1.21).  The stock sold off hard post-election, but looks to have found support and is starting to round up – it was up 7% on the week. As of Friday, these options closed at $0.31. 

Delta Airlines (DAL) – On Oct. 1, we recommended to buy to open the DAL Dec 10 calls (DAL121222C000010000) for $0.65 or better.  The stock has been grinding sideways since we recommended it.  The stock closed at the highest level in four weeks. As of Friday’s close, this position was trading at $0.35. With front month expiration, we are looking to close on strength. We would look to newer trades with more time. 

Facebook (FB)  – see New Positions above. 

Iamgold (IAG) – On Sep. 19, we recommended to buy to open the IAG Dec 17 calls (IAG121222C00017000) for $1.10 or less. As of Friday’s close, this position zero-bid. 

QLogic (QLGC) – On August 21, we recommended you buy to open the QLGC Jan (2013) 12.50 Calls (QLGC130119C0001250) for $1.25 or less.  This position remains zero-bid. 

Rubicon Minerals (RBY) – On June 13, we recommended buying to open the RBY Dec 5 (RBY121222C00005000) calls for $0.25 or less. As of Friday’s close, the position was zero-bid. 

Parting Shot: The Money Ecosystem 

Have you ever wished you were a venture capitalist?  These are the guys who invest in interesting, new companies and then make millions/billions when they go public.  They are rarely scrutinized by theSECor public, even when the companies they bring to market cause huge losses to the public investor including Facebook (FB) and Zynga (ZNGA). 

The struggles of the public stock market since 2000 are now beginning to have meaningful ramifications back through the money ecosystem to the early stage private equity investors.  Amazingly enough, venture capital investing has underperformed the stock market over the past decade, according to the Ewing Marion Kauffman Foundation.  As a result, institutions are becoming less eager to allocate money to this sector.  Dow Jones VentureSource reports that funds raised by venture capital firms in the third quarter were down 32% year over year.  From the second quarter to the third quarter, the asset raise was down by 17%. 

Without a robust initial public offering (IPO), private equity investment horizons have stretched from five to 10 to sometimes 15 years.  Private equity investors have been forced to put more money into portfolio companies to support them while they wait for a chance to go public.  Bigger capital commitments and longer payoff horizons are highly destructive to internal rates of return. 

While a return to normalcy and responsible investing is usually healthy for all markets including the venture capital market, one of America’s greatest strengths is its ability and willingness to fund and foster innovation.  Eventually, innovation is what creates new jobs and a higher standard of living for all. 

Venture capital might be the longest lagging indicator of all major indicators.  Because of the massive funds raised and the ability of venture firms to charge fees on those funds even if they have not been invested, it takes years before the venture firms slow down as a result of a lackluster public stock market.  Because venture returns are measured over years rather than months or quarters, these firms really are not exposed to a slowdown until they have to go out and raise their next fund after years of underperformance.  Venture firms have reached this point. 

A restoration of prudent investing in all capital markets is a necessary condition of returning to a secular bull stock market.  Having the venture industry finally correct to a level that is sustainable should be a positive for the public markets over time. 

Have a great week trading,

Nick Atkeson and Andrew Houghton
Big Money Options

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