Unless you’ve been living in a cave, you’ve probably noticed that Apple (NasdaqGS: AAPL) stock has recently seriously underperformed the overall stock market. On November 8^th, the king of smartphones and tablets hit bear-market territory by falling intraday to a low of $533.72 — more than 24% below its all-time high of $705.07 hit seven weeks ago on September 21^st.  Since the beta of Apple stock is 1.21, we would expect the S&P 500 to fall a bear-market-sized 20% (24%/1.21) to match Apple’s decline. So far, the S&P 500 has only fallen 6.3% intraday (-5.4% on a closing basis):

 Source: Bloomberg

Two questions come to mind: (1) what’s wrong with Apple?; and (2) does Apple’s dramatic stock decline forecast a similar bear-market decline by the overall stock market?

Apple and Nasdaq Are Leading Indicators for the S&P 500

Apple has the largest market capitalization of any stock in the world, so its stock is – by definition – a coincident indicator of the stock market. It comprises 17.4% of the Nasdaq-100 (more than double any other stock) and 4.3% of the S&P 500.  There’s some evidence that it – and the Nasdaq in general – are also leading indicators of the S&P 500 and Dow Jones Industrials. Take a look at the relative performance of the Nasdaq at big tops and bottoms for the stock market:

Source: Bloomberg

Based on this table, Nasdaq is slightly better than Apple at leading the market, but both have been good in the two most recent market turning points. This improving performance by Apple is probably due to the fact that it has become a larger component of the Nasdaq, so the index and the stock mirror each other more closely. Consequently, the recent bear market in Apple shares may be a warning sign for the S&P 500 and Dow Jones Industrials. I’m not the first person to notice the forecasting value of watching the Nasdaq. Market technician Gerald Appel (no relation to the company) – the inventor of MACD – has written extensively about the Nasdaq/NYSE relative strength ratio. And let’s not forget that major U.S. stock indices have formed the largest head-and-shoulders bearish chart pattern in 100 years.

What is Wrong with Apple?

Of course, Apple’s problems could simply be company-specific and portend nothing about the financial health of the other 499 stocks in the S&P 500.  So, what exactly is wrong with Apple? First, let’s not panic. Apple has been a huge stock-market  winner. Since the end of 2008, the stock has trounced the S&P 500 by more than ten-fold (720% vs. 62%):

Source: Bloomberg

Even after its recent bear-market decline, so far in 2012 Apple has outperformed the S&P 500 by 22 percentage points (34% vs. 12%). A little more than a year ago in August 2011, when Apple was trading at $390, I predicted that Apple would rally when I wrote in Steve Jobs Resigns as Apple CEO that “Apple stock looks like a buy to me.” As things turned out, rising from $390 to $705 vindicates my “buy” call, don’t you think?

But several adverse developments have occurred recently suggesting that it may be wise to curb your enthusiasm looking forward:

• Smartphones using Google’s (NasdaqGS: GOOG) Android mobile operating system have risen to 75% market share, with Apple iPhones at only 14.9%.
• iPhone customer loyalty has declined for the first time since its introduction in 2007.
• Apple shocked analysts by selling 3 million fewer iPad tablets in the third calendar quarter (fourth fiscal quarter) than it sold in the second calendar quarter and its market share of tablets is down more than 15 percentage points quarter-to-quarter (50.4% vs. 65.5%).
• Scott Forstall, the inventor of Apple’s iOS mobile operating system, was unceremoniously fired for refusing to sign Apple CEO Tim Cook’s apology letter concerning the quality problems with Apple Maps software in iOS6. Forstall is widely considered the most innovative thinker at Apple and closest in thought process to the late Steve Jobs. Cook fired Forstall because he wasn’t a team player and Cook wants more collaboration, but collaboration results in uncreative group-think and Jobs supported geniuses who were jerks (because he was one himself). As one British commentator put it who believes we have already seen “Peak Apple”:

Apple is the opposite of the open, collaborative, slightly disorganized Google. It worked precisely because it was a dictatorship. But dictatorships without their dear leaders tend to fall to infighting, intrigue and inefficiency. This could be Apple’s future.

• John Browett, the retail head of the Apple Store who replaced Ron Johnson, was fired after only nine months on the job because he destroyed employee morale with layoffs and new performance metrics focused more on profits than customer experience.
• Unlike Steve Jobs, Tim Cook is an operations guy with no showmanship or innovative vision, which would cause Steve Jobs to fire Tim Cook if Jobs were still alive.
• Apple customers no longer think that Apple is “cool.”

All of these problems at Apple lead some smart investors to conclude that Apple stock has further to fall. Bond king Jeffery Gundlach and money manager Martin Sosnoff see the stock falling back into the low $400s where it plateaued for almost the entire second half of 2011. NYU finance professor Aswath Damodaran very-publicly sold his Apple stock last April at $600 because momentum investors were causing the stock price to become too volatile, but Damodaran continues to believe Apple is worth $710 per share. Apple’s huge cash stash of $121 billion doesn’t hurt the bullish thesis.

Apple Will Rebound to $644

Regardless of whether Apple is destined to fall back to $400 in the intermediate term, I believe the stock is near a short-term bottom, having come close to hitting short-term support at the May 18^th low of $522.18. There is speculation that Apple’s next quarterly earnings report is going to be a “blowout” – partly due to Apple’s intentionally-massive increase in purchase obligations to third-party suppliers from $13.6 billion last quarter to $21.1 billion this quarter (page 38 of 10-K). There is also historical evidence that bear markets in Apple stock are followed by explosive earnings gains.

If the “blowout” speculation proves true – or even if it doesn’t but the speculation continues to build prior to the next Apple earnings release in late January – then the stock will probably experience a right-shoulder run-up to the $644 left-shoulder peak reached on April 10, 2012 sometime over the next three months.

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