Diary of a Financier

Anatomy of a crash: Studying momentum collapses to determine Apple’s entry point

In Trading Desk on Tue 12 Mar 2013 at 07:52

Just before Valentine’s Day, I received a few calls from clients who wanted to buy some Apple (AAPL); I even had a bond buyer make an inquiry. Some of these clients had wanted to buy AAPL >$650 in 4q12, but I was acutely aware of the bear divergence underway since the summer 2012.

I don’t need to delve into the foibles of momo investing, but in regard to the latest boom/bust, AAPL, let me say this: The fundamentally-oriented Street has never known how to value momentum stocks. Apple was no exception. Analysts focused on gross margins and potential marketshare—extrapolating recent trends to discount backward a valuation, instead of handicapping the psychology that was driving multiple expansion. ‘Estimates for 2/3q13 iPhone unit sales will ramp (after 1q guidance was lowered) as supply constraints ease and LTE network expansion continues to sweep the globe.’ That’s the party line and it’s awesome. Unfortunately, I think consensus [still] has discount forward unit sales of two devices to every Chinaman at 40% gross margins.

I’m not going to buy AAPL on the expectation that gross margins will increase from 36% (FY13 guidance) to 40%, nor will I buy to speculate that iPhones sales will increase from 47.8M (4q12) to 50M per quarter. I’ll leave that to the bean counters who have the resources for such exacting research. I just want to buy AAPL when it’s reached deep value, and if it doesn’t get there, I won’t buy. Fundamentally, for me, we’re still far from that threshold—even after this 38% correction. When I model the dynamic valuation, I could stomach buying with a margin of safety down by the $380 level.

But, that’s fundamental, and everyone has his own opinion derived from similar models. Different people just happen to react differently to the same information. Value to me is not the same value to you. My margin of safety is not the same as yours, nor do we require the same probabilities or convictions before engaging in a position. I don’t have to buy AAPL; I want to buy AAPL, but only when it’s beyond cheap, when it’s ripe, which is why I’m interested in the technicals too. Technicals communicate the psychology of the market, and I’m interested in establishing when AAPL might be so beaten down that its strongest-handed shareholders capitulate. At that point, a giant purge occurs. Everyone piles on the offer, then, suddenly, no sellers remain. The mainstream media will stop talking about the name, and nobody’s willing to admit they own shares anymore. Utter despondency. That’s when I want to buy.

To construct a baseline scenario, I studied the chart of other such momo darlings, like CMG, LULU, OPEN, PCLN, and even Crude Oil (CL/). Not all of those names reached the depths that AAPL has in its recent plunge, so right away, I was able to eliminate some of the precedents. Oil survived my preliminary filter, but its topping pattern wasn’t reminiscent of AAPL’s. In the end, one fallen angel distinguished itself as a suitable analogue for AAPL: Green Mountain Coffee Roasters (GMCR), purveyors of the Keurig homebrew system…

AAPL v GMCR daily

AAPL v GMCR daily

As you can see, GMCR (in orange) retraced all of its parabolic rally between 6/2010-7/2012, by which milemarker AAPL would bottom between $315-350. The most striking commonality between the two is the lopsided Head & Shoulders top formation made by each. The H&S patterns both precipitated a giant gap down upon the violation of neckline support:

AAPL v GMCR daily (magnified)- comparison of lopsided H&S tops

AAPL v GMCR daily (magnified)- comparison of lopsided H&S tops

From the above, you can see that AAPL has reentered the top of the pricerange in which it traded before launching into a blowoff top. This achievement provided GMCR its 1st support, off which a dead cat bounce commenced, ultimately serving to shake loose the remaining weak hands in one last plunge lower to final support. A study of GMCR shows that these two, critical support levels were also marked by an extension of prior linear regression trends (line of best fit):

GMCR daily

GMCR daily

According to that example, AAPL has already reached its 1st support here ~$435. It should trade higher from here as anxious, weak hands accumulate shares for a trade. Ultimately, my tradable, final support target looks like it should be reached somewhere >$350:

AAPL weekly

AAPL weekly

Again, I’m not compelled to buy AAPL unless it reaches these extreme depths. We’re it not to materialize as envisioned, I just won’t have the necessary edge to skew the odds in my favor.

–Romeo

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  1. […] in early March, I discussed Apple’s (AAPL) fabulous collapse, which I compared to other latter-day momentum darlings.  I […]

  2. […] studying Apple’s ($AAPL) famous collapse back in March, I found analogues throughout recent and distant […]

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