Since the bull market run began in 2009, Apple (AAPL) analysts have been making persuasive arguments for the stock. The fundamental case for Apple includes price-to-earnings, price-to-sales, cash reserves, China as an untapped market, etc. However, as investors have found out, it is the price that matters most as Apple’s stock has taken a hit from the high of $702 on September 19, 2012 to the current price of $443 (March 18, 2013). While fundamentals are important, there is one obvious problem and that is the trading volume.
In the section on Dow Theory, in the Edwards and Magee book Technical Analysis of Stock Trends, volume is interpreted in the following manner:
“…in a Bull Market, volume increases when prices rise and dwindles as prices decline; in Bear Markets, turnover [volume] increases when prices drop and [volume] dries up as they [prices] recover (33).”
When we compare the previous bullish moves in Apple’s stock price, we find that the most recent run-up stands out as trading volume has not only failed to increase with the stock price, it has been on a divergent path by declining. However, we need to see how different this most recent rise in the stock price is in contrast with the previous bullish moves.
In the bull market run of Apple from December 30, 1997 to February 29, 2000, the stock price rose +900% while average trading volume increased +1,000%.
In the bull market run of Apple from April 1, 2003 to December 30, 2007, the stock price rose over +1,400% while average trading volume increased +1,000%.
In the bull market run of Apple from January 21, 2009 to the present, the stock price rose nearly +900% while average trading volume decreased -51%.
The obvious problem with the current rise in the price of Apple from the January 21, 2009 low to the September 19, 2012 high is that while the stock price has increased dramatically, the trading volume has fallen precipitously. Already, Apple has inexplicably declined –36% from the high. There is little in the way to indicated that the blood-letting is over.
According to Robert Rhea, in his book The Dow Theory, “…the volume of trading has proved to be such a useful guide in attaining proficiency in the art of forecasting market trends that it is necessary to urge all students to study intently the relation of volume to price movement (88).”
It would be foolish for us to think that the decline in volume, from 2009 to the present, while the stock price increased wasn’t a warning sign. It is suggestive of the fact that all was not well and therefore the party had to end at some point in time. This is despite the otherwise glowing fundamentals that are associated with Apple.
Now, if the almighty Apple can decline –36% in spite of the glowing fundamentals as the Dow Industrials and Dow Transports keep going higher, then what is the fate of two main components of Dow Theory? By all indications, we should be considered to be in a bear market based on the fact that the price of the Industrials and Transports is increasing as the trading volume dries up.
From our vantage point, there are two distinct outcomes possible for the stock market, based on the above quoted sources. Either the stock market explodes higher than anyone has ever imagined possible or the stock market declines, –20% to –30% from the current level, as average trading volume skyrockets. However, our experience so far has been for volume to decrease as the price increased. Therefore, by our logic, when and if volume starts to increase it will be because institutions will be selling instead of buying the market.
While we have constructed two possibilities, the probabilities are something else altogether. We think that the fact that volume has been in a clear declining trend, the probabilities favor a decline of the stock market over a sustained increase. To put this idea into perspective, when we wrote our April 14, 2012 article titled “Consider the Downside Prospects for Apple,” we said that Apple would decline to $424 (found here). After the article was written, Apple increased by +11%. However, after Apple peaked, the stock declined –30% from the price where our article was written. Our only question is, was it worth seeing a rise of +11% only to realize a loss of –30%?
Because we have a substantial amount in cash and a majority of our holdings that are the profit portion intended to compound over time, we are only compelled to sell those positions that are recent short-term purchases that are more than 5% of our existing portfolio.
Our Canadian Dividend Watch List should be coming out this week