What's wrong with Apple?

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Good morning. Unhedged spent much of last week trying to understand two newly listed companies: Reddit and Trump Media & Technology Group. On Monday, both were sold off strongly. TMTG shares lost more than 20 percent after reporting 2023 revenue of $4 million, less than half of what the average Chick-fil-A franchise makes. Email us: robert.armstrong@ft.com and ethan.wu@ft.com

The previously great Apple

Only five of the Magnificent 7 tech stocks are performing outstandingly in 2024. Amazon, Alphabet, Meta, Microsoft, and Nvidia are all outperforming the market to a greater (Nvidia) or less (Alphabet) degree. But Apple did very poorly (it fell 8 percent compared to the market's gain of 11 percent), and Tesla did very poorly (its shares fell 30 percent):

Tesla's performance may be worse, but it's not as worrying as Apple's, from a market perspective. Tesla stock has always been highly speculative and volatile, and its valuation has been ambiguous. On the other hand, Apple was until recently the largest company by market capitalization (now Microsoft), and still accounts for roughly 6 percent of the S&P 500. It is a symbol of what a technology company can be: hyper-profitable. , very stable and constantly expanding. A stock faltering makes one wonder if something important has changed in the market.

There are six plausible explanations we can think of for what's happening with Apple stock. Interlocking kit:

It became exaggerated. Last December, stocks trailed earnings at 32 times, a peak reached only a few times in the past 10 years and only surpassed in the post-pandemic vertigo of 2021. The multiple now stands at 26 times. For a stock that is expected to increase earnings at less than the S&P 500's average pace this year and next, that's still a lot. With such a high stock price, Apple's dividend and stock buyback program provide less leverage.

Sales growth is expected to remain weak due to the smartphone replacement cycle and weak sales in China. A recent report from UBS estimated that iPhone sales fell 4 percent in February from a year ago, driven by a 9 percent decline in the United States and a 16 percent decline in China. Although Wall Street revenue estimates have been stable recently, the tone has not been great.

The market narrative has changed. The story of big tech and falling prices has given way in recent months to the story of big tech and artificial intelligence, and AI is one area in which Apple lags behind Google and Microsoft.

There has been a shift in investor preferences. For a while, many pundits — including Unhedged — spoke of Apple as a “defensive growth” stock, with high barriers to entry and a large services company to carry it through the economic cycle. But as the US economy continues to outperform expectations and fears subside, defensiveness may become less important.

As the US elections approach, Chinese risks are becoming more acute. Economic nationalism is on the rise in both countries. This has already hurt Apple's sales in China, and the tariffs could hit profit margins in the US soon.

Legal problem. The list is long here, but the most recent and important challenge comes from the Department of Justice, which believes Apple is a monopoly and will try to force the company to remove some of its barriers to entry.

The latter threat appears to us to be the least significant, based on the history of legal challenges against tech giants in the United States. We're willing to bet that once the case is resolved, the industry will have changed enough that the points of contention will become less important to Apple's future. We're also not very impressed with the sales growth explanation. Revenue has been flat at Apple for a while, but the sell-off has been recent. Likewise, the risk China faces is not a new story. Evaluation is not much of an explanation in itself. This leaves the rise of the AI ​​narrative and the decline of the appeal of “defensive technology.” If these two things explain the bulk of Apple's decline, then the stock's relative performance may only improve when the AI ​​hype dies down a bit and the economic backdrop deteriorates. We are keen to hear our readers' opinions on this topic.

Momentum vs. sentiment

Market rule number one: Be fearful when others are greedy. Market rule number two: Don't bet against momentum. Good rules to follow, but now they conflict.

We've discussed sunny vibes a few times recently. Our favorite measure, net upside among investors surveyed weekly by the American Association of Individual Investors, has been consistently positive throughout the year:

Moreover, last week Citigroup's Lefkovich Index moved into “euphoria” territory, which has historically preceded periods of below-average returns. This is a broad measure of sentiment, combining indicators from several markets. What has led to the index's euphoria, as Citi's Scott Kronert points out, is limited hedging options and high debt spread:

Next, momentum. There are many complex indicators of momentum, but delving into technical analysis is dangerous (for us anyway). We prefer to keep it simple, by comparing the index's recent performance to its 200-day moving average, which should show the extent of buying or selling concentration. As of Monday, the S&P 500 was 14 percent above its 200-day average:

This is high. The chart below depicts the strength of recent momentum versus 80 years of S&P 500 performance, although weekly rather than daily data is used. Over the past two months, the S&P 500 has traded about 15 percent above its 52-week moving average. This is in the top decile of historical momentum, as you can see in the chart:

Cheerful sentiment prompts caution, but strong momentum suggests investors should let these sentiments run. What to believe?

It seems that the stock strategists we follow are mostly not concerned about sentiment. As Chris Ferrone of Strategas pointed out yesterday, the increased breadth helps make the market euphoria seem a little less scary:

The immediate risk we see is sentiment (i.e. expectations are high), but fatigue in the more pronounced momentum corners of the market has been met with strength elsewhere. Last week was a good example of this. . . The Momentum Factor ETF (MTUM) stalled, reflecting some modest relative weakness from Tech, but the percentage of shares above its 200-day moving average closed at its highest level in about 3 years (85%). In terms of equal weight, the energy, industrials, financials, and materials sectors actually outperformed technology in the first quarter — you can probably win a bar bet with that fact.

Let's remember the background: constantly surprising economic power. The US Citi Economic Surprise Index, which measures the extent to which data beat analysts' expectations, has been in positive territory all year. We got a fresh reminder of this yesterday, as a better-than-expected ISM survey showed US manufacturing expanding for the first time in a year and a half. As Kronert points out, the S&P 500's performance this year has been remarkably correlated with economic surprises (his chart):

Strong market momentum and raging sentiment at the same time don't worry us much – as long as underlying economic growth continues to surprise to the upside. When growth slows, we will choose one to follow. (Ethan Wu)

One good read

The post-Dalio-Bridgewater transition is not going well.

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