Why Apple fell so hard

We needn’t spell out here all the reasons that have been put forward over the past two months for why the stock was due for a fall. There’s a whole literature of Apple FUD (fear, uncertainty and doubt) — often delivered in the form of top 10 lists — to explain the stock’s steady retrenchment to a share price it hadn’t seen since February.

Which is why I was particularly interested in two theories that emerged Friday.

The first came in the form of a rumor spread by Doug Kass, the author of one of the most famous of those top 10 lists. (See Meet one of the guys.) He tweeted Friday that Apple was getting clobbered by hedge funds hit with big margin calls. The whole market was being driven down by fiscal cliff fears, but the Apple shares in their portfolio — even at their depressed valuation — could still be sold at a profit, so that’s where hedge fund managers turned to raise cash.

The second theory was laid out in Seeking Alpha by Economic Weather Station‘s Jason Schwarz, whom I quote periodically as the author of the Apple slingshot theory:

“If you can keep a good stock down then you are able to load up for the ride back up. It’s like a slingshot — the harder you pull, the more propulsion you generate.”  — Apple: Seven reasons shorts love it

The slingshot, he wrote Friday, is often misunderstood as being caused by negative articles about Apple in the media. Quite the opposite, he says. It’s caused by mutual fund managers rebalancing a stock they’ve loved too much.

I’ll let Jason tell the story:

Suppose you were a mutual fund manager and your strategic models allowed for a maximum 8% allocation in any individual stock. What would have happened to your Apple holdings in 2012? As of September 21st, Apple was up 74.9% year-to-date. Apple allocations at the largest mutual funds had grown to between 13% and 15% of total holdings with the fiscal year end approaching on October 31st. Because of Apple’s strength, because it was such an outlier when compared to the rest of the market, these money managers were forced to re-balance their portfolios in order to comply with their risk models. The Apple slingshots, or in other words the deeper than unexpected selloffs, are caused by systematic institutional re-balancing. This is the unintended consequence of Apple’s status as the most widely held stock of most hedge funds, indexes, pension funds and mutual funds. Apple’s slingshot selloffs occur because of its strength, not because of its weakness. Apple is an outlier.

As you contemplate your mortality as an investor with Apple in the low $500’s, solace will replace your frustration when you realize that those institutional funds who sold Apple back to 8% portfolio allocations are now underweight Apple because of the fiscal cliff selloff pressure that Apple has endured since October 31st. Because the fiscal cliff selloff occurred at the end of institutional re-balancing, it has caused this particular selloff to be especially deep. However, as confidence grows that the fiscal cliff will be resolved, Apple finds itself in a favorable supply/demand stock scenario for the first time since July 26th. The next run is coming and the stock will skyrocket just as it has during the last 10 slingshots because every money manager on Wall Street trusts Apple’s fundamental growth story and they know that maxing out Apple allocations is key to outperforming their index. This slingshot phenomenon will continue to play itself out for as long as Apple occupies the pole position as market leader.

Makes sense to me. And it could explain why Apple, after hitting that nine-month low Friday, bounced nearly $22 to close at $527.68.

Schwarz’s piece is called Apple’s Institutional Slingshot: Rational Explanation Of Irrational Stock Action.