Is Apple's Stock in a Bubble?

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It's football season and no doubt stadiums will be filled this weekend as both the college and pro seasons are well under way.  When you go to the game you try to get there ahead of time, to avoid a parking hassle and to enter the stadium at your own pace.  Once you are at your seat you wait for the stadium to fill and the game to begin.

All is well, relatively calm, and semi-organized during the event.  But when the game is over, chaos suddenly takes over.

Shouting Fire in a Crowded Theater

Entering the stadium is a breeze as other patrons arrive at different times preceding the event, but when the event concludes, it's usually a completely different story.  Everyone rushes for the exits at the same time.  The stadium hallways are packed, the crowd is immense, and the roads are parking lots.  Sometimes it can take significantly longer to leave the event than it took to enter it.

This is the same analogy used for stock bubbles or parabolic price rises.  Everyone slowly piles in, but eventually there is a trigger that sets off a cascade of selling resulting in a similar sort of chaos as investors all head for the same exit.  When looking at a price chart of Apple (NASDAQGS:AAPL) some may say it is currently an example of a brewing bubble (more on that below).

Buyers come and go as they please at their own gingerly pace (in Apple's case for decades).  Eventually the stadium gets full (buyers outnumber sellers) and the action takes place (stock goes up).  But often when that action is complete there can be a rush out of the stock, as everyone heads for the same exit at the same time.  Chaos can ensue and the stock falls far, fast.  This of course has yet to occur for Apple.

Historical Examples

There are many examples throughout history of parabolic moves up in price that then come crashing back down much faster than the initial advance.  The Dutch Tulip Mania in the 1600s, the Mississippi land bubble of the 1700s, Gold (NYSEARCA:GLD) and Silver (NYSEARCA:SLV) in 1980, Japan late 80's (NYSEARCA:EWJ), and countless examples of individual stock and commodities through the years that had astronomical price rises only to come crashing back down eventually.  Some have even said that the Emerging Markets (NYSEARCA:EEM) were in a bubble in the mid 2000's and we are even in a bond (NYSEARCA:TLT) bubble right now. ( VIDEO: What are Dow Transports saying about the Stock Market?)

The chart below is of the inflation driven Gold "bubble" of the late 70's.  After a 4x price rise in under 2 years, Gold came crashing back down in as many years.

Is Apple in a Bubble/Parabola?

When investors speak of parabolic moves, 9 times out of 10 it is because of a charting choice.  Beauty is in the eye of the beholder as the saying goes, and although parabolic stock price moves do indeed exist, they are rare.  There is one easy way to avoid falling into the trap of calling all vertical moves parabolic.  The best way to show this is through charts.  Below I show two charts of Apple stock with the exact same dates, prices, etc.  There is only one key difference.  Can you spot it?

This first chart indeed looks parabolic and is the chart most basic charting programs would incorporate in their software.

This next chart looks a lot different even though for all intents and purposes all of the information on it is the same.  What is the difference?

The difference between the charts is simply their scale.  Notice on the right side, the price axis.  The top chart is your typical standard stock chart that measures price arithmetically. This means the standard measurement is based linearly, in this case in dollars.  The difference in the vertical axis is always the same amount based on a fixed dollar amount.

The second chart is scaled logarithmically.  A log scale displays the values based on an order of magnitude, in this case, percentages.  Based on a log scaled chart, Apple looks a lot different.

For most stocks, using an arithmetic or log scale chart wouldn't make much difference if the price historically is similar to today's price.  In Apple's case, though, price today is a lot larger than it was historically.  A $20 move today is nothing compared to a $20 move in 2005.  Using a log chart fixes this distortion and should usually be the default chart choice to prevent such discrepancies when they do occasionally occur.

What's Next for Apple?

When looked at on a percentage basis, Apple is in a decade long uptrend which I have shown with trendlines on the chart above.  The red trend channel is the shorter time frame and shows no sign of weakness at this point.  If price were to fall below $600, that would be a sign that the 4 year uptrend in Apple has changed to negative, but until that occurs Apple's trend is still healthily up.  At around 20% of the Nasdaq 100 Index (NasdaqGM:QQQ) and over 5% of the S&P 500 (NYSEARCA:SPY), as long as Apple can maintain its uptrend, the broader US indices should continue to frustrate bears.

The ETF Profit Strategy Newsletter provides comprehensive technical analysis that's boiled down to actionable, easy-to-understand analysis that includes support and resistance levels with potential targets and stop losses.  Updates are provided every Sunday and Wednesday.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



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