- What happens when Santa fails to come to town?
- Apple gets hit with two downgrades
- Why the smartphone maker’s price action has broader implications for the market
What happened to the Santa Clause Rally?
Bahhh humbug!
For those less familiar, a Santa Claus Rally involves a rise in stock prices during the last 5 trading days in December and the first 2 trading days in the following January.
Over these 7 trading days in question, stock prices have historically risen 76% of the time (to the tune of ~1.3%) – far more than the average performance over a 7-day period.
But this year the market received a fat lump of coal. Or more accurately – perhaps a “bad apple” (more on that in a moment).
And some feel that’s potentially a bad omen for the year ahead… giving rise to the popular Wall St. maxim:
“… if Santa Claus should fail to call, bears may come to Broad and Wall”
The New York Stock Exchange is located at the corner of Broad and Wall Streets.
For example, since 1969, there have only been 12 times this maxim has proven false.
Put another way, 78% of the time stocks go on to have a negative year if Santa fails to come down the chimney.
Now there’s a few good reasons why Santa may have stayed at the North Pole this year.
For example, he might have come early.
16.2% gains in just 9 weeks prior to Christmas was better than a poke in the eye with a blunt stick!
I argued that much of 2024’s potential gains were possibly pulled forward.
The other reason stocks could be feeling some selling pressure is what we see the index’s largest capitalized stock – Apple.
The smartphone giant received two downgrades this week – pulling the market down with it.
Bad Apples
Apple is the US’ largest capitalized stock – around $2.97 Trillion at the time of writing.
This sees it constitute ~6% of the S&P 500 and ~9% of the Nasdaq.
It’s fair to say where Apple goes – so too does the market.
Last year is a good example.
Apple posted gains of ~48% – helping drive major indices higher. Below we see the strong correlation between Apple and the ETF QQQ
However, with Apple being 6% of the Index, it was a major beneficiary of fund inflows.
For example, according to Bloomberg data, over $32 billion flowed into ETF SPY over 2023 – with billions more flowing into other indexed ETFs.
By necessity, over 6% of that money needed to be invested in Apple given its market weight.
Put another way, if you wanted to match (or exceed) the market’s returns, you needed to invest in Apple.
But now the price of the world’s most loved stock is being questioned – receiving two downgrades – dragging the market lower with it.
Piper Sandler analysts led by Harsh Kumar cut their grade for Apple stock from overweight to neutral, suggesting they no longer expect Apple stock to outperform its peers.
Kumar struck a similar tone to that of Tuesday’s downgrade by Barclays, which cut its rating for Apple from neutral to underweight, though Kumar’s $205 price target is far more optimistic than the Barclays group’s $160 target.
For regular readers – the downgrade should not be surprising.
Recently I’ve issued two posts warning of the excessive valuations for tech (and Apple specifically in August)
With respect to the first article, I stressed Apple is a stock you should own.
For me, it’s one of my core four holdings (along with Google, Amazon and Microsoft).
There are few other stocks which generate as much free cash flow – with more than $20B per quarter – leading to a cash hoard of over $160B.
However, Apple is struggling to grow its top line and is offering very modest (single digit) earnings growth (more on this shortly).
It earned $6.13 per share in 2023 (its fiscal year just ended); and it earned $6.11 in 2022.
That’s hardly in the ‘growth’ category – more akin to what you would find with a consumer staple stock like Procter & Gamble (PG).
To that end – is Apple simply a consumer staple?
Some could argue yes.
Now if you don’t have a position in the stock – I would not initiate a position at ~30x trailing earnings.
That’s taking on too much risk.
For example, at a price of $181 and earnings of $6.13 — that equates to a multiple of 29.5x
For me, a more attractive multiple is in the realm of 20x to 25x earnings.
For example, 25 x $6.13 = $153.25
Now if Apple can grow earnings by say 7% this year (e.g. through stock buy-backs given its massive cash hoard) – this raises the price to $164 (i.e., 25 x $6.56)
Growth vs Value
My personal view on Apple is it’s more a value stock than it is growth.
Yes, they’re growing their services revenue by ~8% per year at margins of around 70%.
That’s an impressive business… where services are clearly its future.
That said, they need to continue to expand (and maintain) their sticky 2B+ user install base (which they have been doing).
But with single digit growth – it’s not what I would consider a business worth paying a 30x multiple (which is applied to the entire business – including its hardware).
By way of comparison – below I compare the price action for Procter & Gamble (PG) vs Apple over the past 3 years:
Jan 5 2024
Proctor & Gamble trades at a forward PE of 23x and operates at margin of around 26%
And much like Apple – PG deserves a premium to the market on the quality of its business.
But let’s consider the 5-year earnings growth outlook for each company:
PG is expected to grow earnings at a faster rate (7.77%) than Apple (6.14%)
Which begs the question:
Is it worth paying almost 6-turns higher for Apple?
For me, the answer is no.
Apple is worth owning. However, you want to own the business at an attractive (long-term) price.
As readers will often hear me say: “it’s not just what we buy – but equally how much we pay”
Let’s finish with a look at the long-term chart.
Where To Take a Bite
Jan 5 2024
Over the past 5 years – Apple has given investors no less than ten double-digit percentage pullbacks to add to the stock.
These pullbacks have ranged from 11% to 40%.
However, the long-term trend remains up and to the right.
Most recently (mid 2023) – its price retraced 17% to trade ~$165 (i.e. 27x trailing earnings)
For me, the last time I added to Apple was the pullback late 2022 at a price of ~$138 (i.e. 22.5x earnings)
That’s the multiple where I am comfortable taking risk in the stock.
As I wrote in August- I still believe investors will get a chance to add to the stock at more reasonable valuation.
From mine, we could see the stock pullback to around $150 to $160 – the bottom of the two-year distribution labelled.
One last point:
If we consider Apple traded for $20 in 2013 – applying a 20% CAGR over 11 years – that gets us to a price of ~$150.
Putting it All Together
The sluggish start to 2024 does not necessarily imply we will have a negative year.
It’s far too early to start drawing conclusions.
However, I do think valuations were excessive coming into the New Year (i.e., where risks were not in investors favour).
Apple is one example where investors are now taking a second look.
There will be more.
For example, yesterday I offered a few reasons as to why investors felt the need to buy stocks over the past two months.
And I get it….
But we should challenge that optimism (and assumptions) with reasons why investors would be wise to weigh the risks opposite the price / multiples being asked.
Apple is a case in point.
Before I close, tomorrow we get the latest monthly US jobs report.
The market expects payroll growth to come in between 170K and 200K monthly jobs added – with hourly earnings to rise 0.3% to 0.4% MoM.
If correct, this could continue to drive the 10-year yield back above 4.0% (which is what I expected coming into the New Year) and force traders to push out their expectations of near-term rate cuts.
That could be bearish for stocks given the market is pricing in at least four to five rate cuts next year.