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American Beauty: The Bloom Comes off the Rose

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Editor's Note: The following is a free edition of Jeff Cooper's Daily Market Report. For a two-week FREE trial of his daily commentary and nightly day and swing trading picks, click here.

American woman, gonna mess your mind
-American Woman (Kale, Peterson, Cummings, Bachman)

Jane. Honey. Are you trying to look unattractive?
-Carolyn Burman, portrayed by Annette Bening in American Beauty

The most important stock in the US and arguably the world did a back flip yesterday.

On Wednesday, Apple (AAPL) suffered its worse one-day loss since 2008.

In a nutshell, AAPL is crashing. For the second time. Following a 27% drop from its Autumnal Equinox high (9/21) to its November 16 low, which coincided with a low in the broad market, AAPL had a huge dead cat bounce from 505 to 595 in a few short weeks.

Many players may have mistaken AAPL’s dead cat bounce for the growl of a new bull market.

However, the strongest, quickest advances are typically bear market rallies which lure those who are long from higher prices to average down. This is the danger of well-loved, arguably, overloved stocks as the lure of the long-term ‘story’ instills  the idea of a stock whose perceived fundamentals outweigh the discipline of a stop loss. After all, if the stock was ‘cheap’ at 700 and the story was intact, it’s a buy at 650, a great buy at 600, and a screaming buy at 550. Right?

This is why I wrote The Trouble With Fundamentals on October 8, 2012:
Every analyst is recommending AAPL. If an earnings P.E. for next year on continuing growth is 14-15 and earnings $70 per share, then the stock should be at $1000, right? This reasoning is why most fund managers don’t beat the market. They are programmed into believing the hypothesis (hype?) that great earnings are driving Apple’s stock higher and as long as the earnings improve it can only go up. However, that is not what is taking AAPL higher. What took the stock higher is the buying by large institutions. They have cornered the float after many years. They have been riding this gravy train and squeezing it for all its worth. Literally.

Arguably, one could say they are buying BECAUSE of earnings, but what happens when there comes a time where every institution has more than a slice of AAPL but a chunk and it represents too big a weight in their overall portfolio because its price has kept going up relative to other names?

Is it possible that liquidation can blind side these institutions while earnings remain robust?

The higher the parabolic advance of a huge capitalization growth name, the more likely an implosion becomes: it takes an ever-growing amount of money to hold up an ‘expensive’ stock. Once the point of equilibrium and saturation is reached, all the earnings in the world can’t hold up a stock. Newer investors start to lose and downside picks up as volume feeds on itself and momentum explodes.

While the hypothesis of earnings works well when a stock is going higher and higher, when the stock starts coming down and earnings are still “there”, it can create a lot of fear and paralysis as market participants' theories are undermined. There is uncertainty and investors hate uncertainty. They begin to wonder if the price of the stock is anticipating something they don’t know about the fundamentals and whether the ‘smart money’ knows something they don’t.

In reality, it’s what I said above, and once equilibrium is reached, selling can beget more selling as a virtuous circle becomes a potentially vicious circle and an American Beauty becomes an American Thorn in the market.
In last Friday’s report, with AAPL backtesting its overhead 200 dma and testing the upper rail of a declining bearish channel, I  showed the following daily AAPL chart and asked, “if this was any other stock than AAPL and it had a $60 price, what would you be thinking?”

The implication was that trade back below the lower channel left AAPL vulnerable for a quick move back to the high of the low-bar day around 526.

Last week, I flagged the time/price square-out at 594/595 and November 29/30 and couldn’t help but wonder whether many players may be blind-sided waiting for a picture perfect 50% retrace to 605 or a test of the 600 strike before selling.

This week proved the power of and demonstrated the value of time/price square-outs as calculated on the Wheel of Time & Price.

Hands down, it is the single best  trading tool around.

What value can be placed on avoiding and or capturing a quick 50-plus point move in a matter of days?

Don’t forget that the Wheel also called the 505 square-out at the November 16 low and the ensuing quick 90-point rally.

There is nothing that fundamentals can glean to capture these kind of moves.

A 10-minute AAPL from late last week shows what proved to be an Exhaustion Gap to our 595 square-out. Monday’s immediate downside gap  to kick off December suggested possible month-end mechanics that may have been a factor in the rally into the end of November.

That said, AAPL carved out an Island Gap.

Another downside gap on Wednesday below 571 which we noted was 90 degrees down from the 595 pivot high and which, if broken, could see a quick selloff to 547, put the nail in the coffin. At least for Wednesday and the pullback buyers who thought a 10-point decline in the stock with the market rallying was overdone, ditto 20 points, ditto 30 points.

The important thing to remember is that intraday relative strength or the LACK thereof is one of the best tells there is in trading. The failure of AAPL to gain any upside traction as the S&P 500 (^GSPC) reversed yesterday indicated the stock was heavy. Going in the bell, all the buyers bailed on this realization with potential buyers keeping their wallets in their back pocket.

Wednesday’s crash in AAPL may have been a point of recognition that the bloom has come off the rose and that the bounce to the 200 dma was just that -- a bounce rather than the beginning of a new leg up, despite the best and brightest AAPL analysts on the Street remaining steadfast with their $900 and $1000 targets.

Let’s take a look at AAPL’s weeklies.

The tipoff to a change in character in AAPL came at point A when following a turn down in the 3 Week Chart, AAPL turned its Weekly Swing Chart back up. This defined a high which was bearish behavior.

This week’s crash in AAPL followed the FIRST weekly Minus One/Plus Two sell setup in AAPL since high. Why? The 3 Week Chart was pointing down followed by 2 consecutive higher weekly highs for the Plus Two part of the strategy.

It is possible that last week's high in AAPL has carved out an ominous ‘droop’ right shoulder of a big picture Head & Shoulders Top in 2012. If so, the projection looks like 350-ish. This is basically half the all time high at 705.

Interestingly, at its high, AAPL was 370 months from when it came public in December 1980. This 370 number ties to the Autumn Equinox which is when AAPL topped at 705.

The October 8 report concluded saying: “AAPL has been the leader. A break of prior resistance (644) calls into question the trend. This is important as AAPL underpins the market not just as a weight in the NDX with all the major funds loaded to the gills but also is a psychological heavyweight."

Not only is it important to distinguish between the stock market and the economy but also between a company and its stock. Remember that Research In Motion (RIMM) topped in June 2008, though its earnings continued to increase until March 2011.

RIMM became a value, then a trap.

I am not saying AAPL will become RIMM. I’m just saying with AAPL’s earnings coming up, it is worth remembering that stocks can top well ahead of their earnings peaks.

RIMM looked invincible shrugging off the bear market in the first half of 2008. Then came the monthly signal reversal bar in June 2008.

Conclusion. The irony is not lost on market participants that as AAPL has declined, RIMM has turned up.

The irony is how many hedge funds are blowing up on the decline in AAPL as capital gains tax considerations potentially fuel the downside.

Strategy. Yesterday, the S&P reversed sharply from the first turndown in the 3 Day Chart since the November 16th.

Wednesday’s quick reversal followed a break of a rising trendline off the mid-November low, closing right on the trendline after tailing off on the runoff.

So we have an outside day down reversal signal bar from the 50 dma to kick off December followed by an outside day up on Wednesday. The jury is out, but trade below Wednesday’s low in the S&P suggests the bloom has come off more than just one American Beauty.
POSITION:  No positions in stocks mentioned.