Investing

How to Play the End of This Tech Bubble

By John Del Vecchio  |  February 5, 2020

What’s next for Apple?

That’s the question I asked myself this morning when I looked at my updated Forensic Accounting Stock Tracker (FAST) software. FAST uses my own proprietary formulas developed over 22 years of performing forensic accounting research. I cover all the details and advantages of using this system in Rule of 72.

Apple, Inc. (Nasdaq: AAPL) is rated an A- overall and ranks inside the top 100 of large-company stocks. Historically, “A-rated” stocks in the FAST model have dramatically outperformed that market average.

Apple’s stock has doubled off its lows and tacked on hundreds of billions of dollars in market value along the way. How much more is left in the tank?

FAST is saying it’s going higher. Earnings quality is high. There’s little to no risk of earnings manipulation.

One qualitative red flag I identified is when the company withdrew unit sales reporting. Rule number one in this line of work is that when a company stops reporting an important metric, it’s a bad sign.

Of course, Apple’s customer loyalty and product quality have been more important in driving the stock’s price higher than iPhone unit sales.

There’s another factor at play here too. Flows into exchange-traded funds.

My bet is that as long as money continues to pour into index funds, Apple can go higher even if its fundamentals don’t justify it. It’s the biggest stock. Index funds have to buy it. Those funds don’t analyze the fundamentals.

Look to Apple

Where this company is headed is important to the market as a whole.

As Apple goes, so might the market. That’s because the major indexes are dominated by the very largest companies. If their stocks continue to go up, then the indexes will rise. However, a rising tide doesn’t lift all boats. Other companies that are in the indexes but aren’t the dominant names could lag.

This happened in the late 1990s. If you didn’t own the most prominent internet companies, your portfolio lagged. Non-tech companies lagged. Badly. There was, in essence, a stealth bear market. The indexes went up but a lot of stocks languished.

I think this could happen again. The next “bear” market might be felt in smaller, less prominent companies, well before it shows up in the indexes. By then, it will be too late for many investors.

Apple is not alone in its bullish move.

In 2019, technology stocks rallied 37%. That far outpaced other areas of the market. The problem is that the increase was all multiple expansion. In other words, investors paying more for the same fundamentals. That’s not a sustainable trend. Relative to the market, technology valuations are at a 15-year high. Technology stocks are 27% more expensive than they were in 2017.

Again, those types of metrics have historically been unsustainable. Now is the time to focus on risk. Can technology stocks trend higher? Yes, for sure. But it might pay to trail a protective stop below the market as it’s working higher. That way you can protect gains while also participating in more upside.

Technology stocks have out-performed seven years in a row. Without an improvement in fundamentals though, I would bet that streak is going to come to an end. When it does, it will be particularly nasty.

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John Del Vecchio

John Del Vecchio is the author of the bestselling book, Rule of 72: Compound Your Money and Uncover Hidden Stock Profits and What’s Behind The Numbers: A Guide To Exposing Financial Chicanery And Avoiding Huge Losses In Your Portfolio.

As the in-house stock market guru and forensic accountant for Dent Research, John stood on the shoulders of the great David Tice, James O’Shaughnessy and Dr. Howard Schilit, and built a framework of algorithms and a multi-factor grading system that has made him one of the more successful short-sellers around.

John is also the executive editor of our Hidden Fortunes newsletter and our trading service Small Cap All-Stars.

He graduated Summa Cum Laude from Bryant College with a B.S. in Finance and was awarded Beta Gamma Sigma honors. He earned the right to use the Chartered Financial Analyst designation in September 2001.MORE FROM AUTHOR