Kass Katch: Short QQQ

This commentary originally appeared at 9:04 a.m. EST on Feb. 14 on Real Money Pro -- for access to all of legendary hedge fund manager Doug Kass's strategies and commentaries, click here.

"What the wise man does in the beginning, the fool does in the end."

-- Warren Buffett

Last night on "Fast Money," with Mel, Dan, Guy, Karen and Joe, I raised concerns regarding the Nasdaq market, and I have taken a short position in the PowerShares QQQ ( QQQ).

Let's go to the tape.

The NBA Market -- Nothing But Apple

With apologies to the New York Knicks' Jeremy Lin, Apple ( AAPL) shares have been nothing short of "Lin-tastic."

Apple's stock is a phenomenon unto itself -- it has taken over clear dominance as the largest-cap stock -- but enthusiasm has a downside.

It has now started to move in a semi-parabolic way, and it has begun to detach itself from the action of the broader markets.

Some in the media are now even projecting that Apple will become the first trillion-dollar-cap stock. The last time this happened was the forecast in early 2000 that Cisco ( CSCO), which reached a market cap of nearly $600 billion, would become the first trillion-dollar company. We all recognize that Cisco was far more overvalued back then than Apple will ever be, but it did proceed to fall 85% to an equity capitalization of less than $100 billion.

These are all warning signs, which, combined with some other factors listed below, have encouraged me to short the Nasdaq.

Technical Moorings Weakening

The Nasdaq's market's breadth has started to diminish (often a sign of a potential top), as a few (and narrowing field of) high-profile stocks seems to be responsible for most of the recent advance.

As I mentioned on "Fast Money" last night, Bob Farrell (Merrill Lynch's legendary technical analysts) has taught us all to be careful when breadth narrows and divergences develop.

On that subject, "Fast Money" panelist Dan Nathan's Risk Reversal blog had some interesting observations on the number of new highs yesterday that underscore the developing S&P 500 divergences:

This is an interesting chart. It shows the SPX vs. a composite index of new 52-week highs across all U.S. exchanges. Today's reading, with the SPX at 1351, is 183 new highs. Back in May, at the highs, the reading was 1200. In July, before we collapsed, it was above 800. This shows the lack of market breadth as we make new highs on the year and how narrow this rally is focused amongst some names like XOM and AAPL. The market would need greater breadth normally to hold these levels and make higher highs. If that doesn't happen, we may be due for a pullback. Something to keep an eye on.

Here are some more technical issues specifically facing the Nasdaq:

  • Some larger-cap stocks have begun to underperform -- Amazon (AMZN), Oracle (ORCL) and so on.
  • The Philadelphia Stock Exchange Semiconductor Index is now weakening -- another technical divergence.
  • Tech, on the shoulders of Apple, is now over 20% of the S&P 500 -- a level that has been repelled over time.
  • Leading old-tech stocks Microsoft (MSFT) and Intel (INTC) are now approaching former rally highs (made in 2008 and 2004, respectively), and both are at similar percentages above their 200-day moving averages that have historically marked intermediate-term highs.

Three Thin-Reed Indicators That Suggest Caution

  1. The combined market capitalization of Google (GOOG) at $200 billion and Microsoft at $257 billion is less than Apple's capitalization at $475 billion.
  2. The combined market capitalization of each of Apple's key vendor rivals -- Samsung, Nokia (NOK), HTC, Motorola Mobility (MMI), Research In Motion (RIMM), Sony (SNE) and LG -- stands at $235 billion (less than half Apple's capitalization).
  3. The 17 brands that make up Apple's smartphone competition have a total market capitalization that falls about $100 billion short of Apple's current equity value.

Let's now take a look at a chart of Apple's shares measured against its moving averages.

The relationship is stretched, unprecedented and probably not sustainable.

Finally, a couple of months ago, I made Apple one of my " 15 Surprises for 2012":

Surprise No. 10: Despite the advance in the U.S. stock market, high-beta stocks underperform. Though counterintuitive within the framework of a new bull-market leg, the market's lowfliers (low multiple, slower growth) become market highfliers, as their P/E ratios expand.

With the exception of Apple, the highfliers -- Priceline (PCLN), Baidu (BIDU),Google, Amazon and the like -- disappoint. Apple's share price rises above $550, however, based on continued above-consensus volume growth in the iPhone and iPad. Profit forecasts for 2012 rise to $45 a share (up 60%). In the second quarter, Apple pays a $20-a-share special cash dividend, introduces a regular $1.25-a-share quarterly dividend and splits its shares 10-1. Apple becomes the AT&T (T) of a previous investing generation, a stock now owned by this generation's widows and orphans.

Strategy: Long Apple (common and calls).

My seemingly outlandish prediction for Apple's 2012 earnings ($45 share) and share price (over $550) back in December 2011 no longer seems so outlandish. Indeed, upward and onward (for Apple) is now a generally accepted viewpoint.

One cannot know how far the heavily weighted Nasdaq Apple's shares might rally to, but some of the observations I have made regarding what is going on within and surrounding Apple (in the S&P 500 and in the Nasdaq) suggests that the time to short technology might be at hand.
At the time of publication, Kass and/or his funds were short QQQ, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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