Tuesday, February 21, 2012

Forget Apple, Buy This Instead

Traders should avoid Apple right now. It has probably reached the bubble stage of its price rise (I'll explain below). But the stock market can still move higher, even if Apple (AAPL) lags.

In fact, I think it's a great time to add to stock market investments. The sector I like the most offers a potential gain of 36%.

Relative strength usually confirms what everyone knows, but this time it's providing a divergence from popular opinion. That's what traders should be paying attention to. My analysis says to sell AAPL even as traders push the stock to new all-time highs. With AAPL soaring past $500 a share, 55 of 56 analysts who cover the stock for Wall Street firms agree it's a buy. My system disagrees.

I use the 26-week rate of change (ROC) to spot buys and sells. Clear, unbiased rules make sure that my love of the iPhone doesn't keep me in a stock too long. ROC also helps spot when stocks are really in a bubble, and the indicator says AAPL has finally reached bubble status.

By adding Bollinger Bands to the ROC, we can create a bubble indicator. Bollinger Bands should contain about 95% of the market action, so it is a rare signal when an indicator moves above the upper Band. This should only happen about 2.5% of the time, or about once a year on average.

The chart below shows that ROC for AAPL just broke above the upper Band for the first time in several years. In the chart, the upper Band has been adjusted to 2.5 standard deviations. Breakouts above that Band should only occur about less than 0.62% of the time. This shows that AAPL really is acting like a bubble stock.



The monthly ROC confirms that AAPL could need some time to consolidate its recent gains. This indicator is below its 20-month moving average. When this happened before, the price of AAPL went nowhere for a few months.



Stocks can still move higher even if AAPL doesn't lead the way. Market leadership rotates, a sign of a healthy market. I designed the 26-week ROC strategy to spot those leadership shifts, and this week it's saying we should increase our exposure to small-cap stocks and buy Vanguard Small-Cap ETF (VB).

Small caps have outperformed large caps over the past 6 months. AAPL is the largest of the large caps and if the leadership is moving away from AAPL, that could mean small caps should continue to be the best performers in the market.

VB is set up to break through resistance. If it does I think it can reach $105 a share. The previous high was at $81 and VB fell to about $57 as it formed a rounding bottom pattern. After breaking out, technicians expect a stock to rise as far as it fell in this pattern. The 24 point decline added to the $81 breakout level gives a price target of $105.



Each buy in this strategy requires a sell, and I'm selling iShares Barclays 20+ Year Treasury Bonds (TLT) to make room for VB.

The strategy says we should be holding Vanguard REIT (VNQ), SPDR S&P 500 ETF (SPY) and Vanguard Small-Cap ETF (VB) after the trades are completed on Tuesday.

Michael J. Carr

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