September 22, 2017

The Market Sentimentalist – Confidence Tricks: Is Apple at Risk of Doing An “Isaac”?

by Amareos.

Apple product launches are always big media events and this year’s was no exception as evidenced by the fact that one was barely able to log-on to a news media site in the days leading up to the launch without seeing some reference to it[1]. What made this event “special”, if that is the correct word, was that Apple marked the tenth anniversary of the first-ever iPhone launch – a product that helped accelerate the company to its current pole position in the market cap leader board – by releasing a special iPhone X alongside, the new iPhone 8/8+ and updated Apple Watch and Apple TV products.

As Apple’s most expensive phone, expectations about the iPhone X were high. Moreover, a great deal of the phone’s features had been “leaked” to the media and hence well flagged before Apple CEO Tim Cook even made it onto the stage. Looking at the intraday moves in Apple’s stock price, what was interesting to note was that the day high (USD 163.96) occurred just as the iPhone 8 details were unveiled and the slide continued as the iPhone X was released, accelerating after the new facial recognition software failed[2]. By the end of the session Apple closed down 0.4%.

Given all of the pre-announcement hype and the extensive leaking of the new iPhone features one is sorely tempted to conclude that such price action is simply a classic, “Buy the rumour, Sell the fact”. Indeed, such price action has been seen before. Dips occurred after the iPhone 3, 4, 5s, 6 and 6s were unveiled, although when put in a longer-term perspective they hardly register – see exhibit below[3].

Exhibit 1: Apple Stock Price & iPhone Announcements

Source: www.amareos and www.google.com

It could, however, also be an early indication of something more troubling to the many stock holders hoping and praying that Apple will be the first to reach the USD1tr cap mark.

Cook described the iPhone X as “the biggest leap forward since the original iPhone was released”. Yet, aside from facial recognition which allows users to unlock their phones by looking at them (a differentiator for sure but one that caused some security concerns[4]), many of the new iPhone’s features – the lack of a home button, an edge-to-edge 5.8 inch screen and wireless charging – already feature on Samsung’s Galaxy S8 phone which was released back in April at a lower retail price[5].

This aspect of the launch is particularly resonant with us because of recent shifts in how the crowd views innovation – one of the topics we identify from the millions of finance articles we analyse every day –in relation to the world’s two leading smart phone producers.

The serious issues Samsung had with the Galaxy Note 7 last year, resulting in a major product recall, hit the crowd’s view of the South Korean company and public negativity rose sharply[6]. However, aided by the successful release of the Galaxy S8 phone, this negativity has abated markedly – see exhibit below.

Exhibit 2: Crowd-Sourced Sentiment – Innovation

Source: www.amareos.com

By contrast, crowd sentiment on innovation towards Apple has been dropping sharply. For such a long-considered technology pioneer, a growing perception that it is losing its edge could impinge upon the stock’s future performance. As the exhibit below indicates, there is as yet no evidence of this occurring, but it is a growing risk.

Exhibit 3: Crowd-Sourced Innovation Sentiment – Apple

Source: www.amareos.com

To understand why the stock price remains supported despite such apparent concerns, one has to consider the crowd’s general perception towards Apple, which is, as we noted in our tweet previewing the launch (see below), strongly positive – across both traditional and social media.

Exhibit 4: A Recent Tweet

Source: www.twitter.com

At face value this appears to be a positive indication about Apple’s stock price – the crowd has a constructive view on the company and by extension its products. However, the key element of that Tweet was the words “no doubt”.

As we have noted on many occasions the interaction between public perceptions and market prices is not as straight forward as crowd sentiment consistently leading the latter[7] – it is much more nuanced. There are times when it is prudent to go with the herd ie. crowd and other times to go against.

We discussed this concept at some length in a Market Insight published last year when we outlined the phenomenon of “crowd fail”[8], which describes the conditions where…

“the predictive power of the many over the few is likely to be inferior”.

We would encourage those interested to revisit the piece in full, but in summary, “crowd fail” occurs whenever there is a strong skew in the public’s perceptions which shows up as a very positive or very negative indicator reading. This high correlation of opinion is simply a fancy way of saying that there is widespread confidence in the future direction of the asset price in question[9]  and it is this correlation (or confidence) that undermines the crowd’s superior forecasting ability.

While an extreme sentiment skew – either positive or negative – lays the foundations for “crowd fail” we fully recognize that there is no logical objection to an already bullish crowd being even more bullish driving prices up even further in the short-term (vice versa for bearish). Cognizant of this, our preference is to look for situations when the momentum of crowd sentiment, having become extreme, starts to reverse.

Nothing in finance is guaranteed, and it may also mean missing the absolute peak or trough of the asset price cycle, but when the crowd is in the early stages of shifting its mind on something it was previously very confident about it should, at least, provide a useful tailwind for the contrarian investor to exploit.

At present, crowd sentiment towards Apple is elevated but its momentum remains positive, suggesting we aren’t there yet. Nevertheless, and especially given the aforementioned decline in the innovation sentiment indicator[10], it warrants close attention. For those investors not prepared to wait, HP Inc. appears to be an interesting play in the technology/hardware space. Like Apple crowd sentiment is high, but unlike Apple it has started to decline markedly and this sentiment reversal that has not been reflected in the stock price – see exhibit below.

Exhibit 5: Crowd-sourced Sentiment – HP Inc.

Source: www.amareos.com

Interestingly, we came across some research recently, which shows that high confidence is detrimental to investment performance not only at the crowd level but also at the individual level, something that might surprise those used to issuing or following “high conviction” trades.

The piece was posted on www.philosophicaleconomics.com the blog of an anonymous author[11] who goes by the twitter handle @Jesse_Livermore (a famous US investor for the early 20th century whose life was covered in the classic finance book “Reminiscences Of A Stock Operator” by Edwin Lefèvre[12]).

In his (we assume he is male but we could be wrong) latest post, the author introduces a coin-flipping game to examine the importance of updating one’s prior investment beliefs based upon subsequent events – a much under-examined aspect of the investment process.

Using the analogy of a repeated coin flipping experiment, JL, (let’s use as short-hand for his[13] nom de plume), illustrates the impact of investor confidence on the length of time it takes before the error in the original belief – which is introduced by construction – is corrected.

Notably, the experiment uses the mathematically appropriate Bayesian method for updating beliefs and hence the result does not rely on behavioural traits such as cognitive dissonance or confirmation bias (their existence just makes the situation worse). The results are shown in the exhibit below.

Exhibit 6: The Coin Flipping Experiment Outcomes

Source: www.philosophicaleconomics.com

Without wanting to delve too much into the details – we strongly recommend readers read the blog post instead –  the importance element of the chart is the differing speeds of convergence to the correct estimate of a coin’s true worth. The higher the initial level of investor confidence, the longer the convergence period. Bear in mind that any divergence equates to an investor’s perception of reality being incorrect, and hence is analogous to making a mistake and generating losses.

This is a stark reminder that high confidence, a trait respected in almost all areas of the business world, is unhelpful to an investor – it can play tricks that are potentially damaging to one’s financial health. As an antidote to this tendency, which we all suffer from and is highly contagious (hence why we observe repeated financial bubbles) one is better off following Aristotle’s advice who, amongst other things, said..

“Doubt is the beginning of wisdom”

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Amareos crowd-sourced sentiment indicators are based on  Thomson Reuters MarketPsych Indices

FOOTNOTES:

[1] Apple certainly has a great PR department. #Appleevent managed to distract from the #Tedcruz that was trending on Twitter the same day – no doubt much to the relief (non pun intended – honest!) of the US Senator.

[2] Live demos of new tech products are always subject to Murphy’s Law – we know!

[3] The surge in Apple’s stock price when the first iPhone was unveiled on January 9 2007 is also barely a blip these days.

[4] Apple stated that there was a one-in-a-million chance can be unlocked by another person, including using a photo of your face. However, and this is speculative we admit, what is to stop someone forcing you to open the phone by staring into the camera. Moreover, it is conceivable that law enforcement officials would be able to gain access to a suspect’s phone, something that they are presently unable to do via the numeric password system currently in use. This is far from irrelevant given last year the FBI took Apple to court exactly over this issue.

[5] We discussed the outlook for Samsung in a Stock Flash note published back in May – see: https://www.amareos.com/financialresearch/samsung-electronics-trust-comeback/

[6] See: https://www.amareos.com/financialresearch/samsung-galactic-nightmare/

[7] If only it were so we would be writing this from a beach located in a hot and sunny clime.

[8] See: https://www.amareos.com/financialresearch/outsmarting-the-crowd/

[9] We are more familiar with high confidence being associated with asset price gains, but there can also be strong confidence in a bearish view, which translates into a very negative crowd sentiment reading.

[10] Also, EU governments are considering applying a turnover tax to large US tech companies in their latest bid (following last year’s tax probe – see: https://www.amareos.com/financialresearch/appletax/) to try and extract tax revenues from activities within the Euro zone region which they judge to be valid.

[11] See: http://www.philosophicaleconomics.com/2017/09/pmbtdo/ . It is a relatively long and involved post, but well worth the effort in our opinion. For the avoidance of doubt, we do not know who the author of this blog ie. JL is, and as such to the best of our knowledge we have no connections – including financial – with the author other than following each other on Twitter. We just appreciate and respect the thoughtful insights he provides and as this post is complementary to the focus of this Market Insight we wanted to share it.

[12] At the risk of sounding trite by using the ubiquitous “must read” tag, in this instance it is appropriate for anyone interested in understanding financial market dynamics – see: http://amzn.to/2wFv7u4

[13] See earlier disclosure.

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