Apple sauce
Yesterday we presented a tidy theory of the Magnificent Seven’s underperformance in the past month or so. Considered as an asset class, the seven are the new defensives stocks — companies with great brands that can grow even in a slowing economy. But the market at the moment, far from playing defence, wants exposure to economic growth through cyclical stocks.
There’s a little problem, though: most of the decline in the seven comes down to one company. Apple is down 14 per cent since Christmas. Tesla is down 11 per cent, but is only a third of Apple’s weight in the S&P 500. The rest of the seven are meandering along, a bit above (Nvidia) or below (Alphabet) the performance of US big caps, generally.
We could repurpose our argument to be just about Apple, which very clearly is a defensive stock, rather than all the Magnificents. But there are specific things going on with the company that explain its even steeper decline.
In April of last year, after another bout of underperformance from the iPhone maker, we wrote a piece called “What’s wrong with Apple?” We considered six explanations:
- It is overvalued
- Sales growth will stay soft
- It lags behind in artificial intelligence
- Defensives are becoming unpopular
- Its high China exposure is problematic
- Legal risks
We were not too impressed with any of those arguments then. Our instincts turned out to be good: the stock rose 50 per cent from when we wrote the piece to the end of the year. But now, all six worries have gotten worse.
Even after the recent sell-off, the stock’s price/earnings valuation is a third higher than it was back in April. The sales growth and AI issues have come together: consumers have not demonstrated wild enthusiasm for AI-enabled phones in general, and the perception that Apple is lagging behind Android on that tech has grown. This casts doubt on the idea that AI will drive a big iPhone upgrade cycle. As Craig Moffett of MoffettNathanson research sums up:
Not only have we not seen any sign of an upgrade cycle . . . we have seen growing evidence that consumers are unmoved by AI functionality (not just Apple’s but indeed everyone else’s as well). Meanwhile, fully agentic AI, the foundation of any real bull case for Apple, seems further away now than it did even five months ago.
The weakness of defensives we discussed yesterday. An ascendant and aggressive Trump increases the odds that Apple will not get a tariff exemption for iPhones (Edison Lee of Jefferies estimates 90 per cent of which are made in China), and makes it more likely that Chinese consumers will become more hostile to the company’s products.
The legal issues are perhaps the most acute risk. The judge in the Google search antitrust case has ruled the company’s payments to Apple for search traffic are illegal. These payments amount to perhaps $16bn or more a year, more than 10 per cent of Apple’s operating earnings in the US. CFRA Research’s Nicholas Rodelli put 60 per cent odds on the legal remedy cutting the payments by at least half.
Apple still looks expensive to us. Let us know what you think.