AAPL

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We think AAPL has gotten way overextended. Maybe it breaks down from here, with a significant and decisive break of both its moving average and trendline. Or maybe it manages to keep itself within the channel, wedging itself into the little triangle formed by the ascending trendline and the horizontal support created by its October and November highs. From there, of course it could break strongly to the upside. But there's no way of making either of those calls right now. Our warning on AAPL shares are more rooted in the company's size than anything else. AAPL is simply too large to keep growing at its current pace, and it has once again nearly maxed out how far it can comfortably push the upper limit of its valuation range.

Let's suppose you could accept that AAPL will grow by 20% annually for the next five years. We find this hard to believe, but let's give them the benefit of the doubt. In that case, paying a P/E of 25 for the stock would be reasonable. Not a bargain by any stretch, but not outrageously expensive either. It would just be a fair P/E for the stock. Let's give AAPL the benefit of the doubt and calculate its current EPS using what they project to make for Dec 09. That would give AAPL an EPS of approx $6 per share. With a pricetag of $196, that gives AAPL a P/E of approx 33. Looking out about 12 months from today, AAPL is expected to have an EPS of $8 per share. If it stayed at today's price of $196, its P/E a year from now would be 25. So there you have it, a stock that should go sideways for the next 12 months, if indeed it wanted to return to a level where its price matched its value.

Considering the stock "should" be at its current price a year from now, there's little risk in buying or shorting it at these levels. It may go higher or lower, or maybe just sideways. But either way, at some point about a year from now, it'll be back at $200 again. We posted similar comments about AAPL's valuation last time it reached the $200 mark. So how do you profit from this? What we like to do is plant this seed in our head, and then watch the chart. If AAPL continues moving higher, our interest in shorting it increases. Perhaps in a month or two, it'll be trading on 2011's EPS. That would make shorting it a whole lot easier. If we thought it was high at $200, then it'll be a screaming short at $250... with a P/E of 42.

We don't actually short individual stocks, especially ones that are trading above an uptrending moving average. But it's still worth keeping tabs on where the four horsemen of tech are trading. They give you valuable insight into how rich the market is becoming. AAPL strengthens our thinking that the market itself is in its early stages of an overbought condition. Each step higher from here, the market is playing an increasingly dangerous game of musical chairs. When the music stops, there won't be any buyers left to fill the sell orders of those who want to take a seat on the sidelines.