Apple (NASDAQ:AAPL) shares are about to form a "death cross." This we know. What's not so clear is whether the ominous chart pattern is something investors should be overly concerned with. Chances are it's not.
What's your sign?
Traders and technical chart analysts generally like to put a lot of emphasis on moving averages as tools to help identify support levels or possibly key trend reversals. A moving average that includes a smaller number of periods, be it days or weeks or months, will change course faster than one that includes a larger number. So when the 50-day moving average crosses the 200-day moving average, chartists read into that cross a key indicator of a major trend reversal.
If the 50-day moving average crossed from below to above the 200-day moving average, that's believed to be a bullish signal referred to as the "golden cross." When the opposite happens and the 50-day moving average crosses from above to below the 200-day moving average, that's supposedly a bearish indicator lovingly referred to as the "death cross."
This is happening with Apple as we speak.
The 50-day moving average is currently $597.90, just $0.45 above the 200-day moving average of $597.45. The formation was spotted a few days ago, and many investors figured it would happen by week's end. The two moving averages haven't officially crossed yet, but they're pennies away from doing so.
Chart readers will tell you that means Apple could have an additional 20% of downside -- on top of the 25% that the stock has already lost during its current pullback from all-time highs.
Sounds deadly, but is it?
Traders are a superstitious lot, but the death cross is more of a flamboyant headline than it is a viable investing strategy. It's fun for bears to talk about impending doom and point to the pattern as evidence, but the theory doesn't hold up unless it's also accompanied by deteriorating fundamentals or other challenges with the actual business.
For example, mobile rival Google (NASDAQ: GOOG) formed a death cross at the end of June. Did the search giant see its value crater by 20% from that point? Not quite.
Shares were in the process of bottoming out when the two moving averages crossed, and Google's upbeat earnings release in July helped trigger a march upward, forming a golden cross in the process. Just over three months after traders spotted Big G's death cross, shares tapped new all-time highs of $774.38 at the beginning of October before the next earnings release knocked shares back down. Hardly fatal.
Microsoft (NASDAQ:MSFT) was a different story. The software giant saw its death cross form just after it reported disappointing third-quarter results. The stock began to recover as the company proceeded to launch its latest version of Windows along with its Surface RT tablet.
Just weeks after the launch of Windows 8, Windows head Steve Sinofsky abruptly resigned, introducing much uncertainty into the fledgling platform's future. That shakeup rattled investors, and shares have continued trending lower ever since. The point here is that these were very much fundamental developments contributing to the stock's decline that just so happened to coincide with that eerie-looking chart.
Back to the Mac maker
On the contrary, Birinyi Associates analyst Collin Monsarrat says that Apple's death cross actually may bode well for investors, as historical data suggests that periods of outperformance typically follow. Apple has seen five death crosses since November 2000, and shares typically "struggle for the week and month following the cross," but fast-forward a few more months and shares end up outpacing the market 60% of the time.
As always, long-term Fools are advised to keep an eye on the actual business. On that front, there are a few legitimate storylines for investors to be mildly concerned with in the short term. The iPhone 5 has been stricken with supply shortages ever since launch, but Apple appears to have reached a balance with supply and demand, as the device is now in stock at its online store (instead of the three- to four-week shipping times previously).
The company lost some tablet market share in the third quarter, but that's a market set to explode by 130% over the next four years, and Apple will make up for it in profit share as iPad unit volumes grow. It's possible that Apple may see earnings shrink in the fourth quarter, if you believe its lowball guidance, but that dip would be an expected cyclical result of revamping virtually all of its major product lines within such a short period of time. Top-line sales will undoubtedly reach uncharted territory.
A death cross accompanied by deteriorating fundamentals can be indicative of pain in store for investors, but it means almost nothing when fundamentals are rock solid.
Evan Niu, CFA, owns shares of Apple. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.