Apple Slingshot: Making Sense of the Apparently Irrational

Tickers in this article: AAPL
NEW YORK ( TheStreet) -- Since 2009, our observation of the Apple (AAPL) slingshot has been adopted as a defining characteristic of Apple stock action.

The term "Apple slingshot" immediately makes sense to those who realize that institutional buying and selling of Apple stock is a more reliable explanation of its deep selloffs and skyrocket rallies than any particular fundamental strength or weakness.

As this slingshot terminology has morphed into mainstream vernacular we've noticed that some still fail to understand the underlying forces that produce the slingshot action.

Let's begin by explaining what the slingshot is not. The Apple slingshot is not a hedge fund conspiracy. It is not caused by any of the negative rationale that you may hear in the media which includes the underwhelming launch of Apple Maps, the lack of innovation from Tim Cook, iPhone 5 supply constraints, iPad mini cannibalization, Samsung competitive threats, the earnings miss and, of course, the absence of Steve Jobs.

To the uninformed, these variables sound reasonable enough to support a selloff but to those who understand Apple's historical stock precedent, these reasons appear to be nothing more than noise. Seasoned Apple investors know there is more to it.

After 56 days in which Apple has sold off $200 it's easy to fall prey to the noise in the media. At this stage of the correction most Apple investors don't know which way is up or which way is down. They're questioning the very air that they breath.

This kind of confusion is normal in the absence of an accurate explanation of the irrational stock action. After all, there is no denying that Apple's fundamental growth story remains the envy of every company on planet earth.

Would Samsung trade places with Apple? In a heartbeat. Would Google (GOOG) trade its Android platform in favor of the iPhone/iPad/App Store trifecta? Yes, please.

Apple innovation and profitability is unparalleled. So why does the stock drop $200 immediately after Apple set itself up for the greatest holiday sales bonanza in history with new iPhone's, iPod's, iMac's, and iPad's? I'll answer that question with another question.

Suppose you were a mutual fund manager and your strategic models allowed for a maximum 8% allocation in any individual stock. What would have happened to your Apple holdings in 2012?

As of Sept. 21, Apple was up 74.9% year-to-date. Apple allocations at the largest mutual funds had grown to between 13% and 15% of total holdings with the fiscal year-end approaching on Oct. 31. Because of Apple's strength, because it was such an outlier when compared to the rest of the market, these money managers were forced to re-balance their portfolios in order to comply with their risk models.

The Apple slingshots, or in other words, the deeper-than-expected selloffs, are caused by systematic institutional re-balancing. This is the unintended consequence of Apple's status as the most widely held stock of most hedge funds, indices, pension funds and mutual funds.