Mad Hedge Technology Letter
July 31, 2018
Fiat Lux
Featured Trade:
(THE BEST IN THE BUSINESS),
(AMZN), (FB), (GOOGL), (AAPL), (NVDA), (CRM)
Scale works, and Amazon (AMZN) is proving it.
Jeff Bezos' company is hyper-charging its levers and pumping out growth to the tune of $2.5 billion in net profit as of last quarter.
This is a big deal for a company that has largely been considered using the AWS engine to fund the e-commerce business.
The topline growth is mind-boggling for a company poised to seize 50% of U.S. e-commerce sales by the end of 2018, up from the current 44%.
It's truly an Amazon stock market in 2018.
The razor-thin e-commerce margins are what Amazon is most renowned for, but it's high margin divisions are creating a higher quality company.
Investors are willing to pay a higher multiple for this version of Amazon in the future.
That is a very bullish sign going forward.
Tech shares sold off last Friday because the Amazon fireworks came to an end and no other company will be able to compare with its earnings.
This is another knock off effect from Amazon existing.
Of the vaunted FANG group, only Alphabet and Amazon impressed during this crunch earnings season at a pivotal time in the market that has looked short on ideas.
FANGs are not created equal and Amazon is by far the creme de la creme of this cohort.
The AWS cloud unit and its digital advertising division are the fodder allowing Amazon to take risks elsewhere.
Amazon is the most efficient business in America. In the past quarter it experienced more fluid data centers and warehouse operations.
If you do this for as long as Amazon has, you eventually learn all the tricks to the trade.
Hyper-accelerating technology offers Amazon a new way to implement new efficiencies, non-existent even a quarter ago boosting operational margins.
AWS surged 48.9% YOY to $6.11 billion improving on 48.7% last quarter.
AWS is also comprising a larger stake of the business than before.
This quarter AWS attributed 11.5% to total revenue compared to 10.8% last year.
The topline growth is staggering for a company duking it out with Apple (AAPL) to be the first trillion-dollar company.
The narrow breadth of the nine-year bull market is becoming even narrower, raising risk levels in the short term.
AWS is expected to grow into a $42 billion business by 2020, a nice double of what it is today.
Jeff Bezos does not need to respond to the administration's digital criticism of him because he doesn't need to. Taking the high road is the solution. If he wants to say something, he can publish it through a proxy via the Washington Post, which he owns.
Amazon's digital ad business has been a revelation.
The bad news is that Alphabet (GOOGL) and Facebook (FB) have cornered the global digital ad market taking in 73%, a nice bump from the 63% in 2015.
And of the global digital ad growth, they are collecting 83% of that growth.
That hasn't stopped Amazon from taking a stab at the digital ad market itself which is the logical move with the number of eyeballs attracted to its platform.
The ad business did $2.2 billion in sales last quarter, a nice increase of 132% YOY.
Even though in its infancy, this super-charged digital ad division could eventually give Alphabet and Facebook a run for its money - another reason Facebook is trading in bear market territory.
Facebook's platform quality is far inferior than Amazon, which uses it for e-commerce rather than posting free user content.
Facebook is still pocketing tons of cash but it's growth narrative has been exhausted shown by the dismal guidance for the second half of the year.
Amazon is incrementally raising the quality of the company in all facets, evident in the topline growth and jump in profitability.
Amazon absolutely does care about the bottom line. Watch for the net profits to surge past $3 billion in the third quarter in its resurgent digital ad business.
And with the ad tech quality floating out there, Amazon will be able to invest in poaching top dogs from Facebook and Google to build this division swiftly into tens of billions of dollars in revenue per year.
It could crescendo into another AWS-esque monster.
In Q2 2017, Amazon posted total revenue of $37.96 billion. Fast forward to 2018 and revenue raced ahead to $52.9, a robust $14.94 billion improvement.
The $14.94 billion in one quarter year-over-year improvement in Amazon total revenue is more than many tech companies earn in one year including outstanding companies such as Salesforce (CRM) and Nvidia (NVDA).
It is important for tech companies to have many irons in the fire and Amazon proves this theory correct.
The competition is cutthroat to the point that large tech companies are morphing into each other then abruptly diverging.
The brilliant ideas are copied, then the next set of ideas filter in to be copied again.
Luckily, these ideas are coming from Amazon, which is one of the most innovative companies in the world with top-level management.
This all adds up to why Amazon posted its third straight profitable quarter of more than $1 billion in profits.
Prime members didn't flinch with the price increase of an annual Amazon prime subscription showing management understands the true pulse of its customers.
Under-promise and overdeliver time and time again and a customer will be stuck with you for life.
In the past, investors only bought this company for topline growth. Now, we have a different animal on our hands turning into a model company with bottom line growth flourishing.
Management has proved that strategically investing in the right businesses bear fruit.
It takes time for these businesses to develop but when they do they turn into cash cows.
Investors will take delight in seeing Amazon's brand as just a topline growth company slowly fading away.
Increasing profits offers more opportunities and funds to create new drivers as well.
Increasing profits also adds more opportunities to reallocate capital to shareholders opening up a new investor base.
The network effect is truly alive and well, and the Mad Hedge Technology Letter has routinely identified this company as the best in the tech industry.
________________________________________________________________________________________________
Quote of the Day
"Technological progress has merely provided us with more efficient means for going backwards," said British writer Aldous Huxley.
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more
Global Market Comments
July 30, 2018
Fiat Lux
Featured Trade:
(THE MARKET OUTLOOK FOR THE WEEK AHEAD,
or POURING GASOLINE ON THE FIRE),
(MSFT), (AMZN), (FB), (NFLX), (TWTR),
(TESTIMONIAL)
Pour gasoline on a fire and you get a reaction. It's a simple matter of physics. That is the natural result of hitting the economy with tax cuts, fiscal stimulus, and low interest rates all at once. But at what price?
Of course, the headline number of the week was the first read on Q2 GDP growth, which came in at a strong 4.1%, the hottest number in four years. What was one of the biggest contributors? Soybean sales, as buyers rushed to beat the imposition of retaliatory Chinese tariffs. Consumers also hit the stores hard, spending their rising by a robust 4%.
The big question now is how much of this is sustainable? The answer is probably not much, which leaves investors with the queasy feeling that by coming in now they risk buying the absolute peak in the stock market. By temporarily pulling forward so much growth you may be creating a growth hole in Q3. So better mark your calendars now.
Q2 almost always delivers a string rebound from a usually weak Q1. The tax cuts delivered a one-time-only boost. But the investment spending that the administration had hoped for hasn't materialized, with a disproportionate portion of corporate profits going into share buybacks instead. Inventories are rising sharply, which is always bad.
We'll know for sure in a year when a recession will most likely begin. And remember, this extra growth is at the expense of an increase in the national debt by 10%, from $21 trillion to $23 trillion. And that is definitely NOT sustainable, but everyone in the world seems to have forgotten that, except me!
Interestingly, the report placed the current inflation rate dead on the Fed's target at 2.0%. That is a guarantee that any continued economic strength will be offset by rising interest rates.
The Facebook (FB) earnings highlighted the poor risk/reward of buying tech stocks at these elevated levels. Facebook shares plunged by 20% on their earnings announcement, creating the largest single day loss of market capitalization in history, some $120 billion. It was obviously a "kitchen sink" quarter.
If you get an earnings beat, as you did with Microsoft (MSFT) and Amazon (AMZN), you get a 2-, 3-, 4% pop in the stock price. If you disappoint, as did Facebook, Netflix (NFLX), and Twitter (TWTR), they crater by 10% to 20%. It is all typical end-of-cycle price action.
On the other hand, Amazon knocked the cover off the ball with its earnings, which came in at double analyst forecasts. The company is about to reach my end 2018 target of $2,000 a share. That is double the February lows.
Amazon Web Services delivered a stunning $6.1 billion quarterly revenue, up 49% YOY. Advertising is now becoming a major factor, as the company challenges Google (GOOG) and Facebook. For more on the longer-term prospects of Jeff Bezos's incredible company please see the special report that I published yesterday.
Bonds (TLT) continued their moribund price action, barely eking out a gain in yields to 2.97%. Either they are already discounting the next recession, are flooded with cash from a global QE hangover, or are getting a nice flight to safety bid brought on by multiple trade wars. Most likely it is all three.
Better to opine from the sidelines than to attempt to trade in the least volatile bond market conditions in 30 years.
As for gold, it continues to be a trader's worst nightmare as it plums new 2018 lows. Clearly, globally rising interest rates are not of what bull markets in gold are made. It doesn't help that Venezuela continues to hammer the market by liquidating its entire gold reserves on its way to national bankruptcy. Whenever distress liquidations take place, they are bad for everyone, not just the seller. Competition from crypto currencies for the speculative dollar doesn't help either.
As I have been sitting on top of an Alp contemplating the future and out of the markets, my 2018 year-to-date performance remains unchanged at an eye-popping 24.82% and my 8 1/2- year return sits at 301.29%. The Averaged Annualized Return stands at 35.10%. The more narrowly focused Mad Hedge Technology Fund Trade Alert performance is annualizing now at an impressive 38.69%.
It will be a big week on the data front, with an FOMC Meeting and an onslaught of jobs data.
On Monday, July 30 at 10:00 AM we obtain the June Pending Home Sales.
On Tuesday, July 31 at 9:00 AM EST, then we get the May S&P CoreLogic Case-Shiller National Home Price Index.
On Wednesday, August 1 at 2:00 PM, the Fed announces its decision on interest rates. Given the hot 4.1% Q2 GDP report, another 25-basis point rate rise is entirely possible.
Thursday, August 2, leads with the Weekly Jobless Claims at 8:30 AM EST, which saw a rise of 9,000 last week to 219,000.
On Friday, August 3 at 9:15 AM EST we get the July Nonfarm Payroll Report. Then the Baker Hughes Rig Count is announced at 1:00 PM EST.
As for me, the highlight of the week was being handed the keys to the City of Zermatt by the mayor for visiting for the 50th year. Yes, I camped out here at the Youth Hostel in 1968. Also, with the honor came a Swiss Army knife with my name on it and a beautiful 10-pound coffee table book outlining the route I usually take to the Matterhorn summit.
I am now contemplating my return to the U.S., which is always hellish. It will require two trains (to Visp and Geneva), two flights (to Amsterdam and San Francisco), the last one of which lasts a punishing 10 1/2 hours. Then there is the eight hours of jet lag to deal with when I get home. So, I'll be getting up at 2:00 AM for a while. During those days I will be posting some of my favorite pieces from the past.
Still, to see the 14,692-foot Matterhorn from where I am sitting in the brilliant sunshine in all its glory, listening to an Alpine river rushing outside my window, and watching the swaying pines, it is all worth it.
Good luck and good trading.
Mad Hedge Technology Letter
July 30, 2018
Fiat Lux
Featured Trade:
(INSTAGRAM TO THE RESCUE),
(FB)
He did it.
Facebook CEO Mark Zuckerberg decided it was time to pull the plug and reset.
After the data leak scandal, Facebook's torrid rise from the pullback of $157 to $219 was one of the best trades of the quarter.
Management felt this was the perfect time to snatch breathing room to fix the faults weighing down the business.
No doubt the daily pounding of negative stories crucifying Zuckerberg in the press took its toll.
Painting a picture of an out-of-touch-with-reality villain, stacking his cash in a luxury Palo Alto estate, did not sit well with Zuckerberg.
Flat North American daily active users (DAU) growth and a slight dip in European usership caused by General Data Protection Regulation (GDPR) was baked into the pie.
Investors already knew that.
Facebook even increased its average revenue per user in North America to $25.91 per user from $23.59 the quarter before.
There were many positives from the earnings report.
Revenue clocked in at $13.23 billion, slightly lower than expectations but nothing to cry your eyes out over and still a 42% YOY rise.
Then came the guidance.
In one word - cataclysmic.
Facebook dropped off a cliff in the aftermarket trading session sliding as much as 24%, a haircut of $150 billion of market share in a span of just an hour.
In all reality, the run-up to such towering levels ignited fears of acrophobia after a nine-year bull market leaving tech as the strongest pillar driving equities higher.
Profit taking was swift.
The same dilemma presents itself with many other top-quality tech stocks trading at all-time highs after similar parabolic moves up because the expectations are excessive.
Facebook rather chop down the tree now than face the music next quarter or the quarter after that, especially in a tech sector transforming at the speed of light.
Management said revenue growth rates would deteriorate "as much as high single digit percentages" in the second half of the year.
Uttering this one-line reversed investor's vertigo in Facebook shares.
This raises the question, has social media peaked?
No, social media is morphing with its users' needs and desires into something that might not look like the "traditional" social media of yore.
Instagram is the new growth driver for Facebook and could produce 20% of revenue by 2020.
Instagram is what Facebook was years ago with robust user growth and solid engagement numbers.
Facebook announced that comprehensive users totaled 2.5 billion users, which include Facebook, WhatsApp, and Instagram platforms.
Instagram's unit is expected to eclipse $8 billion in revenue in 2018.
The reset is code for Facebook's management believing the days of 40% revenue growth is over.
Decelerating into the 30% range is not game over for the stock.
It was bound to happen.
If you told most companies annual revenue would climb by 30%, they would be dancing in the streets.
Users' preference for a story-driven social media experience has made standard Facebook a relic.
Instagram is dynamic and a social media favorite for young adults and youth.
Videos and photos posted vanish in 24 hours catering toward the attention span deprived youth, while also shuttering out all the side bar noise streamlining the visuals.
Its sleek formatting is perfect for the mobile screen at a time when the migration to mobile is picking up a full head of steam.
It's the modern day social media of 2018 and betting the farm on this asset going forward is a risk worth taking.
Investors must remember when Facebook became popular and generated astounding growth numbers. Quality smartphone cameras, high-quality video performance, augmented reality, and photo editing apps weren't at the tip of the users' fingertips yet.
They are now.
Instagram is the response to that, incorporating all these new mechanisms to cater toward the new technology infiltrating our smartphone platforms.
When Millennials want to stay in touch with someone, they ask for an Instagram hashtag first and are shocked if you don't have one.
That never used to happen before.
Welcome to 2018.
The metrics reinforce the move to monetize Instagram.
Instagram recently surpassed the 1 billion monthly active user (MAU) number, up from 500 million in June 2016. Just only recently as September 2017, numbers were strong at 800 million.
Facebook does not disclose ad revenue, but many industry specialists believe Instagram could pull off a sensational year with revenue increasing 70% YOY in 2018.
Maintaining the 5% MAU growth won't happen forever as Facebook proved the past few quarters.
The metric maturation has unfolded the past few quarters forcing Facebook to focus on bumping up the average revenue per user.
Striking while the iron is hot makes even more sense and that means throwing all of its weight behind Instagram.
Facebook is not growing its users in the developed world and they need a response.
This is it.
Certainly, the 2018 version of social media is Instagram.
Social media will morph again in the future, who knows what it will look like, but when it happens, the eyeball migration will happen even faster than the monumental pivot to Instagram.
The network effect will ensure the ad dollars and usership will traverse over to Instagram. In some ways, Facebook is a legacy business in the throes of reinventing itself.
Lowballing next quarter's estimates was a shrewd move.
Notice the time horizon of companies turning into legacy companies is quickening, reinforcing cash-rich tech companies to bet big on a few projects in anticipation of market demand for a hot new industry.
Hits or misses are common, or if you are SoftBank's Masayoshi Son, just invest in all of them. Can't go wrong with that.
This trend speaks volumes of the innovation percolating throughout the corridors of Silicon Valley and why the American tech sector is the crown jewel of the American economy.
And we haven't even talked about WhatsApp yet, the chat messenger that Facebook pocketed for $19 billion in 2014.
WhatsApp has 1.5 billion MAUs and 450 million DAUs.
Brian Acton, the co-founder of WhatsApp, quit in disgust as Zuckerberg piled on the pressure to manipulate data in the same way Facebook has been doing for years.
This departure is the go ahead signal for Zuckerberg to start selling ads on the ad-less WhatsApp platform.
Ka-ching!
WhatsApp is next in line to be monetized after the Instagram pivot, and will harvest a whole new income stream channel for Facebook boosting the stock.
This is not a dead company by far, but tech companies must recalibrate as their cash cows become stale. It's the nature of the tech environment we have thrust ourselves in whether we like it or not.
What to do about the stock?
Allow the stock to show some consolidation around these levels. A strong support level is just below at $160.
We could get around that $160 level if we get a few analyst downgrades, which could be in the cards the next few days.
A long-dated, deep-in-the-money call spread incorporating strike prices around $140 would be worth pulling the trigger on if Facebook can demonstrate it can stay above the technical support.
Facebook has set itself up for an earnings' beat next quarter, as the deterioration it forecasts seems implausible to the extent management described it.
Management wants to shake out all the crud before the next move up commences.
We are entering into a new phase of Facebook. And Facebook has the brute resources and innovational prowess to readjust itself in a tech environment that has remarkably changed since 2017.
Facebook's New Lifeline
________________________________________________________________________________________________
Quote of the Day
"Computers are like bikinis. They save people a lot of guesswork," said former Chicago White Sox baseball player Sam Ewing.
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more