Mad Hedge Technology Letter
October 17, 2022
Fiat Lux
Featured Trade:
(THE BIG TALK)
(SOXX), (CHINA), (NVDA), (MU), (LNG)
A lot of people haven’t talked about what’s going on in China. Other world events have lessened the focus in the East.
Yet people should be talking about China now.
Authoritarian China is a way bigger deal than what’s happening in the backwaters of Eastern Europe, and I’ll explain.
What on earth could overshadow all of that?
The US administration announced Chinese semiconductor bans, essentially blocking the transfer of intellectual property to China and forcing American executives to quit en masse or face the risk of losing US citizenship.
To say this is escalatory is an understatement.
Remember that previous US president Donald Trump forced the same interests to apply for special licenses, but never ramped up the tension to fever pitch and allowed business to advance.
The result is every American executive and engineer working in China’s semiconductor manufacturing industry resigning, paralyzing Chinese manufacturing overnight.
When combined with a global demand reduction, this is a heavy blow to the short-term prospects of American chip companies (SOXX) that have deep interests in China such as Applied Materials, Intel, Micron (MU), Nvidia (NVDA) and AMD.
US Commerce department also levied a bevy of restrictions on supplying US machinery that’s capable of making advanced semiconductors. It’s going after the types of memory chips and logic components that are at the heart of state-of-the art designs.
For companies with plants in China, including non-US firms, the rules will create additional hurdles and require government signoff.
South Korea’s SK Hynix Inc. is one of the world’s largest makers of memory chips and has facilities in China as part of a supply network that sends components around the world.
The biggest name to be added to the list ban is Yangtze Memory Technologies Co. The memory-chip maker is considered the most successful chip company in China wielding the best technology obviously thanks to American technology.
I found it interesting that at almost the same time, China instructed local resellers to stop selling liquid natural gas (LNG) to Europe as mounting proof China views Europe and America through the same lens.
The rapid escalation means the fragmenting of the United States economy and China will accelerate into the future resulting in the inevitable on-shoring of American chip factories back to the United States which we are already seeing.
Other industries will need to be on-shored back to United States and other friendly countries too.
In the short to mid-term, this means higher costs for the American chip companies as reinvesting into capital projects are a multi-billion dollar proposition.
Also, the pain of losing the large China market hurts badly for the stock and is damaging to the annual revenue outlook.
Expect many revenue downgrades coming down the pipeline.
Inflationary costs is another driver of revenue downgrades too as paying these specialists and keeping the lights on have gotten more expensive.
The chip companies won’t be able to substitute the China demand when we are on the verge of recessions in the United States and Europe.
Ultimately, the infamous boom-bust cycle for the chip stocks will get a more prolonged bust this time around as demand and supply are both painfully reduced.
The boom also will be larger because of coming from a lower cost basis.
However, I would highly doubt a bounce back of any chips stocks in the short-term unless broader market forces drag up stocks which could happen.
We will most likely experience strong bear market rallies met by thundering selloffs.
I would avoid any long term investments into chip companies now and just trade the bounces short-term.
“When we launch a product, we're already working on the next one. And possibly even the next, next one.” – Said CEO of Apple Tim Cook
Global Market Comments
October 17, 2022
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, or BLUNDER 3.0)
(RIVN), (TSLA), (V), (JPM), (AMAT), (HPE), (DELL), (KBH), (LEN)
There is no doubt whatsoever that the stock market tried to break down last week and failed. At worst, the Dow Average double bottomed at $29,600, the same level it reached on September 28.
And even that low was a mere 800 points lower than the one we set on June 14.
And that’s how it’s going to go.
Incremental new lows, followed by violent “rip your face off” rallies on enormous volume.
Until it ends.
That happens when markets start speculating about coming interest rate cuts sometime in 2023. And remember, you’re buying stocks for not what the economy is doing today, but for how well it will be performing in six to nine months.
You’re buying the future, not the present, or heaven forbid, the past.
That means you should use these throw-up-on-your-shoes days to scale into your favorite long-term companies. When markets inevitably rally, you can either sell for a short-term profit and rewind the video once again or keep it as part of a long-term holding.
It's a nice choice to have. I’ve been doing it all year.
With some of the greatest market volatility in market history, my October month-to-date performance ballooned to +5.00%.
I used last week’s extreme volatility to roll down strike prices for Tesla (TSLA) and JP Morgan (JPM) option spreads to manage my risk. I was still able to hang on to a 40% long position and threw out a new short in the S&P 500 at the end of Thursday.
My 2022 year-to-date performance ballooned to +75.06%, a new high. The Dow Average is down -18.48% so far in 2022. With the coming Friday options expiration, I will be up +76.49%.
It is the greatest outperformance on an index since Mad Hedge Fund Trader started 14 years ago. My trailing one-year return maintains a sky-high +78.54%.
That brings my 14-year total return to +587.62%, some 3.03 times the S&P 500 (SPX) over the same period and a new all-time high. My average annualized return has ratcheted up to +44.23%, easily the highest in the industry.
Remember that old 60/40 equity/bond investment strategy? The idea was that whenever stocks went down, the losses would be offset by the profits from rising bonds.
This year, it delivered the worst performance in 100 years, down 34.4% year-to-date. That is the inevitable end result of a decade of zero interest rates and free money that took everything up.
So what is the best strategy you could probably employ right now? A 60/40 strategy. Even I find myself checking out bond yields these days, where I got my start in life as a trader 50 years ago. Yes, before there were stocks, there were bonds. Junk is now yielding 10%. Remember, that means a holding doubles in value every six years.
The market is clearly in a mood to throw out the babies with the bathwater. I would be remiss not to mention the recent decline of Tesla posing one of its periodic tests of the faithful, now approaching a once unheard-of price earnings multiple of 30X.
Up until September 20, Elon Musk’s creation was almost immune to the bear market.
Then Twitter (TWTR) happened.
Musk agreed to take majority control of a $44 billion company, of which Elon himself is only contributing $16 billion. He sold Tesla shares last July to fund this. But the market wiped $333 billion, or 34.6%, off the market capitalization of the company. It is a wild overreaction to the move.
This has nothing to do with Tesla itself, as the richest man in the world is buying Twitter with his own pocket change. But it is undeniable that it will be a distraction of management time.
And here is all you need to know about Tesla. Tesla is the fastest growing large company in the world. Profit margins are increasing, thanks to the recent collapse of commodity prices. Unit sales will rise by 40% this year. Every time Tesla opens a new factory at a cost of $7 billion, it generates $15 billion of profit per year, forever!
Remember also, that the stock market gets an 800-pound gorilla off its back with the end of the midterm elections on November 8. It makes no difference who wins, a major uncertainty will be gone. That much IS certain.
And what happens when the Fed keeps interest rates too low for long, then raises them too much? It lowers them again too much, igniting a monster bull market in stocks. That’s also what you’re buying down here. That's what you get when you appoint a central bank governor with a political science major rather than PhDs and Nobel Prizes in Economics like the last ones.
Call it blunder 3.0.
Consumer Price Index Rockets Up to 8.6%, up 0.4% on the month and a new 40-year high. Stocks, bonds, crypto, and currencies were crushed and the US Dollar Soared. Look for new lows in stocks. Growth really took it on the nose. Expect another month of volatility until the next CPI report comes out.
Stocks Mount Historic Rally, gaining $1,420 points, or 5% of the intraday low. Stocks were down 500 in the wake of the CPI report, then up $1,420. It was mostly hedge short covering, as most institutions are too slow to react. Still, we now have a low to trade against.
The Fed Minutes are Out, and our central bank is clearly worried about doing too little than too much, when they are doing too much. At least they did six weeks, or 4,000 Dow points ago. The inflation goal is still 2.0%. Interest rates will go higher before they go lower.
Equity Inflows Hit a Record Last Week, the third highest week since 2008. Long term investors are willing to bottom fish here, even if the final bottom isn’t found for months.
Bond Liquidity Issues Haunting the Fed, and bids dry up in an endlessly falling market. The matter has been greatly exacerbated by a Fed that is now selling $95 billion a month as part of its quantitative tightening policy. It’s becoming increasingly difficult to move big blocks of bonds in a zero-bid market. Spreads are widening and size is shrinking. The bad news is that the worst is yet to come.
You Just Got an 8.7% Raise, if you are older than 61 and collecting Social Security. That is the payment increase that kicks in from January. Fortunately, some thoughtful person eons ago tied payments to the CPI, which is now going through the roof. I’m going to Hawaii with my money, even if the increase means that Social Security goes bankrupt by 2034, when I’m 82.
PC Sales Dive 19.5% in Q3, reaching only 68 million units. It’s the steepest decline since PC data collection began 30 years ago. And you wonder why they are selling the chip stocks so aggressively. High inventories are also a big problem. Lenovo was the top seller in the world at 20.2 million units, followed by Hewlett Packard’s (HPE) 17.6 million, and Dell (DELL) at 15.2 million.
Applied Materials Cuts Estimates, in line with everyone else in the industry. The new government export restrictions will cost it $250-$500 million in the current quarter. But how much is already in the price? Buy (AMAT) on dips.
Home Financing Pours into 5/1 ARMS, which can be had for a doable 5.56%. That compares to over 7.0% for the 30-year fixed, the highest since 2006. It will be low enough to keep homebuilders on life support for a couple of years Avoid (LEN) and (KBH).
REITS are Still Getting Slaughtered, with the plunge in the bond market today to multidecade lows. The REIT Index is down 30% this year, while the (SPY) is off only 21%. Real Estate Investment Trusts do best when interest rates are low. Too many investors piled into REITS in a desperate reach for yield. There’s a great trade here someday, but not yet.
My Ten-Year View
When we come out the other side of pandemic and the recession, we will be perfectly poised to launch into my new American Golden Age, or the next Roaring Twenties. With oil in a sharp decline and technology hyper-accelerating, there will be no reason not to. The Dow Average will rise by 800% to 240,000 or more in the coming decade. The America coming out the other side will be far more efficient and profitable than the old. Dow 240,000 here we come!
On Monday, October 17 at 8:30 AM, the New York Empire State Manufacturing Index for September is released.
On Tuesday, October 18 at 7:00 AM, the D for September is out.
On Wednesday, October 19 at 8:30 AM, Housing Starts and Permits for September are published.
On Thursday, October 20 at 8:30 AM, Weekly Jobless Claims are announced. At 10:00 AM, we get Existing Home Sales for September.
On Friday, October 21 at 2:00 PM, the Baker Hughes Oil Rig Count is out.
As for me, it was in 1986 when the call went out at the London office of Morgan Stanley for someone to undertake an unusual task. They needed someone who knew the Middle East well, spoke some Arabic, was comfortable in the desert, and was a good rider.
The higher-ups had obtained an impossible-to-get invitation from the Kuwaiti Royal family to take part in a camel caravan into the Dibdibah Desert. It was the social event of the year.
More importantly, the event was to be attended by the head of the Kuwait Investment Authority, who ran over $100 billion in assets. Kuwait had immense oil revenues, but almost no people, so the bulk of their oil revenues were invested in western stock markets. An investment of goodwill here could pay off big time down the road.
The problem was that the US had just launched air strikes against Libya, destroying the dictator, Muammar Gaddafi’s royal palace, our response to the bombing of a disco in West Berlin frequented by US soldiers. Terrorist attacks were imminently expected throughout Europe.
Of course, I was the only one who volunteered.
My managing director didn’t want me to go, as they couldn’t afford to lose me. I explained that in reviewing the range of risks I had taken in my life, this one didn’t even register. The following week found me in a first-class seat on Kuwait Airways headed for a Middle East in turmoil.
A limo picked me up at the Kuwait Hilton, just across the street from the US embassy, where I occupied the presidential suite. We headed west into the desert.
In an hour, I came across the most amazing sight - a collection of large tents accompanied by about 100 camels. Everyone was wearing traditional Arab dress with a ceremonial dagger. I had been riding horses all my life, camels not so much. So, I asked for the gentlest camel they had.
The camel wranglers gave me a tall female, which was more docile and obedient than the males. Imagine that! Getting on a camel is weird, as you mount them while they are sitting down. My camel had no problem lifting my 180 pounds.
They were beautiful animals, highly groomed, and in the pink of health. Some were worth millions of dollars. A handler asked me if I had ever drunk fresh camel milk, and I answered no, they didn’t offer it at Safeway. He picked up a metal bowl, cleaned it out with his hand, and milked a nearby camel.
He then handed me the bowl with a big smile across his face. There were definitely green flecks of manure floating on the top, but I drank it anyway. I had to lest my host to lose face. At least it was white. It was body temperature warm and much richer than cow’s milk.
The motion of a camel is completely different from a horse. You ride back and forth in a rocking motion. I hoped the trip was short, as this ride had repetitive motion injuries written all over it. I was using muscles I had never used before. Hit your camel with a stick and they take off at 40 miles per hour.
I learned that a camel is a super animal ideally suited for the desert. It can ride 100 miles a day, and 150 miles in emergencies, according to TE Lawrence, who made the epic 600-mile trek to Aquaba in only four weeks in the heat of summer. It can live 15 days without water, converting the fat in its hump.
In ten miles, we reached our destination. The tents went up, clouds of dust rose, the camels were corralled, and the cooking began for an epic feast that night.
It was a sight to behold. Elaborately decorated huge five wide bronze platers were brought overflowing with rice and vegetables, and every part of a sheep you can imagine, none of which was wasted. In the center was a cooked sheep’s head with the top of the skull removed so the brains were easily accessible. We all ate with our right hands.
I learned that I was the first foreigner ever invited to such an event, and the Arabs delighted in feeding me every part of the sheep, the eyes, the brains, the intestines, and gristle. I pretended to love everything, and lied back and thought of England. When they asked how it tasted, I said it was great. I lied.
As the evening progressed, the Johnny Walker Red came out of hiding. Alcohol is illegal in Kuwait, and formal events are marked by copious amounts of elaborate fruit juices. I was told that someone with a royal connection had smuggled in an entire container of whiskey and I could drink all I wanted.
The next morning I was awoken by a bellowing camel and the worst headache in the world. I threw a rock at him to get him to shut up and he sauntered over and peed all over me.
The things I did for Morgan Stanley!
Four years later, Iraq invaded Kuwait. Some of my friends were kidnapped and held for ransom, while others were never heard from again.
The Kuwaiti government said they would pay for the war if we provided the troops, tanks, and planes. So they sold their entire $100 million investment portfolio and gave the money to the US.
Morgan Stanley got the mandate to handle the liquidation, earning the biggest commission in the firm’s history. No doubt, the salesman who got the order was considered a genius, earned a promotion, and was paid a huge bonus.
I spent the year as a Marine Corps captain, flying around assorted American generals and doing the odd special opp. I got shot down and still set off airport metal detectors. No bonus here. But at least I gained insight and an experience into a medieval Bedouin lifestyle that is long gone.
They say success has many fathers. This is a classic example.
You can’t just ride out into the Kuwait desert anymore. It is still filled with mines planted by the Iraqis. There are almost no camels left in the Middle East, long ago replaced by trucks. When I was in Egypt in 2019, I rode a few mangy, pitiful animals held over for the tourists.
When I passed through my London Club last summer, the Naval and Military Club on St. James Square, who’s portrait was right at the front entrance? None other than that of Lawrence of Arabia.
It turns out we were members of the same club in more ways than one.
Stay healthy,
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
John Thomas of Arabia
Checking Out the Local Camel Milk
This One Will Do
Traffic in Arabia
“Nine-tenths of tactics were certain enough to be teachable in schools. The irrational tenth was like the kingfisher flashing across the schools,” said TE Lawrence, known as Lawrence of Arabia.
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
Hello everyone,
Trust your weekend was relaxing or productive or whatever you wanted it to be.
John titles his Monday newsletter: Blunder 3.0
In other words, when the Fed keeps interest rates too low for too long, then raises them too much too quickly, it then lowers them again too much, which whipsaws, or creates a bi-polar mentality in the market, and then ignites all thrusters in the rocket and takes the market on a merry swing into the stratosphere.
Welcome to the roller coaster…
This one will be with us until at least the mid-terms have been done and dusted and the next CPI figure is released. There’s going to be a lot of talking, but in the end, it will all be about the numbers. You have a choice: you can turn off all social media and the TV and give yourself some peace and stillness for a time or you can continue to digest and ruminate about what’s said and not said in the media. There is a lot of misinformation, to be sure, you just need to be aware of it.
John’s Monday newsletter is focused on reminding you that you are buying now for what is going to happen 6-9 months down the road. So, on the big down days, we will have and have had in days past, remember to buy in small parcels. Close your eyes and pull the trigger, click that key, or get your offspring to do it for you. They have no fear built in yet.
John has been very nimble this year. As a result, he has returned a great one-year return of +78.54%.
Are you worried about the decline of Tesla lately? You shouldn’t be. It’s approaching a price-earnings multiple of 30X, as John points out in Monday’s letter. What soured the sentiment toward Tesla? You guessed it – Musk’s close relationship with Twitter. Musk sold a large amount of Tesla stock to fund his Twitter buy-in. The market sliced $333 billion or 34.6%, off the market capitalization of the company. Has Musk taken multi-tasking to the extreme and dabbled in too many ventures? Taking your eye off the ball at critical times can be a person’s or a company’s undoing. Time will tell if his step into the Twitter space is Musk’s undoing or is Twitter’s constructive renewal.
If you’re still not convinced. John’s wise wisdom here should pacify you. He reminds us that Tesla is the fastest-growing large company in the world. Profit margins are increasing, thanks to the recent collapse of commodity prices. Unit sales will rise by 40% this year. Every time Tesla opens a new factory at a cost of $7 billion, it generates $15 billion of profit per year, forever.
Has anyone ever been to the Middle East? When John was working for Morgan Stanley in the 1980s, he volunteered for a job that involved him flying to Kuwait and riding in a camel caravan – a great social event - with the Kuwaiti Royal Family into the Dibdibah Desert. The chiefs in Morgan Stanley had received the invitation – notoriously difficult to get on this list. MS needed someone who knew the Middle East well, could speak some Arabic, was comfortable in the desert, and was a good rider. It was a risky assignment as the U.S. had just launched air strikes against Libya, destroying the dictator, Muammar Gaddafi’s royal palace, in response to the bombing of a disco in West Berlin frequented by U.S. soldiers. John was the only one who put his hand up.
If you wish to read about all of John’s adventure in the Middle East, let me know.
Most pandemic consumer trends are now starting to wear off. The stationary bike, the new sofa to watch your favourite Netflix series, or truckloads of potting mix to get your herbs and veggies growing are all on the out. One sector, however, is still running strong: pet care.
Hands up who rushed off to the Animal Welfare League and picked up a fluffy bundle to keep your company in the wee hours? Pet ownership is booming in the U.S. Morgan Stanley research has found that there are about 5 million more pets in the U.S. than there were in 2019. That 4% increase in pet ownership has resulted in an 11% gain in pet spending. Pet ownership has become a global phenomenon. The English have a long-standing history of pet ownership – especially dogs. They are brought in handbags to the dinner table in restaurants and on trains. I’ve also seen them at cafes, the hairdresser, and at the gym. In Australia, our pets ride in the back of utes, ride the waves with their master and harass the postman. Cats, naturally aloof, are also popular and merit a mention. Animals have a calming effect on the human body, and it has been scientifically proven that they can lower stress levels and moderate blood pressure. A four-legged friend is definitely worth the effort and ultimately will be considered part of the family.
Have a great week.
Cheers,
Jacque
Don’t judge each day by the harvest you reap but by the seeds that you plant.
-- Robert Louis Stevenson
Mad Hedge Technology Letter
October 14, 2022
Fiat Lux
Featured Trade:
(INSULT TO INJURY)
(TECH STOCKS)
This is the US Central Bank we have, and there are grave consequences to tech stocks because of it.
This is not to start the blame game, but I’ve been warning readers for the entire year and I’ve been proven right time and time again.
I’ll take a victory lap at the end of the year.
The CPI number yesterday was scorching hot representing pain for higher prices in the United States.
The awful inflation number is highly negative for tech stocks as they tend to overshoot to the downside during bear market.
Higher borrowing costs mean that tech firms cannot run profitable businesses if resorting to capital markets to finance their operations.
Borrowing at 8% means that's growing at 7.9% is a loss-making operation.
This also means that again, future interest rate consensus has gone from bad to worse as another .25% interest rate rise is now priced in for next spring 2023.
I hope you like living in your house because you won’t be able to trade up any time soon because interest rates will stay higher for longer.
Although the mainstream media likes to mention how surprised the Fed is that inflation keeps surging, those reading my newsletter know that it hasn’t been surprising to me.
I’ve been consistently spot on.
No central bank can tame interest rates unless the nominal interest rate is higher than inflation. 3% nominal interest rates aren’t higher than 9% inflation.
The investors I know are still borrowing hand over fist to deploy 4% loans into the economy and it’s a great idea as the price of everything has skyrocketed.
These investors are migrating into the service sector where companies can charge an extra 30%-70% more than before the arbitrary lockdowns.
Essentially, interest rates are still highly accommodative, and will be until the Fed raises rates meaningfully.
This is horrible news for technology stocks as the narrative of higher rates for longer pulverizes tech shares.
This problem won’t magically resolve itself and as we head into the winter, higher utility costs through higher energy prices will contribute to a higher inflation percentage.
Eventually, these close to 10% inflation numbers have to moderate because the law of numbers will lap around after 12 months, but it could take a while.
Terrible Central Bank policy means impoverished tech stocks and tech companies have led the way with mass firings. Luckily, interest rates are still low enough that fired tech workers can score great jobs at US health companies like Pfizer and Moderna. Scoring these paychecks means more spending and more inflation.
US CORE INFLATION CHART FROM PAST 40 YEARS