Mad Hedge Technology Letter
July 5, 2019
Fiat Lux
Featured Trade:
(THE BALL IS IN NETFLIX’S COURT)
(NFLX), (DIS), (AAPL), (IQ), (KHC)
Being as volatile as it is, investors are afforded ample opportunity to get into one of the premium tech stocks in the land Netflix (NFLX).
Chasing this one higher is a dangerous thought, as habitual 30% dips is part and parcel of being attached to this supreme online streaming stock.
December of 2018 gave you that sinking feeling when Netflix dropped off a cliff dipping to $260 but spiking after the turn of the year as the Fed swiveled on a dime to save the equity market from implosion.
Let’s make no bones about it, the long-term narrative for Netflix is intact as it’s ever been.
The company simply makes a great product, period, and systematically taps endless demand.
What many cable companies don’t understand is that you cannot make a high-quality film product that wedges in annoying commercials and equally as obnoxious, dictate the window of time in which they should watch the content.
Optionality is value and Netflix has this spot on.
I know many Millennial consumers that would rather jump off a building than subject themselves to commercials.
These factors erode the quality of the product just as if an employer would dictate to one of his or her employees that wanted to take a vacation to Africa.
But the vacation to Africa would have some strings attached.
He or she would only be able to visit at the height of summer in 120-degree Fahrenheit weather while every activity he or she chose to do, would be pre-empted by numerous advertisements that he or she must be shown.
Consumers don’t need these sideshows anymore; the world has developed away from these models and corporates have lost this control.
The loss of corporate control of the consumers is because the internet gives consumers millions of different options at the tip of their fingers.
Tapping into the optionality and the habits that revolve around it is paramount to corporate America.
This is the same reason why big box food companies like Kraft Heinz (KHC) is getting smacked around, consumers have better options and are more aware of them because of technology.
Another example of corporate miscalculation comes in the form of supply chains being redirected from China to South East Asia.
It was clear as day that during my time in China that companies were making a terrible mistake going into China in the first place.
This shows how many corporates are dragged down by a lack of vision and do an awful job of anticipating paradigm shifts that are becoming more common because of the accelerating rate of change of the corporate climate, weather, technology, rule of law, and human migration.
Netflix is effectively blocked from China and China has its own Netflix called iQIYI (IQ), they had no chance from the beginning like Google, Amazon, Facebook, and the many other American tech firms.
Netflix’s business model now has scale working for them and growth numbers will be the main recipients going forward if they focus on high quality content.
That means expect high pay packages to the best media talent in the world.
They can afford to pay a tier 1 actor $50 million per movie because the data buttresses this strategy.
At the same time, Netflix is crushing competition by hoarding the talent with extraordinary pay packages while allowing these highly paid specialists 100% creative control over what they do.
Who would want to work for a company that paid more than double and whose management gave them free reign on creative decisions?
Sounds like an artist’s dream and it’s exactly that for actors like Will Smith who have signed onto Netflix’s project.
I would even suggest that Netflix needs to overpay actors just for the reason of taking them off the market for competitors.
This truly is the lucrative golden age for actors, producers, and directors who are the top 1% of their craft, but for everyone else, it’s a hard slog.
This usually means becoming a tier 1 actor before the migration to online streaming happened.
The picture I am painting is that Netflix’s success and future prospects aren’t about Disney or other competitors, but entirely about them.
He who has the most chips at the table with the best cards is in best position to win and the same goes for Netflix.
The rest of the bunch like Apple (AAPL) and Disney who are late to the party will be feeding off the rest of what Netflix cannot exploit and that’s the best-case scenario.
Disney should be able to have moderate success with its array of great movie, television, and sports content.
I’d be surprised if Disney failed because they possess the ingredients to concoct a delicious cocktail.
Apple has a harder proposition because of the lack of entertainment value in their content. They are still tied to the hardware sales and much of the service sales come from their app store and servicing the hardware.
But Apple does have money, and a lot of it to throw at the problem, but I don’t believe CEO of Apple Tim Cook is the right man to navigate through the travails of the online content world. He’s an operations guy and has never proved anything more than that.
Netflix still has substantial opportunity to grow its brand and the runway is long.
The demand for watching great original movies and television programs without commercials whenever consumers want is still in the first innings.
Even though Disney will remove some non-original content from Netflix’s platform, the content spend on a massive pipeline of new projects will more than fill the void left by Disney’s content.
In fact, Netflix should thank Disney for all those years that Disney allowed them to build their brand through 3rd party premium content like the television program Friends.
I believe Netflix does not need 3rd party content anymore, that is how much Netflix has bolted ahead in the past few years.
The company has introduced price hikes with its 4K premium package going from $14 to $16 per month.
But Netflix is still underpricing itself to the consumer to grab market share, and there is still pricing headway in the future if the company wants it.
In the coming months, Netflix plans to offer more detailed reporting on its metrics and the transparency will give investors even more insight into why this company is brilliant.
I believe the numbers will show that Netflix is absolutely killing it.
As for the trading, Netflix has settled in a range of $320 to $380 and any dips to the $340 range should be quite appetizing.
Add incrementally and use any large dip to drop your cost basis.
Stand aside if you cannot handle heightened volatility.
“Most entrepreneurial ideas will sound crazy, stupid and uneconomic, and then they'll turn out to be right.” – Said Founder and CEO of Netflix Reed Hastings
Global Market Comments
July 5, 2019
Fiat Lux
Featured Trade:
(FRIDAY JULY 19 ZERMATT SWITZERLAND STRATEGY SEMINAR)
(WHERE THE ECONOMIST “BIG MAC” INDEX FINDS CURRENCY VALUE),
(FXF), (FXE), (FXA), (FXY), (CYB),
(WHY US BONDS LOVE CHINESE TARIFFS),
(TLT), (TBT), (SOYB), (BA), (GM)
My former employer, The Economist, once the ever-tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its "Big Mac" index of international currency valuations.
Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success.
The index counts the cost of McDonald's (MCD) premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.
What are its conclusions today? The Swiss franc (FXF), the Brazilian real, and the Euro (FXE) are overvalued, while the Hong Kong dollar, the Chinese Yuan (CYB), and the Thai baht are cheap.
I couldn't agree more with many of these conclusions. It's as if the august weekly publication was tapping The Diary of a Mad Hedge Fund Trader for ideas.
I am no longer the frequent consumer of Big Macs that I once was as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool than a speedy lunch.
The Big Mac in Yen is Definitely Not a Buy
For many, one of the most surprising impacts of the administration’s tariffs on Chinese imports announced today has been a rocketing bond market.
Since the December $116 low, the iShares 20+ Year Treasury Bond ETF (TLT) has jumped by a staggering $16 points, the largest move up so far in years.
The tariffs are a highly regressive tax that will hit consumers hard in the pocketbook, thus reducing their purchasing power.
It will dramatically slow US economic growth. If the trade war escalates, and it almost certainly will, it could shrink US GDP by as much as 1% a year. A weaker economy means less demand for money, lower interest rates, and higher bond prices.
There is no political view here. This is just basic economics.
And while there has been a lot of hand-wringing over the prospect of China dumping its $1.1 trillion in American bond holdings, it is unlikely to take action here.
The Beijing government isn’t going to do anything to damage the value of its own investments. The only time it actually does sell US bonds is to support its own currency, the renminbi, in the foreign exchange markets.
What it CAN do is to boycott new Treasury bond purchases, which it already has been doing for the past year.
The tariffs also raise a lot of uncertainty about the future of business in the United States. Companies are definitely not going to increase capital spending if they believe a depression is coming, which the last serious trade war during the 1930s greatly exacerbated.
While stocks despise uncertainty, bonds absolutely love it.
Those of you who are short the bond market through the ProShares Ultra Short 20+ Year Treasury ETF (TBT) have a particular problem that is often ignored.
The cost of carry of this fund is now more than 5% (two times the 2.10% coupon plus management fees and expenses). Thus, long-term holders have to see interest rates rise by more than 5% a year just to break even. The (TBT) can be a great trade, but a money-losing investment.
The Chinese, which have been studying the American economic and political systems very carefully for decades, will be particularly clever in its retaliation. And you thought all those Chinese tourists were over here just to buy our Levi’s?
It will target Republican districts with a laser focus, and those in particular who supported Donald Trump. It wants to make its measures especially hurt for those who started this trade war in the first place.
First on the chopping block: soybeans, which are almost entirely produced in red states. In 2016, the last full year for which data is available, the US sold $15 billion worth of soybeans to China. Which are the largest soybean producing states? Iowa followed by Minnesota.
A major American export is aircraft, some $131 billion in 2017, and China is overwhelmingly the largest buyer. The Middle Kingdom needs to purchase 1,000 aircraft over the next 10 years to accommodate its burgeoning middle class. It will be easy to shift some of these orders to Europe’s Airbus Industries.
This is why the shares of Boeing (BA) have been slaughtered recently, down some 13.5% from the top. While Boeing planes are assembled in Washington state, they draw on parts suppliers in all 50 states.
Guess what the biggest selling foreign car in China is? The General Motors (GM) Buick which saw more than 400,000 in sales last year. I have to tell you that it is hilarious to see my mom’s car driven up to the Great Wall of China. Where are these cars assembled? Michigan and China.
The global trading system is an intricate, finally balanced system that has taken hundreds of years to evolve. Take out one small piece, and the entire structure falls down upon your head.
This is something the administration is about to find out.
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to a 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
Mad Hedge Technology Letter
July 3, 2019
Fiat Lux
Featured Trade:
(CHIPS ARE BACK FROM THE DEAD)
(XLNX), (HUAWEI), (AAPL), (AMD), (TXN), (QCOM), (ADI), (NVDA), (INTC)
The overwhelming victors of the G20 were the semiconductor companies who have been lumped into the middle of the U.S. and China trade war.
Nothing substantial was agreed at the Osaka event except a small wrinkle allowing American companies to sell certain chips to Huawei on a limited basis for the time being.
As expected, these few words set off an avalanche of risk on sentiment in the broader market along with allowing chip companies to get rid of built-up inventory as the red sea parted.
Tech companies that apply chip stocks to products involved with value added China sales were also rewarded handsomely.
Apple (AAPL) rose almost 4% on this news and many investors believe the market cannot sustain this rally unless Apple isn’t taken along for the ride.
Stepping back and looking at the bigger picture is needed to digest this one-off event.
On one hand, Huawei sales comprise a massive portion of sales, even up to 50% in Nvidia’s case, but on the other hand, it is the heart and soul of China Inc. hellbent on developing One Belt One Road (OBOR) which is its political and economic vehicle to dominate foreign technology using Huawei, infrastructure markets, and foreign sales of its manufactured products.
Ironically enough, Huawei was created because of exactly that – national security.
China anointed it part of the national security apparatus critical to the health and economy of the Chinese communist party and showered it with generous loans starting from the 1980s.
China still needs about 10 years to figure out how to make better chips than the Americans and if this happens, American chip sales will dry up like a puddle in the Saharan desert.
Considering the background of this complicated issue, American chip companies risk being nationalized because they are following the Chinese communist route of applying the national security tag on this vital sector.
Huawei is effectively dumping products on other markets because private companies cannot compete on any price points against entire states.
This was how Huawei scored their first major tech infrastructure contract in Sweden in 2009 even though Sweden has Ericsson in their backyard.
We were all naïve then, to say the least.
Huawei can afford to take the long view with an Amazon-like market share grab strategy because of possessing the largest population in the world, the biggest market, and backed by the state.
Even more tactically critical is this new development crushes the effectiveness of passive investing.
Before the trade war commenced, the low-hanging fruit were the FANGs.
Buying Google, Amazon, Apple, Netflix, and Facebook were great trades until they weren’t.
Things are different now.
Riding on the coattails of an economic recovery from the 2008 housing crisis, this group of companies could do no wrong with our own economy flooded with cheap money from the Fed.
Well, not anymore.
We are entering into a phase where active investors have tremendous opportunities to exploit market inefficiencies.
Get this correct and the world is your oyster.
Get this wrong, like celebrity investors such as John Paulson, who called the 2008 housing crisis, then your hedge fund will convert to a family office and squeeze out the extra profit through safe fixed income bets.
This is another way to say being put out to pasture in the financial world.
My point being, big cap tech isn’t going up in a straight line anymore.
Investors will need to be more tactically cautious shifting between names that are bullish in the period of time they can be bullish while escaping dreadful selloffs that are pertinent in this stage of the late cycle.
In short, as the trade winds blow each way, strategies must pivot on a dime.
Geopolitical events prompted market participants to buy semis on the dips until something materially changes.
This is the trade today but might be gone with one Tweet.
If you want to reduce your beta, then buy the semiconductor chip iShares PHLX Semiconductor ETF (SOXX).
I will double down in saying that no American chip company will ever commit one more incremental cent of capital in mainland China.
That ship has sailed, and the transition will whipsaw markets because of the uncertainty in earnings.
The rerouting of capital expenditure to lesser-known Asian countries will deliver control of business models back to the corporation’s management and that is how free market capitalism likes it.
Furthermore, the lifting of the ban does not include all components, and this could be a maneuver to deliver more face-saving window-dressing for Chairman Xi.
In reality, there is still an effective ban because technically all chip components could be regarded as connected to the national security interests of the U.S.
Bullish traders are chomping at the bit to see how these narrow exemptions on non-sensitive technologies will lead to a greater rapprochement that could include the removal of all new tariffs imposed since last summer.
The risk that more tariffs are levied is also high as well.
I put the odds of removing tariffs at 30% and I wouldn’t be surprised if the administration doubles down on China to claim a foreign policy victory leading up to the 2020 election which could be the catalyst to more tariffs.
It’s difficult to decode if U.S. President Trump’s statements carry any real weight in real time.
The bottom line is the American government now controls the mechanism to when, how, and the volume of chip sales to Huawei and that is a dangerous game for investors to play if you plan on owning chip stocks that sell to Huawei.
Artificial intelligence or 5G applications chips are the most waterlogged and aren’t and will never be on the table for export.
This means that a variety of companies pulled into the dragnet zone are Intel (INTC), Nvidia (NVDA), and Analog Devices (ADI) as companies that will be deemed vital to national security.
These companies all performed admirably in the market following the news, but that could be short lived.
Other major logjams include Broadcom’s future revenue which is in jeopardy because of a heavy reliance on Huawei as a dominant customer for its networking and storage products.
Rounding out the chip sector, other names with short-term bullish price action are Qualcomm (QCOM) up 2.3%, Texas Instruments (TXN) up 2.6%, and Advanced Micro Devices (AMD) up 3.9%.
(AMD) is a stock I told attendees at the Mad Hedge Lake Tahoe conference to buy at $18 and is now above $31.
Xilinix (XLNX) is another integral 5G company in the mix that has their fortunes tied to this Huawei mess.
Investors must take advantage of this short-term détente with a risk on, buy the dip trade in the semi space and be ready to rip the cord on the first scent of blood.
That is the market we have right now.
If you can’t handle this environment when there is blood in the streets, then stay on the sidelines until there is another market sweet spot.
“Google is all about information. So the notion of using and presenting information in the right point at the right time to users is what, in essence, describes Google.” – Said Current CEO of Google Sundar Pichai
