Mad Hedge Technology Letter
June 18, 2018
Fiat Lux
Featured Trade:
(DON'T WORRY ABOUT THE BATS),
(BIDU), (BABA), (AMZN), (AAPL), (MGI), (NVDA), (AMD), (GOOGL), (FB)
The Chinese BATs (Baidu, Alibaba, and Tencent) are China's response to the American FANG group.
It's one of few sectors outperforming the vigorous American tech sector, and valuations have soared in the past year.
Former English teacher Jack Ma founded the Amazon (AMZN) of China named Alibaba in April 1999, which has grown to become one of the biggest websites on the Internet.
This company even has a massive cloud division that acts in the same way as Amazon Web Services (AWS).
Alibaba also has Alipay on its roster, the fintech and digital payments subsidiary of Alibaba.
Baidu, led by Robin Li, is the de-facto Google search of China and is entirely tailored for the Chinese market without English language support.
Tencent, created by Ma Huateng, has an assortment of businesses from social media, instant messaging, online gaming, and digital payments.
Tencent's WeChat platform is the lynchpin acting as the gateway to the robust Tencent eco-system.
The BATs have heavily invested in autonomous vehicle technology set to roll out in the coming years.
These companies are some of the biggest venture capitalists in the world throwing around capital like Masayoshi Son's SoftBank.
Alibaba has seen its share price rocket from $135 in June 2017 to $206.
Baidu has also seen huge gyrations in its share price elevating from $174 in June 2017 to $270.
Tencent, public on the Hong Kong Hang Seng Index, has gone from $273 HKD (Hong Kong dollars) to $412 HKD.
And this is all just the beginning!
An economy growing a stable 6.5% per year with companies able to scale to a mind-boggling 1.3 billion people is something of which to take notice.
China hopes to wean itself from its industrial heritage betting the ranch on a rapidly expanding tech sector.
Does this put China on a collision course steamrolling toward the American FANGs?
Highly possible but not yet.
Even though the BATs modus operandi has been to follow in the footsteps of the FANG's business model, they do not directly compete.
Ant Financial, the fintech arm of Alibaba, was blocked from purchasing MoneyGram International (MGI), effectively, closing any doors leading to the lucrative American digital payments industry.
This also meant curtains for WeChat, the multi-functional app that half of the Chinese use as a digital wallet, in the digital payments space.
The Committee on Foreign Investment in the United States (CFIUS) has made it crystal clear that BAT's capital will be scrutinized more than ever before because of China's open policy of transferring Western technology expertise to the mainland for the purpose of leading the world in technology.
China cannot have its cake and eat it.
The first stumbling block is that the American market does not suit the BAT's FANG business model with Chinese characteristics.
For example, the only other market Baidu search operates in is Brazil.
It has leveraged itself to the Chinese consumer whose purchasing power has spiked from its burgeoning middle class.
Another headwind is the lack of innovation caused by a rigid education system punishing freedom of thought in favor of rote memorization.
Innovation is American tech's bread and butter and investors pay up for this ingenuity that cannot be found elsewhere in the world.
This is also the reason why the BATs need to buy American technology and not the other way around.
Original concepts such as Uber and Airbnb were made in America first and Didi Chuxing and Tujia are rip-offs of these American companies.
The list is endless.
The BATs understand they cannot go head to head with American talent, but that does not mean they won't win out in the end.
To make matters worse, global tech talents do not want to work in China if they are reliant on America to develop something and copy it.
Why not just go work in Silicon Valley for a higher salary?
This was highlighted when the only tech talent to cross over to the other side quit in a blaze of glory.
Hugo Barra was poached from Alphabet in 2013, where he worked as vice present for the Android mobile operating system.
He was installed as the vice president of international development for smartphone maker Xiaomi, the Apple (AAPL) of China.
Barra suddenly threw in the towel at Xiaomi in 2017, offering a harsh critique stating, "What I've realized is that the last few years of living in such a singular environment have taken a huge toll on my life and started affecting my health."
Not exactly the stamp of approval the Mandarins were looking for.
In turn, China has focused its effort on recruiting Chinese-Americans who understand the working environment better and have roots or even family on the mainland.
The dire tech talent shortage is worse in China than Silicon Valley because Chinese tech companies have zero access to non-Chinese talent.
Even with a reverse in immigration policies by the administration, America continues to be the holy grail of tech jobs.
That is why you see hoards of Chinese, Indians, Russians, and every other country's best and brightest waiting in line to make the move.
Taiwanese American CEOs lead some of Silicon Valley's best companies such as the CEO for Nvidia (NVDA), Jensen Huang, and the CEO of Advanced Micro Devices (AMD), Dr. Lisa Su.
Only 1% of Baidu's revenues is extracted from American soil underscoring the BAT's China-first business model. Tencent isn't much better at 5%, and Alibaba heads the list at 11%.
Compare these statistics with Alphabet (GOOGL) making 53% and Facebook (FB) earning 56% of revenue from international sales.
Amazon is still very much an American business but 32% of revenue comes from international sales.
The bulk of this revenue is mainly from Europe where American large-cap tech companies are staunch mainstays.
China has focused on building out its business in Southeast Asia instead.
Those governments are cozy with Beijing and are willing to relinquish some sovereign influence to develop its poor digital infrastructure.
The nail in the coffin for potential BAT companies doing business in America is the total lack of data protection in China.
If you think what Facebook is doing doesn't make you sleep at night, the BATs are running riot with personal data in China.
Expect multiple attempts of hackers breaking into your email while your phone number is constantly harassed by spam messages and robo-calls galore.
This is a normal day in the life of a Chinese national and they are used to it.
China understands they are not ready to eclipse the juggernaut that is Silicon Valley.
The BATs are biding their time organically growing by investing into American tech firms helping their overall products and services.
The past five years have seen a gorge of American investment amounting to 95 deals totaling $27.6 billion.
However, this smash-and-grab investment party is effectively over because CFIUS has clamped down on exporting local technology.
Consequently, the BATs will continue to focus on what they know best - the Chinese market.
Southeast Asia is also ripe to become the next stomping ground for the BATs. Expect them to dominate in this region for years to come.
The runway is long in domestic China. The 6.5% annual growth is entirely biased toward these three companies to prolong their hearty growth trajectories.
The communist party even has a seat on the board at each of these companies highlighting another area of conflict if these companies dive head into the American market.
Let's just say corporate governance in China is a shell of what it is in America.
One day there could be an all-out battle for tech supremacy, but these Chinese companies would need some assurances they would likely come out on top.
That is hardly the case yet and they make way too much money by copying Silicon Valley.
_________________________________________________________________________________________________
Quote of the Day
"The leader of the market today may not necessarily be the leader tomorrow," - said Tencent founder and CEO Ma Huateng.
"U.S. stock performance will be good in 2017, but is set to be outperformed by Japan, Europe, and emerging markets," said a top manager at bond giant PIMCO.
Global Market Comments
June 15, 2018
Fiat Lux
Featured Trade:
(ONSHORING TAKES ANOTHER GREAT LEAP FORWARD),
(TSLA), (UMX), (EWW),
(KISS THAT UNION JOB GOODBYE),
(TESTIMONIAL)
Those of you counting on getting your old union assembly line job back in Detroit can forget it.
The eight-year forecast published by the Bureau of Labor Statistics shows that 4.19 million jobs will be gained in the U.S. in professional and business services, followed by 4 million health care and social assistance jobs, while 1.2 million will be lost in manufacturing.
This is great news for website designers, Internet entrepreneurs, registered nurses, and masseuses in California, but grim tidings for traditional metal bashers in the rust belt manufacturing states such as Michigan, Indiana, and Ohio.
I'm so old now that I am no longer asked for a driver's license to get into a nightclub. Instead, they ask for a carbon dating.
The real challenge for we aged career advisors is that probably half of these new service jobs haven't even been invented yet, and if they can be described, it is only in a cheesy science fiction paperback with a half-dressed blond on the front cover.
After all, who heard of a webmaster, a cell phone contract sales person, or a blogger 40 years ago?
Where are all these jobs going to? You guessed it, China, which by my calculation has imported 25 million jobs from the U.S. over the past decade.
You can also blame other lower waged, upstream manufacturing countries such as Vietnam, where the Middle Kingdom is increasingly subcontracting its own offshoring.
These forecasts may be optimistic because they assume that Americans can continue to claw their way up the value chain in the global economy, and not get stuck along the way, as the Japanese did in the 90s.
The U.S. desperately needs no less than 27 million new jobs to soak up natural population and immigration growth and get us back to a traditional 5% unemployment rate.
The only way that is going to happen is for America to invent something new and big, and fast.
Personal computers achieved this during the 80s, and the Internet did the trick in the 90s. The fact that we've done squat since 2000 but create a giant paper chase of subprime loans and derivatives explains why job growth since then has been zero, real wage growth has been negative, and American standards of living are falling.
While the current crop of politicians extol the virtues of education, the reality is that we are dumbing down our public education system. How do we invent the next "new" thing, while shrinking the University of California's budget by 25% two years in a row?
If my local high school can't afford new computers, how is it going to feed Silicon Valley with a computer literate workforce? The U.S. has a "Michael Jackson" economy. It's still living like a rock star but hasn't had a hit in 20 years.
China can have all the $20 a day jobs it wants. But if it accelerates its move up the value chain, as it clearly aspires to do, then America is in for even harder times.
I'll be hoping for the best but preparing for the worst. How do you say "unemployment check" in Mandarin?
Is This Your Future?
Mad Hedge Technology Letter
June 15, 2018
Fiat Lux
Featured Trade:
(DINNER WITH LAM RESEARCH),
(LRCX), (AMAT), (ASML), (TOELY)
"We can lead, but we cannot carry," said Mike Ryan, chief investment strategist at UBS, about America's role in the global economy.
It was one of those normally mundane seasonal events.
But what I heard blew my mind and will substantially shape my trading and investment strategy for 2018.
By now you already know that I used some of my stock market winnings this year to buy a vintage Steinway concert grand piano (click here for "The Great Inflation Hedge You've Never Heard Of."
Well, you can't own a Steinway without a recital, and ours was held last weekend.
After listening to an assortment of children display their skills with Pachelbel, Ode to Joy, and The Entertainer, we adjourned for a celebratory buffet dinner.
Making small talk with the other parents, I asked one particularly articulate gentleman what he did for a living. He, too, had enjoyed an excellent year, and also used his profits to buy a Steinway, although his was a cheaper upright model.
It turned out that he was the chief technology officer at LAM Research (LRCX).
Had I heard of it?
Not only did I know the company intimately, I had recommended it to my clients and caught the better part of the nearly 400% move since the beginning of 2016. Furthermore, I was expecting another double in the share price in the years ahead.
Was I right to be so bullish?
The man then launched into a detailed review of the company's prospects for the next three years.
The blockbuster development that no one outside the industry sees coming is China's massive expansion of its semiconductor production.
More than a dozen gigantic fabrication plants are planned, the scale of which is unprecedented in history. Some of these fabs are 10 times larger than those built previously.
This is creating exponential growth opportunities for the tiny handful of companies that produce the highly specialized machines essential to the manufacture of cutting-edge semiconductors, including Applied Materials (AMAT), ASML (ASML), Tokyo Electron (TOELY), KLA-Tencor, and LAM Research (LRCX).
Everyone in the industry has boggled minds over the demand they are seeing for their products.
The reality is the artificial intelligence is rapidly working its way into all consumer and industrial products far faster than anyone realizes, creating astronomical demand for the chips needed to implement it.
Bitcoin mining is also creating enormous new demand for chips that no one remotely imagined possible even two years ago.
As a result, the industry has been caught flat-footed with severe capacity shortages. They are all racing to add capacity as fast as they can. Profit margins are exploding.
On October 17, (LRCX) announced Q3 revenues of $2.48 billion, a staggering increase of 51.84% over the previous year, and a gross margin of 46.4%. The operating margin was 28%, generating net income of $591 million.
That gives the shares a very reasonable price earnings multiple of 16.95X, a 10% discount to the 18X multiple for the S&P 500. That is an incredible deal for one of the fastest growing companies in America.
Samsung of South Korea was far and away its largest customer, accounting for 38% of total sales.
On November 14, the company announced an eye-popping $2 billion share repurchase program that is certain to drive the price higher.
If there is one dark cloud on the horizon, it is the loss of the research and development tax credit embedded deep in the proposed Republican tax bill.
This will have a noticeable and negative impact on (LRCX)'s bottom line. Still, my friend thought that the company could offset this loss with faster sales growth and margin expansion.
However, many other technology companies in Silicon Valley won't be able to bridge that gap. It is a hugely anti-technology move for the government to take.
My fellow Steinway owner thought that LAM Research could easily see sales double in three years as long as there is no recession, which I believe is at least two years off. As for the share price, he couldn't comment, but remained hopeful, as he was a large owner himself.
Of course, the trick is how to buy a stock that has just risen by 400% in two years. So, you could start scaling in here, and build a larger position over time.
You only get opportunities like this a couple of times a decade, and it's better to be too aggressive than too cautious.
To learn more about LAM Research, please click here to visit the company website.
A Steinway Model D
_________________________________________________________________________________________________
Quote of the Day
"The market always gets it right," said Jim O'Neill, the chairman of Goldman Sachs International, who coined the term "BRIC."
Global Market Comments
June 14, 2018
Fiat Lux
SPECIAL GOLD ISSUE
Featured Trade:
(GUESS WHO'S BEEN BUYING GOLD?),
(GLD), (GDX), (SLV), ($SSEC),
(WILL GOLD COINS SUFFER THE FATE OF THE $10,000 BILL?),
(GLD), (GDX),
(TESTIMONIAL)
Gold bugs, conspiracy theorists, and permabears had some unfamiliar company last year.
While traders, individuals, and ETFs have been unloading gold for the past five years, central banks have been steady buyers.
Who had the biggest appetite for the barbarous relic?
Russia, which has been accumulating the yellow metal to avoid economic sanctions imposed by the United States in the wake of its invasion of the Ukraine.
Hot on its heels was China, which has flipped to a large net importer of gold to meet insatiable demand from domestic investors. China appears to be buying about 20 metric tonnes a month of the barbarous relic.
It seems the Chinese stocks markets ($SSEC) were not the great trading opportunity that they were hyped to be, which plunged 30% during the first two months of 2016, and is now 60% off its all-time high.
That's a big deal in a country that has no social safety net.
Many Chinese now prefer to buy gold instead of stocks, which are now considered too risky for a personal nest egg.
They are facilitated by the ubiquitous precious metal coin stores, which have recently sprung up like mushrooms in every city.
Only a few years ago, private ownership of gold resulted in China having your organs harvested by the government.
Central bank sellers have been few and far between. Venezuela has dumped about half its reserve to head off a recurring liquidity crisis.
Middle Eastern sovereign wealth funds cashed in some chips to deal with the oil price crash.
Canada has also been selling for reasons unknown to us south of the border.
All of this poses a really interesting question. Gold fell for the four consecutive years that central banks were buying, and the rest of the world was selling.
What happens when the rest of the world flips to the buy side?
My guess is that it goes up, which is why I have issued long side Trade Alerts on gold this year.
