Posts

July 3, 2019

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)

Chips are Back from the Dead

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.

 

July 1, 2019

Mad Hedge Technology Letter
July 1, 2019
Fiat Lux

Featured Trade:

(THE DEATH OF HARDWARE)
(AAPL), (CRM), (NFLX), (HUAWEI)

The Death of Hardware

Apple’s Chief Design Officer Jony Ive, the British industrial designer who made Apple (AAPL) products beautiful, is on his way out.

What else could the man do?

Jonathan Paul Ive was born in Chingford, London in 2967 to a silversmith who lectured at Middlesex Polytechnic.

He pursed automotive design at Newcastle Polytechnic, now named University of Northumbria at Newcastle, and graduated with a BA in industrial design in 1989.

His student successes harvested him the RSA Student Design Award which gifted him a stipend for an exploratory trip to the United States.

Palo Alto, California was his ultimate destination where he befriended various design experts including Robert Brunner—a designer who ran a small consultancy firm that would later join Apple Computers.

Ive signed onto product design agency Roberts Weaver Group following his studies demonstrating his typical attention to detail that he became renowned for.

London startup design agency called Tangerine came calling and Ive used his talents to design microwave ovens, toilets, drills and toothbrushes.

Ive slammed into confict with management at Tangerine who believed his ideas were too modern and exorbitant.

Apple later decided to partner with Tangerine on the basis of some of Ive’s former Silicon Valley friends like Robert Brunner delivering Ive to the forefront of Apple design products where he started hatching his plan to be the ultimate designer at Apple.

The rest is history as Ive went on to produce memorable consumer product designs such as the iMac, iPod, iPhone, and iPad.

His last burst of creativity was applied to produce the Apple Watch which was an overwhelming success.

He will now take his show independent but still collaborate with Apple as his main client.

The new design firm will be called LoveFrom.

This announcement isn’t a shocker and certainly, he really had one foot out of the door ever since the passing of Former Co-Founder Steve Jobs in 2011 put him on less solid footing.

If you remember, Apple had a secret corridor constructed between Jobs’ and Ive’s office epitomizing how closely they collaborated on product development as well as how good of friends they were.

Current CEO of Apple Tim Cook is the exact opposite of what Steve Jobs represented and part of the reason why Apple has lacked that game-changing new product resulting in a reduced share price.

Steve Jobs was a visionary and the person to transform his ideas into physical form was Jony Ive.

You could argue that part of Jony Ive succumbed with Steve Jobs as well as his parabolic career trajectory.

That’s what all those lines of people camping overnight in front of Apple stores was about.

The cult of Apple was at its peak around 2012 where Apple sold the most iPhones and was miles ahead of competition.

Fast forward 7 years and Tim Cook has allowed the relative competition to catch up and even overtake Apple in numerous metrics.

I would argue that Tim Cook was a dependent stop gap to Steve Jobs but the lack of vision in a position where visionaries are rewarded has been Apple’s Achilles heel.

Surely, Apple could have hired an Elon Musk after Tim Cook steadied the rutter.

The results have been monetary success, milking the famed iPhone business for what it’s worth plus more, but missing the boat on premium content.

They could have bought Netflix (NFLX) while it was less potent with the glut of cash in reserve, or they could have penetrated the enterprise business with acquiring Salesforce (CRM) at an earlier stage.

And during this period, Chinese phone makers caught up big time with Huawei now offering a better and cheaper iPhone alternative.

What Jony Ive was leaving the headquarters of Apple represents is the death of hardware.

Out with the old and in the new, and the new is software and the direction Apple is doubling down on.

Apple’s services of iTunes, the App Store, the Mac App Store, Apple Music, Apple Pay, and AppleCare, has become Apple’s “new” business.

Apple’s services segment did sales of $11.5 billion in revenue, up from the $9.9 billion services earned in the second quarter of 2018.

A new all-time record was set for services revenue this quarter.

Apple Pay is available in 30 markets and expect to go live in 40 markets by the end of 2019.

Apple now boasts 390 million paid subscriptions across all of its services, an increase of 30 million sequentially and by 2020, Apple will pass half a million paid subscriptions.

Apple hopes to penetrate further into the magazine business with Apple News+, a $9.99 per month service that offers unlimited access to more than 200 magazines.

Apple plans to surpass $14 billion in services revenue per quarter by 2020.

This is what Apple is doing now and the sad fact is that Ive and his special skills do not fit seamlessly into the main growth drivers of the company anymore.

Software engineers are being cherrypicked left, right, and center as Apple avoids making any big capital investments aside from leasing new buildings to install an army of fresh programmers.

Apple reported $11.45 billion in services revenue topped analysts’ expectations of $11.37 billion.

Apple also reported services margins of 63.8% for the quarter.

Services now accounts for about 20% of Apple’s revenue, up from 16% a year earlier and 13% in the first quarter.

I will give Tim Cook credit for recovering from the 20% drop in Apple’s shares, better late than never.

Now Apple is in the process of shifting up to 30% of their supply chain from China to South East Asia to de-risk from the Middle Kingdom.

 

May 30, 2019

Mad Hedge Technology Letter
May 30, 2019
Fiat Lux

Featured Trade:

(IS TARGET THE NEXT FANG?)
(TGT), (AMZN), (WMT)

May 29, 2019

Mad Hedge Technology Letter
May 29, 2019
Fiat Lux

Featured Trade:

(CHINA TO BAN FEDEX)
(HUAWEI), (AMZN), (FDX), (UPS), (DPSGY), (BABA), (ZTO)

China to Ban FedEx

Sell any and all rallies in FedEx (FDX) – that’s my quick takeaway from the Chinese communist party publishing a sharp retort to their de-facto mouthpiece of a publication called the Global Times signaling FedEx’s imminent demise in greater China.

The Global Times is often used as thinly veiled statements to a wider global audience and mimics the ideology of the ruling communist party and their main positions on critical issues.

As regards to FedEx’s business in China, it said:

There are rising calls for China’s postal service regulator to cut off FedEx from China market, as Huawei has accused the US express courier of diverting and rerouting its packages.

FedEx is crushing the Chinese logistics market currently and is the go-to carrier holding firm at 54.6% market share.

They have been around in China for as long as the economic boom has percolated inside the mainland from 1984, far before any of its local competitors were even up and running by a decade or two.

FedEx’s latest acquisition of Dutch-based TNT Express in 2016 solidified its dominance.

Foreign competition is a mainstay of international shipping patterns in China with the top three rounded out by DHL (DPSGY) with a 25.07% market share and United Parcel Service (UPS) with a 16.94% market share.

If these assertive claims do result in FedEx meaningfully losing China revenue, UPS wouldn’t stand to pick up the leftovers and could be put out to pasture by the same issue of hailing from a country that has an active adversarial economic policy against China’s.

If anyone would benefit, it would by DHL, given that Germany has a far less hawkish stance towards China, and they are unwilling to bite off the hand that feeds them.

The current situation is a concerning sign for the future of Germany as an industrial power and ability to sustain itself against China Inc.

It could be somewhat true that Germany has overextended themselves and only time, Made in China 2025 project, and the mood of the Chinese communist party can delay the inevitability of full tech hegemony over their western European counterpart.

The communist party could choose to just bypass DHL altogether and kick out all foreign invaders gifting courier responsibilities to Alibaba-based (BABA) subsidiaries and the likes of ZTO Express (ZTO) who provide express delivery and other value-added logistics services in China.

DHL will hope that China delays any draconian measures and pray that its active partnership with a local logistic firm has real legs.

DHL’s revenue sharing agreement with SF Express does not preclude them from the anger of Chinese regulators, but the risk of Chinese regulators favoring local couriers has risen another 25%.

Playing by the rules goes a long way in China, even if they change every day, and for customers across DHL’s target audience of industries including technology, health care, retail, automotive, and e-commerce.

DHL CEO Frank Appel said, “Combined with our global operations standards and network support, the agreement provides a solid foundation to continue exploring further opportunities in China in the coming years.”

From an outside perspective, this sounds more like forced cooperation with forced technology transfers with the mainland companies slurping up Germany tech knowhow.

Doing a deal with the devil for access to a 1.3 billion customer market is being put through the ringer.

When I view the snippets through the lens of geopolitics, it’s hard to believe that at such a sensitive time, FedEx would actively “reroute” packages and knowingly approved this behavior, they simply can’t be that clumsy.

The situation smells like an overt show of nationalism by a group of individuals, and it questions the longevity of FedEx operating in China all the same.

FedEx promptly responded confessing:

We regret that this isolated number of Huawei packages were inadvertently misrouted.”

An unintentional mistake offered a golden opportunity to tie the logistics company to the U.S. government’s aggressive nature and going forward FedEx will remain in a shroud of mystery until investors can get further grips on the rates of growth of their Chinese operations.

If FedEx were afraid about this, then they must be tearing their hair out about the domestic behemoth that is Amazon (AMZN) and their desires to install a full-service logistic service to blanket FedEx from e-commerce deliveries.

This has been the initial premise of my short call on FedEx, which has proved correct, and the regulatory nightmare in China will cast another cloud around its business.

Any strength in FedEx shares will be met with a cascade of selling activity, and as the economy slows down because of tariff-induced headwinds, this is a stock to outright short.

Back to China, FedEx slashed its full-year profit forecast for the second time in three months after reporting weaker-than-expected third quarter earnings.

The Chinese economy is absolutely slowing down, and its effects are impacting surrounding Asian nations.

Manufacturing cuts will cause the number of courier packages to slide in China and there is no telling how bad this trade stand-off could get.

It doesn’t look good for FedEx, and I reiterate my short stance on the company.

 

May 21, 2019

Mad Hedge Technology Letter
May 21, 2019
Fiat Lux

Featured Trade:

(HUAWEI HITS THE FAN)
(HUAWEI), (MU), (NVDA), (GOOGL), (FB), (TWTR), (APPL)

Huawei Hits the Fan

If you ever needed a signal to stay away from chip stocks short-term, then the Huawei ban by the American administration was right on cue.

Huawei, the largest telecommunications company in China, is heavily dependent on U.S. semiconductor parts and would be seriously damaged without an ample supply of key U.S. components

The surgical U.S. ban may cause China and Huawei to push back its 5G network build until the ban is lifted while having an impact on many global component suppliers.

The Chinese communist party has exhibited a habit for retaliation and could target Apple (AAPL) who is squarely in their crosshairs after this provocative move.

At a national security level, depriving Huawei of U.S. semiconductor components now is still effective as China’s chip industry is still 5 years behind the Americans.

China has a national mandate to develop and surpass the U.S. chip industry and denying them the inner guts to build out their 5G network will have long-lasting ramifications around the world.

Starting with American chip companies, they will send chip companies such as Micron (MU) and Nvidia (NVDA) into the bargain basement where investors will be able to discount shop at generational lows because of a monumental drop in annual revenue.

Even worse for these firms, Huawei anticipated this move and stocked itself full of chips for an extra 3 months, meaning they were not going to increase shipments in a meaningful way in the short-term anyway.

This kills the chip trade for the rest of the first half of 2019, and once again backs up my thesis in avoiding hardware firms with Chinese exposure.

Alphabet (GOOGL) has cut ties with cooperating with Huawei and that means software and the apps that are built around the software too.

Gmail, YouTube, Google Maps and Chrome will be removed from future Huawei smartphones, and even though this doesn’t amount to much in mainland China, this is devastating for markets in Eastern Europe and Huawei smartphone owners in the European Union who absolutely rely on many of these Google-based apps and view Chinese smartphones as a viable alternative to high-end Apple phones.

Users who own an existing Huawei device with access to the Google Play Store will be able to download app updates from Google now, but these same users will not consider Huawei phones in the future when the Google Play Store is banned forcing them to go somewhere else for the new upgrade cycle.

The fallout further bifurcates the China and American tech ecosystems.

I would argue that China had already banned Google, Facebook (FB), Twitter (TWTR), and marginalized Amazon (AMZN) before the trade war even started.

The American government is merely putting in place the same measures the Chinese communist party has had in place for years against foreign competition.

The recent ban on Huawei was a proactive response to China backing away from negotiations that they already had verbally agreed upon after hawks inside the Chinese communist party gained the upper hand in the tireless fight against the reformist.

These hawks want to preserve the status quo because they benefit directly from the current system and economic structure in place.

The American administration appears to have taken on an even more aggressive tone with the Chinese, as the resulting tariffs are putting even more stress on the Chinese hawks.

However, there is only so much bending they can do until a full-scale fissure occurs and debt rated “A” which is its third-highest classification has recently been slashed to a negative outlook as the tariff headwinds pile up.

The U.S. administration could further delve into its party bag by rebanning Chinese tech firm ZTE who almost folded after the first ban of U.S. semiconductor components.

The U.S. administration is emboldened to play the hand they have now because as long as Chinese tech need U.S. chips, the ball is in the American’s court and going on the offensive now would be more effective than if they carried out the same strategy in the future.

China is clearly attempting to delay the process enough to get to the point where they can install their own in-house chips and can say adios to America and the chips they currently rely on.

It’s doubtful at the current pace of escalation if China can survive until that point in time.

How will China react?

Massive easing and dovishness by the Chinese central bank will be needed to maintain stability and remedy the economy.

The manufacturing sector will face another wave of mass layoffs and debt pressures will inch up.

Chinese exports will get slashed with international corporations looking to move elsewhere to stop the hemorrhaging and rid itself of uncertainty.

Many Chinese tech companies will have entire divisions disrupted and even shut down because of the lack of hardware needed to operate their businesses.

Imagine attempting to construct a smartphone without chips, almost like building a plane to fly without wings.

This is also an easy to decode message to corporate America letting them know that if they haven’t moved their supply chains out of China yet, then time is almost up.

Going forward, I do not envision any meaningful foreign tech supply chain that could survive operating in mainland China because nationalistic forces will aim for revenge sooner or later.

There are many positives to this story as the provocative decision has been carried out during a time when the American economy is fiercely strong and firing on all cylinders.

Unemployment is spectacularly low at 3.6%, the lowest rate since 1969, while wage growth has accelerated to 3.8% annually up from 3.4%.

The robust nature of the economy has led to stock market performance being incredibly resilient in the face of continuous global headline risk.

The positive reactions are in part based on the notion that investors expect the Fed Governor Jerome Powell to adopt an even more dovish stance towards rates.

It’s almost as if we are back to the bad news is good news narrative.

Each dip is met with a furious bout of buying and even though we are trudging along sideways, for the time being, this sets up a great second half of the year as China will be forced to fold or face mass employment or worse offering at least a short-term respite for investors to go risk on.

As for the chip sector, high inventories on semiconductor balance sheets and in the channel will continue, as well as weak end demand in nearly every semiconductor end market meaning a once-in-a-generation magnitude of memory oversupply.

The trade war will most likely turn for the worse giving investors even more beaten down prices that will turn into great entry points when the time is ripe.

 

 

 

August 27, 2018

Mad Hedge Technology Letter
August 27, 2018
Fiat Lux

Featured Trade:
(WHY ALIBABA IS THE FIRST STOCK TO BUY WITH THE OUTBREAK OF TRADE PEACE),
(BABA), (GOOGL), (AMZN), (YELP), (MSFT), (MU), (ZTE), (HUAWEI)