Posts

January 28, 2019

Mad Hedge Technology Letter
January 28, 2019
Fiat Lux

Featured Trade:

(BUY DIPS IN SEMIS, NOT TOPS),
(XLNX), (LRCX), (AMD), (TXN), (NVDA), (INTC), (SOXX), (SMH), (MU), (QQQ)

Buy Dips in Semis, Not Tops

Don’t buy the dead cat bounce – that was the takeaway from a recent trading day that saw chips come alive with vigor.

Semiconductor stocks had their best day since March 2009.

The price action was nothing short of spectacular with names such as chip equipment manufacturer Lam Research (LRCX) gaining 15.7% and Texas Instruments (TXN) turning heads, up 6.91%.

The sector was washed out as the Mad Hedge Technology Letter has determined this part of tech as a no-fly zone since last summer.

When stocks get bombed out at these levels – sometimes even 60% like in Lam Research’s case, investors start to triage them into a value play and are susceptible to strong reversal days or weeks in this case.

The semi-conductor space has been that bad and tech growth has had a putrid last six months of trading.

In the short-term, broad-based tech market sentiment has turned positive with the lynchpins being an extremely oversold market because of the December meltdown and the Fed putting the kibosh on the rate-tightening plan.

Fueled by this relatively positive backdrop, tech stocks have rallied hard off their December lows, but that doesn’t mean investors should take out a bridge loan to bet the ranch on chip stocks.

Another premium example of the chip turnaround was the fortune of Xilinx (XLNX) who rocketed 18.44% in one day then followed that brilliant performance with another 4.06% jump.

A two-day performance of 22.50% stems from the underlying strength of the communication segment in the third quarter, driven by the wireless market producing growth from production of 5G and pre-5G deployments as well as some LTE upgrades.

Give credit to the company’s performance in Advanced Products which grew 51% YOY and universal growth across its end markets.

With respect to the transformation to a platform company, the 28-nanometer and 16-nanometer Zynq SoC products expanded robustly with Zynq sales growing 80% YOY led by the 16-nanometer multiprocessor systems-on-chip (MPSoC) products.

Core drivers were apparent in the application in communications, automotive, particularly Advanced Driver Assistance Systems (ADAS) as well as industrial end markets.

Zynq MPSoC revenues grew over 300% YOY.

These positive signals were just too positive to ignore.

Long term, the trade war complications threaten to corrode a substantial chunk of chip revenues at mainstay players like Intel (INTC) and Nvidia (NVDA).

Not only has the execution risk ratcheted up, but the regulatory risk of operating in China is rising higher than the nosebleed section because of the Huawei extradition case and paying costly tariffs to import back to America is a punch in the gut.

This fragility was highlighted by Intel (INTC) who brought the semiconductor story back down to earth with a mild earnings beat but laid an egg with a horrid annual 2019 forecast.

Intel telegraphed that they are slashing projections for cloud revenue and server sales.

Micron (MU) acquiesced in a similar forecast calling for a cloud hardware slowdown and bloated inventory would need to be further digested creating a lack of demand in new orders.

Then the ultimate stab through the heart – the 2019 guide was $1 billion less than initially forecasted amounting to the same level of revenue in 2018 – $73 billion in revenue and zero growth to the top line.

Making matters worse, the downdraft in guidance factored in that the backend of the year has the likelihood of outperforming to meet that flat projection of the same revenue from last year offering the bear camp fodder to dump Intel shares.

How can firms convincingly promise the back half is going to buttress its year-end performance under the drudgery of a fractious geopolitical set-up?

This screams uncertainty.

Love them or crucify them, the specific makeup of the semiconductor chip cycle entails a vulnerable boom-bust cycle that is the hallmark of the chip industry.

We are trending towards the latter stage of the bust portion of the cycle with management issuing code words such as “inventory adjustment.”

Firms will need to quickly work off this excess blubber to stoke the growth cycle again and that is what this strength in chip stocks is partly about.

Investors are front-running the shaving off of the blubber and getting in at rock bottom prices.

Amalgamate the revelation that demand is relatively healthy due to the next leg up in the technology race requiring companies to hem in adequate orders of next-gen chips for 5G, data servers, IoT products, video game consoles, autonomous vehicle technology, just to name a few.

But this demand is expected to come online in the late half of 2019 if management’s wishes come true.

To minimize unpredictable volatility in this part of tech and if you want to squeeze out the extra juice in this area, then traders can play it by going long the iShares PHLX Semiconductor ETF (SOXX) or VanEck Vectors Semiconductor ETF (SMH).

In many cases, hedge funds have made their entire annual performance in the first month of January because of this v-shaped move in chip shares.

Then there is the other long-term issue of elevated execution risks to chip companies because of an overly reliant manufacturing process in China.

If this trade war turns into a several decades affair which it is appearing more likely by the day, American chip companies will require relocating to a non-adversarial country preferably a democratic stronghold that can act as the fulcrum of a global supply chain channel moving forward.

The relocation will not occur overnight but will have to take place in tranches, and the same chip companies will be on the hook for the relocation fees and resulting capex that is tied with this commitment.

That is all benign in the short term and chip stocks have a little more to run, but on a risk reward proposition, it doesn’t make sense right now to pick up pennies in front of the steamroller.

If the Nasdaq (QQQ) retests December lows because of global growth falls off a cliff, then this mini run in chips will freeze and thawing out won’t happen in a blink of an eye either.  

But if you are a long-term investor, I would recommend my favorite chip stock AMD who is actively draining CPU market share from Intel and whose innovation pipeline rivals only Nvidia.

 

 

 

August 22, 2018

Mad Hedge Technology Letter
August 22, 2018
Fiat Lux

 

Featured Trade:
(WHAT’S IN STORE FOR TECH IN THE SECOND HALF OF 2018?),

(GOOGL), (AMZN), (FB), (UTX), (UBER), (LYFT), (MSFT), (MU), (NVDA), (AAPL), (SMH)

What’s in Store for Tech in the Second Half of 2018?

Tech margins could be under pressure the second half of the year as headwinds from a multitude of sides could crimp profitability.

It has truly been a year to remember for the tech sector with companies enjoying all-time high probability and revenue.

The tech industries’ best of breed are surpassing and approaching the trillion-dollar valuation mark highlighting the potency of these unstoppable businesses.

Sadly, it can’t go on forever and periods of rest are needed to consolidate before shares relaunch to higher highs.

This could shift the narrative from the global trade war, which is perceived as the biggest risk to the current tech market to a domestic growth issue.

Healthy revenue beats and margin growth have been essential pillars in an era of easy money, non-existent tech regulation, and insatiable demand for everything tech.

Tech has enjoyed this nine-year bull market dominating other industries and taking over the S&P on a relative basis.

The lion’s share of growth in the overall market, by and large, has been derived from the tech sector, namely the most powerful names in Silicon Valley.

Late-stage bull markets are fraught with canaries in the coal mine offering clues for the short-term future.

Therefore, it is a good time to reassess the market risks going forward as we stampede into the tail end of the financial year.

The shortage of Silicon Valley workers is not a new phenomenon, but the dearth of talent is going from bad to worse.

Proof can be found in the controversial H-1B visa program used to hire foreign tech workers mainly to Silicon Valley.

A few examples are Alphabet (GOOGL), which was granted 1,213 H-1B approvals in 2017, a 31% YOY rise.

Alphabet’s competitor Facebook (FB) based in Menlo Park, Calif., was granted 720 H-1B approvals in 2017, a 53% YOY jump from 2016.

This lottery-based visa for highly skilled foreign workers underscores the difficulty in finding local American talent suitable for a role at one of these tech stalwarts.

Amazon (AMZN) made one of the biggest jumps in H-1B approvals with 2,515 in 2017, a 78% YOY surge.

The vote of non-confidence in hiring Americans shines an ugly light on American youth who are not applying themselves to the domestic higher education system as are foreigners.

For the lucky ones that do make it into the hallways of Silicon Valley, a great salary is waiting for them as they walk through the front door.

Reportedly, the average salary at Facebook is about $250,000 and Alphabet workers take home around $200,000 now.

Pay packages will continue to rise in Silicon Valley as tech companies vie for the same talent pool and have boatloads of capital to wield to hire them.

This is terrible for margins as wages are the costliest input to operate tech companies.

United Technologies Corp. (UTX) chief executive Gregory Hayes chimed in citing a horrid “labor shortage in the U.S. and in Europe.”

He followed that up by saying the company will have to grapple with this additional cost pressure.

Certain commodity prices are spiraling out of control and will dampen profits for some tech companies.

Uber and Lyft, ridesharing app companies, are sensitive to the price of oil, and a spike could hurt the attractiveness to recruit potential drivers.

The perpetually volatile oil market has been trending higher since January, from $47 per barrel and another spike could damage Uber’s path to its IPO next year.

Will Uber be able to lure drivers into its ecosystem if $100 per barrel becomes the new normal?

Probably not unless every potential driver rolls around in a Toyota Prius.

If oil slides because of a global recession instigated by the current administration aim to rein in trade partners, then Uber will be hard hit abroad because it boasts major operations in many foreign megacities.

A recession means less spending on Uber.

Either result will be negative for Uber and ridesharing companies won’t be the only companies to be hit.

Other victims will be tech companies incorporating transport as part of their business model, such as Amazon which will have to pass on more delivery costs to the customer or absorb the blows themselves.

Logistics is a massive expense for them transporting goods to and from fulfillment centers. And they have a freshly integrated Whole Foods business offering two-hour free delivery.

Higher transport costs will bite into the bottom line, which is always a contentious issue for Amazon shareholders.

Another red flag is the deceleration of the global smartphone market evident in the lackluster Samsung earnings reflecting a massive loss of market share to Chinese foes who will tear apart profit margins.

Even though Samsung has a stranglehold on the chip market, mobile shipments have fell off a cliff.

Damaging market share loss to Chinese smartphone makers Xiaomi and Huawei are undercutting Samsung products. Chinese companies offer better value for money and are scoring big in the emerging world where incomes are lower making Chinese phones more viable.

The same trend is happening to Samsung’s screen business and there could be no way back competing against cheaper, lower quality but good enough Chinese imitations.

Pouring gasoline on the fire is the Chinese investigation charging Micron (MU), SK Hynix, and Samsung for colluding together to prop up chip prices.

These three companies control more than 90% of the global DRAM chip market and China is its biggest customer.

The golden days are over for smartphone growth as customers are not flooding into stores to buy incremental improvements on new models.

Customers are staying away.

The smartphone market is turning into the American used car market with people holding on to their models longer and only upgrading if it makes practical sense.

Chinese smartphone makers will continue to grab global smartphone market share with their cheaper premium versions that western companies rather avoid.

Battling against Chinese companies almost always means slashing margins to the bone and highlights the importance of companies such as Apple (AAPL), which are great innovators and produce the best of the best justifying lofty pricing.

The stagnating smartphone market will hurt chip and component company revenues that have already been hit by the protectionist measures from the trade war.

They could turn into political bargaining chips and short-term pressures will slam these stocks.

This quarter’s earnings season has seen a slew of weak guidance from Facebook, Nvidia (NVDA) mixed in with great numbers from Alphabet and Amazon.

Beating these soaring estimates is not a guarantee anymore as we move into the latter part of the year.

Migrating into the highest quality names such as Amazon and Microsoft (MSFT) with bulletproof revenue drivers would be the sensible strategy if tech’s lofty valuations do not scare you off.

Tech has had its own cake and ate it too for years. But on the near horizon, overdelivering on earnings results will be an arduous chore if outside pressures do not relent.

It’s been fashionable in the past for market insiders to call the top of the tech market, but precisely calling the top is impossible.

The long-term tech story is still intact but be prepared for short-term turbulence.

 

 

 

 

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