Mad Hedge Technology Letter
December 6, 2021
Fiat Lux
Featured Trade:
(THE HAWKS ARE HERE)
(ROKU), (ZM), (TWLO), (SNAP), (SQ), (MSFT), (CRM), (ADBE)
Higher inflation is something this tech bull cycle hasn’t dealt with, and it’s starting to rear its ugly head in the form of volatility and spades of it.
The Fed will have to increase interest rates or face runaway inflation that will crash the economy, but increasing interest rates will also make lives harder for tech companies.
As we try to understand the pace of interest hikes, certain tech companies will fare much better in this inflationary environment than others. To deduce the winners from the losers, investors should understand exactly how inflation affects each particular tech company.
Talk has gone from the Fed moving early to raise short-term rates, to the Fed moving even in early spring which in turn is spooking risk markets from cryptocurrencies, the S&P, and the Nasdaq.
Fed Chair Jerome Fed has done a poor job communicating his sudden hawkish tone and the market has had to quickly reprice risk assets because of the surprising nature of the hawkishness.
In the short-term, tech stocks will need some time to digest this new expectation, which I see as quite healthy, but short-term tough to swallow.
Fed Cleveland President Loretta Mester told the media she is “very open” to scaling back the Fed’s asset purchases at a faster pace so it can raise interest rates a couple of times next year if needed so this isn’t just one guy in Powell trying to move the needle.
Clearly, the Fed is moving in unison, and they threaten to become a major force in moving markets which is all we care about.
All that pressure is causing component and labor costs to rise. Companies that don't have enough pricing power to pass those costs on to their customers will likely see their gross and operating margins shrink.
This matters because tech companies offer some of the most generous salaries in the U.S. and substantial increases in pay hurts them the most.
Higher interest rates attract more consumers and businesses to put more money in higher-yield bonds and savings accounts.
There are 3 ways that higher rates are actually a gut punch to tech growth companies.
First, they increase the costs of borrowing incremental capital to expand a business. In more cases than not, tech growth companies rely on borrowed money because their operation is not yet sustainably profitable. That's bad news for high-growth tech companies, which are burning cash with widening losses.
Second, it reduces the long-term estimates for a company's earnings and free cash flow (FCF) growth meaning their underlying stock price is rerated downwards in the anticipation of this new reality.
Loss accruing tech companies commonly suffer an exodus as their underlying shares are repriced to reflect higher costs.
Just this morning we saw Roku (ROKU), Zoom Video Communications (ZM), Snap (SNAP), Twilio (TWLO), Square (SQ) breach 52-week lows.
The breadth of the market has been hollowed and the goalposts have indeed narrowed because of the hawkish tone at the Fed.
Lastly, higher interest rates drive institutional money into fixed income.
They do this largely by taking profits from crypto, tech stocks, or moving their stash on the sidelines then resurfacing the money into “safer” assets that anticipate weakening bond yields at the longer end of the curve.
So I won’t sit here and say sell all and every tech stock, it’s more nuanced than that.
I executed one position in December and that was Microsoft (MSFT) and it got pulled down with the broader market.
More importantly, I didn’t bet the ranch.
Ultimately, we still bask in the ideology that the tech bull market isn’t over yet because it isn’t, but this aggressiveness out of the blue has forced the overall tech market to temporarily rest with growth tech suffering major drawdowns.
In doing that, the ceiling for a Santa Claus rally is somewhat capped to the upside.
The Fed could have waited until January.
Sure, there will still be winners in tech and the odds of these winners are driven firmly behind the biggest and best like Microsoft, Amazon, Google, and Apple.
These are the type of companies that have the pricing power to raise prices and get away with it because consumers will be willing to pay it.
Other potential winners include cloud service giants like Salesforce (CRM) and Adobe (ADBE). These again are top-quality software stocks that can pass up higher enterprise software costs to the firms that can pay for it.
It’s entirely possible that the Fed could end up walking back some of these aggressive stances in the interest-raising process next year.
Don’t fight the Fed and don’t expect tech growth stocks to reverse until we receive more clarity with interest rate policy, if a reverse is triggered, it will play out with Apple, Amazon, Google, and Facebook, and Microsoft leading the way higher.
“Your margin is my opportunity.” – Said Founder and CEO of Amazon Jeff Bezos
Mad Hedge Technology Letter
December 3, 2021
Fiat Lux
Featured Trade:
(THE ULTIMATE TECH SUPPLY CHAIN SHOCK)
(TSLA), (CMOC), (AAPL), (DRC)
China is monopolizing the raw materials industry in Africa at such a fast pace that it might be a thorn in the side of American EV makers like Tesla and other US tech companies soon.
Tesla (TSLA) has decided to veer its business interests and kowtow to China and is really doubling down there with a Shanghai Gigafactory which now produces more cars than its plant in California.
Under the hood, most of the material is Chinese-made, and the minerals that power the batteries are largely refined and mined by Chinese companies.
As the world adopts EVs, companies are desperate to secure and strengthen their positions in the battery supply chain, from mineral extraction and processing to battery and EV manufacturing.
Vertical integration is more fashionable than ever, where one company controls a number of steps along the supply chain to guarantee supply.
This is not surprising since the supply chain breakdown has forced many companies to stop production for lack of parts.
This battery arms race is being won by China.
China is the world’s biggest market for EVs with global sales of 1.3m vehicles in 2020, more than 40% of sales worldwide.
Chinese battery-maker CATL has cornered about 35% of the world’s EV battery market.
Chinese refineries supplied 85% of the world’s battery-ready cobalt last year; a mineral that helps the stability of lithium-ion batteries.
Democratic Republic of the Congo (DRC) is where most of the cobalt is found, where almost 70% of the mining sector is dominated by Chinese companies.
Meander around DRC’s southern copper and cobalt mining belt, and it looks as if you are in China.
In August, China Molybdenum Company (CMOC), a giant Chinese mining firm, announced an investment of $2.5bn to triple copper and cobalt production at its Tenke Fungurume Mine, already one of the largest in DRC.
That followed its purchase of a 95% stake in nearby Kisanfu copper and cobalt mine for $550m.
Fellow Chinese corporate giant, Huayou Cobalt has a stake in at least three copper-cobalt mines in DRC and dominates at every step of the cobalt supply chain, from mines to refineries to battery precursor and cathode production.
Some car and battery manufacturers are beginning to reduce the amount of cobalt in their batteries to de-risk themselves from China.
Nickel-rich batteries could be a solution, but the same Chinese companies that dominate cobalt mining in DRC, Huayou Cobalt and CMOC, are also cornering nickel extraction and processing in Indonesia, which has the world’s largest nickel reserves at 72m tons.
This means China is now the largest global market producer of nickel, far surpassing the efforts of Europe and the US.
In Europe too, companies are beginning to gain on China’s lead. By the end of the decade, the continent is expected to have 28 factories producing lithium-ion cells, with production capacity due to increase by 1440% from 2020 levels.
That growth is being driven by companies such as Britishvolt in Northumberland and Sweden’s Northvolt, as well as Asian firms expanding production into Europe.
European investment in mining and the production of battery and cathode materials is not keeping pace.
China is creating the equivalent of one battery Gigafactory a week compared with one every four months in the US.
A new global lithium-ion economy is being developed, and the United States lagging Europe and China means they will need to pay a premium for the raw materials in the future.
It’s almost as if the U.S. is going through a round 2 of outsourcing their rust belt manufacturing, but this time it’s Internet 3.0 manufacturing.
The U.S. has fallen asleep at the wheel and allowed China to coax itself into relevancy by undercutting global competitors, the same is happening in the raw material industry that is fundamental to the survival of the United States tech and EV prowess.
The quickness and potency of a mercantilist one-party state can be felt here as many broader issues are bogged down in the U.S. in Congress and get stuck there in perpetuity.
When allowed to flourish, US capitalism is the most mesmerizing force in global economics, but it is also prone to stumbling over itself.
Policymakers need to reroute their energies to the raw material precious metal sector to make pricing competitive for the American consumers, or the share prices of US tech companies will be hurt.
Like the supply bottlenecks caused pain for many American companies, companies like Apple (AAPL) or Dell might not be able to build smartphones and laptops without the right raw materials.
Tesla might not be able to build a car anymore without bowing down to the Chinese forces.
Don’t be surprised in a few years if tech companies need to halt production due to China not selling certain parts to certain countries, this could be the next battleground between the United States and China.
“Inadvertent creation of a micro black hole, or some as-yet-unknown technology could spell the end of us.” – Said Founder and CEO of Tesla Elon Musk
Mad Hedge Technology Letter
December 1, 2021
Fiat Lux
Featured Trade:
(TAKE A REST FROM FINTECH)
(PYPL), (SQ), (BNPL), (AMZN), (TWTR), (AAPL)
The fintech trade is tiring — that is what the underperformance of stocks like PayPal (PYPL) and Square (SQ) is telling us.
Jack Dorsey’s Square has retraced around 25% from its peak and is bang on even from where it was 365 days ago.
Not what you want to hear if you’re a fintech trader.
The pullback from PYPL is even more precipitous declining around 40% from its peak.
Certainly, it would be cliché for me to say that the low-hanging fruit is gone from the fintech trade, but that’s exactly what is happening here.
Not only that, but I would also like to point out that most companies without a home-field advantage ecosystem are getting penalized for exactly that — not having an ecosystem.
Wasn’t it weird how the whole tech sector literally gave us a rip-your-face-off selloff the other day yet, Apple was one of the only tech stocks that reacted positively?
As we move into the late stages of the economic cycle, the goalposts are certainly narrowing for the tech companies, and that’s bad news for SQ and PYPL.
Another way to get penalized is to let that moat narrow which is effectively what has happened to PYPL and SQ.
And that’s the thing with PYPL, it’s just a way to pay, and not an ecosystem.
It plays second fiddle to that of wall gardens and the user trapped in it who is spending and can’t find a way out.
Another point I would like to make is that Twitter (TWTR) at these levels is an ideal buy-the-dip candidate precisely because it’s a great walled garden whose potential has yet to be untapped.
And readers shouldn’t let the mismanagement of the company by former CEO Jack Dorsey turn you off from a great long-term investment.
PYPL would kill for a platform like Twitter and instead needs to grovel to other strategic platforms to allow them to use PYPL’s technology.
PYPL is finally exposed, and I guess more accurate would be to say they are getting undercut by stickier technology that is more convenient to the consumer.
And what does that get you in late 2021?
Downgrades and slews of them which cut blocks the stock at its knees.
We just got one from Bernstein the other day and then it almost becomes a self-fulfilling prophecy with other analyst outlets doing the same thing in a copycat league.
Instead of catching a falling knife in SQ and PYPL, traders need to let these stocks breathe and find support where we know buyers will come in to breed confidence in an upward trajectory.
Easier said than done.
What has been all the rage so far denting PYPL and SQ’s model?
Enter Buy Now Pay Later (BNPL).
Naturally, the differentiated mechanism around which this technology revolves around is the delay in paying, which is never a good concept for a fintech player who rather gets paid ASAP.
Delayed payment is one headache, but then the downward force on fees is another monumental concern, if not downright scary.
This will no doubt trounce margin expansion moving forward and evidence of slowed growth in the latest quarter does not portend well for the company, especially as pandemic tailwinds continue to fade.
Another talking point is BNPL’s lack of credit checks meaning the quality of purchasers will naturally decline, may I even say attract fraudsters as well, and the companies will need to build up loss reserves to compensate for a riskier purchaser profile.
Klarna is another major BNPL company, and they were part of this new industry that took in around 20% of all sales on Cyber Monday.
That rather high number bodes poorly for PYPL in the short term.
Reinforcing the strategic hole of a lack of walled garden is that PYPL is desperate to cultivate partnerships like PYPL’s Venmo joining forces with Amazon (AMZN) — Starting next year, you'll be able to use the money anybody Venmo’s you to buy products directly from Amazon — so long as you live in the US.
But again, Amazon is infamous for replacing outside technology with its own in-house solution over time.
PYPL’s counter solution for BNPL is to enter the BNPL lovefest as well which will effectively trigger a race to zero.
Stopgap solutions will inevitably cannibalize its own business model.
Then let’s point to another walled garden — Tim Cook’s Apple with its Apple wallet.
It’s getting better and with the Apple Card, do they ever really need to spend one second considering a partnership with PYPL or SQ.
There is an inquisition going on in the fintech industry and big body blows will need to be landed for some clear-cut solutions that will ultimately lead to consolidation.
In this precarious environment, don’t get too fancy while fintech is getting elbowed out the way, head to higher ground where balance sheets can absorb just about anything.
“Our goal was never to create a better taxi.” – Said CEO of Lyft Logan Green
Mad Hedge Technology Letter
November 29, 2021
Fiat Lux
Featured Trade:
(THE FUTURE LOOKS BRIGHT FOR THIS AD TECH STOCK)
(TWTR), (FB)
