Tech Letter Archives - Mad Hedge Fund Trader

The Best Way to Alpha Your Tech Portfolio

Overperformance is mainly about the art of taking complicated data and finding perfect solutions for it. Trading in technology stocks is no different.

Investing in software-based cloud stocks has been one of the seminal themes I have promulgated since the launch of the Mad Hedge Technology Letter way back in February 2018.

I hit the nail on the head and many of you have prospered from my early calls on AMD, Micron to growth stocks like Square, PayPal, and Roku. I’ve hit on many of the cutting-edge themes.

Well, if you STILL thought every tech letter until now has been useless, this is the one that should whet your appetite.

Instead of racking your brain to find the optimal cloud stock to invest in, instead of scouring the grains of sand to find a diamond, I have a quick fix for you and your friends.

Invest in The WisdomTree Cloud Computing Fund (WCLD) which aims to track the price and yield performance, before fees and expenses, of the BVP Nasdaq Emerging Cloud Index (EMCLOUD).

What Is Cloud Computing?

The “cloud” refers to the aggregation of information online that can be accessed from anywhere, on any device remotely.

Yes, something like this does exist and we have been chronicling the development of the cloud since this tech letter’s launch.

The cloud is the concept powering the “shelter-at-home” trade which has been hotter than hot since March 2020.

Cloud companies provide on-demand services to a centralized pool of information technology (IT) resources via a network connection.

Even though cloud computing already touches a significant portion of our everyday lives, the adoption is on the verge of overwhelming the rest of the business world due to advancements in artificial intelligence and the Internet of Things (IoT) hyper-improving efficiencies.

The Cloud Software Advantage

Cloud computing has particularly transformed the software industry.

Over the last decade, cloud Software-as-a-Service (SaaS) businesses have dominated traditional software companies as the new industry standard for deploying and updating software. Cloud-based SaaS companies provide software applications and services via a network connection from a remote location, whereas traditional software is delivered and supported on-premise and often manually. I will give you a list of differences to several distinct fundamental advantages for cloud versus traditional software.

Product Advantages

Speed, Ease, and Low Cost of Implementation – cloud software is installed via a network connection; it doesn’t require the higher cost of on-premise infrastructure setup maintenance and installation.

Efficient Software Updates – upgrades and support are deployed via a network connection, which shifts the burden of software maintenance from the client to the software provider.

Easily Scalable – deployment via a network connection allows cloud SaaS businesses to grow as their units increase, with the ability to expand services to more users or add product enhancements with ease. Client acquisition can happen 24/7 and cloud SaaS companies can easily expand into international markets.

Business Model Advantages

High Recurring Revenue – cloud SaaS companies enjoy a subscription-based revenue model with smaller and more frequent transactions, while traditional software businesses rely on a single, large, upfront transaction. This model can result in a more predictable, annuity-like revenue stream making it easy for CFOs to solve long-term financial solutions.

High Client Retention with Longer Revenue Periods – cloud software becomes embedded in client workflow, resulting in higher switching costs and client retention. Importantly, many clients prefer the pay-as-you-go transaction model, which can lead to longer periods of recurring revenue as upselling product enhancements does not require an additional sales cycle.

Lower Expenses – cloud SaaS companies can have lower R&D costs because they don’t need to support various types of networking infrastructure at each client location.

I believe the product and business model advantages of cloud SaaS companies have historically led to higher margins, growth, higher free cash flow, and efficiency characteristics as compared to non-cloud software companies.

How does the WCLD ETF select its indexed cloud companies?

Each company must satisfy critical criteria such as they must derive the majority of revenue from business-oriented software products, as determined by the following checklist.

+ Provided to customers through a cloud delivery model – e.g., hosted on remote and multi-tenant server architecture, accessed through a web browser or mobile device, or consumed as an application programming interface (API).

+ Provided to customers through a cloud economic model – e.g., as a subscription-based, volume-based, or transaction-based offering Annual revenue growth, of at least:

+ 15% in each of the last two years for new additions

+ 7% for current securities in at least one of the last two years

Some of the stocks that would epitomize the characteristics of a WCLD component are Salesforce, Microsoft, Amazon-- I mean, they are all up, you know, well over 100% from the nadir we saw in March 2020 and contain the emerging growth traits that make this ETF so robust.

If you peel back the label and you look at the contents of many tech portfolios, they tend to favor some of the large-cap names like Amazon, not because they are “big” but because the numbers behave like emerging growth companies even when the law of large numbers indicate that to push the needle that far in the short-term is a gravity-defying endeavor.

We all know quite well that Amazon isn't necessarily a pure play on cloud computing software, because they do have other hybrid-sort of businesses, but the elements of its cloud business are nothing short of brilliant.

ETF funds like WCLD, what they look to do is to cue off of pure plays and include pure plays that are growing faster than the broader tech market at large. So, you're not going to necessarily see the vanilla tech of the world in that portfolio. You're going to see a portfolio that's going to have a little bit more sort of explosive nature to it, names with a little more mojo, a little bit more chutzpah because you're focusing on smaller names that have the possibility to go parabolic and gift you a 10-bagger precisely because they take advantage of the law of small numbers.

One stock that has the chance for a legitimate ten-bagger is my call on Palantir (PLTR).

Palantir is a tech firm that builds and deploys software platforms for the intelligence community in the United States to assist in counterterrorism investigations and operations.

This is one of the no-brainers that procure revenue from Democrat and Republican administrations.

In a global market where the search for yield couldn’t be tougher right now, right-sizing a tech portfolio to target those extraordinary, extra-salacious tech growth companies is one of the few ways to produce alpha without overleveraging.

No doubt there will be periods of volatility, but if a long-term horizon is something suited for you, this super-growth strategy is a winner, and don’t forget about PLTR while you’re at it.

Quote of the Day - August 25, 2021

Tech Letter

“When we launch a product, we're already working on the next one. And possibly even the next, next one.” – Said Current CEO of Apple Tim Cook

August 23, 2021

Tech Letter

Mad Hedge Technology Letter
August 23, 2021
Fiat Lux

Featured Trade:

(THE FUTURE OF AI PATENTS AND LAW)
(ARTIFICIAL INTELLIGENCE)

The Future of AI Patents and Law

Tech Letter

The world is rapidly shifting into a new paradigm where not only do people invent, but people also build artificial intelligence that can invent.

This will have massive ramifications for the business world and the tech industry which is the avant-garde of the business world.

Recent decisions from South Africa and Australia that an artificial intelligence machine can be listed as inventor on a patent could spur these two locales into being one of the most competitive tech scenes in the world.

The U.S. and Europe will need to figure out what it means to be an inventor.

Registering A.I. as an inventor could potentially mean that multinational corporations won’t shoulder the blame if some sort of insidious experiment with A.I. goes horribly wrong crushing half of mankind.

It also opens up the possibility of some “A.I. invented” app triggering 1000X growth delivering prosperity to half of mankind.

The wide range of possibilities is enough to keep one up at night, and the deeper knock-on effect is that A.I. is now prime for game time.

It’s true that the past interactions of A.I. have been bush league, and simply, the technology wasn’t enough along to make a dent in the universe.

However, the rapid acceleration of not only the quantity of A.I., but the increasing quality of A.I. means that countries will need to make some high stakes business decisions on where A.I. fits into the law and patent system.

Courts in the U.S. and U.K. are expected to issue rulings later this year, and policymakers are gathering information on how to deal with the rising use of AI.

Another piece to the puzzle is how China will treat A.I. and the knock-on effects on American consumers and American businesses.

This sub-sector has been identified as one of the “must-win technologies of the future” by the U.S. administration.

China also leads in A.I. as it relates to facial recognition and has a database of 1.3 billion citizens to pull data from.

China is pursuing a centrally controlled strategy with hyperlocal implementation. Values and goals are set from above, and resources are made available.

At the local level of municipalities, cities and provinces, regional administrations compete for the new AI clusters.

The result is a national and regional administrative state that works closely with research, investors, and industry to build a successful AI ecosystem.

The implementation of the national strategy varies greatly from region to region. While cities such as Tianjin and Shanghai have already launched multi-billion-dollar AI city Venture Capital funds and had entire districts and islands built for new AI companies. Other provinces are still in the process of learning and development.

As it stands now, American corporations are acutely aware of incorporating AI into their business models and the risks associated with it.

In either case, American companies need a verdict and the initial framework of how to treat A.I. in terms of who owns the patents and what that means, or they risk falling behind places like China who are hellbent on being the first A.I. superpower.

Just look at social media companies that otherwise would be on the hook for the costs associated with negative content on their platforms if it weren’t for cheeky legislation better known as Section 230.

Section 230 is a section of title 47 of the U.S. Code enacted as part of the United States Communications Decency Act which generally provides immunity for website platforms from third-party content.

Imagine if all companies were protected from anything negative that A.I. manufactured and not only with social media.

One could extrapolate that this could be horrendous for the health of many social communities, but one could also understand how investors could win out big time if a flood of capital nosedived into controversial projects that became money generators.

Tech companies, especially the big 6, have the capital and connections in Washington to advance the initiative.

Drug discoveries for diseases like cancer have been of massive interest for AI researchers with scientists hoping to leverage the technology to discover cures for complex diseases.

It’s not surprising to see companies like Apple, Google, Microsoft, and so on get in on the health game with the revenue potential for these future health solutions and medicines in the 10s of trillions of dollars.

Another project that comes to mind that would benefit from AI law is Elon Musk-supported Neuralink.

Elon Musk wants everyone to get brain surgery. Specifically, he wants everyone to get a brain implant — the brain-machine interface created by his company, Neuralink. He says it will be able to solve any number of medical conditions — including paralysis, anxiety, and addiction.

A project like this is high risk — a lot could go wrong with it.

But what if the law was set up to just allow investors to write off the externalities and fiscal costs of a failed project?

U.S. District Judge Leonie Brinkema has ruled that this type of legislation faces an “uphill battle” in overturning a rejection by the U.S. Patent and Trademark Office.

A U.K. court heard arguments in July on the same question. The European Patent Office has scheduled a hearing in December.

These rulings also have massive consequences in where the new Silicon Valley migrates to and if the rules are favorable in South Africa, what’s stopping Facebook from exploring an opening of a Cape Town subsidiary?

Not much is the answer.

Artificial intelligence uses a machine to perform steps that mimic the work of a human mind but at exponential speed and performance.

AI computers can identify new drug molecules or new uses for old drugs, but it still takes human researchers to develop those results into a new medicine.

Many bigwigs in Silicon Valley have already clearly stated that the U.S. “lacks the comprehensive IP policies it needs for the AI era and is hindered by legal uncertainties in current U.S. patent eligibility and patentability doctrine.”

The issue of inventorship is just a small part of the dilemma over how to deal with AI, such as what types of AI software are eligible for a patent and who owns the massive amounts of data required to “teach” the machines.

A decision clarifying which AI inventions are eligible for patenting would be impactful.

Ultimately, AI is a high-stake game that gets more important by the day.

Quote of the Day - August 23, 2021

Tech Letter

“Failure is not an option here. If things are failing, you are not innovating enough.”- Said Founder and CEO of Tesla Elon Musk

August 20, 2021

Tech Letter

Mad Hedge Technology Letter
August 20, 2021
Fiat Lux

Featured Trade:

(IS NVIDIA WORTH A LONG-TERM INVESTMENT?)
(NVDA), (AMZN), (VMW)

Is Nvidia Worth a Long-Term Investment?

Tech Letter

A can’t-miss stock in technology investing has to be Nvidia (NVDA).

We got confirmation from the latest earnings report that they are still too hot to handle.

Sure, the bulk of revenue still mostly comes from gaming, but gaming is still a secular growth driver.

They had another strong quarter overall, with revenue of $6.5 billion and year-on-year growth of 68%.

They set new records for total revenue as well as for Gaming, Data Center, and Professional Visualization.

The pandemic minted a fresh wave of new gamers which has been a generous gift to an already robust company.

The audience for global eSports will soon approach 0.5 billion people, while the number of those who live stream games is expected to reach over 700 million.

Meanwhile, the number of PC gamers helps set the stage for a new audience that will help drive Nvidia’s future products.

Gaming, with revenue of $3.1 billion, was up 11% sequentially and up 85% from a year earlier.

Demand remained exceptionally strong, outpacing supply.

Nvidia has two powerful new GPUs for gamers and creators, the GeForce RTX 3080 Ti and RTX 3070 Ti, delivering 50% faster performance than their prior generation with acclaimed features such as real-time ray tracing, and AI Rendering.

Laptop demand was another blistering division that was again helped by the importance of quality devices in a locked-down world.

From the top-of-the-line gaming laptops to those through mainstream price points as low as $799 that brings the power of GeForce CPUs to gamers, the entire range of products was in high demand.

Highlighting Nvidia’s stranglehold at the cutting edge of technology and the future is its developments in the self-driving sphere.

In autonomous trucking, DRIVE ecosystem partner, Plus, signed a deal with Amazon (AMZN) to provide at least 1,000 self-driving systems to Amazon's fleet of delivery vehicles.

The systems are powered by NVIDIA DRIVE for high performance, energy-efficient and to take advantage of its centralized AI computer.

An autonomous trucking start-up, Embark, is building on NVIDIA DRIVE.

The system is being developed for trucks for four major auto manufacturers representing the vast majority of largest size trucks in the US.

The NVIDIA DRIVE platform is being rapidly adopted across the transportation industry from passenger-owned vehicles to rob taxis, to trucking and delivery vehicles.

The goal is to get Nvidia products in everything that autonomously moves one day, a big goal, but I have seen crazier things come to fruition.

Nvidia expanded AI software and subscription offerings make it easier for enterprises to adopt AI from the initial development stage through to deployment and operations.

The enterprise continues to be a core set of Nvidia’s operations.

In the Enterprise, the application that is driving AI is that every enterprise must move toward being a tech company, take advantage of connected clouds, connected devices, and artificial intelligence to achieve it.

Nvidia just helps facilitate the opportunity to deploy AI services out of the edge.

And in order to do so, there are several things that have to happen; first, they have to create a computing platform that allows them to do training in the IT environment that they understand, which is a virtualized, which is largely managed by VMware (VMW).

And Nvidia’s collaboration with VMware is creating a new type of system that could be integrated into the enterprise that has been quite a significant effort and it's in volume production today.

The second is a server that allows the enterprise customers to deploy their AI models out to the edge.

The AI engine through software suite that they’ve been developing over the last 10 years now has been integrated into this environment and allows the enterprises to basically run AI out of the box.

Putting all of the state-of-the-art AI solvers and engines and libraries that Nvidia has industrialized and refined over the years, are all available to anyone that signs up for an Enterprise license.

The largest eyebrow-raiser in the earnings rhetoric was news from the data center which is expected to have another strong quarter with sequential growth driven largely by “accelerating demand.”

This acceleration has boosted record revenues in both hyperscale cloud and industrial enterprise.

Now we are seeing accelerated growth for the short to midterm.

The acceleration in hyperscale and cloud comes from the transition of the catalyst providers in taking AI applications, which are now heavily deep learning-driven into production.

Ultimately, Nvidia’s gaming division is its cash cow operating at a tremendously high level and the accelerated growth in the data center will help sweeten margins for the foreseeable future.

Gaming demand is continuing to exceed supply and the company expects channel inventories to remain below target levels.

The one controversy that most analysts were waiting for was an update on its acquisition of British chip company Arm Ltd.

Upper management, more or less, offered some vague one-liners expressing “concern” and noting that the deal is “taking longer than initially thought.”

Getting Arm Ltd. onboard to add another monkey branch in its neural network would be a major feather in Nvidia’s cap, but the global regulatory climate has been harsh as of late.

This could be a headwind for future cash flow expectations, yet, ultimately, if there is any weakness in the stock, I would dollar cost average this one out on any 3-5% dip.

Nvidia is highly volatile, and this is not the stock to day trade. Considering we are at new all-time highs of $200, I wouldn’t chase this one higher but wait for the next small dip.

Fortunately, time and time again, Nvidia proves they are at the forefront of tech innovation, powered by a brilliant CEO, and instead of market timing the stock, it should simply be a cornerstone of a long-term buy and hold portfolio.

I am bullish on Nvidia long term with high conviction.

Quote of the Day - August 20, 2021

Tech Letter

“The AI technology will keep you out of harm's way. That is why we believe in an AI car that drives for you.” – Said CEO of Nvidia Jensen Huang

August 18, 2021

Tech Letter

Mad Hedge Technology Letter
August 18, 2021
Fiat Lux

Featured Trade:

(WILL THE ARK INNOVATION FUND CRASH?)
(ARKK), (TSLA)

Will the Ark Innovation Fund Crash?

Tech Letter

Michael Burry, the audacious hedge-fund icon who is famous for being represented in the movie “The Big Short,” is aggressively taking the other side of Cathy Woods, a name synonymous with tech growth.

Such prominent names at loggerheads with each other signals a divergence in interest rate expectations and the fallout, or lack of it, for tech growth stocks.

That is fundamentally the crux of the issue, with the stock market levered so heavily that even a quarter rate rise would undermine it.

Woods seems to minimize any ill-effects that broader volatile behavior will have on her niche area of the tech market.

Statistically speaking, growth tech outperforms the broader market when already low-interest rates are expected to trend lower.

The inverse holds true when interest rates are expected to rise, then tech growth stocks will underperform the broader market and even non-growth tech.

This is precisely why in 2020, elevated growth names rode the wave of the pandemic and shelter-at-home trade as the Fed lowered rates to fuel the stock appreciation.

The party is somewhat over now; or at least the low-hanging fruit has been plucked.

Burry disclosed that his firm, Scion Asset Management, held bearish put options against 235,500 shares of Woods’ actively managed ARK Innovation exchange-traded fund (ARKK) at the end of the second quarter.

The new position was valued at almost $31 million, according to the quarterly filing, which is required for hedge funds above a certain size.

Burry also has a growing put position worth $731 million in Tesla (TSLA), which remains Wood's highest conviction stock.

Woods responded saying, “I do not believe that he understands the fundamentals that are creating explosive growth and investment opportunities in the innovation space.”

Woods doesn’t understand that this isn’t a call based on a long-term forecast of growth tech outperforming the broader market but more of a short-term call that even slightly rising interest rates will penalize high beta names more than the rest.

No doubt that Burry has a clearly defined entry and exit point while Woods seems to be in the business of blanket statements disregarding idiosyncratic particulars which is a dangerous game.

There is the premise out there that a slightly rising interest rate will rotate money back into FANG names who can, by and large, stomach the ensuing bond rise opposed to loss-making growth stocks that depend on cheap money to fuel unproven business models.

Last year was sensational for ARK Invest, there is no point to play this down, it raked in billions of new assets from spectacular performances by Wood’s active ETFs focused on high-growth innovation-driven stocks. Several were among 2020’s best-performing funds, with returns of more than 100%.

But the funds have struggled to maintain that momentum this year. Many of their stock holdings are trading at frothy valuations that are betting on outperforming expected growth in the future.

As inflation flares up and interest rates rise, the current value of the growth companies’ future cash flow diminishes.

The ARK Innovation ETF is now 6% down for the year, with $500 million asset outflows in the past month.

Burry hasn’t been always right such as pulling out of GameStop (GME) in 2020 before the frenzied buying, which left a 2,000% surge on the table.

Wood also told us that Burry may not understand the current growth environment, as inflationary pressures are likely to be short-term in nature.

"Most bears seem to believe that inflation will continue to accelerate, shortening investment time horizons and destroying valuations," Wood explained. But Wood thinks supply-chain-related issues will be resolved, helping relieve inflationary pressures.

Wood pointed to a sharp drop in certain commodity prices in recent weeks (including lumber, copper, and oil) in regards to explaining why inflation may not linger for as long as some think. Used-car prices are also beginning to fall after an extraordinary rise, and a strengthening US dollar has also put pressure on commodity prices, according to Wood.

Nevertheless, Woods fails to chime in on China closing one of its biggest ports or Southeast Asian manufacturing hubs like Vietnam, Thailand effectively being shutdown from the delta virus.

Ultimately, Woods offers an overly blasé attitude towards an extremely niche problem. It is almost as if she would say the same thing no matter what condition the broader market is in.

And while cheerleading the stocks you are invested in is not a criminal act, to completely miss that Burry most likely has a different timeline than Woods shows that she has tunnel vision in terms of the phase of the economic cycle we are in.

I would say with conviction that it’s normal for Tesla to retrace after a 600% move up in 2020. There is nothing wrong with it and I see it as healthy market behavior.

Burry is essentially betting on a revision to the mean, which is high risk, ostensibly, Tesla most likely won’t rise another 600% in 2021 as well which is where Burry comes in.

I won’t sit here and advocate to market time mean revisions of tech growth stocks as we are not in that business, but this little skirmish screams to jump back into best-of-breed tech stocks to protect ourselves at frothy levels.