Tech Letter Archives - Mad Hedge Fund Trader

The Best Tech Stock You’ve Never Heard of

If you asked me which is the best company that most people do not know about then there is one clear answer.

The Trade Desk (TTD).

This company was founded by one of the pioneers of the ad tech industry Jeff Green, and he has spent the past 20 years improving data-based digital advertising.

Green established AdECN in 2004 and its claim to fame was the world’s first online ad exchange.

After three years, Microsoft gobbled up this firm and Green stayed on until 2009 when he launched The Trade Desk. This is where he planned to infuse everything he learned about the digital ad agency into his own brainchild.

Green concluded that creating a self-service platform, avoiding privacy issues, and harnessing big data for digital ad campaigns was the best route at the time.

Green hoped to avoid the pitfalls that damaged the digital ad industry mainly bundling random ads together that diluted the quality and potency of the ad campaigns.

It did not make sense that a digital ad for baby diapers could be commingled with an ad for retirement homes.

Green created real-time bidding (RTB), which is a process in which an ad buyer bids on a digital ad and, if won, the buyer’s ad is instantly displayed on the selected site.

This revolutionary method allowed ad buyers to optimize ad inventory, prioritize ad channels, and boost the effectiveness of campaigns.

(RTB) is a far better way to optimize digital ad campaigns than static auctions, which group ads by the thousand.

In real time, advertisers are able to determine a bespoke ad for the user to display on a website. Green used this model to develop his company by building a platform tailor-made to execute (RTB).

Naturally, he won over many naysayers and his company took off like a rocket.

Results, in a results-based business, were seen right away by ad buyers.

A poignant example was aiding a performance-based ad agency in trimming ad waste by more than 50% for a national fast food chain with thousands of locations across America.

It took just one year for The Trade Desk to carve out a profitable business as ad agencies flocked to its platform desiring to take advantage of (RTB) or also commonly known as programmatic advertising.

Customer satisfaction is evident in its client retention rate of 95% for the past few years highlighting the dominating position The Trade Desk possesses in the digital ad industry.

The Trade Desk has not raised fees for ad buyers lately, but the value added from The Trade Desk to customers is accelerating at a brisk pace.

A great value proposition for potential clients.

The vigor of the business was highlighted when Green cited that each second his company is “considering over 9 million ad opportunities” for their ad inventory shows how The Trade Desk is up to date on almost every single ad permutation out there.

This speaks volume of the ad tech, which is the main engine powering the bottom lines at Google search and rogue ad seller Facebook (FB).

Google only gets 63,000 searches per second and shows that The Trade Desk has pushed the envelope in providing the best platform for ad buyers to seek its perfect audience.

Green’s mission of supporting big ad buyers optimize their ad budget has really caught fire and in a way that is completely transparent and objective.

The foundations that Green has assembled became even more valuable when Alphabet (GOOGL) chose to remove DoubleClick IDs, which would now prevent ad buyers from cross-platform reporting and measurement.

Previously, DoubleClick ID could cull data from assorted ads and online products based on a unique user ID named DoubleClick ID.

Ad purchasers then would data transfer to pull DoubleClick log files and measure them against impressions served from other ad servers across the web.

Effectively, ad buyers could track the user through the whole ad process and determine how useful an ad would be to that specific user.

In an utter conservative move to satisfy Europe’s General Data Protection Regulation (GDPR), DoubleClick IDs are no longer available for use, and tracking the ad inventory performance from start to finish became much harder.

Cutting off the visibility of the DoubleClick ID in the DoubleClick ecosystem was a huge victory for The Trade Desk because DoubleClick ID measured 75% of the global ad inventory.

Ad buyers would be forced to find other measurement systems to help calculate ad performance.

Branding and executing as the transparent and fair ad platform helping ad agencies was a great idea in hindsight with the world becoming a great deal more sensitive to data privacy.

The Trade Desk is perfectly placed to reap all the benefits and boast excellent technology to capitalize on this changing big data landscape. It is already seeing this happen with new business wins including large global brands such as a major food company, a global airline, and another large beverage company.

The global digital ad market is a $700 billion market today and trending toward $1 trillion in the next five to seven years

The generational shift to mobile and online platforms will invigorate The Trade Desk’s bottom line as more big ad buyers will make use of its proprietary platform to place programmatic ads.

Content distribution systems are fragmenting into skinny bundles hyper-targeting niche content users such as Sling TV, FuboTV, and Hulu.

There are probably 30 different ways to watch ESPN now, and these 30 platforms all require ad placement and optimization.

Some of the names The Trade Desk is working with are the who’s who of digital content ownership or distribution including Baidu (BIDU), Google, Alibaba (BABA), Pandora (P), and Spotify (SPOT) -- and the names are almost endless.

It’s the Wild West of ads and content these days because TV distribution has never been more fragmented.

Content creation avenues are desperate to boost ad income and are increasingly attempting to go direct to consumers.

Ad-funded Internet TV barely existed a few years ago. And ad inventory is all up for grabs benefitting The Trade Desk.

All of this explains why the stock is up more than 180% in 2018, and this is just the beginning.

The growth numbers put Amazon (AMZN) and Netflix (NFLX) to shame.

The Trade Desk scale on inventory has spiked by more than 700% YOY.

The option to hyper-target increases as more ad inventory is stocked.

Management mentioned in its second-quarter performance that “nearly everything went right. We executed well and one of the most dynamic environments we've seen.”

It is one of the most bullish statements I have heard from a public company.

Quarterly revenue ballooned 54% YOY to a record $112 million, and the 54% YOY growth equaled the 54% YOY growth in Q2 2017.

Ad Age's top 50 worldwide advertisers doubled ad spend in the past year positioning The Trade Desk for continued hyper-growth, not only for 2018 but in 2019 and beyond.

Mobile spend jumped nearly 100% YOY, accounting for 45% of ad spend on the platform, which is 400% higher than the industry average for mobile ad spend according to eMarketer.

Data spend was also a huge winner rising by nearly 100% smashing another record.

In the meantime, the overseas business continued its robust growth in Europe and Asia, up 85% YOY.

The Trade Desk confidence in its performance chose to increase guidance to $456 million for the year, a 48% YOY improvement.

When upper management says “when we see surprises, they typically are to the upside” you take notice, because this tech company is perfectly placed in a growth sweet spot.

Massive developing markets are just starting to dabble with programmatic advertising. Markets such as China will see it become the new normal soon, opening up even more business for The Trade Desk.

The Trade Desk is also rolling out new products that will automate more of the process and reduce the number of clicks.

Wait for the pullback to get into this ad tech stock because even though it is up big this year, we are still in the early innings, and shares will march even higher.

________________________________________________________________________________________________

Quote of the Day

“I have a deep respect for the fundamentals of television, the traditions of it, even, but I don't have any reverence for it,” – said Netflix chief content officer Ted Sarandos.

August 28, 2018

Tech Letter

Mad Hedge Technology Letter
August 28, 2018
Fiat Lux

Featured Trade:
(SPOTIFY STILL HAS SOME UPSIDE),
(SPOT), (AMZN), (AAPL), (P)

Spotify Still Has Some Upside

Tech Letter

Investors sulking about Spotify’s (SPOT) inability to make money do not get the point.

Yes, the job of every company to be in the black, but the No. 1 responsibility for a modern tech company is to grow, and grow fast.

Tech investors pay for growth, period.

As investors have seen from Netflix, companies can always raise prices after seizing market share because of the stranglehold on eyeballs inside a walled garden.

That potent formula has been the bread and butter of powerful tech companies of late.

Spotify is a captive of the music industry, of which it is entirely dependent for its source of goods, in this case songs.

At the same time, the music industry has fought tooth and nail to destroy the likes of Spotify, which benefits immensely from distributing the content it creates.

History is littered with failed music streaming services outgunned in the courtroom. Pandora (P) is the biggest public name out there whose share price has tanked over the long haul.

The music industry will battle relentlessly to exterminate Spotify and force up the royalties these Internet giants must pay as their main input.

But that does not mean Spotify is a bad company or even a bad stock.

Every company has its share of pitfalls. Throw in the mix that Amazon (AMZN) and Apple (AAPL) have music streaming services that do not even need to make a profit, and you will understand why some might be wary about putting new money to work in music streaming business stocks.

The primary reason that Spotify shares will outperform for the foreseeable future is because it is the preeminent music streaming platform.

Also, there is favorable latitude to make way toward the goal of monetization, and ample space to improve gross margins.

Global streaming revenue growth has gone ballistic as the migration to mobile and cord cutting has exacerbated the monetization prospects of the music industry.

Streaming revenue was a shade under $2 billion in 2013, and continued to post a growth trajectory of more than 40% each year since.

As it stands now, total global streaming revenue registered just a tick under $7 billion per year in 2017, and that was an improvement of 41.1% from 2016.

There are no signs of yielding as more avid music fans push into the music streaming space.

Social media platforms have helped publicize popular artists’ content.

Music is effectively a strong part of youth culture, which will eventually see the youth integrate a music streaming app into their daily lives for the rest of their adult lives.

The choice among choices is Spotify in 2018.

The company was dogged by many years of famous artists removing their proprietary content from the platform citing unfavorable terms.

A prime example was in 2009 when Lady Gaga’s hit song “Poker Face” only received $167 in royalty payments from Spotify for the first million streams. This highlighted the rock-solid position Spotify has curated inside the music industry.

Individual artists’ fight against Spotify has been dead on arrival from the outset, but the benefits and exposure from cooperating with the company far outweigh the drawbacks.

Eventually, almost all artists have relented and reinstalled their music on Spotify. They depend on alternative moneymaking avenues to compensate for lack of royalties, which is mainly live music.

That is why it costs an arm and a leg to go see Taylor Swift in living flesh now, and why those summer festivals dotted around America such as Coachella command premium ticket prices.

How does Spotify make money?

It earns its crust of bread through paid subscriptions but lures in eyeballs using an ad-supported free version of its platform.

Naturally, the paid version is ad-less, and this subscription is around $5 to $15 per month.

In the second quarter, Spotify’s paid subscription volume surpassed 83 million, a sharp uptick of 40% YOY.

Ad-supported users came in at more than 101 million, even under the damage that General Data Protection Regulation (GDPR) did to western tech companies.

The ad-supported subscribers rose 23% YOY, and the paid version expects between 85 million to 88 million paid subscribers in the third quarter.

Many of the new paid subscribers are converts from its free model.

Spotify is poised to increase revenue between 20%-30% for the rest of the year.

The rise of Spotify's developing data division could extract an additional $580 million of revenue in 2023, making up 2% of total revenue.

Remember that Spotify’s reference price set by the New York Stock Exchange (NYSE) was $132 in April 2018. The parabolic move in the stock on the verge of eclipsing $200 undergirds the demand for high-quality tech companies.

When Spotify did go public, the robust price action was with conviction, making major investors - such as China’s Tencent, which possess a 9.1% stake and Tiger Global Management, which owns 7.2% - happy stakeholders.

In the last quarter’s earnings report, Spotify CFO Barry McCarthy reiterated the company’s goal to push gross margins from the mid-20% range to “gross margins in the 30% to 35% range.”

A jump in gross margins would go a long way in making Spotify appear more profitable, and that is the imminent goal right now.

The path to real profitability is still a long way down the road and small victories will offer short-term strength to the share price.

If Spotify can retrace to around the $185, that would serve as a perfect entry point into a stock that has given investors few chances in which to participate.

July and August have only offered meager entry points into this stock, one around the $180 level in August, and another around $170 in July.

Spotify enjoyed a great first day of being public after its unorthodox IPO ending the day at $149. The momentum has continued unabated while Spotify has posted all the growth targets investors come to expect from companies of this ilk.

Bask in the glow of the growth sweet spot Spotify finds itself in right now.

The long-term narrative of this stock is intact for a joyous ride upward, and only whispers of Amazon and Apple meaningfully attempting to monetize this segment could derail it.

For the time being, the music part of Amazon and Apple are just a side business. They have other priorities, such as Apple’s battle to avoid being exterminated from communist China, and Amazon’s integration of Whole Foods and new-fangled digital ad business.

The Dominant Music Streaming Platform of 2018

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Quote of the Day

“Ever since Napster, I’ve dreamt of building a product similar to Spotify,” – said cofounder and CEO of Spotify Daniel Ek.

August 27, 2018

Tech Letter

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)

Why Alibaba is the First Stock to Buy with the Outbreak of Trade Peace

Tech Letter

According to the government agency, China Internet Network Information Center, the Chinese Internet community has surpassed 802 million, which only represents a 57.7% penetration rate, miles behind the 89% penetration rate in America.

The gargantuan scale of the Chinese Internet world means China has three times as many Internet users than America, and this is a big deal.

The additional 30 million added to the Chinese Internet ecosphere in the first half of 2018 shows the scale in which local Chinese tech companies are playing with and use to their clear-cut advantage.

Ostensibly, most business strategies in China revolve around scaled tactics as the backbone to operations.

There is even more room to expand in the Middle Kingdom and one clear victor sits atop the parapet looking at the riffraff below and that is Chinese Internet conglomerate Alibaba (BABA).

Alibaba, led by Chinese Internet pioneer Jack Ma, posted its highest-performing growth quarter in the past four years.

Total quarterly revenue ballooned an incredible 61% YOY to $11.8 billion, highlighting the dominant position Alibaba possesses in the Chinese e-commerce landscape.

If you want to know what Amazon (AMZN) is going to do next watch Alibaba.

Profit margins were somewhat sacrificed in the process because of M&A activity that saw Alibaba move into the physical supermarket business snapping up 35 Hema supermarket locations then reinvesting into the business. Echoes of Whole Foods?

Alibaba did not stop there, funneling another $3 billion into food delivery app ele.me, which plans to merge its operations with Yelp (YELP) lookalike app Koubei.

If you thought Silicon Valley moves at a rapid pace, the Chinese Internet space moves faster than lighting.

Alibaba last year dipped into the retail segment as well pocketing a department store chain with 29 stores along with 17 shopping malls.

Alibaba is the closest replica the world has to Amazon and thus is an ideal barometer of the health of the overall Chinese consumer and a peek under the complicated hood that is the Chinese economy.

Alibaba also provides onlookers at how China and its Internet behemoths are coping with the global trading war that has invaded the news headlines from its outset.

The short answer to all this is that China is coping quite well and by no means is ready to back down.

Indeed, there will be peripheral pressures exerted from the fringes, but the core engines remain intact and Chairman Xi can fall asleep in his Beijing abode more than peacefully.

A reason for the stalemate between the two governments is that both are quietly confident they have the levers in place to absorb whatever Molotov cocktails the other has to throw at them.

Investors would be mad to dismiss China’s capabilities after experiencing a mesmerizing economic rise enriching hundreds of millions of Chinese nationals that can be found comfortably living in western megacities in luxury real estate often with a real estate portfolio dotted around the world.

Alibaba’s management made it known on the earnings report that it is not worried much about the trade war because it is largely focused on the domestic Chinese consumer, which has been one of the best economic stories of the past decade.

The overseas expansion unfolding under Alibaba’s tutelage is away from the western world and predominantly focused on Southeast Asia and Eastern Europe where cheap, value-for-money hardware and software allows citizens at these income levels to participate in the e-commerce game.

These individuals can’t afford iPhones on a salary of peanuts. And Alibaba has targeted the undeveloped world as a potential lever of substantial growth.

The regulatory harshness of the west has shut out Huawei and ZTE from its shores. Australia followed suit as well, banning the two telecom companies even though it enjoys a better relationship with Beijing than Europe or North America.

China has already planned a workaround because the engines driving the Chinese tech miracle are semiconductor companies such as Micron (MU), which sells boatloads of DRAM memory chips to Chinese tech companies that flood the world with smartphones and other gadgets.

Beijing has already formulated a plan to circumvent American chips by tapping Korean, European, and Japanese chips to replace the current American supply that could vanish at any time.

Shenzhen-based chip company HiSilicon fully owned by Huawei is responsible for supplying Huawei with chips and is the biggest local designer of integrated circuits in China.

This is what the future of China looks like when China can finally build up the adequate supply necessary to achieve its plans to dominate global technology, America, and the world.

But the plan is still in the process of playing out. The awkwardness was highly visible when the administration’s ban of selling U.S. manufactured components to telecommunications company ZTE resulted in the company almost shutting down until a last-second change of heart by the administration.

The near-death experience will invigorate ZTE to muster its own local supply of chips to avoid the unreliable foreign supply and a deja vu feeling.

American chip companies won’t be able to enjoy the Chinese market for long as all these negative experiences for Chinese companies has forced Chinese tech companies to search and secure a guaranteed chip supply.

At the same time, Chinese local smartphone players have gone from 0 to 60 in no time with companies that barely existed a few years ago, such as Oppo, Vivo coming into the fore along with Huawei picking up 43% of the global smartphone market.

This is bad news for Apple as local competitors are learning fast and furious how to build premium smartphones via re-engineering the current technology or through forced technology transfers.

These companies subsequently offer these phones at the lowest possible price point. And at some point in the near future Apple could be expendable if Chinese smartphones start to display the type of quality the best phones show.

Chinese domestic consumption and investment comprise 90% of the GDP growth in China and are propped up by three robust trends including real wage growth boosting the middle-class population, high savings rate that of which Americans would be jealous, and easy access to credit vehicles.

When I was recently in the Middle Kingdom, it was highly evident that as the generations became younger, their quality of life was higher than their parents.

The opposite is happening in America with millennials earning demonstrably less than their parents’ generation while the American middle class is shrinking at an accelerated pace.

Beijing knows this and hopes to wait things out as it feels time is a positive variable for China and not America.

It is true that if this trade war took place in 20 years in the future, China would be in a stronger strategic position to extract whatever concessions it desires because even though Chinese growth is slowing, it is still growing at 6.5%.

And if you don’t believe what I just said then just look at Alibaba’s cloud division, which grew 93% YOY opening artificial intelligence-based data centers around Europe to battle Amazon (AMZN) and Microsoft (MSFT).

Europe was once Elysian Fields for American tech companies, but with European regulators going after American tech and China encroaching on European turf, the future looks a lot less certain for the FANGs there than ever before.

Alibaba’s operating margins dipped 10% YOY but the slide will be returned to shareholders in the future in the form of high-quality revenue and is worth the investment into the most innovative ideas of tomorrow.

I did not even mention the large stake Alibaba has in Ant Financial, which operates the ubiquitous digital payment app Alipay.

It would be analogous to Amazon if it owned Visa.

Alibaba is one of the best tech companies in the world headed by a former Chinese English language teacher in Hangzhou.

If America becomes too difficult or expensive with which to do business, Alibaba and Chinese tech will just recalibrate their strategy to deeper infiltrate the confines of Southeast Asia and the rest of the undeveloped world.

Any price war on undeveloped soil favors the Chinese as they have mastered scale better than anyone on the planet.

The stellar Alibaba numbers also mean the trade war has no end in sight as each player thinks they have the upper hand. But it also means the tech giants from both countries will come out unscathed and will lead their country’s respective equity markets higher for the foreseeable future.

The Jeff Bezos of China – Alibaba’s Jack Ma

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Quote of the Day

“Technology is nothing. What's important is that you have a faith in people, that they're basically good and smart, and if you give them tools, they'll do wonderful things with them,” – said Apple cofounder and former CEO Steve Jobs.

August 23, 2018

Tech Letter

Mad Hedge Technology Letter
August 23, 2018
Fiat Lux

Featured Trade:
(THE RACE TO ZERO FOR BROKERAGE COMMISSIONS)
(JPM), (WFC), (ETFC), (SCHW), (AMTD)

The Race to Zero for Brokerage Commissions

Tech Letter

The other shoe has dropped.

No more waiting for it as it was only a matter of time, but it was going to happen soon enough.

The acceleration of the race down to zero for brokerage commissions has moved into full throttle.

In a bid to engage new customers, especially millennials, J.P. Morgan (JPM) will offer its customers 100 free stock or ETF trades for one year.

The new service will be available on Chase’s mobile banking app called “You Invest” and also does not require a minimum balance as do so many of the competitors.

Last year, J.P. Morgan was still charging customers a horrific $24.95 per trade, a ridiculous sum in an age of brokerages slashing fees left and right.

Recently, I chronicled the start-up fin-tech brokerage Robinhood, which rolled out the zero-commission model to the chagrin of the traditional brokerages on the verge of major disruption.

Well, Wall Street has stood up and taken notice. There is no way back from this new normal.

The catalyst for J.P. Morgan to change direction was its lack of competitiveness in the digital brokerage space and a free model of luring in business is seen as a quick recipe to correct its ills.

J.P. Morgan has pumped in $300 million in the past two years into digital initiatives but still lacks the volume it was hoping for. This could help capture fresh accounts that could eventually turn into a meaningful business.

Freemium models made popular in Silicon Valley are catching fire in other parts of the economy as potential customers can dabble with the service first before committing their hard-earned money.

This is dreadful news for the fin-tech brokerage industry as it indicates a whole new level of acute pressure on margins and revenue.

The brokerage business has been under fire the past few years after regulators discovered Wells Fargo (WFC) was cunningly ushering clients into higher fee trading vehicles, taking a larger cut of commissions.

Wells Fargo did everything it could to rack up costs for high net worth clients. The atrocious behavior was a huge black eye for the entire industry.

Technology has forced down the cost of executing a trade and each additional trade is almost nil after fixed costs because of software and hardware carrying out these functions.

E-brokerages are set for a rude awakening and their cash cows are about to be disrupted big time.

Charles Schwab (SCHW) has 11.2 million brokerage accounts, and no doubt clients will get on the ringer and ask why Schwab charges an arm and a leg to execute trades.

Schwab might as well start charging clients for emails, too.

The cut in commissions has already started to affect margins with Schwab revenue per trade sliding from $7.96 in 2017 to $7.30 in the most recent quarter.

TD Ameritrade (AMTD) is experiencing the same issues with revenue per trade of $7.83 last year dropping to $7.30 last quarter.

The beginning of the year provided e-brokers with respite after euphoric trading sentiment pushed many first-time equity buyers into the markets, making up for the deceleration in revenue per trade.

However, that one-off spike in volume will vanish and margins are about to get punctured by fin-tech start-ups such as Robinhood.

J.P. Morgan’s move to initiate free trades is a huge vote of confidence for upstart Robinhood, which charges zero commission for ETFs, option trades, and equities.

I recently wrote a story on the phenomenon of Robinhood, and the new developments mean the shakeout will happen a lot faster than first anticipated.

TD Ameritrade, E-Trade (ETFC), Fidelity, and Charles Schwab could face a deeply disturbing future if Silicon Valley penetrates under the skin of this industry and flushes it out just like Uber did to the global taxi business.

E-Trade shares have experienced a healthy uptrend and it is now time to pull the rip cord with the rest of these brokerages.

It will only get worse from here.

Investors should be spooked and avoiding this industry would be the right move at least for the short term.

The golden age of trading commissions is officially over.

Turning this industry into a dollar store variety is not what investors want to hear or hope for.

The decimation of commission fees has coincided with the rise of passive investing.

Only 10% of trades now are performed by active traders.

Brokerages earn demonstrably less with passive investing as the volume of trading commission dries up with this buy-and-hold-forever strategy.

Index funds have been all the rage and quite successful as the market has returned 400% during the nine-year bull market.

When the market stops going up, the situation could get dicey.

The real litmus test is when a sustained bear market vies to implode these ETFs and what will happen with a massive unwinding of these positions.

A prolonged bear market would also scare off retail investors from executing trades on these e-brokerages.

Many will take profits at the speed of light not to be seen or heard again until the next sustained bull market.

Moreover, it is certain the global trade war is scaring off retail investors from their trading platforms as the uncertainty weighing on the markets has thrown a spanner into the works.

Tech has been the savior to the overall market with the top dogs dragging up the rest, but for how long can this continue?

Other industries are experiencing minimal earnings growth and tech cannot go up forever.

Regulations are starting to bite back at the once infallible tech narrative.

Chinese tech is also having its own headaches where Tencent has been perpetually stymied by local regulators blocking access to gaming licenses needed to monetize blockbuster video games.

Tencent missed badly on its earnings report and there is no end in sight to the delay.

Social media has been torn apart as of late and the weaponization of its platforms is accelerating with government operations moving onto them to fight against each other.

Interest rate revenues are the saving grace for these brokerages that account for 50% or more of revenue.

As interest rates rise, there will be a bump in interest rate revenues. However, as competition heats up and commission falls to zero, will these clients stick around for the e-brokers to reap the interest rate revenues or not?

Millennials are hard-charging into Silicon Valley start-ups such as Robinhood, and the traditional brokers’ clientele are mainly directed on the lucrative middle-age cohort.

The next development for e-brokers is who can best harness artificial intelligence to best enhance their customer experience and products.

If the Charles Schwab’s of the world must compete with nimble Silicon Valley start-ups in technology, then they will find a hard slog of it.

One of these big e-brokers is likely to implode setting off another round of consolidation.

The race down to zero is fierce, and I would avoid this whole industry for now.

There are better secular stories in technology such as the e-gaming phenomenon capturing the hearts and minds of global youth.

________________________________________________________________________________________________

Quote of the Day

“Expect the unexpected. And whenever possible, be the unexpected,” – said Twitter and Square cofounder and CEO Jack Dorsey.

August 22, 2018

Tech Letter

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 Letter

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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Don't Miss the August 22 Global Strategy Webinar

Newsletter, Tech Letter

My next global strategy webinar will be held on Wednesday, August 22 at 12:00 PM EST, which I will be broadcasting live from Silicon Valley in California.

Mad Day Trader Bill Davis will be my willing co-conspirator.

I'll be giving you my updated outlook on stocks, bonds, commodities, currencies, precious metals, energy, and real estate.

The goal is to find the cheapest assets in the world to buy, the most expensive to sell short, and the appropriate securities with which to take positions.

I will also be opining on recent political events around the world and the investment implications therein.

I usually include some charts to highlight the most interesting new developments in the capital markets. There will be a live chat window with which you can pose your own questions.

The webinar will last 45 minutes to an hour. International readers and new subscribers who are unable to participate in the webinar live will find it posted on my website within a few hours. I look forward to hearing from you.

To log into the webinar, please click on the link we emailed you entitled, "Next Bi-Weekly Webinar - August 22, 2018" or click here.