Mad Hedge Technology Letter
January 10, 2024
Fiat Lux
Featured Trade:
(LITHIUM CRATERS)
(TSLA), (NIO), (RIVN), (LCID)
EVs were the darling of tech until the hype ran out.
How do I know this?
The price of lithium has nosedived.
The lack of interest is undermining projects, nixing deals, and triggering a scramble for cash that has put a damper on the EV industry.
If anyone thought that EVs would really move the needle for tech, then think again because tech is over-reliant on AI to save the day in 2024. Throw in the Fed pivot too.
Lithium has dropped by 80% in price since the end of 2022 signaling a dramatic slowdown in the electric vehicle market.
The demand for this product isn’t what it used to be.
Sure, there are those (TSLA) lovers in big coastal cities who can’t get enough of the product, but these types max out at 3 Teslas and sit on them until an upgrade a few years later.
With inflation wreaking havoc in every part of American society, this promises to elongate the refresh cycle for tech products like iPhones and Teslas.
Nickel and cobalt have also tumbled, weighed down by an influx of new production amid concerns that the shift to EVs may not be as smooth and quick as predicted.
It’s a dramatic reversal from the froth of recent years that sent prices soaring and sparked a rush by some of the auto industry’s biggest players to secure future supply.
Chemaf Resources Ltd. last year put itself up for sale after a slump in the cobalt price left it struggling to finish key projects in the Democratic Republic of Congo, and London-based Horizonte Minerals Plc scaled back work on its Brazilian nickel mine as it searches for funds to complete construction, and announced an emergency $20 million financing late last year.
Building new mines takes years and sometimes decades, and stalled projects can often be hard to restart. And while most crucial battery markets are now in surplus, shortages are already forecast toward the end of the decade as the greening of the economy accelerates.
In the case of lithium — a once-tiny commodity market that has been catapulted into the global spotlight due to its vital role in EV batteries — the extreme boom and bust of the last few years shows the difficulties in trying to forecast future supply-demand balances and prices, for both producers and their investors.
Yet supply charged ahead as demand growth underwhelmed, and the price won’t come back for years.
It’s highly possible that lithium could be in a drought until close to 2030.
Cobalt has lost two-thirds of its value since a recent peak in 2022, with top-two supplier Glencore Plc forced to build stockpiles of the metal.
Nickel tumbled 45% last year, weighed down by a flood of low-cost supply from Indonesia, where new techniques to produce battery-grade material are threatening to completely upend the industry.
Jumping off the EV bandwagon, the consumers aren’t impressed as much, and snagging the next incremental EV buyer has become hard.
The bad is out there for everybody to see such as the annoyance of running out of electricity and not getting those software updates properly.
Consumers are starting to remove those rose-tinted glasses and look at Ev's dark side too.
This explains why Tesla was discounting its vehicles so aggressively because management sensed the lack of desire from new buyers.
Unfortunately, this could be a bust year for Tesla as they give way to software companies to carry the load. Smaller EV firms like Rivian (RIVN) and Lucid (LCID) are some that I would avoid. Nio (NIO) is another EV company in free fall. I would say stay away from the EV sector in the short term.
Mad Hedge Technology Letter
January 8, 2024
Fiat Lux
Featured Trade:
(S174)
($COMPQ)
One of the least talked about tax code blunders S174 could derail Silicon Valley ($COMPQ).
What happened?
Basically, all costs related to R&D cannot be expensed, including labor for software development.
These costs have to be capitalized and amortized over 5 years – or 15 if labor is done outside of the US.
This is a massive game changer that makes IT salaries substantially more expensive on paper.
This topic has come up a few times in private conversations that I have had, even though startups are arguably the hardest-hit companies of all.
What’s the fallout?
An unexpectedly high tax bill out of nowhere.
Many US software businesses amassed surprisingly high tax bills in 2023, seemingly out of nowhere, due to a tax change that took effect in July of the previous year, which many small companies knew nothing about until finalizing their 2022 returns.
The change was expected to be repealed (reversed) in December 2022, so many accountants didn’t inform customers for that reason. So, businesses got a surprise when the first tax payments fell due last April.
The amendment to S174 means employing software engineers can no longer be accounted as a direct cost in the year they are paid – unlike the norm, globally. Here’s a simplified example of the change from the final tax year before the change.
Here is how amortization works:
- 10% amortized for the first year
- 20% amortized for years 2 to 5
- 10% for year 6
Less hiring of software engineers and more software engineering layoffs are already happening at smaller US tech companies.
This could slash around 100,000 software developers at small companies.
One of these changes was Section 174, set to come into effect 5 years later, in 2022. These parts deliver the blow by making it clear that software development costs need to be amortized over 5-15 years.
What’s the damage?
Microsoft: $4.8B additional tax paid in 2023. The company generated a $72B profit that year, so this tax increase was manageable. It’s still a very large amount!
Netflix: around $368M in additional tax paid – also manageable with $4.4B annual profit.
What’s the key takeaway?
Innovation across all US software companies will take a hit if Section 174 isn’t repealed.
The tax change incentivizes software companies without large cash reserves to invest less in research and development. Or they can just move abroad.
But the change isn’t just bad for small software companies; it hurts even the largest ones – it is why Microsoft and Amazon are also advocating for its reversal.
I won’t pretend that Silicon Valley is full of little companies because it’s not.
I can easily see many firms like Google and Apple offshoring more jobs abroad for lower wages if they cannot amortize the full amount of wages in one year.
It puts American tech at an acute disadvantage, but I do believe US tech is so far ahead of its peers than in the long term, it won’t matter too much.
Just take Europe, many of the backwater countries are just a fraction of the size of Apple or Microsoft.
US tech is gargantuan and we forget that sometimes.
In the short term, the pressure is squarely asserted on the balance sheet. How will Silicon Valley nudge up the EPS with even more expenses coming down the pipeline?
The solution is clearly firing more American developers and reallocating the workload to other colleagues and a partial workload will go to AI.
US tech is famous for working smarter and this is just another hurdle to jump over.
In the first part of the year, this puts a lot of pressure on external tailwinds mainly the Fed pivot to power us through to new highs.
Buy the dip in tech.
“I would like to die on Mars. Just not on impact.” – Said CEO of Tesla Elon Musk
Mad Hedge Technology Letter
January 5, 2024
Fiat Lux
Featured Trade:
(SILICON VALLEY AND THE US ECONOMY HEATS UP)
($COMPQ)
In December, the US economy and the American tech sector ($COMPQ) showed who is boss in the world economy by blasting past employment expectations.
This comes at a time when every professional economist is calling for a gloomy outcome in the short term.
From the tech side of the equation, remote jobs are rebounding at a blistering pace.
Full-time workers plunged by 1.5 million in just one month to the lowest since February 2023.
Part-time workers made gains of 762,000 the highest on record.
Multiple jobholders hit a time-high 8.56 million.
What does this tell us?
Work from home can do more than one job and those are mainly tech jobs. A lot of the time they are IT and software engineering jobs as well.
The other group this could have affected is the group affected by Bidenflation which has crippled the budget of many low-income workers living in the US and this cohort needs two low-paid jobs.
The reality is that these multiple job holders are a mix of each group.
It’s now highly common for remote workers to work 3 or 4 jobs at once because these workers don’t need to be physically present in any office.
They can simply clock in and clock out when they choose to and this has been a boon for tech companies who have taken advantage of this trend and fired many full-time workers who became too pricey.
For the past year, Silicon Valley has taken a machete and chopped off the fat from its business model.
Their leanness was a massive reason for the overperformance of tech stocks last year and even though that same boost won’t happen to the same extent in 2024, it has given the blueprint to management on how to run a tech company.
The largest economy in the world saw the addition of 216,000 new jobs in December 2023, surpassing projections of a decline from the previous month, as per data from the Labour Department.
The joblessness rate remained steady at 3.7 percent, a figure that is notably low historically and counters predictions of a slight increase.
These impressive job market statistics arise amidst the context of rising interest rates. The Federal Reserve has aggressively raised and maintained high rates for the benchmark lending rate to moderate demand and control inflation.
In terms of wages, December witnessed a consistent rise, with a 0.4 percent increase from November 2023, according to the Labor Department. Year-over-year, average hourly earnings went up by 4.1 percent.
Tech jobs are evolving into a different type of existence with agility becoming more important and that is highly positive for tech companies.
Silicon Valley was at the forefront of the firing spree last year, but job numbers were more than compensated by the additions in government, health care, and services.
The strength of the US economy means that it’s painfully obvious that traders are still too early betting that the Fed will drop rates by 1.5% by the end of 2024.
My belief is that we will end up with a drop of .5%-.75% of Fed Funds rate cuts which means we have a little ways to go to reverse from this overshoot.
This idea that the economy is stronger than people think is verified by rising wages and lower unemployment.
I do believe that high inflation and high rates are here to stay and the 0% rate of yore was just a weird anomaly that defied historic data.
Delaying the “recession” yet another year means once we absorb this pullback, tech stocks will be off to the races again.
Mad Hedge Technology Letter
January 3, 2024
Fiat Lux
Featured Trade:
(FORMING THE NEXT BUYING OPPORTUNITY)
(APPL), (TSLA)
Apple didn’t release a new iPad model in 2023 which speaks volumes to the short-term trajectory of the tech firm that Steve Jobs built.
The current CEO Tim Cook is still living off of Jobs’ past creativity.
I believe the new Apple VR headset named the Vision Pro is still a speculative product that won’t result in any meaningful revenue for at least the next few years if at all.
Part of the blame for Apple’s underperformance stems from the poor macro environment for pure multinational corporations as deglobalization accelerates.
Apple also took their lineup of smartwatches off the display cases minutes before last Christmas signaling a continued malaise for big tech companies that are finding it rough to move the needle along.
Many behemoth tech companies are feeling the pressure to squeeze that incremental revenue out of the consumer and Apple is no different from a company like Tesla which is under attack from Chinese EV maker BYD.
Competition is real and it’s only getting worse.
The proverbial low-hanging fruit has been plucked dry.
Luckily, the lack of expansion didn’t mean that Apple’s stock went down in 2023.
It was very much the opposite with Apple marauded over 40% higher because of the ultra-lucrative tailwind of the “Fed pivot.”
More minutely, Apple managed to underperform other big tech which is where the blips in the operating and creative spheres start to show up.
In 2023, which ended in September, Apple’s iPad revenue dropped 3.4% to $28.3 billion. On a unit basis, iPad sales were even worse, falling 15%.
Even for Apple’s new products, like Mac computers, consumers showed less desire for devices with minor upgrades. Sales of Mac PCs and laptops fell nearly 27% to $10.2 billion in fiscal 2023. Unit sales declined 11%.
In order to return to revenue growth and support its $3 trillion market cap, Apple needs to strike it rich with some new products and global demand for smartphones and laptops to recover.
Despite less-than-stellar performance, Apple is no slouch. The company recorded $383 billion in total revenue in 2023 and earned nearly $97 billion in net income.
Last November, Apple CFO Luca Maestri said the company’s December quarter will experience no growth compared with last year. He warned that Macs, Wearables, and iPads would see a sales drop.
Much of this weakness will eventually drop shares lower, but it is highly likely that a dip will be a garden variety.
Yesterday’s downgrade was a little surprising, but I do believe analysts are prone to issue a downgrade as a reversion to the mean play.
Many might argue that Apple doesn’t deserve as high of a stock price, because its recent near-term ceiling is relatively sagging compared to the past.
That said, its $2.85 billion market cap isn’t too shabby and just a shallow pullback will allow bulls to coalesce around another optimal entry point.
A drawdown will certainly result in a rip-your-face-up move.
Betting against Apple has traditionally been the worst strategy of modern stock trading.
Bears will smartly take profits and run for the hills to get out of the way of the next wave of buy orders.
Wait for the dip to buy Apple.
Mad Hedge Technology Letter
December 27, 2023
Fiat Lux
Featured Trade:
(BUYER BEWARE)
(TIKTOK)
