Mad Hedge Technology Letter
August 5, 2019
Fiat Lux
Featured Trade:
(THE CHINA TARIFF BOMBSHELL AND TECHNOLOGY),
(AAPL), (NVDA), (INTC), (MU), (WDC), (BBY)
Posts
With one little tweet, the state of technology and the companies that rely on the public markets that serve them went haywire.
U.S. President Donald Trump levied another 10% on the $300 billion that had not been tariffed up yet compounding the misery for anyone who has any vested interest in trade with mainland China.
The tariffs will take effect on September 1st.
How does this shake out for American technology?
Any brand tech name that has substantial supply chain operations can kiss their stay in the Middle Kingdom goodbye.
If management didn’t understand that before, then it's clear as night that they need to shift their supply chain out of the reaches of the Chinese communist party.
The U.S. Administration tripling down on China being our archnemesis means that any sort of cross-border economic trade or cultural exchange will be viewed through the prism of warped geopolitics.
The U.S. President Donald Trump has in fact taken a page out of the Chinese playbook turning everything he sees and touches into a transactional tool for what he is pursuing at the time or in the future.
Specific companies facing the wrath of the tariffs are companies as conspicuous as Apple filtering down to the SMEs that make local business local.
Semiconductor chips are a huge loser in this new development as the price of electronic goods will rise with the tariffs.
If you want a name that lies in the heart of electronic consumer goods, then BestBuy (BBY) would encapsulate this thesis and unsurprisingly they were taken out to the back of the woodshed and taught a lesson dropping 10% on the news.
Any technology outfit that imports goods from China will be hit as well and this means semiconductor chips along the lines of Nvidia (NVDA), Intel (INTC), Western Digital (WDC) and Micron (MU) among others.
Chips are the meat and bones that go into end products like iPads and a slew of smart devices.
Demand will be hit because of the cost of producing these types of consumer products will rise.
The softness is showing up in the numbers with Apple’s iPhone revenue down 12% year-over-year.
Samsung of Korea also showed that this isn’t just an American problem with their semiconductor division’s operating profits down 71% year-over-year.
The Korean conglomerate is in a spat with the Japanese government over war crimes from the second world war causing the Japanese government to bottleneck the supply of chemicals needed to produce high-level semiconductor chips.
The export restriction will drag down SK Hynix display business who is one of the largest producers of DRAM chips and also a Korean company.
Consumers are also using their phones longer with Apple iPhone customers holding their device up to 4 years delaying the refresh cycle.
The company that Steve Jobs built will have to repurpose themselves for a brave new tech landscape that includes heavier regulation, trade tariffs, and device saturation.
When investors talk about the “low hanging fruit,” at this point, Apple isn’t one of them.
And if you think the services business is a cakewalk, ponder about how many apps and behemoths that spit out a whole lineup of apps.
Apple still has its ecosystem and should guard it with its life, this is the same ecosystem that can charge Google around $10 billion per year to slap on Google search as the primary search engine on Apple devices.
Expect tech to telegraph a deceleration in revenue for the last quarter and next year.
The tech environment is brittle at this point and uncertainty wafts in the air like a hot stack of pancakes.
Global Market Comments
July 29, 2019
Fiat Lux
Featured Trade:
(MARKET OUTLOOK FOR THE WEEK AHEAD, OR THE BAD OMENS ARE THERE),
(INTC), (GOOGL), (AMZN), (JPM), (FXB),
(PLAYING THE SHORT SIDE WITH VERTICAL BEAR PUT SPREADS), (TLT)
The Omens are there.
I am normally a pretty positive guy.
But I was having a beer at Schwarzee at the base of the Matterhorn the other day, just having completed the climb up to the Hornli Hut at 10,758 feet. I carefully watched with my binoculars three helicopters circle the summit of the mountain, around the Solvay Hut.
These were not sightseeing tours. The pilots were taking great risks to retrieve bodies.
I learned at the Bergfuhrerverein Zermatt the next day that one of their men was taking up an American client to the summit. The man reached for a handhold and the rock broke loose, taking both men to their deaths. The Mountain Guide Service of Zermatt is a lot like the US Marine Corps. They always retrieve their dead.
It is an accident that could have happened to anyone. I have been over that route many times. If there was ever an omen of trouble to come, this was it.
The markets are sending out a few foreboding warnings of their own. Friday’s Q2 GDP report came in at a better than expected 2.1%, versus 3.1% in Q1.
Yet the Dow Average was up only a meager 51.47 points when it should have gained 500. It is an old market nostrum that if markets can’t rally on good news, you get the hell out of Dodge. Zermatt too.
It is the slowest US growth in two years. The trade war gets the blame, with falling exports offsetting healthy consumer spending. With the $1.5 trillion tax cut now spent, nothing is left but the debt. 2020 recession fears are running rampant, so paying all-time highs for stock prices is not a great idea.
You might be celebrating last week’s budget deal which heads off a September government shutdown. But it boosts the national debt from $22 to $24 trillion, or $72,000 per American. As with everything else with this administration, a short-term gain is achieved at a very high long-term cost.
Boris Johnson, the pro-Brexit activist, was named UK prime minister. It virtually guarantees a recession there and will act as an additional drag on the US economy. Global businesses will accelerate their departure from London to Paris and Berlin.
The end result may be a disunited kingdom, with Scotland declaring independence in order to stay in the EC, and Northern Ireland splitting off to create a united emerald island. The stock market there will crater and the pound (FXB) will go to parity against the greenback.
The European economy is already in a downward spiral, with German economic data flat on its back. GDP growth has shrunk from 2.0% to 0.7%. It seems we are not buying enough Mercedes, BMWs, and Volkswagens.
Yields on ten-year German bunds hit close to an all-time low at -0.39%. The Euro (FXE) is looking at a breakdown through parity. The country’s largest financial institution, Deutsche Bank, is about to go under. No one here wants to touch equities there. It’s all about finding more bonds.
Soaring Chip Stocks took NASDAQ to new high. I have to admit I missed this one, not expecting a recovery until the China trade war ended. Chip prices are still falling, and volume is shrinking. We still love (AMD), (MU), and (NVDA) long term as obviously do current buyers.
Existing Home Sales fell off a cliff, down 1.7% in June to a seasonally adjusted 5.27 million units. Median Home Prices jumped 4.7% to $287,400. A shortage of entry-level units at decent prices get the blame. Ultra-low interest rates are having no impact.
JP Morgan (JPM) expects stocks to dive in Q3, driven by earnings downgrades for 2020. Who am I to argue with Jamie Diamond? Don’t lose what you made in H1 chasing rich stocks in H2. Everyone I know is bailing on the market and I am 100% cash going into this week’s Fed meeting up 18.33% year-to-date. I made 3.06% in July in only two weeks.
Alphabet (GOOGL) beat big time, sending the shares up 8% in aftermarket trading. Q2 revenues soared 19% YOY to an eye-popping $39.7 billion. It’s the biggest gain in the stock in four years, to $1,226. The laggard FANG finally catches up. The weak first quarter is now long forgotten.
Amazon (AMZN) delivered a rare miss, as heavy investment spending on more market share offset sales growth, taking the shares down 1%. Amazon Prime membership now tops 100 million. Q3 is also looking weak.
Intel (INTC) surged on chip stockpiling, taking the stock up 5% to $54.70. Customers in China stockpiled chips ahead of a worsening trade war. Q3 forecasts are looking even better. Sale of its 5G modem chip business to Apple is seen as a huge positive.
I've finally headed home, after a peripatetic six-week, 18-flight trip around the world meeting clients. I bailed on the continent just in time to escape a record heatwave, with Paris hitting 105 degrees and London 101, where it was so hot that people were passing out on the non-air conditioned underground.
Avoid energy stocks. The outcry over global warming is about to get very loud. I’ll write a more detailed report on the trip when I get a break in the market.
My strategy of avoiding stocks and only investing in weak dollar plays like bonds (TLT), foreign exchange (FXA), and copper (FCX) performed well. After spending a few weeks out of the market, it’s amazing how clear things become. The clouds lift and the fog disperses.
My Global Trading Dispatch has hit a new high for the year at +18.33% and has earned a robust 3.09% so far in July. Nothing like coming out of the blocks for an uncertain H2 on a hot streak. I’m inclined to stay in cash until the Fed interest rate decision on Wednesday.
My ten-year average annualized profit bobbed up to +33.23%. With the markets now in the process of peaking out for the short term, I am now 100% in cash with Global Trading Dispatch and 100% cash in the Mad Hedge Tech Letter. If there is one thing supporting the market now, it is the fact that my Mad Hedge Market Timing Index has pulled back to a neutral 60. It’s a Goldilocks level, not too hot and not too cold.
The coming week will be a big one on the data front, with one big bombshell on Wednesday and the Payroll data on Friday.
On Monday, July 29, the Dallas Fed Manufacturing Index is out.
On Tuesday, July 30, we get June Pending Home Sales. A new Case Shiller S&P National Home Price Index is published. Look for YOY gains to shrink.
On Wednesday, July 31, at 8:30 AM, learn the ADP Private Employment Report. At 2:00 PM, the Fed interest rate decision is released and an extended press conference follows. If they don’t cut rates, there will be hell to pay.
On Thursday, August 1 at 8:30 AM, the Weekly Jobless Claims are printed.
On Friday, August 2 at 8:30 AM, we get the July Nonfarm Payroll Report. Recent numbers have been hot so that is likely to continue.
The Baker Hughes Rig Count follows at 2:00 PM.
As for me, by the time you read this, I will have walked the 25 minutes from my Alpine chalet down to the Zermatt Bahnhoff, ridden the picturesque cog railway down to Brig, and picked up an express train through the 12-mile long Simplon Tunnel to Milan, Italy.
Then I’ll spend the rest of the weekend winging my way home to San Francisco in cramped conditions on Air Italy. Yes, I had to get a few more cappuccinos and a good Italian dinner before coming home.
Now, on with the task of doubling my performance by yearend.
Good luck and good trading.
John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader
Mad Hedge Technology Letter
July 3, 2019
Fiat Lux
Featured Trade:
(CHIPS ARE BACK FROM THE DEAD)
(XLNX), (HUAWEI), (AAPL), (AMD), (TXN), (QCOM), (ADI), (NVDA), (INTC)
The overwhelming victors of the G20 were the semiconductor companies who have been lumped into the middle of the U.S. and China trade war.
Nothing substantial was agreed at the Osaka event except a small wrinkle allowing American companies to sell certain chips to Huawei on a limited basis for the time being.
As expected, these few words set off an avalanche of risk on sentiment in the broader market along with allowing chip companies to get rid of built-up inventory as the red sea parted.
Tech companies that apply chip stocks to products involved with value added China sales were also rewarded handsomely.
Apple (AAPL) rose almost 4% on this news and many investors believe the market cannot sustain this rally unless Apple isn’t taken along for the ride.
Stepping back and looking at the bigger picture is needed to digest this one-off event.
On one hand, Huawei sales comprise a massive portion of sales, even up to 50% in Nvidia’s case, but on the other hand, it is the heart and soul of China Inc. hellbent on developing One Belt One Road (OBOR) which is its political and economic vehicle to dominate foreign technology using Huawei, infrastructure markets, and foreign sales of its manufactured products.
Ironically enough, Huawei was created because of exactly that – national security.
China anointed it part of the national security apparatus critical to the health and economy of the Chinese communist party and showered it with generous loans starting from the 1980s.
China still needs about 10 years to figure out how to make better chips than the Americans and if this happens, American chip sales will dry up like a puddle in the Saharan desert.
Considering the background of this complicated issue, American chip companies risk being nationalized because they are following the Chinese communist route of applying the national security tag on this vital sector.
Huawei is effectively dumping products on other markets because private companies cannot compete on any price points against entire states.
This was how Huawei scored their first major tech infrastructure contract in Sweden in 2009 even though Sweden has Ericsson in their backyard.
We were all naïve then, to say the least.
Huawei can afford to take the long view with an Amazon-like market share grab strategy because of possessing the largest population in the world, the biggest market, and backed by the state.
Even more tactically critical is this new development crushes the effectiveness of passive investing.
Before the trade war commenced, the low-hanging fruit were the FANGs.
Buying Google, Amazon, Apple, Netflix, and Facebook were great trades until they weren’t.
Things are different now.
Riding on the coattails of an economic recovery from the 2008 housing crisis, this group of companies could do no wrong with our own economy flooded with cheap money from the Fed.
Well, not anymore.
We are entering into a phase where active investors have tremendous opportunities to exploit market inefficiencies.
Get this correct and the world is your oyster.
Get this wrong, like celebrity investors such as John Paulson, who called the 2008 housing crisis, then your hedge fund will convert to a family office and squeeze out the extra profit through safe fixed income bets.
This is another way to say being put out to pasture in the financial world.
My point being, big cap tech isn’t going up in a straight line anymore.
Investors will need to be more tactically cautious shifting between names that are bullish in the period of time they can be bullish while escaping dreadful selloffs that are pertinent in this stage of the late cycle.
In short, as the trade winds blow each way, strategies must pivot on a dime.
Geopolitical events prompted market participants to buy semis on the dips until something materially changes.
This is the trade today but might be gone with one Tweet.
If you want to reduce your beta, then buy the semiconductor chip iShares PHLX Semiconductor ETF (SOXX).
I will double down in saying that no American chip company will ever commit one more incremental cent of capital in mainland China.
That ship has sailed, and the transition will whipsaw markets because of the uncertainty in earnings.
The rerouting of capital expenditure to lesser-known Asian countries will deliver control of business models back to the corporation’s management and that is how free market capitalism likes it.
Furthermore, the lifting of the ban does not include all components, and this could be a maneuver to deliver more face-saving window-dressing for Chairman Xi.
In reality, there is still an effective ban because technically all chip components could be regarded as connected to the national security interests of the U.S.
Bullish traders are chomping at the bit to see how these narrow exemptions on non-sensitive technologies will lead to a greater rapprochement that could include the removal of all new tariffs imposed since last summer.
The risk that more tariffs are levied is also high as well.
I put the odds of removing tariffs at 30% and I wouldn’t be surprised if the administration doubles down on China to claim a foreign policy victory leading up to the 2020 election which could be the catalyst to more tariffs.
It’s difficult to decode if U.S. President Trump’s statements carry any real weight in real time.
The bottom line is the American government now controls the mechanism to when, how, and the volume of chip sales to Huawei and that is a dangerous game for investors to play if you plan on owning chip stocks that sell to Huawei.
Artificial intelligence or 5G applications chips are the most waterlogged and aren’t and will never be on the table for export.
This means that a variety of companies pulled into the dragnet zone are Intel (INTC), Nvidia (NVDA), and Analog Devices (ADI) as companies that will be deemed vital to national security.
These companies all performed admirably in the market following the news, but that could be short lived.
Other major logjams include Broadcom’s future revenue which is in jeopardy because of a heavy reliance on Huawei as a dominant customer for its networking and storage products.
Rounding out the chip sector, other names with short-term bullish price action are Qualcomm (QCOM) up 2.3%, Texas Instruments (TXN) up 2.6%, and Advanced Micro Devices (AMD) up 3.9%.
(AMD) is a stock I told attendees at the Mad Hedge Lake Tahoe conference to buy at $18 and is now above $31.
Xilinix (XLNX) is another integral 5G company in the mix that has their fortunes tied to this Huawei mess.
Investors must take advantage of this short-term détente with a risk on, buy the dip trade in the semi space and be ready to rip the cord on the first scent of blood.
That is the market we have right now.
If you can’t handle this environment when there is blood in the streets, then stay on the sidelines until there is another market sweet spot.
Mad Hedge Technology Letter
May 20, 2019
Fiat Lux
Featured Trade:
(THE BIG PLAY IN CISCO)
(CSCO), (JNPR), (ANET), (INTC), (GOOGL), (AMZN)
You can’t steal the mojo from the company that sells network software and infrastructure equipment.
Cisco (CSCO) is effectively an indirect bet on people using the internet because companies need the network infrastructure to offer all the cool and useful services that tech provides.
Technology and the services that result from it continues to be at the heart of customer strategy and now more than ever, Cisco’s market-leading portfolio and differentiated innovation are resonating with them as they transform their IT infrastructure.
Cisco is also a fabulous bet on 5G as the most recent technologies like cloud, AI, IoT, and WiFi 6 among others are developing together to revolutionize the way business operates and delivers new experiences for customers and teams.
Cisco is fundamentally changing the way customers approach their technology infrastructure to address the rising complexity in their IT environments.
They have constructed the only integrated multi-domain intent-based architecture with security at the foundation.
This is designed to allow customers to securely connect their users and devices over any network to any application.
Enterprise networks today must be optimized for agility and heightened security, leveraging cloud and wireless capabilities with the ability to extract insights from the data and security integrated throughout.
Cisco is in pole position to deliver this to customers.
Last quarter saw the launch of new platforms expanding the enterprise networking assets with the launch of subscription-based WiFi 6 access points and Catalyst 9600 campus core switches purpose-built for cloud-scale networking.
By combining automation and analytics software with a broad portfolio of switches, access points, and controllers, Cisco is creating a seamless end-to-end wireless first architecture.
With the newest Catalyst 9000 additions, Cisco has completed the most comprehensive enterprise networking portfolio upgrade in their history.
Cisco rebuilt their entire access portfolio with intent-based networking across wired and wireless.
Cisco also now have one unified operating system and policy management platform to drive simplicity and consistency across networks all enabled by a software subscription model.
In the data center, their strategy is to deliver multi-cloud architectures that bring policy and operational consistency no matter where applications or data resides by extending Application Centric Infrastructure (ACI) and offering HyperFlex to the cloud.
According to Cisco’s official website, its HyperFlex product is “a converged infrastructure system that integrates computing, networking and storage resources to increase efficiency and enable centralized management.”
Cisco’s partnerships with Amazon Web Services (AWS), Google Cloud, and Microsoft Azure are great examples of how they continue to work with web-scale providers to deliver new innovation.
Some new additions are Cisco’s cloud ACI for AWS, a service that allows customers to manage and secure applications running in a private data center or in Amazon Web Services cloud environments.
They also expanded agreements with Alphabet (GOOGL) by announcing support for their multi-cloud platform Anthos to help customers build secure applications everywhere from private data centers to public clouds with greater simplicity.
Going forward, Cisco will integrate this platform with its broad data center portfolio, including HyperFlex, ACI, SD-WAN, and Stealthwatch cloud to deliver the best multi-cloud experience.
Organic growth has surpassed 4% for five straight quarters and expanded margins and positive guidance for the current quarter will reaccelerate PE multiples, increasing as more investors buy into the strong narrative.
CEO of Cisco CEO Chuck Robbins boasted on the call that “we see very minimal impact at this point based on all the great work the teams have done, and it is absolutely baked into our guide going forward” when referring to the headwinds of the global trade war.
It’s been quite the new normal for chip firms to guide down for the rest of 2019, and Intel’s (INTC) worries are emblematic of the growing challenges facing the tech industry.
Cisco bucked the trend by issuing strong forward guidance of 4.5% to 6.5% revenue growth in its fiscal fourth quarter, and earnings of 80 cents to 82 cents per share.
In an in-house survey, Cisco found that 11% of respondents have upgraded networking infrastructure and 16% expect to do so in the next 12 months.
The “minimal impact” of the trade war indicates to investors that even with negative tech sentiment brooding around the world, Cisco’s best in class tech infrastructure still cannot be sacrificed and the migration of companies to digital directly benefits Cisco who provides the building blocks for software and hardware tech companies to develop around.
Cisco even felt bold enough to hike prices giving consternation to current customers.
Both Juniper (JNPR) and Arista (ANET), lower quality network infrastructure companies, have indicated their enterprise businesses are growing faster than the overall market and Cisco’s price hike was probably a bad time to up margins in the current frosty climate.
Even more worrying is data that suggests a general Enterprise pause in spending at a minimum and could entrap the broader tech market as many capital expenditures could be put on hold in the late economic cycle.
Keep in mind that Cisco’s Catalyst 9000 line had an abnormally strong last fourth quarter due to brisk adoption accelerating meaning comps will be hard to beat in the next earnings report.
However, these are minor bumps on the road at a time when the major narrative is running smoothly and shows no signs of stopping.
Cisco shares will continue to rise if they continue to upgrade their products and back it up with their best of breed reputation that could spur more price hikes.
Investors should wait for dips to buy in this name until there are any signs of product quality erosion which I believe will not happen in 2019.
Mad Hedge Technology Letter
May 16, 2019
Fiat Lux
Featured Trade:
(WHY YOU SHOULD AVOID INTEL)
(INTC), (QCOM), (ORCL), (WDC)
In the most recent investor day, current CEO of Intel (INTC) Bob Swan dived into the asphalt of failure below confessing that the company would have to guide down $2.5 billion next quarter, 25 cents, and operating margins would shrink by 2 points.
This is exactly the playbook of what you shouldn’t be doing as a company, but I would argue that Intel is a byproduct of larger macro forces combined with poor execution performance.
Nonetheless, failure is failure even if macro forces put a choke hold on a profit model.
Swan admitted to investors his failure saying “we let you down. We let ourselves down.”
This type of defeatist attitude is the last thing you want to hear from the head honcho who should be brimming with confidence no matter if it rains, shines, or if a once in a lifetime monsoon is about to uproot your existence.
In Swan’s spiffy presentation at Intel’s investors day, the second bullet point on his 2nd slide called for Intel to “lead the AI, 5G, and Autonomous Revolution.”
But when the company just announces that its 5G smartphone products are a no go, investors might have asked him what he actually meant by using this sentence in his presentation.
The vicious cycle of underperformance leads back to Intel seriously losing the battle of hiring top talent, and purging important divisions is indicative of the inability to compete with the likes of Qualcomm (QCOM).
Assuaging smartphone chip revenue isn’t the only slice of revenue cut from the chip industry, but to take a samurai sword and gut the insides of this division as a result of being uncompetitive means losing out on one of the major money makers in the chip industry.
Then if you predicted that the PC chip revenue would save their bacon, you are duly wrong, with global PC sales falling 4.6% in the first quarter, after a similar decline in the fourth quarter of 2018, according to analyst Gartner Inc.
The broad-based weakness means that revenue from Intel’s main PC processor business will decline or be unchanged during the next three years, which leads me to question leadership in why they did not bet the ranch on smartphone chips when the trend of mobile replacing desktop is an entrenched trend that a 2-year old could have identified.
The cocktail of underperformance stems from slipping demand which in turn destroys profitability mixed with intensifying competition and the ineptitude of its execution in manufacturing.
In fact, the guide down at investor day was the second time the company guided down in a month, forcing investors to scratch their heads thinking if the company is fast-tracked to a one-way path to obsoletion.
If Intel is reliant on its data centers and PC chip business to drag them through hard times, they might as well pack up and go home.
Missing the smartphone chip business is painful, but if Intel dare misses the boat for the IoT revolution that promises to install sensors and chips in and around every consumer product, then that would be checkmate.
Adding benzine to the flames, Intel’s enterprise and government revenue saw the steepest slide falling 21% while the communications service provider segment declined 4%.
The super growth asset is the cloud and with Intel’s cloud segment only expanding 5%, Intel has managed to turn a high growth area into an anemic, stale business.
Then if you stepped back a few meters and understood that going forward Intel will have to operate in the face of a hotter than hot trade war between China and America, then investors have scarce meaningful catalysts to hang their hat on.
Swan said the company saw “greater than expected weakness in China during the fourth quarter” boding ill for the future considering Intel derives 24% of total revenue from China.
Investors are fearing that Intel could turn into additional collateral damage to the trade war that has no end in sight, and chips are at the vanguard of contested products that China and America are squabbling over.
Oracle (ORCL), without notice, shuttered their China research and development center laying off 900 Chinese workers in one fell swoop, and Intel could also be forced to cut off limbs to save the body as well.
The narrative coming out of both countries will not offer investors peace of mind, and a primary reason why the Mad Hedge Technology Letter has avoided the chip space in 2019.
It’s hard to trade around the most volatile area in tech whose global revenue is becoming less and less certain because of two governments that have deep-rooted structural problems with each other’s trade policies.
Today’s tech letter is another rallying cry for buying software companies with zero exposure to China in order to shelter capital from the draconian stances of two tech sectors that are at odds with each other.
Let me remind you that Intel and Western Digital (WDC) were on my list of five tech stocks to avoid this year, and those calls that I made 6 months before are looking great in hindsight.
