Mad Hedge Technology Letter
April 13, 2022
Fiat Lux
Featured Trade:
(THE RISE AND FALL OF SEMICONDUCTORS)
(NVDA), (AMD), (SMH)
Posts
The once smoking hot semiconductor industry and its stock prices have rolled over.
First, let me refresh some memories of how we got here in the first place.
During the pandemic and lockdowns, it was thought that semiconductor companies were the winners as consumers, unable to leave their homes, were forced to huddle inside glued to their screens.
Never had the world’s demand for electronics been so elevated and the bringing forward of economic overperformance is now on the downtrend.
It appears that chip companies will be unable to follow up that performance with an encore.
November 2021 represented the short-term high-water mark for chip companies as many stocks in the best of breed have cratered by 50% since then.
AMD (AMD) has dropped to $97 from $155 and the price action is emblematic of boom-bust cycles that chip companies are infamous for.
Now the short-term future doesn’t seem as rosy as it once was and the current uncertainty has delayed investments as chip companies have read the tea leaves and given up capital investments like new chip factories.
Top dog Nvidia (NVDA) which produces CPUs and is at the core of every cutting-edge technology in the world has also been stung by its share price dropping around 30% since the peak in November 2021.
This isn’t the death of the chip industry, and the share price will need to digest the confluence of bad news.
Chip companies are also highly volatile in their price action with the same type of pullback in Apple or Microsoft 3X less volatile.
Peeling back the layers, what is the situation closer to the ground?
The US Central Bank turning on the hawkish turbo boosters mean that many parts of the equity market are feeling their impulsive reaction.
No doubt the Fed has been behind the curve for almost a year, but that’s another topic.
Their sudden reversal means they have no choice but to bring forward a recession by hiking rates faster than expectations and the losers in this is growth tech.
At the consumer level, higher inflation means that sticker prices for electronics have trended higher for various items.
Not only that, the inflation across the board and deep hits to the overall cost of living have taken purchasing power out of the pockets of the median US shopper.
The math simply doesn’t work out if shoppers are paying more for gas, groceries, and housing, they are simply less inclined to refresh their phones, iPads, TVs, and so on.
Other big-ticket items on the chopping block are products like appliances.
There is a major guzzler of chips like washing machines, fridges, and heating and cooling systems that all require sensors.
The semiconductor market is cyclical. When the economy is thriving, it is doing well because when consumers are confident, they tend to spend on the incremental device.
Adding insult to industry is that the tightening of capital markets will make borrowing more expensive and the path to profits narrower.
Just as critical, no CEO or CFO likes to discover that the cost of capital has jumped to a prohibitive rate, because these are the tool they tap to build multi-billion dollar factories.
Holding off on investments sacrifices long-term growth and capacity for short-term balance sheet strength.
Without too much pretentious banter, high interest rates mean relatively less profit.
Much of the decline is starting to get priced into the stock prices of NVDA and AMD.
I believe investors should be dollar cost averaging as these stocks fall possibly another 5-10%.
I would be shocked if these stocks fall another 20% from here.
Mad Hedge Technology Letter
May 21, 2021
Fiat Lux
Featured Trade:
(THE STRENGTH OF AMD)
(AMD), (INTC), (TSM), (XLNX), (SMH)
Advanced Micro Devices Inc. (AMD) is a chip stock that needs some serious attention, even more so because of their new share repurchase program that has no end date.
They are led by one of the best tech CEOs in Silicon Valley Lisa Su, who has been in charge since 2014.
She transformed the company into a profitable one, secured incremental market share from Intel Corp. (INTC) and diminished concerns that AMD has a weak balance sheet.
Strength begets strength as AMD introduced a $4 billion stock buyback plan, its first repurchase authorization since 2001, signaling the chipmaker’s robust momentum in their own business.
The buyback will be distributed through cash from operations and will total about 4% of AMD’s market value.
AMD's stock in the high $70s right here looks like a screaming buy.
Share buyback is not only something Apple and Microsoft do, but other smaller players are getting in on the action displaying the great breadth and depth of the tech market.
We don’t see this anywhere else in any other industry because profitable companies simply return money back to shareholders and tech has the luxury of accelerated future earnings and revenue growth to buttress this.
Cut it up however you want, the tech sector is responsible for the bulk of earnings as it relates to the total market and that won’t change.
AMD delivered $832 million in free cash flow in Q1 2021.
The company has now pivoted from a net debt position to a balance sheet that will harness over $3 billion in net cash by the end of the current quarter.
This strength of the balance sheets is even pertinent if you strip out the Xilinx deal which will bring in their own array of financial pluses to add on to the might of AMD's current cash flow situation.
An accumulating share count is something to be wary of in any stock and given that AMD had the opportunity to reduce share count, it was a no-brainer.
Years ago, AMD had 766 million shares outstanding, and it would have climbed to over 1.6 billion considering the Xilinix shares by the end of this year.
This obviously makes EPS metrics appear rosier in future earnings reports and inching them up is a nod to AMD CFO Devinder Kumar who usually has a big say in these decisions.
Under Su’s helmsmanship, the company’s market value has toppled the $90 billion mark from only $2 billion just seven years ago.
That was the year she was named CEO and she hasn’t looked back.
Su’s key to returning AMD to profitability was to rely on the quality of product delivered — these new products snatched market share from Intel.
As what a savvy CEO usually does, she has played down success in order to tamper down high expectations in the stock price and business by saying, “without a doubt it does not get easier.”
I don’t think it was ever easy to begin with but that’s beside the point.
Su’s AMD has gone from an inferior chipmaker building cheaper knockoffs to Intel products to a premium provider of computer processors that win orders solely based on superior performance.
AMD has already repurchased $77 million of stock in its prior buyback plan two decades ago.
Su has rejuvenated AMD’s reputation and performance at a critical juncture and as chip shortages become the norm in this boom-and-bust industry.
The public health problem triggered a crazy demand for remote work and the devices that facilitate a work from home economy.
During this sensitive period, the world’s largest chipmaker, Intel, had struggled to develop its manufacturing technology, one of the foundations of its decades-long dominance of the computer industry.
The chip shortage is an example of the periodic mismatch between supply and demand in the semiconductor market whose companies avoid dipping into capital expenditure until capacity is stretched to the extreme limit.
This is an expensive business to get into, constructing high-performance chips is time-consuming and an engineering headache, thus barriers of entry are incredibly insurmountable.
Most new chip foundries and designers don’t happen unless sovereign nations make it a national security issue which is the case lately.
Ancillary industries started to hoard chips 6-8 months ago and I believe that these pressures will begin to subside soon as supply chains start to normalize.
These longer-term contracts to secure inputs we are seeing now will eventually be reduced easing the supply crunch as demand begins to slow and capacity begins to rise.
Even Su predicts supply of AMD chips, which are built by Taiwan Semiconductor Manufacturing (TSM), will catch up throughout 2021.
As the tech consolidation rips through chip stocks, I see this as an unequivocal buying opportunity for the strongest of names.
If AMD continues to build on their strong financial position — continue to offer more share repurchases and even a sweet dividend — it clearly means they are building premium products buyers want and that satisfaction not only filters down to the end-user of their chips but the owners of the stock.
I first recommended this stock at $18 at the advent of the Mad Hedge tech letter in 2018, and I am still bullish AMD long term period.
It was a great company in 2018 — it’s gotten even better in 2021 — don’t miss out.
Mad Hedge Technology Letter
May 18, 2020
Fiat Lux
Featured Trade:
(CHINA’S BIG SEMICONDUCTOR PLAY),
(SMH), (SOXX), (DOCU), (AKAM), (NVDA), (AMD), (XLNX)
We received a convincing data point as to why we trade cloud companies and not the semiconductor chips.
The rift between blacklisted telecom equipment giant Huawei Technologies and the U.S. administration has had a dramatic side-effect on the business models of U.S. chip companies.
The U.S. commerce department now will require licenses for sales to Huawei of semiconductors made abroad with U.S. technology signaling more turbulent times ahead.
Huawei is the Chinese smartphone maker and telecom provider who has stolen intellectual property from the West and used mammoth subsidies funded by the Chinese communist party to build itself into one of the premier telecom equipment sellers and number two maker of smartphones in the world.
I seldom issue trade alerts on semiconductor chip companies because I'd rather not compete with the Chinese communist party and their capital funding capacity.
China is hellbent on subsidizing its own chip capacity as many Western chip companies are blocked from doing deals with them.
A recent example is the Chinese communist party injecting $2.25 billion into a Semiconductor Manufacturing International Corp. wafer plant to ramp up development in the sector.
To read about this, click here.
Exploiting the economic freedom and laws of the West has worked out perfectly for Chinese tech enabling them to develop juggernauts like Tencent and Baidu.
In fact, state-sponsored hacking of Western intellectual property is not considered a malicious activity in China.
There is the Chinese notion that everything is fair game in business and war and protecting company secrets falls on the shoulders of the cybersecurity sector.
To read more about the fallout in the West from China’s aggressive trade strategy, click here.
The concept that you should only blame yourself if you allow your secrets to get stolen prevails in China.
The consequences are impactful with U.S. chip companies suffering large drops in revenue without notice.
Leading up to the coronavirus, chip companies experienced a revenue slide of 12% in 2019 to $412 billion largely due to the trade war.
An example is Xilinx Inc. (XLNX) who will fire 7% of its workforce citing lower revenue from Huawei and delayed adoption of superfast 5G networks.
Along with the West getting smacked by the trade war, the ripple effect of increased uncertainty and guide-downs across the semiconductor supply stems from China’s economy being hit even worse than the U.S. economy.
There are no winners here and it will be a hard slog back from the nadir.
Either way, the sabre-rattling doesn’t stop here and each tweet and counterpunch will cause heightened volatility in chip shares.
Then consider that the existence of supply chains will most likely uproot, and we got indication of that type of activity with Taiwan Semiconductor’s (TSM) announcement to build a new chip factory in Phoenix.
To read more about this impactful deal then click here.
This would have never happened during prior administrations where all manufacturing was offshored to China.
As it stands, China has been circumventing existing U.S. law to clampdown chip sales by buying U.S. chips from 3rd party channels.
Once many of the supply chains come back, it will be almost impossible for Chinese to procure those same chips.
The Taiwan semiconductor manufacturing facility in Arizona will ultimately employ 1,600 high-tech workers.
Building is slated for 2021 with production targeted to begin in 2024.
Moving forward, the U.S. administration will make it implausible for many U.S. chip companies to offshore using the reasons of national security and domestic job demand to ensure that many factories are rerouted back to U.S. shores.
The boom and bust nature of chip companies make for treacherous spikes and drops in share prices.
The insane volatility is why I stay away from them as the Mad Hedge Technology Letter mainly opts for short-term options trades.
Nvidia (NVDA) and AMD (AMD) are great individual chip stocks that I would encourage readers to buy and hold.
Another option is to just park your money in the semi ETF VanEck Vectors Semiconductor ETF (SMH) or iShares PHLX Semiconductor ETF (SOXX).
On the flip side, cloud stock’s backbone of recurring monthly revenue is just too savory.
The constant cash flow with minimal international risk along with pristine balance sheets is what makes U.S. cloud companies top on the list of trade alert candidates.
That won’t stop anytime soon as the pandemic has offered us more conviction into the moat between cloud stocks and the rest of technology.
I apologize if I sound like a broken record, but I love my Akamai’s (AKAM) and DocuSign’s (DOCU), they have the growth portfolio that backs up my thesis.
Buy cloud stocks on the dip.
Mad Hedge Technology Letter
January 28, 2019
Fiat Lux
Featured Trade:
(BUY DIPS IN SEMIS, NOT TOPS),
(XLNX), (LRCX), (AMD), (TXN), (NVDA), (INTC), (SOXX), (SMH), (MU), (QQQ)
Don’t buy the dead cat bounce – that was the takeaway from a recent trading day that saw chips come alive with vigor.
Semiconductor stocks had their best day since March 2009.
The price action was nothing short of spectacular with names such as chip equipment manufacturer Lam Research (LRCX) gaining 15.7% and Texas Instruments (TXN) turning heads, up 6.91%.
The sector was washed out as the Mad Hedge Technology Letter has determined this part of tech as a no-fly zone since last summer.
When stocks get bombed out at these levels - sometimes even 60% like in Lam Research’s case, investors start to triage them into a value play and are susceptible to strong reversal days or weeks in this case.
The semi-conductor space has been that bad and tech growth has had a putrid last six months of trading.
In the short-term, broad-based tech market sentiment has turned positive with the lynchpins being an extremely oversold market because of the December meltdown and the Fed putting the kibosh on the rate-tightening plan.
Fueled by this relatively positive backdrop, tech stocks have rallied hard off their December lows, but that doesn’t mean investors should take out a bridge loan to bet the ranch on chip stocks.
Another premium example of the chip turnaround was the fortune of Xilinx (XLNX) who rocketed 18.44% in one day then followed that brilliant performance with another 4.06% jump.
A two-day performance of 22.50% stems from the underlying strength of the communication segment in the third quarter, driven by the wireless market producing growth from production of 5G and pre-5G deployments as well as some LTE upgrades.
Give credit to the company’s performance in Advanced Products which grew 51% YOY and universal growth across its end markets.
With respect to the transformation to a platform company, the 28-nanometer and 16-nanometer Zynq SoC products expanded robustly with Zynq sales growing 80% YOY led by the 16-nanometer multiprocessor systems-on-chip (MPSoC) products.
Core drivers were apparent in the application in communications, automotive, particularly Advanced Driver Assistance Systems (ADAS) as well as industrial end markets.
Zynq MPSoC revenues grew over 300% YOY.
These positive signals were just too positive to ignore.
Long term, the trade war complications threaten to corrode a substantial chunk of chip revenues at mainstay players like Intel (INTC) and Nvidia (NVDA).
Not only has the execution risk ratcheted up, but the regulatory risk of operating in China is rising higher than the nosebleed section because of the Huawei extradition case and paying costly tariffs to import back to America is a punch in the gut.
This fragility was highlighted by Intel (INTC) who brought the semiconductor story back down to earth with a mild earnings beat but laid an egg with a horrid annual 2019 forecast.
Intel telegraphed that they are slashing projections for cloud revenue and server sales.
Micron (MU) acquiesced in a similar forecast calling for a cloud hardware slowdown and bloated inventory would need to be further digested creating a lack of demand in new orders.
Then the ultimate stab through the heart - the 2019 guide was $1 billion less than initially forecasted amounting to the same level of revenue in 2018 - $73 billion in revenue and zero growth to the top line.
Making matters worse, the downdraft in guidance factored in that the backend of the year has the likelihood of outperforming to meet that flat projection of the same revenue from last year offering the bear camp fodder to dump Intel shares.
How can firms convincingly promise the back half is going to buttress its year-end performance under the drudgery of a fractious geopolitical set-up?
This screams uncertainty.
Love them or crucify them, the specific makeup of the semiconductor chip cycle entails a vulnerable boom-bust cycle that is the hallmark of the chip industry.
We are trending towards the latter stage of the bust portion of the cycle with management issuing code words such as “inventory adjustment.”
Firms will need to quickly work off this excess blubber to stoke the growth cycle again and that is what this strength in chip stocks is partly about.
Investors are front-running the shaving off of the blubber and getting in at rock bottom prices.
Amalgamate the revelation that demand is relatively healthy due to the next leg up in the technology race requiring companies to hem in adequate orders of next-gen chips for 5G, data servers, IoT products, video game consoles, autonomous vehicle technology, just to name a few.
But this demand is expected to come online in the late half of 2019 if management’s wishes come true.
To minimize unpredictable volatility in this part of tech and if you want to squeeze out the extra juice in this area, then traders can play it by going long the iShares PHLX Semiconductor ETF (SOXX) or VanEck Vectors Semiconductor ETF (SMH).
In many cases, hedge funds have made their entire annual performance in the first month of January because of this v-shaped move in chip shares.
Then there is the other long-term issue of elevated execution risks to chip companies because of an overly reliant manufacturing process in China.
If this trade war turns into a several decades affair which it is appearing more likely by the day, American chip companies will require relocating to a non-adversarial country preferably a democratic stronghold that can act as the fulcrum of a global supply chain channel moving forward.
The relocation will not occur overnight but will have to take place in tranches, and the same chip companies will be on the hook for the relocation fees and resulting capex that is tied with this commitment.
That is all benign in the short term and chip stocks have a little more to run, but on a risk reward proposition, it doesn’t make sense right now to pick up pennies in front of the steamroller.
If the Nasdaq (QQQ) retests December lows because of global growth falls off a cliff, then this mini run in chips will freeze and thawing out won’t happen in a blink of an eye either.
But if you are a long-term investor, I would recommend my favorite chip stock AMD who is actively draining CPU market share from Intel and whose innovation pipeline rivals only Nvidia.
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)
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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