delisting Chinese companies in the US

The Senate passed a bill that, as news reports have it, would require that any company traded on a domestic stock exchange establish that it is not controlled by a foreign government.  The bill is being framed as setting accounting standards to protect shareholders and guard against fraud.

My thoughts:

–most US investment disasters are home-grown.  Think Bernie Madoff, Enron, Michael Milken, Henry Blodget.  There are also cases like Moviepass or Blue Apron or Trump Hotels and Casino Resorts, where the major sin is ineptitude.

–the real intention is to deny China access to US capital markets, as well as to cast China as a villain, diverting attention from Trump’s tragic failure to deal with the coronavirus

–there’s a good chance the move will backfire.  The major effect of removing the US from the China equity equation will likely be to restore Hong Kong to front of mind for foreigners’ research and investment into the world’s larges economy.  Also, the more onerous US rules become, the more likely it will be that even investors of average means will begin to move funds abroad.

inflation? maybe? …gold? no way!

I turned on CNBC in the middle of the day to look at the stock prices crawling across the screen below the talking heads.  I happened to hear the discussion, as well.

The topic was gold as an inflation hedge.  The back and forth sounded kind of like one of those Time Life infomercials selling the Greatest Hits of the (1960s, 1970s…) …or maybe the commercials that let you know you can get the same auto insurance as Snoop Dogg even if you have a bad driving record.

Even though the participants didn’t know much about gold (what a surprise), I find their unstated premise very interesting.  What do we do as investors if inflation comes back?

no sign of garden variety inflation 

The standard analysis of inflation is that it arises in an advanced economy during an employment boom when money/fiscal conditions are too loose.  Government policy stimulates firms to expand.  But there are no more unemployed workers.  So companies poach from each other, offering ever higher wages to lure workers from rivals.  Not the case, at least right now, in the US, where the administration’s white racism and anti-science stance have leading firms, if anything, figuring out how to leave.

developing world variety, though…

This is the situation where a corrupt or inept government favors politically powerful industries of the past, borrows heavily–especially from foreigners–and shows itself unwilling or unable to repay what it owes.  The local currency begins to slip as this picture becomes clearer–evidenced by government budget deficits–and foreign investors head start to pull their money out.  This raises the price of imported goods and starts an inflationary spiral.

Trump has recently invited this framing of the US situation by hinting that he will punish China by defaulting on a portion of the $1 trillion+ Beijing has lent to Washington.  He also seems to have suggested the possibility of a more general default  during his presidential campaign.

In the case of the US, past bouts of inflation have been fueled by domestic fixed income investors fleeing Treasuries much faster than foreigners.  My guess is that this would already be happening, except for two factors:

–the gigantic amount of debt the Fed is buying, and

–there’s no obvious other place to go.  Japan is a basket case, the EU isn’t much better, Brexit dysfunction rules the UK out and the renminbi isn’t a fully convertible currency.

guarding against inflation

For currency-induced inflation, the winning equity stance is to have revenues in the strong currencies and costs in the weak.  For wage-cost inflation, the economic remedy is to tighten government policy, that is, raise interest rates.  That hurts all financial instruments.  Least badly hurt would be traditional defensives.

 

 

 

 

 

 

 

 

Monday’s trading

 

I think yesterday could turn out to mark an important shift for US stock trading.

 

First, some performance figures:

year-to date       from the March low       yesterday          2 years     3 years

NASDAQ                   +2%                    +34%                           +2.4%           +22.6%       +48.2%

Russell 2000           –20%                    +33%                           +6.1%            -18.0%          -2.5%

S&P 500                    -9%                     +20%                           +3.2%             +8.9%        +20.2%

 

The S&P is just there for reference–and because it’s the key US equity benchmark.  The comparison I want to draw is between tech-heavy global-reach NASDAQ and the made-and-sold-in-the-USA Russell 2000 mid-cap index.

The difference year to date, 22%, in favor of NASDAQ, is huge.  Even more dramatic, the spread over the past two years, again for NASDAQ, is a whisker over 40%.  Over three years, it’s +50%+.  For the R2000, it’s like DJT (Trump Hotels and Casino Resorts) all over again.

Unfortunately for all of us Americans I think this will remain the primary trend for at least as long as the current administration is in office.

However, fear of the economic damage created by Trump’s pandemic denial has caused investors to stretch NASDAQ/R2000 valuation differences to the breaking point.  Yes, we’re considerably off the lows.  But economically sensitive stocks (R 2000) are still being priced, relative to NASDAQ, as if we were still at the worst level of panic.

But the market seems to be coming to believe that the relative rubber band has been stretched too far.

Evidence?

–during the rebound from the late March lows, the Russell 2000 has kept pace with the NASDAQ for the first time in a long while–despite the much greater damage from the pandemic domestically than abroad

–post their initial large upward leap, there has been a duel for maybe a month within NASDAQ between tech like Shopify, Zoom and Beyond Meat that’s perceived to benefit from the pandemic, and more traditional tech firms.  On fear days, the former go up, both in absolute terms and relative to the market; on more optimistic days, they go down.

–the epic underperformance of the Russell 2000.

In other words, the market is back to analyzing and pricing risk again, instead of just panicking.

To my mind, yesterday suggests the market is starting to expand its horizons and sort through the rubble of economy-sensitive stocks in a more serious way.  I think this will continue.  For how long?   I don’t know.  My guess is at least a month.  But maybe much longer.

 

same conclusion, different thought process

Coming at this from a different direction (the one that actually started me down this track):

A competent growth stock manager should easily be 500 basis points ahead of his/her benchmark, year-to-date.  Could be a lot more.

This is gigantic.  It’s like being up 15 – 0 in the fourth inning of a baseball game.

Strategy has got to shift from trying to score more runs to protecting the lead.  Unlike baseball, this is straightforward for a portfolio manager to do.  Become more like the index.  You won’t gain more outperformance ( which you don’t need) but you won’t lose any either.  You do this by buying the domestic cyclicals that have been market laggards for so long.  An added plus, they’re still in the bargain basement.

 

 

 

 

 

 

Trump and Taiwan Semiconductor Manufacturing (TSMC)

Note:  the post just before this has a brief description of TSMC.

new restrictions on TSMC

Last week the Trump administration announced that foreign users of American-made semiconductor design software or production equipment will need permission from Washington to use these to fashion chips for Chinese telecom company Huawei, the world leader in 5-G wireless technology.

At the same time, TSMC announced that it will be opening a new $12 billion fab in Arizona in 2024, its second in the US.  No details yet on why, although presumably Washington is footing the bill.

my thoughts

Huawei is TSMC’s second-largest customer, after Apple.  60% of TSMC’s output goes to the US, 20% to China.

I’m a fan of TSMC as a company but not of TSM as a stock.  This is because I don’t have any edge in evaluating TSM.  I find Taiwanese accounting opaque and I believe a ton of local knowledge is needed to be successful in sizing up that market.  While the latter is true just about everywhere, Taiwan is, for me, an extreme case.

I wonder how this new Trump rule can/will be enforced.

What would I do if I were TSMC?  I’d see if I could rearrange assembly lines to avoid making Huawei chips using US-sourced machines.  My ultimate goal, however, would have to be to minimize the threat to my business by transitioning away from US equipment suppliers.  This might mean giving extra assistance to Japanese or EU companies, or encouraging technology transfer to develop Chinese alternatives.  It could mean moving advanced production equipment to foundries on the mainland to supply Huawei from there–making clear this output is not coming from Taiwan.  I’d probably be figuring I’d shed current generation US-made equipment I already own by moving it to the new US foundry.

If I were a current US supplier to TSMC?  If I wanted to keep TSMC business, I’d be starting to figure how to shift at the very least that part of my operations out of the US.  The same if I were a US-based maker of semiconductor design tools.

 

I think this will end up being another aspect of the “chaotic disaster” that is the Trump economic policy.  In this case, though, the purpose of the move appears solely to be to deflect attention from Trump’s worst-in-the-world response to COVID-19, in support of his lie that somehow not his bungling but Beijing and/or the Obama administration are responsible for the unnecessary deaths of tens of thousands of Americans.

I continue to think that Trump and his enablers in government and the media are doing enormous damage to the long-term economic prospects of the US.  What strikes me most about the developing TSMC situation, however, doesn’t have much directly to do with the stock market.  It’s that Trump et al are concerned only about covering up what they’ve done; their cynical strategy is to lie and to distract by doing more harm elsewhere.  There isn’t the slightest hint of remorse for what they’ve done nor sympathy for the relatives of the death.

 

 

 

 

 

 

 

 

Taiwan Semiconductor Manufacturing (TSMC): background

what TSMC is

In the early days of semiconductors, chip-making firms tended to be vertically integrated, meaning the companies that designed semiconductors also manufactured them in their own plants.

That changed as the semiconductor industry began to expand rapidly in the early 1990s, for several related reasons:

–chip designs became progressively more specialized and complex, putting increased focus on the design process

–the cost of building chip fabrication plants to manufacture newer, higher-specification, designs rose exponentially, putting them out of reach for all but the biggest firms, and

–TSMC opened in 1987 as a third-party manufacturer, allowing dedicated design shops to set up on their own and still be able to have their designs fabricated.  The design business, something at which Americans have excelled, has flowered since.

Today, TSMC is the most advanced chip manufacturer in the world, and by far the best third-party fabricator, matched only by Samsung, an integrated firm, and maybe Intel.

 

semiconductor equipment makers

Today’s semiconductor fabs are extremely expensive.  TSMC has just agreed to build a new fab in Arizona, for example.  The cost:  $12 billion.  (More on this in the accompanying post)  The equipment inside, the most advanced pieces of which can cost hundreds of millions of dollars, comes from a small number of specialized machinery firms, which are located mostly in the US, Japan or the EU.  Because of the complexity of semiconductor manufacturing and the expense and long lead times involved in developing and testing new equipment, there tend to be very close cooperative research and development relationships between the fabs and their equipment manufacturers.

 

foundries are the future…

…absent some revolutionary change in computer technology.  A decade ago, when I was more up-to-date on semiconductors, a state-of-the-art fab cost about $4 billion.  Operated efficiently, it would churn out, say, $7 billion worth of output.  Both figures are out of reach for most firms.  Hiring a trusted third party to manufacture your designs is the easiest way to go.  Although the ratio of sales to assets has shrunk since I was better informed, the absolute numbers have risen a lot.

 

 

 

 

 

time for market rotation?

market rotation

We all understand what the winning formula for the pandemic stock market looks like:  overweight NASDAQ, underweight the Russell 2000;  overweight secular growth stocks with worldwide sales, underweight US-centric business cycle sensitives.

At some point, however, at least one of two things happens:

–evidence starts to build that the worst of the pandemic-induced slump in economic activity is past us.  Companies start hiring again; credit card sales start to pick up; houses begin to be sold…   or,

–the valuation difference between safe havens and pandemic losers becomes so great that contrarians begin to sell the former to buy the latter.

In either case, the market rotates away from what has been successful so far into something else.

Two questions:  when and toward what.

On the valuation front, year to date NASDAQ is down by 3% (among heavyweights, MSFT is +12%), the Russell 2000 is -27%.  Yes, this is the trend we’ve seen through most of the economically toxic Trump administration.  But the magnitude is different.  This is a huge gap in a short amount of time.

Nevertheless, despite the fact I would really like to shift my holdings away from recent winners, price action isn’t giving me the slightest encouragement to do so.

For me, the “toward what” isn’t really clear either.  So it may be that professional investors will take the very unusual step of simply raising cash and waiting.

As for me, I’m staying on the sidelines with the same tech/cloud-heavy portfolio.

 

a third factor 

A cardinal rule for investment success during my 40+ year involvement with stocks has been to avoid worrying too much about politics.  Think calmly and objectively instead.  It’s becoming difficult to ignore the increasingly bizarre and worrisome actions of the Trump administration, though, which are also taking on more and more of a 1984 tone.

Lack of attention to education, retraining workers and aging infrastructure–failings of both major political parties–are bad enough.

But now there’s Trump’s doubling down on his worst-in-the-world response to COVID-19, which has so far cost the US more deaths than all our armed conflicts since WWII.  (According to the Financial Times, 90% of these deaths were preventable had Trump not continually asserted the pandemic was not real.)

Then there are his recent threats to bar Chinese students from US universities and to deny Chinese-made goods entry to the US–more signature shoot-yourself-in-the-foot moves.  Perhaps more important in a pragmatic sense, Trump threatens a lot but does nothing.  To me, this is the worst of all possible worlds because it exposes his underlying weakness.

Finally, as an Army veteran I’m particularly disturbed that Trump is destroying the career of the Navy captain who rescued his crew when he found his aircraft carrier a coronavirus hotspot.  At the same time he’s pardoned a convicted war criminal and is now trying to have charges dropped against former General Flynn, who confessed to lying to the FBI to conceal his work as an agent of the Russian government.  In other words, Duty, Honor, Country and the content of one’s character mean nothing.

 

A rant, yes.  But there is a point.  The Hitler vibe is certainly not a positive for potential buyers of US goods and services in foreign markets.  Nor are indifference to human life and race hatred a big draw for foreign investment or tourism here.

 

 

 

 

 

 

 

 

 

 

 

 

restricting portfolio investment in China

According to press reports, the Trump administration has ordered a government pension fund not to hold a non-US equity index fund, about 4% of whose value is Chinese stocks, on the grounds that the Chinese shares represent a national security threat.  Because the board of the fund has ignored this order in the past, Trump is asking Congress to remove a majority of its members and replace them with his loyalists.

If there is a conceptual argument for this action it is that buying shares in Chinese publicly-traded companies, albeit indirectly, potentially lowers the firms’ cost of capital, making it easier for them to expand–and that ultimately this expansion might be somehow bad for the US.  This is a real stretch.  As a practical matter, whether this fund owns the index the board figures is best for pensioners or one like it that excludes Chinese shares won’t make much difference, either to China or to the fund.  Why inject politics into the decision, then?

I see three possibilities:

Assuming Congress allows the change of board members, Trump can force the change he wants and has a talking point about taking action against China at a time when others are ignoring him.  Or, the idea may be to establish the principle that Trump can control the fund’s investment decisions.  Maybe then the fund would like to take over a hotel lease in Washington, or a golf club in Scotland, or pump money into an underground coal mine in West Virginia.  Or it could be this is a tiny first step in a plan toward barring all American investors from buying Chinese shares.  If this last, it would likely only result in Americans’ moving investment accounts to, say, Canada, losing Washington tax revenue.