the market is rotating…

…away from secular growth and toward business-cycle sensitives.

Over the past five trading days, including today (I’m writing just after noon), the Russell 2000 is +6.8% and the NASDAQ is up +2.4%.  Half of the relative gain has come so far today.

Unless/until we get bad coronavirus news, I think this movement will continue.

What to do?

The safest thing to do is to stick to your long-term strategy.  Use this as an occasion to adjust holdings, not a cause.  I think the primary reason for the current move from secular growth to cyclical is the huge performance differential that has built up between the two indices, not a fundamental change in trend.  Sort of like the losing team getting a turn at bat.

On the other hand, for someone willing to put in the time and effort, I think this could be a counter-trend rally that goes on for a couple of months before reversing itself.  To pluck a number out of the air, it could mean a 10% relative gain from here for the Russell over NASDAQ.

As for me, about a month ago I bought a small amount of an R2000 ETF and a smaller amount of MAR.  That lost me a tiny amount of performance.  I added to both two weeks ago.  That has worked out better so far. I added more R2000 today, bringing my total shift to just under 10% of my portfolio.

If what I said two paragraphs up turns out to be correct–and if I reverse what I’m doing at the right time–I’ll have gained around 100 basis points in performance.  The figure would be much higher if we could see an end to Trump’s highly damaging economic policies, or if his election opponent weren’t a septuagenarian whose fastball appears to have lost a lot of zip.

is this enough reward to justify taking the risk of being wrong?   Unless you’re involved with your portfolio every day–and I am now that art school is  over (graduation tomorrow)–probably not.  But it keeps my hand in.

 

 

 

Trump and TSMC (ii)

Over the weekend The Economist published an article about the administration’s attack on Huawei, denying Taiwan Semiconductor Manufacturing Company (TSMC) the use of US intellectual property in making chips for the Chinese telecom firm. The article basically paralleled my post from the 18th.  And it concluded that the ban could easily end up hurting the US far more than China.  In other words, it’s vintage Trump.

Although I didn’t mention it a week ago, I think it’s interesting to observe the behavior of the US companies affected by the initial order, which prevented them from supplying US-made chips to Huawei.

A basic fact about chip manufacturing is that although the output comes from gigantic, multi-billion dollar factories, the chips themselves are tiny and weigh next to nothing.  Output can easily and cheaply be shipped anywhere.  So plants don’t need to be located near customers.  They are highly automated, so no need for a large nearby workforce, either.  The key variables in locating a fab: areas where there are no earthquakes and where government tax breaks and subsidies are the highest.

Anyway, US firms continued to supply Huawei as usual after the initial directive, just from non-US facilities.

 

My point isn’t about administration ineptitude in taking months to realize this elementary workaround.  It’s that the chipmakers acted as businessmen.  They did what they thought was best for the long-term survival and prosperity of their firms.  Logically, it’s what they should have done as stewards of other peoples money.  More important, it’s what they did do.  That is, we have a reason to think that they will continue in this manner–to at least plan to put their operations out of the reach of Washington.  In addition, they will presumably pressure their suppliers of capital equipment–the semiconductor production equipment makers, some of which are heavily concentrated in the US–to do likewise.

 

 

 

 

 

 

 

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.