Correction Update: Not Time to Be Brave Yet

What Counts is the Rate of Change of the Rate of Change


Dear Subscriber,

Once again--Making a semi-cycle call within the overall business cycle was just the prudent thing to do. These semi-cycle and the US business cycles are not correlated very much (if at all). Listening to semi-giant Texas Instruments earnings call this afternoon revealed weakening demand and softer pricing in almost every one of their end markets.  “Revenue increased 4 percent from the same quarter a year ago; however, demand for our products slowed across most markets,” CEO Rich Templeton said in the earnings release. The chipmaker forecast an earnings-per-share range of $1.14 to $1.34 for its fourth quarter, versus the analyst consensus of $1.38, according to FactSet. It also said sales for the December quarter will be.

Friends--when you do something like outperform the market averages by 15-20 times, YOU WOULD BE AN IDIOT if you did not protect those profits. Just as important--when the average annual stock market return of the S&P 500 is 7% a year (with dividends since 1989) and we have over 320% of average profits on our positions in just the last 24-36 months, we just earned 45 YEARS of market earnings in just THREE years. 

Now the big reason we sold 90% of our semiconductor and semiconductor positions in August and early September was the clear evidence that the semi-conductor CYCLE had peaked. 30 years of following the commodity semis taught me that you ride them during the up cycle (pricing and demand) and sell that when your research (and industry research that you trust) says pricing power and demand has peaked.

10 years into a bull market people are torn between missing out on another market upleg and given back hard-earned profits. I remember at as a Publisher of the investment newsletter from famed market timer Elaine Garzerelli which we launched in 1995 (14 years into the 1981-2000 bull market) how it became the most successful newsletter launch EVER by selling "bear market insurance" that Elaine and quantitive model (which had called the 1987 crash) would ring the bell to exit stocks. Like I said in the October Newsletter, fear of mission out (FOMO) is as powerful as fear of loss. 

This cycle will bottom again...and we will ride the upcycle again. For thing, it takes 3-4 years to build and optimize a world-class semiconductor fab. The ones being built in China will not be optimized for 3-to-5 more years. Micron's new plant in Virginia will not be built and optimized for 4 years.  BUT my real point is we play the stock market game to BUILD wealth faster than passive indexes--if we don't book those profits we are not being true to our mission.  To that end, let's look at  TQQQ, Nvidia and our last unit of AMD.

TQQQ is right around our purchase price at $55--it will explode if Amazon and Microsoft give us their usual beat and raises this week. Amazon does have rising labor costs and transportation costs that will lower their gross margins. But it's subscription/membership/3rd party shipping model is still growing and their AWS cloud biz and advertising continue to transform the low margin e-commerce. Ditto Microsoft with their transition to subscription business model. Bottom line you can nibble on TQQQ here with a $50 sell stop if they fail to deliver this week. 


Nvidia Chart is blown-up--it needs a BIG upside surprise on Nov 15 its earnings call. Nvidia (NVDA) reported 2nd Quarter July 2018 earnings of $1.77 per share on revenue of $3.1 billion. The consensus earnings estimate was $1.65 per share on revenue of $3.1 billion. The whisper number was $1.80 per share. Revenue grew 40.0% on a year-over-year basis.

The company said it expects third-quarter revenue of $3.185 billion to $3.315 billion. The current consensus revenue estimate is $3.34 billion for the quarter ending October 31, 2018. We need to see 40% year-over-year top line or we take profits.


AMD--announces Thursday. They will announce the first sales numbers from ALL their new 7nm GPUs and CPUs. They have been stealing CPU market share from Intel with its well-understood manufacturing issues. We added another position under $26 and that still looks like the right call. HOWEVER--IF we don't see the progress I expect--we will take the rest of the AMD profits wait for a much lower entry point. 

We are still up 146% this year in AMD--that is still 20 YEARS of market return in 8 months! So let give AMD the benefit of the doubt here.

MORL MRRL BDCL NEWT NRZ --they are fine to buy under their 200-day long AS LONG AS YOU ARE reinvesting your dividends as they flop around with rising mortgage rates. 

My Worry Here is Sentiment

A day like to today was a trading bot vs. trading person war. When the indexes hit their 200-day moving averages and bounced off them the algos came in hard for a day trade. The market is searching for an investable bottom. This process is a dance you and I have seen a dozen times in this bull market. We have STILL not had the "big swoosh" down on huge volume that cleans out the weak holders of stocks.

But right now investors seem to be searching for a reason to sell. That’s a big sentiment shift from just a few months ago when even bad news didn’t seem to dent the market that much or for that long.  But the two things that usually sink the market, Fed-led recessions and overly rich stock valuations, are something investors should NOT be concerned about--yet. The price-to-earnings ratio of the S&P 500 has fallen to 16.5 based on this year’s earnings, below its five-year average.

Here’s the thing, though: In every sell-off, what ends them is when eventually fears are replaced with facts. The facts suggest that should happen well before any real damage to the economy is done.  We are looking at a LOT of places for new transformational winners. But I can tell you the other worry here--leadership! Homebuilding has rolled over--people want to rent or they can't qualify with student loans and 5% mortgages and the SALT tax deduction ceiling in high property tax states.  Autos rolled over months ago. Industrials rolled over with the last round of China tariffs--and now China tariffs are looking to go to 25% across the board as the POTUS believes he can get them to crawl to him and capitulate (like I have said--only someone who has NOT done a lot of business would think that. Chinese negotiate forever but losing face to the orange round-eye? Being humbled? NEVER).

The Small Cap Russell 2000 index has rolled over (lower highs). Transportation Index has rolled over. Defensive stocks (consumer staples, utilities and consumer non-discretionary) are suddenly "ports in the storm."  All the markets outside the US are in corrections or bear markets led by China. 

In short, the path of least resistance is down. October is always volatile in the US because its the last month that mutual fund and hedge fund managers can sell losers to wash profits on winners. October is the month the LAST bull market peaked--October 13th--the FIRST DAY we started Fox Business Network! When I told the 5 people who watched out 4 pm show that a financial meltdown was coming fast and they should be SELLING not buying stocks I got hate mail from all 5 viewers! 

The headwinds are clear: Overall 2019 earnings estimates have to be discounted and priced-in with an assumed 3.5% 5-year bond rate (as opposed to the 1% 5-year bond rate a few years ago). Price-earnings ratios are down to 16.5 but the disruptive growth NASDAQ 100 is 20 and small caps 25.

P/E RATIO 10/19/2018Forward EstimateRussell 200051.1525.42Nasdaq 10024.9520.05S&P 50022.7716.5

NET NET? The economy and the stock market only move together at the top and bottom of the business cycle. The market is confused right by so many moving parts--headwinds like inflation and tariffs most investment managers have never seen before! The earnings comps in 2019 obviously will NOT reflect the corporate tax cut any longer.  Apples-to-apples comparison looks like 9% ish EPS growth for 2019 vs. 2018--NOT an earnings recession--just the lower rate of change of the rate of change. THAT has to be priced into stocks too--and did I mention the mid-term elections?

ALL those moving parts and assumptions plus the hawkish Fed have made the market schizophrenic--until the big guns of leadership announce their EPS growth and start buying back another $800 BILLION of stock.  IF the big guns don't deliver--we take another leg down and the ONLY thing that saves the market is for Trump to announce the Chinese have agreed to capitulate and BOOM--the relief rally will be powerful and swift for the companies most negatively affected by tariffs. 

But like I said--the market and I expected this tariff bullshit to end right after Canada/Mexico--but now China is our new villain in the daily reality show aka The White House. I give 3 percent chance of a Christmas miracle--a sudden settlement with China and removal of 25% tariffs. Like I have also said many time-China can pull a lot of levers to increase GDP and their stock market. They have $6 trillion of foreign reserves sitting in the bank for one. Their working citizens save 40% of their paycheck--in the bank (and other "non-bank" investment companies). 

Our plan? Sit back and count our SECURED profits and our monthly and quarterly dividends at near 20% rates and reinvest them WHILE we let the market re-price out favorite growth sectors to 2019 reality. LARGE dominant US tech companies (without regulatory risk like Facebook) have led since 2014 and the odds are they will lead again.The "rotation to value" stocks lasted about 3 weeks.Look--if your industry, sector or company has been disrupted in the last 10 years, that "value" stock is LOSING value to the disruptors--they are not safe undervalued securities--they are has-beens. Creativedestruction happened like it's supposed to in free market capitalism. 

The LAST leg of this bull market will be led by the UNSTOPPABLE High-Quality Growth stocks leading our supersectors with PRISTINE balance sheets and defendable margins, market share, and EPS. The Power Pivot companies transforming their business models into subscription-based revenues. The leaders buying key technology tuck-in players to add to their lead with accretive earnings growth. 

How will we know the market has peaked? #1 If it does NOT hold the recent lows and crashes through support on huge volume. #2 IF UBER goes public with $120 billion market value and a whole bunch of other $billion unicorn stocks rush in to go public before the window closes including companies that should never be public. When short-term rates exceed long-term rates (the so-called inverted yield curve.) When unemployment starts to tick up. 

OR when the 50-day moving average on the S&P 500 moves down through the 200-day moving average. Or our Transformity Macro-Market Index goes negative (indicating recession in next 4-6 months). It stands today at a positive Q1 2019 growth rate >2%. 

Our forecast still says ONE more upleg for the market PURELY because the best EPS growing stocks will get TOO cheap--we just ain't there yet.

Cheers! Now go hug your 40 years of semiconductor profits earned in the last three years.!


Updates/AlertsTobin Smith