July Post Fed Newsletter

Where is The Earnings Recession?


Dear Subscriber,

This July newsletter will be shorter than normal--we need to get some more earnings in to see where the new opportunities are. Our Chegg (CHGG) continues to shine now at $45 (from our $25 buy under). I'll talk about Chegg and AMD below and our other chip plays next week--short version is we are buying a pullback on Xilinx and Nevada--but right now AMD is ripe for a double-dip.

What Should We Expect in 2H 

You know the Occam's razor (or Ockham's razorprinciple-- if there are two explanations for an occurrence, the one that requires the least speculation is usually correct. Another way of saying it is that the more assumptions you have to make, the more unlikely an explanation.

Well let's talk about the "known knowns" aka the market impacting events we don't have to assume for over the next six months:

1) Every Central Bank in the world is dovish and staying dovish and supporting asset prices with Central Bank interest rates at historic lows and continued "QE" aka quantitative easing. Net positive for equities and bonds. One day the music ends--but not today. 
2) The US Treasury is going to raise $1 trillion in 2019 to add to the $1 trillion it raised in 2018 and demand for those bonds is almost infinite aka the TINA effect--there is no alternative because the ECB and JCB bonds being issued are at negative rates. That keeps the US dollar strong. That keeps rates low. In an extremely low inflation world, after inflation earnings growth rules. 
3) Our Federal Reserve has now missed its 2% inflation goal and inflation forecasts for the US economy for 9 straight years. The Fed record is worse than the NY Knicks. The REASON the Fed can't forecast inflation right is they are using 20th-century models ("Phillips Curve" and "Taylor Rule") in the age of digital deflation and Boomer demographic retirement era.
4) There is no inflation in wages because 66% of Americans without a college degree are competing for fewer of the same jobs. At the skilled professional level, the $revenue per skilled worker is so high (Facebook's revenue per employee is $1.8 million vs. $230k per employee at Waste Management for example) that the digital and knowledge-based economy has 5-10X the gross profit margins of the service and manufacturing economy. This is THE disinflation formula of 2020--and the Fed still does not get it. Add in 16,000 Americans and 28,000 Europeans turning 65 or 70 every day till 2030, and Millenials taking their place in the workforce getting paid lower wages, GDP growth of 2% looks like 4% from years past. ONLY 3-5 year secular growth sectors and tech leaders can deliver the actual top and bottom-line growth you and I need to really grow our wealth. Or corporate turn around stories. 
5) The public float of stocks in America contracting. Public companies are buying back >$1 trillion of their stock and new IPOs are not adding enough issuance to match the "de-issuance" of stock buybacks. 
6) The non-US economies have slowed because of trade war uncertainties, and those uncertainties will not go away until it is politically expedient for the US elections in 2020. 
7) US stocks market is valued at 18X forward earnings--valuation average is 16.8--stocks are not cheap. But no earnings recession--with more than 55% of Q2 earnings reported earnings growth turned out up 7%. 
8) Enterprise software stocks are in a bubble because their valuations are 2X standard deviations higher than long term averages. We continue to stand at watch for real SaaS opportunities like Cloudera (CLDR) at 1.5 times $1 billion of 2020 revenues. CLDR STILL a BUY under $6.50.
9) Value investing has trailed growth investing badly for 10 years and will continue to because of much of what traditional value investors consider "value" are legacy companies and industries disrupted by 20th-century disruption.
10) Almost 90% of the increase in index values since 2009 has come from just 100 transformational companies. Transformational growth companies ARE the stock 
11)  With 20% of market capital in momentum-based trading funds and 60% of the rest of the market in index funds, volatility (as measured by the VIX) will continue between 12 ish and 30ish. We will continue to BUY the dips and take profits when our valuations are hit.
Raising Chegg (CHGG) target to $55 with buy under $40
12) And finally, for all the reasons above, the way we will keep our 54% per year return track record alive (including dividends) is to BUY the dips in the most transformational companies and take profits when the fundamentals change. We will continue to hedge our growth sectors with 15%+ or higher income investments and reinvest those dividends to build a mountain of income for the future.  

The Transformity Research MacroMarket bear market reading is 16.1 for August--less than 5% chance of recession. That means without some spectacular "exogenous" event (war, mass trade war retaliation or Bernie Sanders elected POTUS) we are long stocks but "buying the reverse momentum dips." 

The Atlanta Fed's GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2019 is 2.0 percent on July 30. The NY Fed's is 2.2%--we combine the two to get our 2.1% GDP estimate for third-quarter GDP.


Action to Take: Add another AMD position + January 17, 2020 $35 Call Option  $2.50 or better

The AMD news of missing Street revenue numbers should not have surprised anyone. Their 7-year run of supplying custom GPU chips to Playstation and Xbox platforms that are being phased out is not news.  The temporary China slowdown was not news. Game consoles and China were responsible for 2H downside. But CPU/GPU share gains on Intel and Nvidia remain on track with Rome, Ryzen and Navi in the midst of their ramps. And both Microsoft and Sony have announced new gaming platforms featuring AMD chips--which start to ship early 2020. 

AMD released new 7nm 3rd Generation Ryzen desktop CPUs, new Ryzen 3000 desktop processors with integrated graphics and three new GPUs in its 7nm Navi family on July 7. We expect further growth after AMD launches its 7nm Rome server processor family, too. AMD also improved its EPYC server by doubling the number of cores available per package. As customers switch from Intel’s aging Xeon chips to EPYC, AMD’s market share will grow. 

But again, AMD's console-related unit volumes and ASPs will both rise sharply during the second half of 2020, given Microsoft and Sony will each roll out a next-gen console by then. Both companies have disclosed that their next-gen consoles will be powered by an AMD chip containing an 8-core CPU and a GPU that supports real-time ray tracing and (if one has a TV set or monitor that supports it) 8K-resolution graphics rendering.

August 7 is key. AMD announced on its Q2 call that it's hosting a launch event on August 7 for its second-gen, 7nm, Epyc CPUs (codenamed Rome), which it promises will deliver up to twice the performance of comparable, first-gen, Epyc CPUs. On the call, CEO Su said that relative to first-gen Epyc, AMD has "more than twice the number of platforms in development" with partners, as well as "four times more enterprise and cloud customers actively engaged on deployments prior to launch." And with Intel having recently pushed back the start of volume shipments for its next-gen Xeon server CPU family to the second half of 2020 from the first half, the opening that Rome provides AMD just got a lot bigger.

Also, Su disclosed on the call that AMD is prepping high-end Navi GPUs. In time, the company is also expected to launch 7nm offerings for its Ryzen Threadripper CPU family, which targets enthusiast and workstation PCs, as well as its Ryzen Mobile notebook processor line (it features CPUs with integrated GPUs).

Net Net: Considering the 85% AMD run-up in the months prior to its earnings report, it's understandable that investors weren't thrilled with its outlook. But the revenue and market share gain and earings story is far from over or peaked

Time to take advantage. Full update and new positions next week.