March 2018 Newsletter

 The WTF Market is Here: Here's The Plan

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Well after the shit show of today futures are UP and back over the broken 200-day moving average for the S&P 500. IF this stock puke follows that one a few weeks ago, we have tested A tradable bottom again. The $40 trillion question is did we test THE bottom?

Here is the S&P 500--we are not yet to <30 on the Relative strength indicator (RSI)

Here is the QQQ--same RSI reading meaning we have not reached maximum oversold conditions.

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Here is Volatility VIX for the Nasdaq 100--not over bought like in early February (the green blip) 

Action To Take: IIF Naz 100 rallies tomorrow we will add new PUT Options into the close to hedge our long positions as we await the "news" IP sanctions against China. AS you will read a wee bit later it strongly appears that THOSE actions could directly impact our semiconductor stocks and perhaps semi-equipment (if China goes as batshit crazy as our 71-75 and 82-year-old commerce and economic "leaders" have clearly become).

I said last week that the equities market are still "obviously in price correction mode" which means:
1) The LAST to get smacked in a correction are the leaders--tech and financials--and financials were smacked for the LAST 10 trading days first and now the final leg of the valuation correction will be the 26% of the S&P 500 valuation aka technology--CHECK
2) High P/E multiple and stocks 30%+ over their 50-day moving average technology stocks get clobbered like Tesla and Netflix-CHECK
3) The autonomous vehicle and enabling chip/technology stocks got hit on Nvidia news of halting live testing so that hit Alphabet Nvidia and AMD (shoot me now for NOT taking that $12.75 spike on buyout rumor)--CHECK
4) The Facebook data inquiry infected all the social media stocks and they face a regulatory reckoning-CHECK
5) The 10-year bond is telling the stock market that there IS no insipient inflation on the way and that "global synchronous" GDP expansion has not rolled over but "Goldilocks economy neither too hot or too cold" is still here--CHECK
6) The sinking dollar...which should be going UP in value with higher Fed Funds rates is still sinking
7) Which is making oil prices (in $dollars of course) HIGHER but the energy stocks have "spit out the bit" and have actually gone DOWN. I literally cannot remember oil E&P stocks go down when oil prices are up almost 15% in 2018. That price action still worries me. 
8) Our Transformity Macromarket Recession Risk Index moved lower to 16.3 with the lower US first-quarter reading by the Atlanta Fed now just 1.8%--we take the NY Fed GDP number of 2.85% GDP and blend them...but still Key point 1st quarter GDP estimates have to come down. 

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9) BIG profits from last year mean BIG taxes for traders that have to be paid by April 18th. At the margin they are sellers of the stocks with the most profits from LAST year...which are many of our companies. As a guy who has paid some mid-six figure tax bills in my day I can tell you this: I waited till the LAST friggin day to sell stocks or borrow against them to pay those bills! 

KEY POINT:  Buckle up--there is NO REASON to expect volatility to fade--here is why. AS I have shared many times on this journey since 2013 but more in the last 12 months, the markets and money managers are in a game of chicken and musical chairs.  On the one hand, IF they take off risk TOO EARLY, they vastly underperform the S&P 500 index and the get their assets under management (AUM) taken away. They are on a razor edge here...and unlike us most are long only and DO NOT HEDGE (which I continue to think is insane BTW).

Conversely, IF they stay too long at the party, and especially with leverage (not OUR problem thank with our hedges and long options closed) the average hedge fund is DOWN for the year and last year while we were 63% up THEY were up about 8%.

In today's thin air (i.e., high P/E valuations for the market leading Tech stocks) active money managers have to REALLY thread the needle...which is WHY we see this volatility now that the "Short volatility trade" is over (which as I have mentioned many many times is why 2017 was SO FRIGGING weird i.e., below 10 VIX for most of the year.)

Key Point: WITH higher volatility rates stocks WILL get repriced for their new levels of volatility vs.assets. ONE big reasons stocks performed so well last year is the discount for volatility--- let's call it the "brain damage" factor--was so insanely low due to the $200 billion invested in the volatility "carry trade." In other words...IF you sold options or futures contracts that profited IF the VIX went a lot higher--and it did not--YOU the seller pocketed the premium. $ONe hundred billion + in profits were made that way as those speculators were in effect selling market correction insurance in a market that never corrected. 

That game blew up obviously in February--and the losses were in the $hundred billion range. 

Market Risk TELL #1 Update: Deutsche Bank.  DB continues to fall lower--not a good sign. 

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Action to Take: STAND BUY I said on Friday last week "If we don't bounce off the 200-day as per usual we will protect ALL profits." We bounced...and failed. 
 


ACTION TO TAKE: Check your Email--and don't panic! There is NO recession risk here...this is a correction of the estimate of 15-20% earnings growth in S&P 500 stocks that got PRICED IN with the melt-up into the tax act and then in January with the 8% surge from giddy civilian investors adjusting their 401k assets to stocks.

We are flying by the technicals and we NEED A CAPITULATION day or days to shake out the rest of the weak hands and scared to death latecomers. I always hate writing that but ALL of us have very expensive educations in the stock market...they don't. The earnings reports start to the rescue 3rd week of April.

What are we looking for?

  1. UNDER 30 Relative Strength Readings for SP 500, Dow and Nasdaq
  2. BIGGER than average volume down days--the "flush" 
  3. VIX over 30 or better
  4. CRAZY put option to call option volume and prices--which we are are getting close to

Key Point: WE HAVE NOT gotten the flush yet--but do have NEW RISK factors for our stocks that I do NOT LIKE.

#1 The corporate buyback money is on the sidelines for the next 40-50 days...that is NOT good.

Corporate America is stuck on the sidelines as the S&P 500 plunges to its lowest level since early February. That’s because regulators mandate that companies refrain from stock buybacks for about five weeks before reporting earnings through the 48 hours that follow. First-quarter reporting season kicks into high gear in two weeks.

S&P 500 firms have bought back almost $4 trillion of their own shares since the bull market began nine years ago, data compiled by S&P Dow Jones Indices show.

KEY POINT: As I have pointed out many many times the marginal buyer of stocks for the last 10 YEARS has been corporate repurchases and takeovers. In short US pubcos are THEMSELVES themselves the biggest source of demand for U.S. Stocks in the last 10 years. 

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Key Point: THAT CORPORATE demand helped mitigate damage in early February when stocks tumbled into the first correction in two years. Goldman Sachs’buyback desk had its busiest week ever during the rout and companies were called “basically the only buyers.” Volume in S&P 500 stocks was 3 percent below the 30-day average Monday.

Problem #2: The F#$#^ING POTUS & "America First" Trade War is on.
On Sunday (their Monday) China announced tariffs on about 130 U.S. goods, including a 25% penalty slapped on U.S. pork and 15% on fruit. The news means China has made good on its threat to retaliate against the Trump administration’s tariffs on Chinese steel and aluminum imports. Trump folks tell me "no worries--this is the Art of the Deal in real life. He leads with outrageous demands and then settles way below--take his words seriously NOT literally." 

Bullshit. His tweets took $100 billion of market cap off of Amazon. His tweets are causing a trade war and Treasury Secretary Steve Mnuchin can't come on the TV tomorrow and say (as he did last Sunday) "WE ARE CLOSE to an agreement with China. We are working the back channels" don't worry blah blah blah. Worse, with the Trumpedo now "not constrained" by advisors and cabinet members who actually understand that it is insane to say "Trade wars are EASY to win" Trump has NO BUFFER between insane Trump and REALLY INSANE Trump. 

Look No matter what your politics are--as an equity investor this 71-year-old living in the 20th century has now gone from a sentiment asset to stocks to aSENTIMENT LIABILITY.

Fairly soon the mid-term elections will started to become priced into stocks. Losing the House in Congress and a negative outcome to the Mueller investigation would, of course, bring impeachment proceedings. That is another risk to stocks on the near horizon. 
Problem #3: This INSANE F#^#$^$# IP Trade War Hits our Semiconductor Companies RIGHT Between the Eyes

Donald J. Trump@realDonaldTrump

We cannot keep a blind eye to the rampant unfair trade practices against our Country!

7:37 AM - Mar 14, 2018

WELL here ARE are the top 20 companies with the highest revenue exposure to China, according to Goldman Sachs.
Recognize any?

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The list is dominated by technology chip suppliers that sell their products to manufacturers in China. Any trade issues between the U.S. and the Asian country could severely disrupt the global technology supply chain for companies such as Apple.

Here’s a partially overlapping list of the 20 U.S. companies in the S&P 500 with the highest share of sales in China:

CompanyTicker‘China’ sales ($mil)Total revenue - most recent reported fiscal year ($mil)Share of sales to ‘China’

Skyworks Solutions Inc.SWKS,-3.72%$3,018$3,65182.7%

Qualcomm Inc.QCOM,-1.26%$14,579$22,29165.4%

Qorvo Inc.QRVO,-2.71%$1,880$3,03362.0%

Broadcom Ltd.AVGO,-3.39%$9,466$17,63653.7%

Micron Technology Inc.MU, -0.28%$10,388$20,32251.1%

Texas Instruments Inc.TXN, -3.12%$6,600$14,96144.1%

IPG Photonics Corp.IPGP, -3.62%$621$1,40944.1%

Advanced Micro Devices Inc.AMD,+0.21%$1,747$5,32932.8%

Microchip Technology Inc.MCHP,+0.02%$1,090$3,40832.0%

Amphenol Corp. Class AAPH, -2.46%$2,067$7,01129.5%

Xilinx Inc.XLNX,-4.43%$597$2,34925.4%

Intel Corp.INTC,+0.16%$14,796$62,76123.6%

Western Digital Corp.WDC, -0.29%$4,271$19,09322.4%

Corning IncGLW, -3.05%$2,230$10,11522.0%

Starbucks Corp.SBUX,-0.02%$4,512$22,38420.2%

Agilent Technologies Inc.A, -3.49%$900$4,47220.1%

Avery Dennison Corp.AVY, +0.02%$1,300$6,61419.7%

Apple Inc.AAPL,-0.20%$44,764$228,57219.6%

Nvidia Corp.NVDA,-0.07%$1,896$9,71419.5%

Applied Materials Inc.AMAT,-0.26%$2,746$14,53718.9%

Source: FactSet

 

Worse: Later this week Trump administration is expected to release a list of potentially targeted products for China’s alleged intellectual-property violations. Senior administration officials have said they are looking at 1,300 different product categories, including such high-tech areas as semiconductors, communications, and aerospace.

U.S. industry will have 30 days to comment. After that, the U.S. has at least 180 days to decide which products—if any—to hit with tariffs.

Action To Take: HOLD Semiconductor and Equipment Providers--but make sure you have them hedged. We can't WAIT for the "Art of the Deal" to magically appear--so far every "great deal" this Administration has opened with has gotten 90% diluted (see steel and aluminum tariffs). BUT the Chinese WILL retaliate on the IP tariffs without question. 
AMAT
ACLS
ASML
LRCX
MU
AMD
NVDA

The Crypto Currency Bust is NOW hurting AMD And NVDA in "ASPs" aka Average Selling Prices for their GPUs

The decline in cryptocurrency mining demand could finally be impacting the semiconductor market, according to a new report from Morgan Stanley. In the firm's latest weekly semiconductor report, analyst Joseph Moore said February Semiconductor Industry Association data suggests DRAM sales continued to tick higher last month, while NAND sales declined moderately. MCU sales were down 13.9 percent.

Falling Ethereum prices, which dipped to around $370 last week after peaking at nearly $1,300 in January, are sucking the life out of GPU demand, Moore said. At current prices, the economics of mining are simply not appealing and there is no financial incentive driving GPU demand, he said.

Why It's Important

The prices of preferred crypto-mining cards are already starting to fall, suggesting previous market shortages are being alleviated, Moore said. The price of the Advanced Micro Devices, Inc. Radeon 580 is down from $530 to $399 on Amazon, while the price of the NVIDIA Corporation GeForce 1060/6 GB is down from $500 to $399, according to Morgan Stanley. 

“We would not expect cards to get to the launch pricing levels given higher-priced GDDR5 DRAM, but we are clearly seeing the effect of easing shortages," Moore said. 

For investors, Moore said the impact of falling cryptocurrency demand will have the biggest impact on AMD’s business. Last week, AMD said its 2017 revenue exposure to the cryptocurrency market was in the mid-single-digits, and Morgan Stanley estimates that exposure climbed to 10 percent in the fourth quarter.Moore said Nvidia likely has significantly less exposure to the cryptocurrency mining market given the lower hash rates of their devices.

WHY Am I SO Worried About The Impact on Our Tech Stocks and The Growing Trade War?

THIS IS WHY. In a two-week span, President Donald Trump ordered up an array of tariffs against numerous countries, blocked Chinese takeovers of U.S. companies and sought new restrictions on future Chinese investment. China now responds with tariffs of its own on imports of 128 U.S. goods. These insane "America First" actions in a world of global supply chains put the world on the verge of an all-out trade war, featuring tit-for-tat reprisals, heated rhetoric, and appeals to the World Trade Organization, which is ill-equipped to respond to trade tariffs based on "national defense" priorities. 

1. What is a trade war?

The dictionary says it’s “an economic conflict in which countries impose import restrictions on each other in order to harm each other’s trade.” Trump’s tariffs and the threatened retaliation from other countries meet this definition, but so do centuries of protectionist skirmishes by numerous countries in countless sectors. The recent escalation is stoking fears that Trump has set off a full-blown trade war by singling China out for retaliation for intellectual property theft. The quid-pro-quo actions by the U.S. and China over steel tariffs, Trump’s invocation of national security to justify some of his moves -- which could open a Pandora’s Box of similar claims by other nations -- and Trump’s threat to further punish the EU if it imposes counter-duties also add to the trade-war atmospherics.

2. What happened in previous trade wars?

One of the most notorious examples is the Smoot-Hawley Act passed by Congress in 1930 which took a recovering economy and killed it and really started the Great Depression. The law hiked U.S. tariffs by an average of 20 percent, initially to protect American farmers but then broadened as other industries lobbied forprotections. As demand collapsed, countries scrambled to maintain their gold reserves by devaluing their currencies or imposing even more trade barriers. Global trade fell off a cliff.

3. Who wins in trade wars?

No one. When President George W. Bush raised steel tariffs in 2002, U.S. gross domestic product declined by $30.4 million, according to the U.S. International Trade Commission. The U.S. lost about 200,000 jobs, about 13,000 of which were in raw steel-making, by one estimate. A report by the pro-free trade Peterson Institute for International Economics estimated that Bush’s tariffs cost about $400,000 for every steel-industry job saved. The World Trade Organization also ruled that the Bush tariffs were illegal. 

4. What has Trump done so far?

He’s imposing tariffs on up to $60 billion of as-yet unspecified products imported from China in retaliation for what he calls decades of intellectual property theft. He imposed tariffs of 25 percent and 10 percent, respectively, on steel and aluminum imports, which prompted China to say it could hit back with tariffs of its own. While he temporarily exempted allies, including the European Union, from the metals tariffs, he expects them to grant concessions to the U.S. to maintain the exemption.

5. Why did Trump invite this fight?

In a March 2 Twitter post, he declared trade wars “good, and easy to win.” His focus remains reducing the U.S. trade deficit, which shows the country imports hundreds of billions of dollars more than it exports. Stepping back from trade deals like the North American Free Trade Agreement and the Trans-Pacific Partnership also appeals to Trump’s base of voters in America’s Rust Belt. But talk of a trade war is alarming to many U.S. business leaders, who largely support existing trade deals, and the securities markets, which fear lower profits and slower economic growth if the U.S. turns protectionist and other countries retaliate.

6. Who has retaliated?

China hit $3 billion of U.S. wine, fruit, pork, steel pipe and other exports with tariffs on April 2. Many of the 128 products on the list originate from states that favored Trump in the 2016 presidential election. So far, high-volume agricultural exports to China, such as soybeans, haven’t been swept into the mix. An even bigger worry for the U.S. is that China, the U.S.’s biggest creditor, will scale back purchases of Treasuries in retaliation. China’s ambassador to the U.S. doesn’t rule out the option. Other countries haven’t retaliated for the steel and aluminum tariffs, which took effect March 23, largely because Trump temporarily exempted many of them. Still, the EU is unhappy and warned it will respond with its own 25 percent tariffs on $3.5 billion of American goods. Like China, the EU says it will focus particularly on products from states that are part of Trump’s political base, including iconic U.S. brands of motorcycles, blue jeans and bourbon whiskey. In turn, Trump warned that he would impose a 25 percent penalty on European car imports if the EU carried out its threat.

Would SOMEONE ask the POTUS if he understands the Smoot Hawley disaster?

7. When does the WTO get involved?

The U.S. took the first step on March 23, filing a "request for consultations" with China at the WTO on technology licensing. China also notified the WTO how it could respond to the steel tariffs with levies of its own. But retaliatory actions that unfold quickly can test the WTO’s somewhat ponderous deliberative process. The arbiter of international trade disputes was born in 1995 out of a set of agreements struck by countries trying to reduce trade barriers. If a government’s complaint about another nation’s trade barriers is seen as grounded, the WTO recommends acceptable retaliation. In the case of steel, Trump is invoking a seldom-used clause of a 1962 U.S. law that gives him the authority to curb imports if they undermine national security. Under WTO rules, countries can take trade actions to protect “essential security interests.” Other nations could challenge the validity of the U.S. use of that clause. They also could copy the U.S. move by citing national security to block imports themselves.

8. Will tariffs backfire on the U.S.?

Without a doubt. Take steel tariffs. Many more people are employed in industries, such as auto manufacturing, that buy steel to make products, than in steel-making itself. Some consumers may also have to pay higher prices. Trade tensions could boost inflation more than desired by Federal Reserve policymakers, who might feel the need to raise rates more aggressively than planned. On the other hand, if the tariffs result in job losses and the economy slows, the Fed might want to ease the pace of rate hikes.

9. Are tariffs the only weapon in trade wars?

No, there are many others. Clamping down on Chinese investments in the U.S., which Trump is already doing, is one example. Talking down, or manipulating lower, one’s currency is another. Countries through the years have used other means to keep foreign goods out and protect homegrown companies, a practiceknown as mercantilism. Trump accuses China of using government subsidies to prop up its domestic industries. Some practices are overt, such as quotas, and others covert, such as unusual product specifications, lengthy inspections of goods at entry ports and intricate licensing requirements.

The Reference Shelf

  • QuickTake explainers on Trump’s claim that China stole U.S. intellectual property, the 1962 law Trump cited for his steel tariffs, the difficulty of the U.S. quitting Nafta and Trump’s solar-panel tariffs.
  • Canada and Mexico got a reprieve from the new tariffs.
  • Bloomberg Economics says an all-out global trade war could cost economies about $470 billion by 2020.
  • How China can punch back.
  • The "nationalists" are back in power in Washington.
  • Why Trump’s steel and aluminum tariffs might set a bad precedent.
  • China stands to gain from Trump’s steel tariffs, Michael Schuman writes in Bloomberg View.
  • How Trump’s tariffs could aim for China but hurt U.S. allies more.

This is still a vacation week. WE will use an uptick tomorrow to hedge our semiconductor portfolio against the economic insanity of our history challenged POTUS. PS--we HAD a unilateral trade agreement with ALL our Allies to go after China on IP--its called the TPP agreement.

Why we chose to pursue this trade war alone is head-shakingly ignorant of economics and history but it is NOT SURPRISING for Mr. Trump to ignore economics and history eh?

PS: I am about to launch an a Transformity Investor PRO service that takes equities and options buying AND SELLING to a new BIG TIME level. If this bull market has 1-2 years more to as our Macro Market Index says, there are going to be GREAT opportunities to SELL options at these trading peaks and buy puts and vice versa on these capitulation bottoms.  Just like we did with Micron options last week. This service will be daily and very hands on...but based on the last 6 months of real life testing I think we can add 30-40% ADDITIONAL profits to your long-term capital gains with this new service. 

Drop me an email at tsmith@transformityresearch.com if you want to be in the initial group. We have to limit the size to 50 or so members to make sure we are not moving options prices and everyone has enough to go around. 

We got a number of requests to "get on the list" for the first group...more news shortly!

Hang tight--we get great returns vs. bonds BECAUSE we can take the brain damage of corrections!

Toby

 

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Blog/EletterTobin Smith