Semi Update: 4.24.18

Protecting 100-200+300-400% Gains: We have a "Sell the News" Market That Needs to FULLY CORRECT and thus Tech Has Become Cement

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Action: CLOSE Facebook May $170 Call: It failed to break $169 resistance...and now great earnings reports are not enough for anyone. 

We get much higher returns in the stock market in return for the brain damage of market volatility. With 40% of S&P 500 reporting earnings this week...this is the line in the sand week obviously. So far it's quicksand.

The $25 trillion question is: Have we reached the final top of the 10-year bull market? The answer is since we don't see a recession in the next 4-6 months, we are getting the REAL correction in the market leaders. Since we own most of the leadership stocks, the question is
A) Is leadership about to change? B) Will value lead for the first time in 10 years? C) Is the bond market yield curve flattening mean anything in a world where OTHER Central banks still have net negative interest rates?

Here is what we know. The earnings numbers are coming in as expected and there is a post-market surge...then the conference call and guidance is not insanely good and the stock reverses and drops 1% or more. Google, Caterpillar, Lam Research last week etc etc etc.
The Indexes are back to the valuation from the beginning of the year yet earnings are 19% higher--so this correction can't be about "earnings" per se. This is about expectations being too far ahead of the just very good reality--and thus we need to get expectations LOWER than actual reality. 

What we DO know is that this leg down is taking down leadership--FANG stocks and the biggest winners semiconductor ecosystem--and the fears are not unfounded.

#1 Apple supply chain--"We are in full panic mood." Taiwan Semiconductor Q2 guidance down $1 billion and further channel checks say we have hit "Peak High-End Smartphone" as the iPhone X is a bomb vs. expectations and the X "supercycle" is over and getting priced out. Memory has been best performing price wise. Texas Instruments announced better than expected numbers AND it trading up 5% in the market. They are NOT a big chip provider into the Apple supply chain (or other expensive phones). 
#2 Social Media regulation--Facebook and Alphabet/Google have started the march to data regulation and the only model we have is the European regulatory model. That means higher regulatory compliance cost and PERHAPS softer ad sales. 
#3 Potential Trade War Retaliation: The market has priced in the "Trumpian Two Step" aka a Trumpian bombastic opening barrage but later a host of exemptions etc. Trade retaliation is at best an overhang on the market i.e., another reason for the marginal seller to sell.
#4 Four Rate Hikes still priced in for the Fed in 2018: Fed funds rates look to be 2.50% by year-end. Financial tightening HAS HAPPENED. Libor was 35 basis point 12 months ago--today its 2.45%. About $350 trillion of financial products and loans are linked to Libor, with a large chunk hinged to the dollar-based benchmark.  I talked about this as one of the hidden risks in equities since A) the rise offsets some of the tax rate cuts 2) the rise in Libor DOES HELP Financial services firms with fixed cost loans and rising loan rates tied to Libor (which is why we are LONG Financial Services with FINU ETF Buy Under $100).
#5 Commodity/Industrial Input Prices Rising:  Many industrials have reported input costs paper, steel, aluminum are higher. The consumer basic staple companies are at multi-year lows because they have no pricing power (read: Amazon) 
#6 VIX is still low/NO capitulation selling yet: In the playbook of corrections we have not yet seen the 25+ VIX and the 2X average volume capitulation selling. We are going to keep our powder dry until we see the true end-of-correction
#7 Mid-Term Election is getting priced into equities. The Dems look better every day to take the House...that would slow down some of the Trumpian pro-business zeitgeist .
#8 Higher interest rates MEAN higher volatility in equities. The reason is the higher the bond yields make equity risk less attractive AND the cost of borrowing money to buy stocks. Last years insanely low volatility was ...insane. 
#9 New Leadership? While our Financials play the FINU is chugging higher (Buy Under $100)  the regulatory changes and Apple slowdown + down Q2 TSMC semi foundry outlook has created a SELL NOW mentality and bring risk down. 

Sometimes the simplest answer is the right one. When "Beat, Raise" guidance is not rewarded after 24 quarters of being rewarded, the simplest answer is ALL good news is priced into growth stocks and rising interest environment and now Quantitative Tightening from the Fed (plus trade wars, insane POTUS tweets etc) have caught up to marginal buyers of stocks. With our 62% return LAST year (thanks to some timely option trades) the market seems to have pulled a LOT of performance into 2017--that is a formula for a real correction. 

In short we have to get stock prices down and earnings yields up to a point they are attractive--and clearly, that is lower stock prices. We are at 16 forward multiple--that is lower than the 17 average--and no marginal buyers.  Add to that the flattening of the Treasury curve, typically a harbinger of an economic slowdown that could spark fear among investors. Still, others may not have the stomach for an environment of heightened equity volatility amid concerns about a regulatory crackdown on market leaders in the technology sector.

My trader pal Tommy Lutz said via text “I think great earnings were expected, so it’s a ‘sell the news’ event. Some future regulation fears around advertising for internet names have everyone selling the news around earnings."

Key point: Rising rates are a wet blanket for stocks EVEN if 83 percent of S&P 500 stocks reporting so far have outperformed. Rising rates make investors less tolerant of wiggles in earnings and less risk taking. 
Really Key Point: Did we reach the top tick for the 10-year bull market? Our research says no BUT we clearly need a repricing of risk in the leadership stocks. We do NOT have a recession coming in the next 4-6 months.
Transformity Macro-Market Index: 16.8

The average correction lasts 6 months...that would take us into July to return to the previous highs. The January meltdown was a head fake--as we have shared since the data came in it was really a flash crash caused by the "VIX carry trade" where $200 billion was short the VIX (i.e., sold call options and collected premium) and they had a massive margin call when the VIX exploded.

The 8% January melt-up set-up the whole scenario. Then we called this market the Micron market as MU had become the poster child for the insatiable demand for NAND and 3D memory and had been priced for it. We bought put options against the ballistic rise into earnings--got great earnings and guidance--and it came back to earth (and we made 400-500% profit depending on you MU put entry).

Then Lam Research came with earnings and beat but guided to a softer Q2 2018 and then Taiwan Semiconductor--which makes almost 60% of semiconductors gave $1 billion lower guidance due to the soft Apple iPhone X sales.

LRCX and AMAT and ASML and MU are all at key 200-day support lines. But Relative Strength is not yet oversold. 

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Applied Materials is the only Semiconductor play to have broken its 200-day support. it NEEDS to climb back over the next 2-3 trading days or will take our profits and buy put options as it would be a broken stock. The WAY to do that is to buy the OUT of the money put when the stock bounced back but does NOT got past and bt6-=-hold its 200-day.

ASML is in great shape

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ACLS is bottoming again. With ASML announcing 30 new EUV machines for delivery in 2019 vs. 20 this year. ACLS is now an insanely low valuation. It is a big buyout candidate at just a 5.6 P/E with at least $30 value. 

WE dodged this bullet with Taiwan Semiconductor largely on fears of Apple dependence. The growth of Nvidia was the driver of the stock but Apple became 30% of revenues with iPhone chips. WE will avoid this collapse with the other chip names.

The strongest chip name is not surprisingly Nvidia. Its the game over dominator in AI processing . . .because of its software as much as its GPU chips. We want it BACK over the 100-day key support otherwise we will hedge.

Consider this Part one of the April Newsletter--I want to get through this week with 40% of Semis set strategy for Q2.

Go Warriors and Capitals!
 

Toby

 

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