memory chip

DRAM & NAND: Betting On The Semiconductor Supercycle

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“Digital technology, pervasively, is getting embedded in every place: every thing, every person, every walk of life is being fundamentally shaped by digital technology — it is happening in our homes, our work, our places of entertainment. It’s amazing to think of a world as a computer. I think that’s the right metaphor for us as we go forward.” – Satya Nadella, Microsoft CEO

If the world is a computer, storage and memory are the hydrogen and carbon molecules needed to sustain life. Because computers without memory are empty screens. Unable to perform the functions that give rise to technologies like AI and Deep Learning. 

Yet our world is moving closer and closer towards this computer-first reality. Smart home penetration is a perfect barometer. 48 million smart home devices entered new homes in 2019. This $27B market should grow near 21% CAGR for the next three-to-five years. And that’s just one example. 

As AI technology improves so does the number of potential applications. A few markets ripe for AI penetration include: 

  • Automotive 
  • Consumer Electronics
  • IT & Telecommunication
  • Medical 

But these markets won’t experience innovation without proper storage and memory technologies. 

Enter semiconductors. 

Last week we discussed why AI will turn semiconductors into a secular growth powerhouse. You can read that here. One major consequence of this new demand driver is the insatiable need for more data. 

McKinsey notes in their article, Artificial-intelligence hardware: New opportunities for semiconductor companies, the intensity of AI data storage needs (emphasis mine):

AI applications generate vast volumes of data—about 80 exabytes per year, which is expected to increase to 845 exabytes by 2025. In addition, developers are now using more data in AI and DL training, which also increases storage requirements. These shifts could lead to annual growth of 25 to 30 percent from 2017 to 2025 for storage—the highest rate of all segments we examined.”

This week we’re focusing on public companies aimed at capturing this demand and turning it into record profits and margins. 

But before we dive into specific companies, let’s break down the differences between memory and storage. 

DRAM & NAND: Know The Difference

It’s helpful to think of memory and storage in two ways: 

  1. DRAM is the memory used to store code for algorithms, processes, etc.
  2. NAND is the memory used to store data for pictures, music, etc.

DRAM: Short-Term Memory

Memory uses DRAM (dynamic random access memory) to perform its functions. DRAM is a volatile memory, meaning it stores memory when a device is on. But when you power off, so strip the memory. 

When you think of DRAM, think of your main computer processor and graphics cards. DRAM is also used in portable gaming devices and video game consoles. There’s a few key advantages of using DRAM (via rfwireless-world.com): 

  • Can be deleted and refreshed while running a program
  • Smaller size
  • Higher storage capacity 
  • 100x faster than NAND

That said, there are drawbacks to DRAM memory, such as: 

  • Data requires constant refreshing
  • Complex manufacturing process
  • Volatile memory

DRAM demand is here to stay thanks to autonomous driving, video game consoles and AI applications. Micron (MU) CEO Sanjay Mehrotra said (emphasis mine), “AI servers will require six times the amount of DRAM and twice the amount of SSDs compared with standard servers.”

ATPInc wrote a great article on the massive AI-induced DRAM demand, saying (emphasis mine), “As AI workloads continue to grow, hyperscale data centers require more and more memory. In the first quarter of the year, DRAM supply remained tight mainly due to the massive construction projects of data centers, some of which are bigger than football fields.” 

Another ATPInc article highlighted the importance of DRAM in cloud computing technologies. The article reads (emphasis mine), “In recent years, the use of DRAM has been increasingly extending beyond the personal computer and consumer electronics sphere. Higher capacities and low latencies are among the driving factors why DRAM is figuring extensively in industrial applications such as smart factories, health care, military, automotive, networking systems and data centers.

Dram will also be critical to IoT bc of its low latency. For instance, According to Gartner, “driverless cars contain over 80 GB of DRAM versus 5.5 GB in PCs and 2.5 GB in handsets, exemplifying the sharp increase in the memory demands of these emerging technologies.”

More companies will use AI and shift storage centers to the cloud. This will inevitably lead to increased DRAM demand and a sustained DRAM upcycle. But DRAM isn’t the only memory chip experiencing the AI demand bump. 

NAND: Memory At The Edge  

Storage is our long-term memory. It allows computers and applications to store large datasets, which it can then retrieve information when needed. 

There’s a few main differences between NAND and DRAM: 

  • NAND doesn’t need power to keep data
  • Ideal for portable devices
  • Cost-effective per-byte with high storage capacity 
  • Easily replaceable

NAND is the most exciting memory/storage component of the semiconductor technology stack. We’ll see more devices use AI-based technology at the edge. This will increase demand for NAND memory chips, which operate best at the edge due to their reduced energy requirements, portability and ability to store massive amounts of data. 

An IndustryResearch study reaffirms this belief in their report, GLOBAL 3D NAND FLASH MEMORY MARKET REPORT, saying (emphasis mine): 

“The global 3D NAND Flash Memory market size is projected to reach USD 47800 million by 2026, from USD 15540 million in 2020, at a CAGR of 20.6% during the forecast period.”

Why are they projected to grow at such a high clip? AI Adoption. Check out this statistic from Eetasia (emphasis mine): 

“AI technologies are now set to be rapidly adopted in embedded systems: analyst firm IDC expects the market for AI-optimized processors for edge computing systems to grow at a compound annual rate of 65% in the years to 2023. But this move to adopt AI raises questions about the sustainability of embedded developers’ current approach to the provision of memory for code storage.”

Flash-based (NAND) memory chips accounted for 17% of the global storage market in 2018. Toshiba estimates that by 2025, NAND memory will account for 40% of global chip storage. Again, the massive demand increase is driven by AI-enabled devices that need compute and storage power at the edge. 

ElectronicSpecifier reiterates the impotence of NAND memory devices for the future of AI-enabled technologies (emphasis mine): 

“Consumer products, such as smartphones, tablets and cameras, along with industrial equipment and sensors, automotive systems and medical devices, all rely upon flash memory, often integrated alongside their processors, that stores both data and the code they execute. However, data centres find attraction in flash memory due to its near real-time response to read/write requests, and high data transfer rate. As demand for massive data processing for artificial intelligence (AI) and machine learning applications grows, so interest in flash-based storage will evolve in tandem.

Now we know DRAM, NAND and why we’ll see tremendous growth in both memory chips. Let’s review a few companies we can buy to express our bullish DRAM/NAND theory. 

Public Companies Dominating The Memory Market

The memory market is an oligopoly between five companies (market share in %): 

  • Samsung (005930/SSNLF): 35% 
  • Micron (MU): 16.5%
  • Western Digital (WDC): 15%
  • SK Hynix (000660): 9.5%
  • Intel (INTC): 8.5%

An oligopoly in a commoditized market means one thing: lowest-cost competitor wins. In semiconductor language that means more storage space on less surface area. Yet the race towards smaller chips and lower prices resulted in a 46% price collapse in the NAND market in 2019. 

Thanks to the demand drivers, all these companies’ charts are setting up for very bullish moves. 

Let’s review our top three ideas in this space. 

I’ll provide a general description of the business, the bull case and what the charts are saying. Stick with us next week where we dive deep into an individual name that we love in this space.

Micron (MU): Our Favorite All-Around Memory Play

Business Description: Micron Technology, Inc. manufactures and sells memory and storage solutions worldwide. The company operates through four segments: Compute and Networking Business Unit, Mobile Business Unit, Storage Business Unit, and Embedded Business Unit. It offers memory and storage technologies, including DRAM, NAND, NOR Flash, and 3D XPoint memory under the Micron, Crucial, and Ballistix brands, as well as private labels. – TIKR.com

Bull Case: 

  • MU is one of the cheapest NAND companies in public markets (2.3x EV/Sales & 5x EV/EBITDA)
  • NAND memory accounts for 25-30% of total revenue
  • 3rd largest DRAM manufacturer in the world
  • 10%+ ROC over 30 years
  • CEO an industry leader in non-volatile memory (NAND)
  • Given memory chip price collapse, there’s fewer suppliers catering to more customers (demand/supply imbalance)
  • Rise in demand should offset the natural decline in ASP (average sale price) of NAND chips
  • Fewer players will result in focus on profit stabilization, not cost cutting and margin compression

Note: Alex sent out an in-depth MU write-up to Collective members this week. The full report is only available to Collective members

Valuation: 

  • 5YR Average Growth Rate: 9.56%
  • 5YR Average EBITDA Margin: 44%
  • Capex as % of Revneue 5YR Average: 36%
  • 2024 EV/EBITDA Multiple: 9x

The above assumptions get us ~$87/share by 2025. That’s 71% upside from the current stock price. 

Tape Reading: 

MU currently has a pattern within a pattern. Both bullish. The daily chart (shown below) reveals a bullish inverse H&S pattern: 

daily chart of MU

MU Daily Chart

Now let’s zoom out further to the monthly time frame. The monthly time frame shows a coiling symmetrical triangle ready to propel higher: 

MU Monthly Chart

MU Monthly Chart

The stock is also above the 20MA pointing to further bullish sentiment. 

Samsung Electronics (005930/SSNLF): Our Favorite International Play

Business Description: Samsung Electronics Co., Ltd. engages in the consumer electronics, information technology and mobile communications, and device solutions businesses worldwide. It offers mobile phones, tablets, wearables, virtual reality, and audio products; TVs, and home theaters; OLED and LCD panels; laptops, computers, chrome books, HDM, memory and system LSI products, monitors, and printers; and home appliances, such as refrigerators, air conditioners, ovens, air purifiers, cooktops and hoods, microwaves, dishwashers, washers, dryers, vacuum cleaners, and heating products, as well as TV and home theater accessories. It also provides security and monitoring, trackers, Wi-Fi routers, hubs, sensors, outlets, and buttons. In addition, the company is involved in the technology and venture capital investment businesses; manufacture of semiconductor equipment and components; and provision of repair services for electronic devices. – TIKR.com 

Bull Case: 

  • Samsung is the cheapest memory chip manufacturer in the world by quantitative metrics (1.23x EV/Sales & 4.67x EV/EBITDA)
  • The company will invest a mind-numbing $115B into its semiconductor business over the next decade
  • It commands top market share in NAND memory chip production
  • The company’s stock rises and falls based off the results of two divisions: smartphones and semiconductors
  • William Keating notes Samsung’s semiconductor prowess (emphasis mine): “Samsung is one of only two companies in the world to have demonstrated volume production on a 7nm process, with an impressive and credible roadmap all the way to 3nm. We believe that the true value of this capability will still take some years to be realised.”
  • Samsung is one of the few companies with the supply capabilities to service the upcoming positive demand shock, as such, it will garner more of the operating profits
  • The company might produce the world’s first 160-layer NAND memory chip
  • Low expectations for revenue growth present low-risk upside optionality 

Valuation: 

  • 5YR Average Growth Rate: 2%
  • 5YR Average EBITDA Margin: 30%
  • Capex as % of Revenue 5YR Average: 13%
  • 2024 EV/EBITDA Multiple: 8x

The above assumptions lead to $66B in 2024 EBITDA. Applying our 8x multiple gets us $528B in Enterprise Value. Add back cash and subtract debt and you get $550B in shareholder value. That’s 56% upside versus today’s market cap of $325B. 

Tape Reading: 

Samsung’s tape looks very strong on the monthly time frame. The stock is breaking out of a three-year Cup & Handle pattern: 

samsung monthly chart

Samsung Cup & Handle on Monthly Chart

A breakout above the neckline would also signal new all-time highs. 

Western Digital (WDC): Our Contrarian, Turnaround Play

Business Description: Western Digital Corporation develops, manufactures, and sells data storage devices and solutions. It offers client devices, including hard disk drives (HDDs) and solid state drives (SSDs) for computing devices, such as desktop and notebook personal computers (PCs), smart video systems, gaming consoles, and set top boxes; flash-based embedded storage products for mobile phones, tablets, notebook PCs, and other portable and wearable devices, as well as automotive, Internet of Things, industrial, and connected home applications; flash-based memory wafers; and embedded storage solutions and flash products. – TIKR.com 

Bull Case:

  • Trades 1.18x EV/Sales and <6x EV/EBITDA
  • Second largest manufacturer of SSD hard drives (behind Samsung)
  • 1,400+ patents around NAND and SSD technologies
  • Gross Margin will expand to 2016-2018 levels of ~33%
  • Operating Margin will expand to 12-15% 
  • Long-term support at current stock price
  • Company repays debt, buys back stock and pays a dividend (5%)
  • Company will deleverage as it moves through the more bullish part of the cycle

Valuation: 

  • 5YR Average Growth Rate: 4% (GDP-type growth)
  • 5YR Average EBITDA Margin: 15% (vs. historical 13-21% estimate)
  • Capex as % of Revenue 5YR Average: 4.2% 
  • 2024 EV/EBITDA Multiple: 8x

The above assumptions lead to $20B in 2024 revenue and $3.55B in EBITDA. Applying our 8x multiple gets us $28.4B in Enterprise Value. Subtract $7B in net debt and you’re left with $21.4B in shareholder value, or $70/share. That’s an 84% upside from current prices. 

Tape Reading: 

WDC’s a picture-perfect bottom-picker’s stock. Price is currently anchored to a long-term support level of $38/share. You can clearly see the support when viewing a monthly chart (see below): 

WDC monthly chart

WDC Monthly Chart

The current price offers a great reward/risk trade set-up. Investors can buy at the close of this month’s candle with a stop below support (around $33/share). 

Risks To Companies’ Bull Thesis

There’s a two main risks we’re worried about with our bullish NAND thesis: 

  • Competition from Chinese chip manufacturers

China’s investing $100B to bring chip development to the mainland. China chip success would mean less revenue from companies like MU, which generate roughly 50% of their revenues from China. 

New Chinese entrants would also likely result in price wars and lower margins. Currently, the oligopoly is best served to stabilize prices and enjoy generally high profit margins for everyone. 

  • Global Macro Slowdown

As the general economy goes, so do semiconductor companies. A global slowdown would reduce semiconductor orders and R&D.

Is It Time To Buy Intel? [DIRTY DOZEN]

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The few who can understand the system will be either so interested in its profits, or so dependent on its favours, that there will be no opposition from that class, while, on the other hand, that great body of people, mentally incapable of comprehending the tremendous advantage that capital derives from the system, will bear its burden without complaint and, perhaps, without even suspecting that the system is inimical to their interests.   ~ The Rothschilds

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Good morning!

In this week’s Dirty Dozen [CHART PACK] we talk CAPEX trends and the premium given to US earnings before diving into the fulcrum of global assets (real yields), what they mean for metals, growth stocks, and policy makers. We then discuss some pockets of the market that are seeing rampant speculation and finally end with a long semi pitch in the hopes we see some mean reversion, plus more.

Let’s dive in.

***click charts to enlarge***

  1. According to the Levy-Kalecki equation, it’s net investment that drives aggregate profits — I’ve written about this here. This is why it’s important to track CAPEX trends, because one company’s spending (CAPEX) is another’s profits. Knowing this, it’s a good sign that GS’s proprietary CAPEX tracker has v-bottomed off its COVID lows and is back in positive territory.

 

  1. The premium given to US earnings relative to the rest-of-the-world is at levels that have only been seen a few other times over the last 60-years. If history is any guide, this rich value premium is unlikely to persist for much longer.

 

  1. Sentiment and positioning is stretched in a few pockets of the market — some of which we’ll discuss below. But as these sentiment indicators from Nomura show, there’s still plenty of room for sentiment to improve before we can say things are exuberant (China being the exception).

 

  1. Real yields are the fulcrum of global markets as macro hedge fund manager Adam Fisher points out in this great interview on the Capital Allocators podcast (link here). The falling dollar, rising gold, and juggernaut trends in growth and momentum stocks all have falling real yields to thank for their moves. The inflation-adjusted UST 10yr yield hit an all-time record low. With yields fast approaching zero, we need to begin asking ourselves, is this as good as it can get?

 

  1. The hedge fund Bridgewater recently published a paper exploring this very question. It’s titled “Grappling with the New Reality of Zero Bond Yields Virtually Everywhere”, here’s the link. They point out that roughly 80% of all global local currency debt now yields below 1%.

 

  1. Bridgewater goes on to write about how managing the monetary base is likely to take the place of interest rate management (since yields can’t be lowered much further) in combating slower growth and falling inflation. Here’s a section from the report where they lay out what this will look like:

Zero nominal yields also create a unique linkage between real yields and inflation. Because there is an arbitrage between the breakeven inflation rate and actual inflation, a deflationary downturn that pushes breakeven inflation down is extra risky because the combination pushes real yields up as the economy contracts (because the real yield plus breakeven inflation must equal the nominal yield, and the nominal yield is relatively stable), i.e., you have a higher discount rate on cash flows as cash flows fall.

“On the other hand, if reflation is successful, central banks will likely delay the rise in nominal yields relative to inflation, forcing real yields to fall. And there is no lower limit to either real yields or breakeven inflation. As a result, a successful reflation can drive real yields much lower even if they start at low levels, and policy failure (i.e., deflation) will drive them higher.”

 

  1. This will be bad for the dollar but good for precious metals. A couple months ago I wrote about my strong conviction that gold will make new all-time highs within the next six months. Well, we got there last week. This long-term chart of the inflation-adjusted price of gold though shows that its still 30% below its 1980 peak and slightly below its 2011 high (see my framework for analyzing precious metals here).

 

  1. While I remain bullish on precious metals and silver in particular. There are a number of indicators suggesting both metals are due for a breather (retrace) before another leg up. This chart shows that speculative call buying in the main silver ETF hit levels last seen in 2011, which happened to mark the peak. With that said, the precious metals markets are prone to parabolic moves that defy the norms so it’s important we let the tape guide the way.

 

  1. The dollar’s (DXY) 14-day RSI hit its lowest level in over a decade last week. Its 10-day moving average (blue line) is showing oversold conditions that have typically marked or preceded short-to-intermediate-term bottoms.

 

  1. Have investors in the FAAMG stocks built a bridge too far? Speculation marked by Put/Call ratios shows that investors in the stocks are the most bullish and most complacent of a drawdown than at any other time in the group’s history.

 

  1. Semiconductors are seeing their best profit growth relative to the Nasdaq in nearly three years.

 

  1. There’s plenty of strong charts in the semi space. One of the laggards though is Intel. Now, there’s obvious fundamental reasons for this underperformance. But with the stock at its lower weekly Bollinger Band and the number of buy ratings as a percent of the total near a decade+ low, it might be worth thinking about a reversion to the mean / catch up play here. Note, the last time analysts were anywhere close to this bearish on the stock was in 2013, which happened to coincide with a major bullish breakout from a long-term base.

 

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Stay safe out there and keep your head on a swivel.

Big Breakout in Bitcoin [DIRTY DOZEN]

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Spreadsheets make everything look linear and controlled, but the real world oscillates, overshoots, collapses, and rebounds. A company with operational and financial flexibility—what we mean by staying power—is able to exercise options that are quite valuable at different points in the cycle. Without the firm handle on that flexibility that credit analysis provides, we’d argue you can’t fully understand the wealth-creation process as an equity investor.  ~ Mitchell Julis

Good morning!

In this week’s Dirty Dozen [CHART PACK] we check out the technical setup in bitcoin, look at the year-to-date performance in precious metals, contrast that with the worst rolling returns in commodities since the Great Depression, muse on what could kill the current dominant trends and thus cause the most pain, and end with a long shipping trade, plus more…

Let’s dive in.

***click charts to enlarge***

  1. Bitcoin (BTCUSD) just broke out of one of its tightest coils in a long while. Compression regimes such as these often lead to powerful expansionary ones (big trends). There’s a number of fundamental reasons to like the play right now, as well. The second round of $1,200 stimulus checks to fund retail speculation is one of them. Now may be a good time to put on a position if you don’t already have one…

 

  1. Gold has put in its best year-to-date returns in 30-years (orange line). While we’re sure to see a shakeout at some point, the macro fundamentals very much support this trend and it’s ultimately going to go much higher (see my framework for analyzing precious metals here).

 

  1. The bull market in gold is coinciding with the worst 10-year rolling returns from commodities since the 1930s. It’s anybody’s guess when this deflationary regime will end, exactly. But the trends that will be born out of the next regime reversal will be incredible.

 

  1. In a similar vein, BofA points out that the “All-weather” portfolio (25% stocks, 25% bonds, 25% cash, 25% gold) has just seen its best 90-day returns in history. We are likely at the “As Good As It Gets” point with this asset mix. Which begs the question, where is the pain trade here?

 

  1. Are we seeing the “permanent death of value” as some are now starting to proclaim? Or, are we near the zenith of its sagging relative performance to growth?

 

  1. BofA did a good job of spelling out the current zeitgeist and the reasoning behind some of the big moves we’re seeing (highlights by me).

 

  1. If you look at markets around the world and start putting all the pieces together, an interesting picture begins to form. This picture suggests we’re getting closer to a reversal of the feedback loops that have supported this deflationary (Core Domination) thematic and soon the feedback loops will begin to support the Periphery over the Core (inflationary assets over deflationary). Graph is from a report I’m working on.

 

  1. Yields are the fulcrum of the global financial system. Falling yields have been a large reason behind our continued bullishness these last three months at MO; fat risk premium, TINA, and all that…

Well, the MOVE Index, which is a measure of US rate volatility implied by 1-month OTC options on Treasuries just hit an all-time low. Harley Bassman, the creator of the index, says this of it (emphasis by me):

“One can think of the MOVE as ‘the VIX for Bonds… By its design, MOVE has the unique ability to provide a signal for changing risk sentiment in the fixed income markets. While I would not call it predictive in isolation, rare is the case where a simultaneously low MOVE, flat Yield Curve, and tight Corporate Spreads are not soon followed by bothersome market conditions.”

 

  1. Compression precedes expansion in markets. It’s no different in bonds (yields).

I’m always on the lookout for the pain trade. And if there’s one thing the market could do to piss in the herd’s cheerios right now, it would be a spike in yields. You wouldn’t even need a large jump, just a 75bps move in the 10yr would be enough to kill the growth and All-Weather trade and explode volatility across all assets.

And on that note, here’s an interesting chart from BofA. It shows the semiconductor index (SOX), a bellwether for growth, is currently discounting ISM levels over 60. ISM has a strong correlation — often a leading one — to yields (higher ISM = higher yields). If the ISM were to rise above 60 we’d likely see yields rise a good amount too.

 

  1. If this were to occur it would be during the most complacent positioning in the options market in 20-years.

 

  1. Meanwhile, Citi’s Pulse Monitor Bear Market Checklist shows that the risk of an extended bear market is increasing. An “imminent bear market” signal is triggered when amber and red combined readings rise over 50% — current readings are 40% with four “danger” signals. Total warnings were just 25% when I shared this table last month.

 

  1. Dorian LPG (LPG), a propane VLGC owner/operator, is breaking out of a tight coiling wedge bottom. The virus did some temporary damage to the bullish shipping thematic but with a non-existing order book and practically no willing parties to finance new builds, it’s a matter of time before the Capital Cycle drives shipping stocks much higher.

LPG trades on the cheap, has a strong balance sheet, good management, and is buying back a large percentage of its market cap. The current technical setup gives a good risk-reward entry.

Stay safe out there and keep your head on a swivel.

Monday Dirty Dozen [CHART PACK]

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Through bitter experience, I have learned that a mistake in position correlation is the root of some of the most serious problems in trading. If you have eight highly correlated positions, then you are really trading one position that is eight times as large. ~ Bruce Kovner

Good morning! 

In this week’s Dirty Dozen [CHART PACK] we look at the latest credit, fiscal, and monetary data points from around the world. We then talk about the widening US deficit and what that could mean for the US dollar. We end with some sentiment and positioning, take a look at buybacks, as well as a stock that’s set to benefit from the strong US housing market. Plus more… 

Let’s dive in.

***click charts to enlarge***

1. @Callum_Thomas shared this chart from GS on the twitters last week, showing equity ownership in the US broken down by age group. What’s interesting is that those in the 55-year and over group have seen their share of equity ownership climb from 52% in 1990 to 75% today. This is another one of those pernicious effects of the long-term debt cycle which has led to the current wealth and income divide we see today.

 

2. China was the country that saved the global economy from slipping into a much more painful and prolonged economic depression in the 2010s following the GFC, thanks to their China-sized fiscal stimulus. While China has once again turned on the liquidity spigots in response to COVID, their ability to drive credit growth has become diminished. You can only build so many ghost towns, high-speed rail lines, and bridges to nowhere before you start to see a negative impulse from investment.

 

3.  Luckily for markets though, the rest of the world has aggressively stepped up to the fiscal plate. Here’s GS’s latest summation of the total fiscal response year-to-date. The numbers are mind-boggling…

 

4. The fiscal response along with a weakening dollar has helped put a bottom under EM markets.

 

5. And this chart from HSBC shows that US excess money Y/Y has a high leading correlation (5-months) to multiple expansion in the SPX.

 

6. The question for markets looking forward is will the liquidity hose continue to spray at full bore? While the fiscal side is looking more precarious in the US with debates over extending the additional UI benefits, HSBC points out that the Fed still has plenty of room to maneuver, noting: 

“So far the Fed has only tapped c45% of the total funds from the US Treasury, according to our credit strategists. In other words, the Fed still has ample firepower to combat any deterioration in financial conditions and risk-off waves in markets.”

 

 

7.  Nominal policy rates across the EM world have fallen to their lowest levels ever. What happens if this trend continues and the entire world effectively ends up at the zero-lower-bound?

 

8. I know we live in a post-deficits-matter world with MMT and all… But, the US fiscal balance is set to reach the peak hit during WW2 with the next round of stimulus. At some point, the US’s financing needs will begin to surpass the structural demand for those safe assets. And we’ll see that imbalance correct itself either in higher interest rates or a lower dollar. My money is on the latter.

9. Speaking of the US dollar… HSBC’s latest survey shows that USD bears are in the ascendancy. On the surface, this would appear to be a check against the USD bear thesis. However, as the USD chart on the right shows. Most of the respondents believe the USD bear trend is nearer its end than its beginning.

 

10.  Buybacks are an integral part of my macro fundamental framework. A high net buyback yield (buybacks-net issuance) has kept this bull alive for much of the cycle. With announced buybacks off to a slow start for the year, it’s yet to be seen whether this fundamental driver can keep the party going.

11. Those who still think this bullish rise in risk-assets makes “no-sense” have not been looking at the right data points. We have record-breaking levels of fiscal easing and stubborn bearish sentiment/positioning coming off record lows. That’s it. That’s the bull case. 

 

12. In Tim Duy’s latest “Fed Watch” note on the economy, he comments on the returning strength of the housing market (link here). A favorite play of ours to participate in this thematic is the home services plan company, Frontdoor Inc (FTDR). Brandon put out an update on this stock back in April when it was trading around $36 — Collective members can find the report hung up in our Research Library.

Stay safe out there and keep your head on a swivel.

Momentum Versus Mean Reversion

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*** The following is an excerpt from Alex’s weekly Market Note ***

The Nasdaq is 3 standard deviations above its 200-week moving average. The trend has only been this stretched a handful of times over the last 30-years.

Fund flows into tech are nearly 2.5 standard deviations above their 12-month average. A point at which has marked intermediate tops over the past 3-years (red highlights below).

Breadth in the tech sector has been narrowing but is still not at levels that typically precede large-scale weakness. Though that could quickly change.

The latest BofA Global Fund Manager Survey (you can find the report hung up in the Comm Center #Research channel) had the largest percentage of respondents call Long US Tech & Growth the “most crowded trade” in the survey’s history.

The only other instance that comes close is “Long US Dollar” in February of 2015, which happened to precede a top and 5-years of sideways chop.

But… while the trend is stretched, the trade crowded, valuations high, and short-interest at record lows. The path of least resistance remains up — at least for now.

The Nasdaq is in a buy climax and buy climaxes last longer than anybody expects them too (see 99’-00’, the last time Nasdaq was this far above its 200wma.

The bullish thrust off of the March lows has been incredibly strong and is dominated by large bullish candles. The tape reflects a large imbalance between demand and supply, which the bullish trend is working to correct.

Strong thrusts such as these tend to go through a distribution phase (a topping process) that plays out over a couple of weeks before we see a change in trend. It’s during these times that we see breadth materially deteriorate and the tape chop sideways. The Nasdaq made new all-time highs this week and though breadth has weakened it’s not yet giving a sell signal.

In an old research paper (link here), Michael Mauboussin recalled a study titled “Crowd Synchrony on the Millennium Bridge” that was published in Nature. Michael wrote:

On June 10, 2000, the Millennium Bridge opened to the public with great fanfare. London’s first bridge across the Thames in over a century, it had a sleek design—the architect wanted it to look like a “blade of light.” However, when thousands of people stepped on the bridge that day, it started to sway from side to side so much that people had to stop or hold on to the rails. Fearing for the public’s safety, officials closed the bridge two days later and, following a retrofitting, it reopened in February 2002.

What led to this high-profile failure? People exert a small amount of lateral excitation when they walk. Normally, these excitations cancel out when a group crosses a bridge. However, the Millennium Bridge initially had insufficient lateral dampeners, which allowed a little swaying when a sufficient number of people were on the bridge. That swaying forced people to change their gait by widening their steps, leading to greater lateral excitation and more swaying. The wobbling and crowd synchrony emerged simultaneously.

The crucial insight is the existence of a critical point. Simulations show that roughly 165 people can walk on the bridge with little impact on the wobble amplitude (see Exhibit 1). But adding just a few more pedestrians causes the amplitude to change dramatically, especially as the feedback between gait adjustment and wobble amplitude kicks in (see the dashed line in Exhibit 1). For the first 165 bridge crossers, there’s little wobble and no sense of any potential hazard even though the bridge is on the cusp of a state change.

The study helps illustrate how critical tipping points are reached in complex non-linear systems, of which the market is one.

Recursive action drives feedback loops which leads to amplification and eventually tipping points from critical states.

The current trend in the Nasdaq can be looked at through this lens. The stretched trend and the increasing absence of sizable dips show that the primary rule “buy dips, buy highs” is becoming more widely adopted. More agents (traders and investors) are adopting it because it’s been profitable to do so.

At some point, adoption of this rule will reach a critical mass and the lack of rule diversification will set the stage for the feedback loops to run in the other direction.

We’re not there yet but we’re getting closer with each passing day. Until then, play the trend until it bends.

Monday Dirty Dozen [CHART PACK]

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I have a friend who has amassed a fortune in excess of $100 million. He taught me two basic lessons. First, if you never bet your lifestyle, from a trading standpoint, nothing bad will ever happen to you. Second, if you know what the worst possible outcome is, it gives you tremendous freedom. The truth is that, while you can’t quantify reward, you can quantify risk . ~ Larry Hite

Good morning!

In this week’s Dirty Dozen [CHART PACK] we cover wide-scale insider-buying in energy and financials, talk about the troubling dearth of CAPEX intentions in the IT space, discuss the ugly earnings trends, make the case for fiscal, throw some rocks at the FANG trend, and end with a long pitch for a fintech advertising company. Plus more …

Let’s dive in.

***click charts to enlarge***

  1. Jesse Stine published a market note this past where he shared some great charts like the one below as well as his take on the market, which I find myself in much agreement with. Here’s a link to the report and an excerpt:

“As we see trillionaires AAPL, AMZN, MSFT, and stuff like TSLA single-handedly dragging the indexes higher day after day after day after day, the vast majority of the market hasn’t gone anywhere in 3 months. My point here is that there’s very little “froth” in 95% of the U.S. market and/or global markets. Thus, it’s difficult to argue for a “crash” on the horizon for a majority of stocks. I’d love to see money rotate out of the trillionaires into the rest of the market. We rarely see such orderly rotation out of the big boys, but you never know.”

 

  1. @GavinSBaker shared this chart from the recent MS CIO Survey showing that IT Spend Intentions are down -4.4% YoY, marking the first decline in a decade and the largest decline + negative revision on record… This matters because one person’s (or company’s) spending (CAPEX) is another’s profits. If companies don’t become more optimistic about the future and ramp their CAPEX back up, well, then… let’s just say the market rodeo that started in February is only just beginning.

 

  1. The earnings picture is more precarious once you take into account the fact that the trend was down and out before COVID even hit. This market is being propped up purely by TINA (fat relative risk premiums) and fiscal injections. Nothing wrong with that. I mean, I trade the trend and am definitely no financial justice warrior… But, at some point this becomes unsustainable.

 

  1. What this economy needs and needs soon considering COVID cases are spiking again and another round of lockdowns now seems all but inevitable in large parts of the country, is a new New Deal. We need to get fiscal. Like, really fiscal. And invest in our declining capital stock. You know, build some roads and bridges. And better yet, some small modular nuclear power plants! And luckily for us, according to this report from McKinsey, there’s a lot of low hanging high return fruit available for us to choose from.

 

  1. Of course, who really cares about fiscal, CAPEX, and future earnings when you can just pile your money into the narrowing leadership of the very top-heavy Nasdaq.

 

  1. I prefer to ride freight trains, not step in front of them. That’s why I’m not looking to short this buy climax we’re seeing in the FANG stocks — not until the tape says so, at least! But, I do enjoy pointing out the signs of increasing fragility within the trend. And on that note, here’s one more. Short interest in FANG stocks just fell to a record low, below 1% of float (chart via BofA).

 

  1. Q2 earnings season is about to pick up and lucky for the market the consensus estimates are… how do you say… dour? 20Q2 earnings are expected to decrease 43.1% from 19Q2. The low bar is set, now let’s see if the market can clear it!

 

  1. It seems that analysts aren’t the only ones with pessimistic outlooks. Combined US Index Commercial positioning (the opposite of speculative positioning) is at 5yrs highs — levels that typically mark bottoms, not tops.

 

  1. Personally, I’m in the camp that the rise of the Robinhood trader’s impact on the market is overblown, except for in smaller less liquid areas of the market. With that said, they seem to definitely be skewing the options market and, I think, are largely behind the extreme Put/Call ratios these last few weeks. The following is from a NYT article via a tweet from @MacroCharts.

 

  1. I knew cyclicals were out of favor and all but I didn’t know it was this bad. Apparently, hedge fund positioning in cyclical stocks (think consumer discretionary, energy, industrials etc…) recently hit all-time record lows…

 

  1. But I get it… They’ve done nothing but go down or sideways as of late. Which reminds me, they’re suggesting that bonds might make a better investment. Bonds (below is bond yields) continue to give those long risk, a free hedge. Not sure how much longer this will last, but why not ride the trend until it bends?

 

  1. Cardlytics Inc (CDLX) is a well-run fast-growing company. Brandon, our resident value investor extraordinaire, pitched this one to fellow Collective members back in April. The stock has since risen 80% and still looks like a good buy (it’s breaking out of a month + long wedge as we speak). Operators can find the report hung up in our internal research page.

Stay safe out there and keep your head on a swivel.

Monday Dirty Dozen [CHART PACK]

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That is the nature of pattern recognition, asking ‘What can I infer about this situation based on similarities to what I already know and trust that I understand?’ There is less emphasis on trying to reason out things on the basis that they are special because they are unique, which in a financial context is perhaps the definition of a speculation… It creates an impulse always to connect new knowledge to old and to primarily be interested in new knowledge that genuinely builds on the old.
~ Alice Schroeder

Good morning!

In this week’s Dirty Dozen [CHART PACK] we walk through some relative global performance tables. Check out some strong technical charts in the clearance bin out of Latin America. Look at two actionable FX setups and end with some macro data showing a fuzzy picture, plus more…

Let’s dive in.

***click charts to enlarge***

  1. Last week we saw the close of another trading month as well as another quarter. The fantastic and FREE Koyfin platform shows us which markets around the world performed best on the month. Chile took the top spot with an 8.8% return over the last 30-days.

 

  1. Chile, along with a number of other EM countries, has put in solid-looking bottoms. The chart below is a monthly and shows the country is rebounding from deeply oversold levels as well as 20+ year low valuations.

 

  1. There are some very nice technical setups in select DM FX right now as well. CADUSD has put in a double bottom and is coiling in a bullish wedge following a strong upward thrust. This is a pair that I want to get long…

 

  1. The same with the Mexican peso (MXNUSD) which we are long. But this looks like a good place to add to one’s position or enter a new one. I like the long-term potential for this trade.

 

  1. BNP Paribas shows though that positioning is getting a bit crowded against the USD — though CAD is even more so.

 

  1. Goldman Sachs wrote about how to think about the USD’s countercyclical behavior, writing “To gauge how currencies perform in different parts of the economic cycle, we divide monthly FX returns since 2000 into four buckets, depending on the level and 3-month change in the global PMI. While the Dollar outperforms all other currencies when global growth is low and falling, the worst part of the cycle for the Dollar comes when growth rebounds from a weak level. We think this helps explain why the Dollar outlook is so hotly debated right now. Investors are currently grappling with the durability of the recovery given negative virus news, and therefore the outlook for growth-sensitive assets, including the broad Dollar.”

 

  1. UBS’s US Consumer Health Gauge is at levels similar to those hit during the GFC and hasn’t yet begun to turn down. This just shows the precariousness of our current economic situation. The economy and the market need the government to keep the stimulus and UI benefits flowing or else things will unravel rather quick like…

 

  1. The veteran technician Martin Pring shared this great chart on the twitters last week writing “The price oscillator comparing a 3-to-a-24-month moving average for part-time employment has likely peaked. Most previous reversals signaled an end to the recession. All but 2001 were great equity buying opportunities.”

 

  1. Old man Buffett has started stepping into the energy space and scooping up assets at a steep discount. Will this be the signal needed to pull in others who’ve been sitting on the sidelines? There’s a LOT of value to be found in the space if one knows where to look.

 

  1. A lot of people are pointing out the overbought technical levels of the Nasdaq. While it’s true the trend there is getting hot, it’s not one I’d want to step in front of. I’d much prefer to be long until a valid sell setup triggers. Right now, the tape is all strength.

 

  1. Not many people expected this just a few months ago… But earnings revisions in the US are now the most positive they’ve been in 20-years.

 

  1. People tend to make the mistake of overweighting the importance (in market terms) as to which political party is in power. This chart shows that the market does care though about a change in leadership, regardless of party. It prefers continuity over uncertainty.

Stay safe out there and keep your head on a swivel.

Monday Dirty Dozen [CHART PACK]

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All men dream: but not equally. Those who dream by night in the dusty recesses of their minds wake in the day to find that it was vanity; but the dreamers of the day are dangerous men, for they may act their dreams with open eyes, to make it possible.  ~  T.E. Lawrence

Housekeeping Note: We’re opening up an enrollment period to join our Collective. The enrollment period will close this coming Sunday. If you’d like to learn more about what the Collective is then go ahead and click this link below. Also, don’t hesitate to email me with any questions you may have.

CLICK HERE TO LEARN MORE ABOUT OUR COLLECTIVE

Good morning!

In this week’s Dirty Dozen [CHART PACK] we walk through positioning indicators for the equity market and check out the worst 5-day fund flow streak for an ETF in over a decade. We then look at some dollar charts that suggest a short-term bottom in the USD may be near while the longer-term outlook doesn’t look so hot. We then end on a positive note for the broader US macro picture.

Let’s dive in.

***click charts to enlarge***

  1. UBS’s US Composite Positioning indicator, which measures the active manager positioning using a “proprietary database of over 930 MFs with AUM of $5.5trn across US equity MFs and allocation funds”, shows that the big players, on the whole, are under positioned risk. Though they’ve been aggressively working to correct this over the last couple of weeks.

 

  1. But that under-positioning has been somewhat balanced out by the speculative fervor that shows in the options market where Put/Call Ratio MAs (inverted) are at levels that create fragility and tend to preceded decent-sized corrections. One major reason why the odds favor a continuation of the move lower this week.

 

  1. Vanguards Total Stock Market Index (VTI) saw its largest 5-days of outflows in over a decade last week. Hmm…

 

  1. Copper is the market you want to follow for sniffing out early trends in global growth. A promising sign on that front is that the cash market / 3-month copper curve is close to flipping into backwardation. This implies a tightening market and likely higher copper prices ahead (chart via Bloomberg).

 

  1. According to CS 42% of Russel 2000 companies have negative earnings. That’s the highest on record. Now, there are two ways to look at this (1) wow, this is really bad or (2) huh, this is maybe as bad as it can get and perhaps a bottom is near for small-caps? I don’t yet have a strong side.

 

  1. This other chart from CS shows the differences in COVID trends between those states that opened early and those that didn’t. I get the sense that that COVID and the lockdown risk narrative might be coming back to the fore.

 

  1. In a recent note, DB pointed out the tightening supply dynamics in the oil market. They wrote “US oil production dropped by a very large -600kb/d this week equalling the 3 April decline, while the oil-directed rig count also fell by a further 10 rigs. Oil production from the US has now given up two full years of gains.” That’s quite significant…

 

  1. Here’s some good news. More US companies have been offering a brighter financial outlook than a gloomy one as the quarter comes to a close (chart via Bloomberg).

 

  1. Last week CS made the bear case for the dollar, pointing out its 1.5stdev overvaluation and the deterioration of the US’s net investment position over the last decade and a half.

 

  1. While I am sympathetic to the bearish USD case over the longer-term. I’m becoming quite concerned that the opinion is nearing a consensus — at least at the IB level, if not the broader market (yet). Plus, positioning is nearing levels that have marked short-term bottoms for the DXY in the past (chart via UBS).

 

  1. The Conference Boards Leading Economic Index YoY% recently turned up from its lows. Now, it’s too early to say whether this is a change in trend or just a bump along the road lower. But…

 

  1. If it is a change in trend then that’ll bode very well for the stock market. Because, when the LEI YoY is below zero and rising, the equity market tends to have its best average annualized equity returns — averaging 29.5%, which isn’t too shabby.


CLICK HERE TO LEARN MORE ABOUT THE MO COLLECTIVE

 

Stay safe out there and keep your head on a swivel.

Monday Dirty Dozen [CHART PACK]

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You cannot trade the market. Instead, you can only trade your beliefs about the market. However, you can only do that successfully if you understand the fundamental concepts behind low-risk ideas, expectancy, and position sizing. ~ Van Tharp

In this week’s Dirty Dozen [CHART PACK] we look at a record high in the DIX index, giving a very bullish signal. We then cover the troubling change in COVID trend growth in some US states and what they could mean for markets. And finally, we end with some charts showing the historical value opportunity on offer in select European markets, plus more.

Let’s dive in.

***click charts to enlarge***

  1. This is an interesting chart from @MacroCharts. He tweeted “When the history books are written about 2020… Save a page for how Stocks plunged at the fastest pace ever – and nearly all News Stories contained the word “BUY” at the *exact* bottom.

“It may have been the ONLY time in history this ever happened. Time will tell… Yolo!”

 

  1. Three weeks ago I shared this DIX chart from @SqueezeMetrics pointing out that the index had hit an all-time high. Well, last week it once again broke that record. This is incredibly bullish as it shows large players are purchasing big blocks of stocks in off-exchange transactions. You can find more info on the DIX here.

 

  1. Bernstein published a report on US COVID trends recently where they point out the troubling trend in case growth amongst many US states. In the chart below, they show their projections for where daily new cases could be headed should this rise go left unchecked.

 

  1. This matters to the markets for a number of obvious reasons. One of them being that a rising case count raises the likelihood of a return to shutdowns. This chart from DB shows the relationship between market volatility and global case growth.

 

  1. COVID-19 has acted as an accelerant on many existing trends such as the rise of e-commerce. This chart from RBC Captial shows that despite the rebound in brick and mortar based shopping, the trend growth in online shopping hasn’t slowed.

 

  1. There’s a lot of funky charts out there that are just complete head-scratchers. Take this one from DB for example, the percentage of US consumers expecting the economy to be worse off in 6-months time is at its highest print in 10-years. At the same time, those expecting things to be better in half a year is at its highest level ever. I’d be interested to see how this splits out according to political leanings.

 

  1. On a similar note, we haven’t seen too many other times throughout history where consumer confidence (red line) and the market (white line) were this disconnected.

 

  1. Nearly 20% of US companies now classify as “Zombie Firms” according to DB. A business gets classified as a zombie when there debt servicing costs are higher than there profits. This is not good for a capitalistic system. We are seeing our markets disintegrate in real-time and it doesn’t seem like we have any reasonable people driving the bus, who could possibly redirect course from here.

 

  1. I’ve been pointing out the attractiveness of some European and EM markets in these pages over the last two months. Here’s a group of charts from MS that help make the bullish case for Europe.

 

  1. And within Europe, you might want to look at value stocks from the periphery seeing as how both groups are at or near historical record low valuations (chart via MS).

 

 

  1. Citi’s Bear Market Checklist is still not giving an imminent warning of a bear market. Their checklist is only showing a reading of 30% of red and amber signals. You need a reading of above 50% to signal a bear ahead.

 

  1. One of the strongest looking sectors from a technical standpoint right now is Biotech. The biotech index went out last week on its highs and at all-time highs at that. The space has also large outflows recently which is generally a bullish sign when combined with contrasting price action.

Stay safe out there and keep your head on a swivel.

The Narrative Pendulum

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Fractalized sine waves are encoded into the very fabric of our reality. Like the Golden Ratio and the second law of thermodynamics, they appear throughout the universe on nearly every level of scale and function. It’s no surprise then that they underlie the structure of our market.

This makes intuitive sense because a sine wave is just a continuously swinging pendulum. And crowd dynamics naturally follow the path of a pendulum. Swinging from one local extreme to another. 

The market is in effect a large complex information transmission system. All acting participants make bets using their particular knowledge set which then in aggregate sets the market price. This, then, provides new information for the actors to incorporate into their decision-making process so they can then make new bets. Thus, creating a neverending feedback loop of information, assessment, action, new information.  

These infinite feedback loops, when combined with group psychology and crowd dynamics, necessitate the constant back and forth we see in markets.

Each rally sows the seeds for a reversal and each reversal sows the seeds for a rally. Ad infinitum. 

Michael Mauboussin discusses how this dynamic creates a neverending process of market trends and crashes in a paper titled “Who Is On the Other Side?”. In it, he shares work done by economist Blake LeBaron which animates this concept using an agent-based model (here’s a link to the original paper). 

The model is computer generated and the “agents” are imbued with decision-making rules and objectives similar to those that drive market participants (i.e., make money, try not to lose money, don’t underperform the average for long periods, etc…) 

Here’s a section from the paper (emphasis by me): 

LeBaron’s model replicates many of the empirical features of markets, including clustered volatility, variable trading volumes, and fat tails. For the purpose of this discussion, the crucial observation is that sharp rises in the asset price are preceded by a reduction in the number of rules the traders used (see exhibit 5). LeBaron describes it this way:

“During the run-up to a crash, population diversity falls. Agents begin to use very similar trading strategies as their common good performance begins to self-reinforce. This makes the population very brittle, in that a small reduction in the demand for shares could have a strong destabilizing impact on the market. The economic mechanism here is clear. Traders have a hard time finding anyone to sell to in a falling market since everyone else is following very similar strategies. In the Walrasian setup used here, this forces the price to drop by a large magnitude to clear the market. The population homogeneity translates into a reduction in market liquidity. 

“Because the traders were using the same rules, diversity dropped and they pushed the asset price into bubble territory. At the same time, the market’s fragility rose.”

 

Really grokking this concept and understanding how this plays out in markets is critical to learning to play this game at the second and third levels and beyond. It’s the fundamental difference between being a reactionary self-proclaimed contrarian that routinely gets steamrolled by price-trends. And an effective contrarian, who knows how to read something I call the “Narrative Pendulum”, which allows you to get on and stay on the right side of the trend. 

I talk about this concept in-depth in a recent video I put together. If you’re interested in giving it a watch just click the link below. It’s free and doesn’t require anything on your end, other than just an hour of your time. But I promise the information is illuminating and will change the way you view and interact with markets in more ways than one.

Video: How To Read the Swing of the Narrative Pendulum

I’d love to hear your feedback after you’ve given it a watch. Just shoot me an email at alex@macro-ops.com with any Q’s and comments you have. I look forward to hearing from you!