Manager Comment - BlueBox Global Technology Fund, Oct 24 (and Sep 24)

September quarter results have been fairly mixed, but started with a shock: when ASML accidentally released its earnings report a day early, it revealed that bookings had missed by half, causing a sharp correction for much of tech, especially other semiconductor equipment names. This looks mistaken, as ASML is in no way a useful leading indicator for current IT demand: with lead times of years, not months, its very lumpy orders currently reflect expected chip demand in the late 2020s, not late 2024! With both Taiwan Semiconductor and Lam Research subsequently reporting perfectly good results, we took the opportunity to return our total semiconductor weight almost to its maximum, buying a new position in 科天 and adding to six of our semi-related names, which had underperformed by an average of 12% since we trimmed semiconductors in early August.

The BlueBox Global Technology Fund was down 2.4% in October, lagging our benchmark, down 1.1%. The fund ended the month up 14.9% year-to-date, very respectable in absolute terms, but significantly behind the index, up 23.3%. The main negative contributors in October were, unsurprisingly, semiconductor-related: ASML (-19%), Monolithic Power Systems, Inc. (-18%), ASM International (-15%) and TOKYO ELECTRON LIMITED (-13%). The winners were Palantir Technologies (+12%), Booking.com (+11%), Taiwan Semiconductor (+10%) and 英伟达 (+9%).

英伟达 continues to be a major problem for active technology strategies: the stock has risen 168% this year, while averaging nearly 13% of global tech benchmarks, meaning that it has accounted for the majority of the upside of the entire IT sector. The only large-cap tech stock globally that has outperformed 英伟达 this year has been 微策略 (a vast bitcoin fund with a small software company on the side). This may now present a major market risk, especially for passive tech investors, as 英伟达 is quite clearly over-earning currently, and a significant reversal could cause short-term panic.

英伟达 is a great long-term story about using parallel processing to get through lots of data very fast, and genAI is all about processing mountains of data; but 英伟达 is currently dominant because not only does it have some of the best parallel processors, but it also controls the CUDA platform upon which most AI systems are being created. Everyone therefore needs 英伟达 chips, but 英伟达 is supply-constrained at 台积公司 , its foundry supplier, giving it massive pricing power. Almost all the genAI projects, amounting to tens of billions of dollars, therefore have to pay an “NVIDIA Tax” to access the scarce chips they need.

This is not sustainable. Everyone in the IT industry (except 英伟达 ) is trying to work out how to find a good substitute for its chips in leading AI systems, and eventually someone will succeed. 英伟达 will then be faced with a competitive market, potentially leading to a sharp erosion of its pricing power. Maybe that won’t be until 2026, but possibly it’s already happened and we just don’t yet know it. Whenever that moment comes, a stock that is now 16% of global tech benchmarks could face a dramatic rush for the exit. This would drag much of tech down too … but probably only briefly, as what is bad for 英伟达 is likely to be good for AI spending: the end of the 英伟达 Tax, making investment cheaper and extending the AI boom. We would therefore be inclined to see such an event as a buying opportunity, allowing us to add to our most AI-exposed names ahead of what could be a very sharp recovery.

However, this is only tinkering around the edges: whatever the short-term outlook, we see no evidence that the overall trend of 15% growth for the Technology sector as a whole is at risk. Paying too much attention to the short-term gyrations of the market is a mistake, as in the real world vast sums are still being spent across a wide spectrum of technology, as companies develop and deploy successive rounds of tech-driven disruption in every walk of life. Technology enablers continue to be the main beneficiaries, stealing almost all the profit growth from the rest of the market, as they have done since 2007. These very profitable enablers remain the main engine of profit growth globally, giving BlueBox investors exposure to the strongest technology trends, without the absurd valuations and poor business models of many of the high-profile, but profitless, disrupters.

Old commentary from Sep 2024:

The volatility of recent months continued into September for Technology, with a sharp initial fall in tech indices, but then a brisk recovery through to month end. Equity markets began to broaden out after a period of unusual concentration, hitting new all-time highs, even as tech indices failed to regain the levels of mid-July. Semiconductor benchmarks and 英伟达 (the poster-child of generative AI) in turn under-performed the rest of tech. This feels like a healthy rebalancing of the market, but it created a mild headwind for the chip-heavy BlueBox Global Technology Fund, which was up 1.1% in September, against 1.9% for our benchmark. Year-to-date the fund is up a healthy 17.8%, comfortably above our long-term annual growth trend, but behind the benchmark.

The biggest positive contributions came from Palantir Technologies (+18%), AMD (+10%), Trimble Inc. (+10%) and Arista Networks (+9%); while the main laggards were 三星电子 (-13%), Adobe (-10%), ASML (-7%) and Murata (-5%). We trimmed Palantir and Arista, and added to ASML and Adobe. We also cut our NVIDIA position at the beginning of the month, as we were concerned by the sharp margin drop reported a few days earlier, which may indicate heightened risk that the company’s dominance of AI spend is nearing its end.

As we have noted in recent commentaries, in times of macro uncertainty July to October tends to be quite a weak period for tech markets in general and semiconductors in particular, hence several trims of our chip positions since early June. On this occasion, beyond macro concerns, a factor that may also be weighing on chip names is massive buying of semiconductor production equipment by Chinese companies: this additional capacity could threaten the market positions of several Western chipmakers; while equipment suppliers might be vulnerable to a sudden further tightening of US export controls. As a result, the year does indeed seem to be following the pattern of summer/autumn volatility and weakness, but our earlier cuts to the fund’s semiconductor weights have provided us with plenty of scope to increase them again, probably by early November, during reporting season and ahead of the US election.

However, this is very much tinkering around the edges: whatever the short-term outlook, we see no evidence that the overall trend of 15% growth for the Technology sector as a whole is at risk. Paying too much attention to the short-term gyrations of the market is a mistake, as in the real world vast sums are still being spent across a wide spectrum of technology, as companies develop and deploy successive rounds of tech-driven disruption in every walk of life. Technology enablers continue to be the main beneficiaries, stealing almost all the profit growth from the rest of the market, as they have done since 2007. These very profitable enablers remain the main engine of profit growth globally, giving BlueBox investors exposure to the strongest technology trends, without the absurd valuations and poor business models of many of the high-profile, but profitless, disrupters.

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