A Trembling Market
NewDeal Invest
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WEEKLY UPDATE
A significant macro week with a hefty stack of earnings reports
Let’s state it right away: This has been a week with plenty of action and significant fluctuations. After a slow start to the week, we received inflation data from Europe on Wednesday showing 2.6%, which was slightly higher than the market had hoped for.
Later that same day, we kicked off the week’s central bank meetings with the Bank of Japan going against the grain by raising interest rates by 0.25%. The aim of diverging from other central banks was to address the very weak yen, which investors rewarded with a rise. However, Japanese stocks were hammered down by 8% for the rest of the week as it became more expensive for foreign investors to buy into Japan with a stronger yen.
The Bank of England went the other way, cutting interest rates for the first time since early 2020, though it received little market notice.
The FED, on the other hand, kept rates steady on Wednesday, also as expected. However, soft rhetoric regarding the September meeting further supported the market’s expectation of a rate cut at that time.
Thursday began with bad macro news from the US ISM number, which is a measure of purchasing managers' sentiment about the economy, with a reading above 50 indicating economic growth and below indicating the opposite. Particularly surprising were the purchasing prices on the upside at 52.9 versus the expected 51.8. At the same time, expectations for hiring and new orders were disappointing, with readings of 43.4 and 47.4 versus expected 49 and 49.3, respectively. This was the lowest number since November 2023, when this round of stock gains began.
The week ended with a disappointing job report on Friday, with only 143,000 jobs created versus the expected 175,000. This further fueled recession fears and led to red markets across the board. The declines following both the disappointing PMI numbers and the job report were somewhat unexpected. We have long seen stocks rise when weak data has reinforced expectations of US rate cuts. But this was not the case this week, and it shows that investors are currently nervous about a potential recession impacting company revenues, with rate cuts not being sufficient or timely.
Earnings Reports on the Disappointing Side
In a week characterized by the forementioned weak data, a number of earnings reports from major tech companies were also released. Mixed results from Microsoft, Meta, Apple, Intel, and Amazon led to large fluctuations throughout the week. We can’t say that the earnings reports were outright bad, but we must acknowledge that substantial positive surprises will be needed before investors reward with further stock price increases.
NDI-FutureTech
Buy tech stocks when fear is at its highest
NDI-FutureTech fell by 10.5% this week compared to Nasdaq’s decline of 3.4%. Another relevant index that we have referred to multiple times in this newsletter is the Bessemer Venture Partners Cloud Index. This index tracks publicly traded growth companies, especially in cloud software, and is down 7.4% for the week.
NDI-FutureTech's larger decline compared to Nasdaq and the Bessemer Venture Partners Cloud Index is due to our broader tech exposure compared to Nasdaq and Bessemer, which are both fairly concentrated on large cap and mid cap stocks. NDI-FutureTech's larger share of small and mid cap tech results in greater stock price fluctuations, both when the market falls due to fear and also more significant upward movements when fear subsides. For example, we have seen the following companies with large price movements during the week:
However, nothing has changed in the long-term investment theses for these three companies (or the tech sector as a whole). They will all benefit significantly from developments in computer technology over the next 5-10 years. But the companies' market prices have now fallen substantially, providing opportunities to buy the stocks or a broader tech investment like NDI-FutureTech at a much more attractive price than just 1-2 weeks ago.
So, we encourage considering using this drawdown to buy tech stocks. It should be noted right away that we cannot predict whether prices will fall further before they turn around. But what we point out is that stock prices have fallen significantly over the past month, and given the potential they collectively possess, it is probably a good opportunity to get on board.
Generally, tech stocks offer high long-term returns if invested correctly, that is, in a highly diversified manner, and they offer even higher long term returns, if one takes advantage of the fluctuations that inevitably come during periods of greater market uncertainty.
Tech stocks are difficult to price because earnings typically lie years into the future, and those earnings are hard to forecast. Compare NVIDIA with Coca-Cola. To price the stocks, we need to estimate future earnings, which means estimating the total market size, the company's market share, and the profit margin. For Coca-Cola, which produces soda, it is reasonable for the stock market to estimate the size of the total market, Coca-Cola's market share, and Coca-Cola's profit margin over a 5-10 year horizon. Think through the same exercise with NVIDIA, Arm, and Tesla, and you can understand that these companies can double or halve in price depending on the mood of the stock market!
Earnings galore
Some stocks rise 20% on earnings, and others fall 20%. These dramatic fluctuations are often due to random variation in quarterly numbers, resulting in significant fluctuations in the company’s present value. This is because future earnings in a company are modeled in a way where the current quarter and the company's guidance for the next quarter serve as the basis for exponential growth over many quarters. Therefore, it is entirely natural and inevitable that there are strong stock reactions to seemingly small adjustments in the quarterly numbers.
Whether a stock moves up or down on earnings day depends solely on market expectations. If the market has guessed too high, the stock falls, and if the market has guessed too low, the stock rises.
At NewDeal Invest, we analyze companies with a focus on their technology and long-term competitiveness. We do not try to guess the market’s reaction to earnings but consider the market’s pricing relative to our view of the company and alternative investment opportunities. Therefore, we view both the current drawdown and the significant stock fluctuations through the earnings season as good opportunities to generate additional returns for our investors.
Our View on various stock Segments
Big Tech
Big Tech earnings reports revealed that investments in AI infrastructure are expected to grow in the future, what’s called CapEx investments. This means these companies are shifting from being software companies with “zero marginal costs” to becoming production companies, AI factories, that produce ‘tokens’. Factories do not have zero marginal costs but rather benefit from economies of scale. Our view is that Big Tech's opportunity to establish economies of scale within AI infrastructure is highly attractive to investors in the long term (3-5-10 years).
BUT in the short term, it is possible that the stock market will be concerned about rising investments, which will lead to increasing depreciation, negatively affecting earnings per share, and this will put pressure on stock prices over the next 1-2 years. Our strategy at NewDeal Invest is to be underweight in Big Tech, so any potential weak stock performance in Big Tech relative to small and mid cap tech will give us the opportunity to accumulate in Big Tech over the next few years.
Data Center Segment
AMD with 115% growth in the server segment. Intel with disappointing numbers (as expected). Vertiv Holdings with guidance worse than expected. Arista Networks and Celestica report solid demand. We generally see the current correction as a good opportunity to increase exposure to the entire data center segment.
SemiCap Sector
Has concerningly high revenue from China, and pricing is high, so here we are very cautious. We don’t foresee a major downturn in this segment, but given the political risk, it is also hard to imagine significant stock price increases. Therefore, we prefer to focus on other segments of the chip sector, as well as small and mid cap tech.
PC and Phone Chips
The cyclical downturn is ongoing, but we expect recovery in the fall with the advent of AI-enhanced phones and PCs. Companies like Apple, AMD, Intel, Qualcomm, and Arm are expected to see potential growth in this area.
Auto and Industrial Chips
Currently, there are no signs of recovery. We speculate that the bottom may be reached by 2024 or early 2025. We are cautiously accumulating stocks in this segment, including ON Semiconductor, STMicro., Infineon, Texas Instruments, Lattice Semi, Nordic Semi, Silicon Labs, Navitas Semi, Aehr Test Systems as well as Qualcomm, Arm and AMD. We are buying slowly during downturns and planning to invest significantly when the cycle begins to turn.
Small and Mid-Cap Tech
As always, the earnings reports are a mix of surprises. Small and mid-cap tech stocks have been selling off sharply due to recession fears and concerns about potential delays in rate cuts. This is a classic scenario where fear sets the price, and it is generally a good time to buy these stocks. We will continue to monitor and invest accordingly.
NEXT WEEK
A calmer week ahead
With most of the major tech companies having now presented their financial reports, and as we are more than halfway through the earnings season, the coming week will be somewhat quieter in comparison. The most notable ones in tech are Shopify, Uber, Super Micro Computer, and Sony, and then the small and mid-cap segment will really start to release their reports.
Following this week’s mixed economic data and interest rate decisions, upcoming US job data will be of particular interest. These numbers will provide further insights into the potential for a recession and the timing of rate cuts.