Written in December 18th, 2017.

The Falling of Global Tech Stocks is an Adjusting Phase Towards the Final Boom

An opportunity to buy carefully for the possible new height in price of the industry

Arriving in December, President Trump’s tax reform has encouraged a new climax in the U.S. stock market. Yet, the tech stocks that have been doing well over the year, are suddenly facing an invisible wall. Looking at Nasdaq, SOX, or tech-stock based stock markets like Taiwan and China, are all performing weak in trend. What does this phenomenon of weak performing mean exactly? Is it the beginning of a downturn of the economy, or a resurfaced opportunity to invest? It is our belief that even though the price of the stock market is rather high, and the economy cycle is gradually pacing towards a later phase, the expanding cycle of tech industry is not yet over. The falling and adjusting of the stock markets this time is a step towards a greater boom. Investors should seize this opportunity and invest with caution.

We are optimistic that in the near future, tech stocks would take the lead again, and become a major force in the later phase of the bull market, for four fundamental reasons:

1. U.S consumer spending and consumer electronics retails are growing strong:

The first thing we need to look into is the U.S. consumer spending needs, and a prior background knowledge needs to be addressed here first. This article will not be discussing market needs other than U.S., and for a reason: The current global consumer spending increase, especially the technology products sales, is basically driven mainly by the U.S. We can see it in Chart 1, though China, Europe and Japan, and other emerging markets are also with enormous economic volume, when looking at the volume of domestic consumer spending, they still have a certain gap comparing to the U.S. (The domestic consumer spending total in U.S. roughly equals to China, Japan, Germany, India, Britain, and Brazil combined). In other words, the status of U.S. domestic consumer spending alone is enough to determine the trend of global consumer needs. Applying it to the analysis, as long as we can ensure the exact trend of U.S. consumer spending, pairing it with the leading role of U.S. in technology research and development and sales, we can have a better understanding of the layout of the global industries. Thus, there is no need to do other pointless analysis.

Chart 1: In 2006, the volume of U.S. domestic consumer spending alone is 44% of the top 10 countries combined.  Unit: Million of Dollars  Source: Euromoniter International

Looking at Chart 2, U.S. has gone through a stronger Q2 and Q3 in economic growth (at 3.1% and 3.3%), yet the growing pace is still going. The latest sales report in November has indicated that the domestic consumer spending has come to a high spot that is rarely seen over the past few years, with YoY growth at 5.8% (the YoY in Chart 1 indicates the advance real sales YoY that has deducted inflation influence, still the over 3% growth is the highest over the past three years). The consumer spending will be even stronger coming into the shopping season, meaning that the GDP in Q4 will undoubtedly reach over 3% in three consecutive quarters. How difficult can it be? Last time we have seen a three consecutive quarters GDP YoY over 3% is back in 2005, which is 12 years ago! After a year that President Trump took office, this is a pretty impressive performance in economy.

Chart 2: Advance Real Retail and Food Services Sales YoY (Red) vs Advance Retail Sales of Electronics and Appliance Stores YoY (Blue) – both perform well, and the sales of electronics keep rising  Unit: %  Source: FRED

Would such strong performance in economic expansion benefit the tech industries then? It would all depends on the consumer spending. Looking back in the past 30 years, we can realize that even in the period of economic expansion, electronics sales has its pattern and cycle. When the growth has lasted for 3-4 years, it would arrive at a plateau period and then facing an adjusting phase or even a bigger decline. In a normal economic expansion cycle, a negative growth period as in 2015-16 is a rare occurrence, which is also the main reason that Taiwan stock market (2015) declined into an adjusting phase from the 10,000 point mark. However, starting in the second half of 2016, the needs for electronics has increased drastically, reaching at 6.4% in YoY in November, a best record since 2011. Referring to the past experience, when the trend of electronics sales is certain, the chance of it going the other way is unlikely. Thus, it is safe to say that the technology consuming cycle is not yet over.

2. Economic growth and tax cuts will stimulate the private sector investment in U.S., benefiting tech stocks

Besides consumer spending, another source driving the growth of tech industries is the private sector investment. Considering that when building a competitive edge in production and sales, the needs for upgrade in both technological hardware and software have always been the backbone of private sector investment. And judging from the past experience, the expansion of corporate profits (Chart 3) is essential to the growth of private sector investment. A certain order is related to the both, in short, the growth in profits would encourage the needs of investment, but excessive investment would eventually kill the expansion in profits. Thus, the expansion in profits would take place first, then the bigger investment frenzy would initiate. We can see it in both 2001 and 2009 at the beginning and the end of economic cycle, that the corporate profits has improved significantly, and the private sector investment began to increase gradually. And since that in 2015, U.S. and the global economy have faced a setback causing the corporate profits to fall, also slowing the pace of private sector investment. Yet, we can clearly see that this year, corporate profits is starting to improve significantly. Combining it with the fact that as the tax cuts deploy next year with a booming economy, the corporate profits will definitely climb to a different level, resulting in a new expansion of private sector investment.

Chart 3: US Corporate Profits (Black) vs US Gross Fixed Capital Formation (Blue)  Unit: Billion of Dollars  Source: Tradingeconomics

Let’s look at another more acute numbers! The important categories of New Orders for Durable Goods (detailed in my publication) that we continue to follow. As in Chart 4, whether the New Orders for Durable Goods of Computers and Electronics Products (Red) that representing the whole industry aspect or the New Order for Durable Goods of Electronic Components (Blue) that relating more to Taiwan, both have reached a new height in October since the economic recession, and the growing trend keeps going strong. Noticeably, the situation of this industry expansion seems to have rid of the patterned cycle since 2000, and more like the industry boom bubble back in the 90s. Still, whether it would become such a trend still need more observation, but as the private sector investment remains increasing, the boom of tech industry would not suffer the downturn at this moment.

Chart 4: U.S. Durable Goods: New Orders for Computers and Electronics Products (red) vs New Orders for Computers and Electronics Products: Electronic Components (blue), both have reached a new height in the decade.  Unit: Million of Dollars  Source: FRED

3. Tax Reform will not be a short side for tech stocks, tech stocks profits are still growing fast

Finally, we will be discussing that since President Trump’s Tax Reform made a breakthrough in the GOP majority Congress, the market begins to see tech stocks and the tech industry as a “punished” industry, which is a huge misconception. Obviously, as Goldman Sachs has evaluated, since the real effective tax rate is lower, after the Tax Reform is passed, the overall profits of the tech industry will decrease, unlike other industries (Chart 5). Yet, this does not constitute a reason to look down on tech stocks, how so?

Chart 5: After the Tax Reform, the profits of the tech industry will decrease.  Unit: %  Source: Goldman Sachs

The reason is simple, tech industry is still the one industry that has the most potential in earnings. We can see it clearly in the Factset report, tech industry is one of the few that keeps adjusting the forecast of earnings upwards. As in Chart 6, 7, 8, the forecast of earnings in Q4 2017, 2017 and 2018, the adjusted values have all surpassed the forecast values. The speed of growing earnings of the whole industry this year, is only behind the Energy/Materials industries due to their low baseline last year. Even comparing it to the Energy/Materials and Financials industries (low baseline this year as well) next year, it only falls a bit behind, which the earnings growth is better than the market for two consecutive years. If such trend is solid, then the decline this time due to the market atmosphere, would be a good opportunity to invest.

Chart 6: S&P 500 Earnings Growth: Q4 2017

Chart 7: S&P 500 Earnings Growth: CY 2017

Chart 8: S&P 500 Earnings Growth: CY 2018
Source of the above: Factset

4. Oversea capital reflux due to Tax Reform will significantly benefit the tech industry

The last point that most have neglected, is the tax cut for oversea capital reflux that the Tax Reform planned to do. This could stimulate the tech stocks in both fundamental aspect and issue aspect. Why? The reason is that once the reflux of huge oversea capital occurs, they can only be utilized in three ways: 1. raising the payroll to maintain the competitiveness and attraction of the corporations in the job market. This would then encourage the overall consumer spending, and as we have mentioned in the first part of this article, consumer spending and tech consuming cycle is highly related, which is the first good news. 2. More possibly, the corporations would use the capital to do necessary investments, and as the second part of this article mentioned, private sector investment frenzy and the tech cycle is highly related too, which is the second good news. These two points are basically the trend following the fundamentals.

But the one that has more potential is the third aspect, the stimulation of the issue aspect! When the huge oversea capital reflux occurs, they would likely be used to issue more dividends, apply treasury stock, or conduct business mergers across or within the industries! Then, the ones that possess more oversea capital will be the ones that become the center of attentions in the market next year.

Chart 9: S&P 500 total sum of oversea earnings, mainly concentrated on tech stocks.  Unit: Billion of Dollars  Source: Factset

Form 1: Top 10 U.S. companies with overseas cash/total cash & marketable securities, including 6 tech companies and taking the top 5 spots.  Source: Bloomberg

What are the companies? As in Chart 9, the tech industry is obviously the one that has the most capital overseas. Form 1 also indicates that top 10 U.S. companies that hold most overseas capital, there are 6 tech companies (GE excluded) in them; comparing to other industries, they have a crushing advantage. In other words, if the Tax Reform is passed successfully, looking from fundamental aspect or issue aspect, tech stocks should not be the abandoned ones in 2018. More likely, they will be great investment opportunities that investors should wisely invest, and wait for the industry to reach its height to receive a rewarding gain.

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Disclaimer

The information and comment in this article is for reference only. Readers using this website should acknowledge that the company shall not be liable to you for any direct, indirect, punitive, incidental, special or consequential damages arising out of or in any way connected with the use of or access to the website or for any information obtained through the website. Any reliance upon any such opinion, advice, statement, memorandum, or information shall be at readers’ sole risk.

Written in Feb 13th, 2017. 

Cheap U.S. dollar presents the opportunity to buy in, waiting for another grand bull market trend to reappear.

US Dollar Index will reach a new height since the recession.

In the course of the past two years, as United States ended the QE stimulus programme and started the rate-rising cycle, US Dollar Index has begun its long-term bull market trend. However, since the market fluctuates rapidly, if investors fail to trade in the right moment, starting to move along with the market atmosphere, it would often end up chasing for nothing. On such note, it is pleasing to see that over the past two years, we have pointed out in June 2015 and July 2016 that the right timing for buying US dollars (see chart 1). And by reviewing the outcome, our strategy is spot on. In this article, we are to inform you that after the correction happened at the beginning of this year, US Dollar Index is now showing an excellent opportunity to invest, and this time the gain will be significant.

Chart 1. The red circles show the timing when we predict longing U.S. currency over the past two years, providing investors decent returns.  Unit: index  Source: Marketwatch

Why is the upcoming quarter the perfect opportunity to invest in US dollars? There are three major factors based on the economic fundamentals that will lay out a great chance to buy in at a lower price.

A. The trading statistics indicate that US dollars will go weak then strong.

Chart 2. U.S. imports (blue) vs exports, imports is speeding up faster than exports.  Unit: index   Source: FRED

As the US and global economy are starting to expand prominently, the status of US import and export keeps getting better (see chart 2). Specifically, the import numbers are showing a great acceleration. It suggests that besides the increasing actual needs that contribute to the numbers, there are other factors at play! What is the cause of it? Basically, it is related to the Border Adjustment Tax that President Trump and Republican congress are beginning to discuss. The new tax bill is going to charge all import goods a 20% import duties (the tax rate is undetermined; it resembles other countries’ import value-added tax), and duty free for export goods. The bill will be going through the legislative process approximately this spring; therefore, companies with import business will begin to increase their imports as early as possible, in order to avoid the impact of the new tax bill. And due to the recent spike of sales in US, the inventory level has come to a new low point of the last two years. Thus, the increasing needs for import goods will become more apparent in the next six months (see chart 3).

Chart 3. U.S. inventories to sales ratio: steadily improved in last year, companies worked hard to digest inventories.  Unit: %  Source: FRED

Under such circumstances, since that current account is the key element to determine the long-term trend of exchange rate, during this short period of expanding imports of goods, US dollars will suffer from certain pressure, and also affecting the trend of other currencies. However, making early expansion of imports still has a limit. As the details of the new policy settled, and putting in motion in the 4^th quarter this year (new fiscal year in 2018) to next year, such increasing needs for imports will be replaced by another cycle of dealing with inventories. Then, the whole trading trend and other non-US market’s exports needs will be reversed, or even emerges a bigger need gap. Then, the US trade deficit will significantly decrease, and so will other countries’ trade surplus, which would lead to US dollars appreciating to a new height.

B. The inflation statistics indicate that US dollars will reach the bottom and bounce back.

The second factor that the US dollars will gradually reach the bottom and start to bounce back is the trend of US inflation. It will significantly affect the interest rate of US in the future, and also affect the possible trend of US dollar Index. The numbers of inflation are relative, which means that the inflation numbers of US should be compared to other major corresponding countries. And looking from US Dollar Index’s point of view, it would be the trend of Inflation in the euro area. We can see in chart 4, since 2011, the numbers of US inflation usually are better than the ones in euro area. In that case, the US currency strategy comparing to euro area is rather tighter in a long term period. This is also the reason that the bull market of US dollar has continued for six years.

Chart 4. Trade weighted U.S. Dollar Index (blue) vs Harmonized Index of Consumer Prices in Euro area YOY (red) vs Consumer Price Index YOY in U.S. (green)  Unit: index, %, %    Source: FRED

And the most important reason causing the recent euro bounce back, and the US Dollar Index setback, is because of the inflation in euro area has started to warm up. In December, the level of inflation has reached a new height of 1.1% in the last three years. As the base period is lower, the level of inflation in euro area can maintain at 1-1.5% in the first half year. It is safe to say that the deflation crisis of euro area is relieved momentarily. As to the reason that the inflation level can rise in euro area this time, besides from its own gain of economic recovery, a great deal is contributed from the rising oil price and strong US currency. Since the rising price of commodities affect the inflation in both US and euro area, the rise of inflation level in euro area is greatly contributed by the strong US currency. In other words, US currency needs to stay strong, for euro to have the capacity to continue improving through inflation, and in the longer future, has the chance to shift the currency policy and stimulate the euro to appreciate. Yet, this scenario still needs time to accumulate to realize, and it will not take place in this year at least.

Why? The main reason is the new policy of custom duties of Trump government we mentioned above. It will not only greatly increase the imports price level, but also increase the price of domestic commodities (since oil and commodities imports currently do not seem to be duty-free). This will heat up the possible gradual inflation in the later half year that benefits from low base period. Then, combining with a booming employment market, tax cut and expanding infrastructure constructions all in motion, the inflation level and interest rate of US will significantly increase and accelerate, and pushing the US dollars to appreciate.

C. US economic growth is still better than other major countries.

Chart 5. U.S. GDP YOY (red) vs Euro area GDP YOY (purple) vs Trade weighted U.S. Dollar Index (green)  Unit: %, %, index    Source: FRED

The last key factor that will affect global currencies and capital movements, is the economic fundamentals. We can see in chart 5, Trade Weighted US Dollar Index in the past twenty years has gone through two bull market and one bear market cycle. The most important factor relating to this, is that after European Union expanded east, there was a rapid growth in euro area in the beginning of this century, and US Dollar Index is also at a relatively high position. Then, the decline kept moving downwards, until after the recession in 2008. After the recession, due to the European debt crisis and the new emerging European market began to stale, the economic growth of euro area started to fall behind US.

What about the future? Although the economic growth in the euro area last year (2016) finally surpassed US in the past ten years (1.7% vs 1.6%), US Dollar Index also began to go weak in the start of this year, this is not a shift of the long term trend. As shown in chart 6, in the first three quarters of last year (the statistics of the 4^th quarter is not yet announced when this article is written), the needs of exports (first chart to the left) has been a great help. Even though the domestic needs in the euro area has increased, it is roughly the same as the recovery base period since 2014. And last year, the private investment and inventories in the euro area for the first three quarters are pretty weak. This circumstance is very different from US, for its economic growth is basically all supported by the private consumption (see chart 7). Last year, the increase of domestic needs in US is doubled than the euro area. The increase of domestic needs is the most important factor of whether the local economy can maintain a long term expansion. In other words, the prominent economy performance last year in the euro area, or to say that the euro area can recover and start heating up the economy, the weak euro currency leading an increase in exports needs is notably the great help.

Chart 6. Net exports to GDP (left) , Private Consumption Expenditures to GDP, Investment and Inventories to GDP    Unit: %    Source: FRBNY
Chart 7. U.S. Personal Consumption Expenditures: supporting the entire GDP growth    Unit: %    Source: FRBNY

Obviously, due to last year’s lower base period of private consumption and investment in the euro area, it should be doing rather well this year. However, the base period of US private investments and inventories is also pretty low, and should be doing pretty well this year. Overall, the euro area still relies on the increase of exports needs, and the benefits of lower base period, thus, the trend of surpassing US economy growth might just be a spark in the pan (the numbers still need to be confirmed and finalized as well since the US GDP in the 4^th quarter and last year might have a small increase). This year, US will still beat the euro area in economic growth at about 0.5%-1%. Thus, the bull market trend for the US currency will maintain its course.

Investing timing: seize the moments before the 3^rd rate rise and invest separately.

Due to the early imports trend in US, that ignites the market sales and early consumption sales, the price of commodities in the market will rise, and eventually resulting the booming capital market in US and the globe, and heat up the trend of inflation. Thus, whether there would be a rate rise in March or not, it is certain that there will be a third rate rise in the first half year. According to the experience in the past three years, three months before the announcement of major currency policy is the best time to buy in US Dollar Index. The three time period are listed below (can also see chart 8):

1. October 29^th, 2014, US ended the QE stimulus programme (the end of currency easing cycle).
2. December 16^th, 2015, the first rate rise for the past ten years in US (the start of currency tightening cycle).
3. December 14^th, 2016, the second rate rise in US (confirming the currency tightening cycle).

The three time periods are the green circles in the chart below. The purple circles are the periods three months before the according rate policies, which are the best timings to long the US Dollar Index.

Chart 8. U.S. Dollar Index chart in the past three years: three months before crucial decisions are the best timings to buy in.    Unit: index    Source: Stockcharts

Simply put, investment is to buy at the expectation and sell at the realization. When rate rise is a reality, and everyone is optimistic about US currency, and not so excited about euro and emerging markets currencies at the start of this year, US currency began to depreciate, and euro and emerging markets currencies are doing rather well. And when the public starts focusing on markets outside of US and emerging markets’ increasing economy growth, and neglects the possible impacts of the next rate rise, it would then be a good timing to start invest in US Dollar Index! Besides the US Dollar Index will have a steady position in the upcoming quarters, as the influence the rate rise sets in, it will cause the capital market and emerging markets currency certain amount of pressure. Therefore, you can long the US Dollar Index at a lower price at the time period we have suggested in the past two years, you should also do the exchange of other currencies (including US Dollar Index currencies, CNY, NTD, and emerging markets currencies) to US currency in the second quarter, in order to avoid the depreciation risk resulted from the rate rise cycle each quarter in the US.

Disclaimer:

The information and comment in this article is for reference only. Readers using this website should acknowledge that the company shall not be liable to you for any direct, indirect, punitive, incidental, special or consequential damages arising out of or in any way connected with the use of or access to the website or for any information obtained through the website. Any reliance upon any such opinion, advice, statement, memorandum, or information shall be at readers’ sole risk.