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  • Could China Conflict Curtail Chip Comeback?

    At the recent trade talks in South America, the US and China both kicked the can down the road as neither one were obviously willing to do a deal nor had done any background work to get a deal done. Instead we have a bunch of empty promises and vague and conflicting descriptions of what was not really even agreed to.

    Essentially worthless
    However, the market was happy that nothing happened as stocks rallied based on hope that something might happen in the future as the alternative of continuing on to higher tariffs was an unpalatable alternative.

    The semiconductor and tech industries remain at the core of the trade conflict and perhaps are the most critical and difficult trade issue to resolve. While selling soybeans may feed a few more people more food, chips and the technology infrastructure associated with them represents technological and therefore military dominance between the two superpowers who are locked in a new struggle with technology substituting for thermonuclear devices.

    At some point we will likely no longer be able to kick the can further down the road and we will need to resolve trade issues. The longer the delay, the better off for China as they have the current advantage. Much as with North Korea, where a similar can has been kicked down the road with no agreements or resolution sooner or later there will be an explosion (figuratively or literally).

    Even though there was talk of a 90 day timer, even that information was conflicted as it was unclear whether it was 90 days from the dinner or 90 days from January 1st (90 days or 120 days??). Our view is that by not addressing the issue it will come back some time in the spring.

    Article: No EUV before 7nm?-michael-ramirez.jpg


    The sword of Damocles gets frozen
    From a stock perspective, the near term pressure is off so the stocks have popped. However we think that investors need to be aware that the sword hanging over tech stocks did not go away but is just delayed.

    While tariffs are not going further up they are not going away and espionage is still ongoing.
    We don't see China/Xi as caving in over the next 3-4 months (much as Kim in North Korea hasn't caved). In fact, it would appear the US was willing to kick the can down the road due to domestic issues and pressure and thus was more of a strategic win for China who benefits from a delay in further tariff increases.

    Our view is that the ongoing trade issues will be an ongoing "discount" to many chip and tech stocks that will not fully go away until we get a real, permanent resolution. This discount will likely increase as we near the end of the 3-4 month period when people will start looking for an answer. We could easily find ourselves back where we started with no real progress. We also remain concerned that tech companies could get the short shrift in trade talks as California is not the political base of the administration which seems to care more about less strategic soybeans and their farmers.

    An admission of the politicization of M&A - QCOM/NXP
    Its obviously no surprise that the Chinese admitted that the QCOM/NXP deal was sunk for political reasons. We had clearly stated this in several of our previous notes. It shows, as we had suggested, that the Chinese will use all tools at its disposal, to get an advantage in the trade and technology wars. The US administration seems to think they have the upper hand as there are more Chinese imports than US exports and therefore more exposed to tariffs but tariffs are obviously only one lever that China has to respond.

    M&A is likely more critical to US companies and thus may be more valuable than adding to tariffs. In blocking and burying the QCOM/NXP deal (which is not coming back from the dead), the Chinese blocked the US becoming even more dominant in semiconductor telecommunications technology.

    Given that China has used M&A approval as a weapon in the past, its a safe bet they will use it in the future to get their way in tech, which they clearly care about.

    KLAC/ORBK - What does the trade truce really mean?
    The knee jerk reaction is that the current truce period is likely good for the KLAC/ORBK deal approval as the Chinese probably don't want to take an offensive action during this ceasefire period.

    You can add to that logic the fact that China has approved several deals recently that are much larger than the rounding error size of the KLAC/ORBK deal. UTX's $30B purchase of Rockwell Collins was approved along with Disney's $71B deal to buy Fox entertainment.

    The UTX deal is more of a proxy for KLAC/ORBK as Rockwell Collins is a defense electronics manufacturer. While we think the KLAC/ORBK deal goes through and the trade truce is a good omen we remain concerned about the length of time for a relatively small deal as we are quickly approaching the self imposed end of year deadline for the deal. Could it be that the Chinese care more about a chip related deal?

    What will it take to make you Capitulate?
    (Apologies to Musk's girlfriend Grimes for stealing lyrics- Appreciate Power)

    In looking at AMAT's recently announced quarter, we wonder if capitulation is what it will take for the semi equipment stocks to move on and up.

    Applied had a very bad quarter with a big miss on guidance and the stock dropped sharply in the after market on the news. Yet the following day the stock seemingly recovered on no other news.

    Some investors and industry participants suggested that Applied's "capitulation" in admitting to the down cycle rather than fighting reality was the reason for the bounce in the stock in the face of otherwise ugly news.

    On the call, Applied CFO, Dam Durn, had suggested that they didn't know where the bottom of the cycle was and seemed to be capitulating to the fact that cyclicality still exists rather than trying to fight it and suggest otherwise.

    Is capitulation of the chip/tech slowdown the "cathartic cleansing" we need to have the stocks get over it and move on? Perhaps so...

    The stocks
    We have had a nice bounce off the bottom here and have gotten another bounce from the trade truce. Our concern remains that these are more emotional reactions rather than hard facts that support a real recovery and thus could be short lived.

    We are well past the peak season and holiday driven demand, of semiconductor sales and about to head into the weakest quarter of the year (Q1) for chips which is almost always a sort of postpartum period after the holidays and usually the low point for memory sales/pricing. Q1 also contains Chinese new year which also slows sales.
    This suggests that we will not get positive data over the next few weeks/ months to support the bounce or a more extended recovery.

    We might consider taking some short term gains off the table as we may get a chance to buy them back at a lower valuation.


    Also Read: Could China Conflict Curtail Chip Comeback? Part 2