As technical triggers fire and fizzle and tactical traders try to be the second mouse to get the cheese, the fundamentally minded investor is waiting for a potentially significant CPI report, the start of earnings season, and the return to company-specific drivers.
Here’s the jumbled chart setup: short-term downtrend (lower highs with each bounce), caught below a sliding 20-day average and flat 50-day, attempting to make the 100-day average matter as a bottoming area, as it did nearly a year ago. Is it too cute for a close replay, or just cute enough?
Is it possible that the Dow Jones’s intraday low of around 4,278 on Monday was the low for this corrective period? Sure. If not there, how about 1% to 4% below the summertime lows? So why not?
Possibility, but it will be difficult to have high confidence in any particular scenario until we see more sustained buying demand at these levels. The prospect of a sharp break in either direction feels real in markets that have been under pressure for six weeks. The market constantly hints for conviction and sometimes needs to move the price higher to find those who have it at those levels.
So to speak, the inflation/shortage themes have become all-consuming. Of course, for good reason. Earnings season and the stock market’s reaction to what we know will be a litany of “we’re trying to figure it out, costs are going up” management calls will reveal whether or not the grip of these issues is loosening at all.
Here’s how the bond market is pricing the five-year inflation outlook (in its inherently imprecise way). Nearing springtime highs, close to the 2011 peak (close to 2008 levels), and slightly above the Fed’s comfort zone. On high alert, but not panicked. Of course, oil prices are a direct driver of headline CPI, so a portion of the breakeven move is simply math.
As shaky as the market’s footing has been, a look inside reveals a market trying to regroup after the vast majority of stocks experienced 10% to 20% drops, and a touch-and-go rotation toward reopening/re-acceleration plays is underway. Canaccord Genuity observes a rebound in the cyclical S&P sectors following their summer retreat.
Canaccord Genuity Inc.
The two-year Treasury yield ripping to a post-Covid high bakes in some Fed tightening risk, though this is partly due to the passage of time. Two years from now, in October 2023, most economists anticipate at least two rate hikes.
Today’s market breadth is strong, with about 60% upside volume, with small-caps and the average S&P stock outperforming.
Credit markets remain unmoved, with no sign of macro risk or portfolio stress accumulating to alarming levels.
The VIX is only slightly lower, just under 20, but traders should be on the lookout for more late-day fades and failed bounces as the CPI report approaches.
What to expect from the chip industry on this earnings
The highly anticipated earnings release from TSMC, or Taiwan Semiconductor Manufacturing Company, follows a stellar September performance. Last month, sales surpassed $5.5 billion, a new high for the company.
TSMC, a major supplier to Apple, has gained 8.5 percent this year and was trading at around 575 Taiwan dollars ($20.44) on Tuesday.
The earnings report comes against the backdrop of a global semiconductor shortage that has reverberated throughout the supply chain, affecting the production of a wide range of products in recent months. In response, TSMC intends to invest $100 billion in capacity expansion over the next three years.
Investors will be watching the company’s wafer demand outlook closely, as reports suggest it plans to raise chip prices by up to 20% in the near term. Other key issues to watch for include the company’s capital expenditure guidance and views on supply chain inventory.
Goldman Sachs, Inc.
According to Wall Street, TSMC’s revenue will increase by 12.7 percent over the previous quarter, with gross profit and operating margins of 50.9 percent and 40.5 percent, respectively. The stock is rated “buy” by the firm, with a target price of 1,014 Taiwan dollars.
Goldman is keeping a close eye on TSMC’s longer-term gross margin outlook, as well as visibility into the company’s “mid-term capex plans” for a glimpse into the company’s “topline and profitability in the next couple of years.”
According to the investment bank, TSMC’s capex guidance could be raised, citing “substantial silicon demand growth in key mega trends” as well as “more green field capacity expansion plans going forward.”
“With rising market speculation on potential demand peaking, particularly on consumer products like PCs, TVs, and smartphones, we could see inventory correction in 2022.” “We will look for specifics on TSMC’s forecast for end-demand outlook in each application, as well as its view on foundry tightness continuing into 2023,” Goldman analysts added.
Morgan Stanley & Co.
Analysts at Morgan Stanley, led by Charlie Chan, believe that investors should focus on the “imminent cyclical downturn” rather than gross margin. The investment bank is “staying on the sidelines” on TSMC due to “growing cyclical concerns.” With a target price of 580 Taiwan dollars, it is equal weight on the company.
Chan and his team will investigate the reasoning behind the wafer price increase, as well as its impact on the company’s long-term financial forecast. Analysts anticipate that TSMC will maintain its full-year capex guidance of $30 billion, but they will also look to the company for additional capex guidance and its views on its overseas fabrication strategy.
Needham rates the stock as a buy, with a target price of 690 Taiwan dollars.
“TSMC’s competitor, Samsung Foundry, announced 3nm availability in [the first half of 2022], while TSMC has been sticking to a [second half of 2022] timeline, putting Samsung ahead of TSMC on paper.” Needham analyst Charles Shi said, “I expect TSMC to provide an update on the 3nm schedule and look for any pulling forward of the schedule.” 3nm refers to a more advanced chip than those currently on the market.
Shi anticipates that TSMC will provide guidance on its 2nm production due to “increasing competitive pressure” from Intel’s 20A product, “a node that is equivalent to TSMC’s 2nm.” In addition, he will be paying close attention to management’s comments on pricing and supply chain inventory as we approach 2022.
Following TSMC’s record September sales, Wedbush is increasing its target price of 700 Taiwan dollars ahead of the earnings release. Analyst Matt Bryson expects his estimates to be in line with TSMC’s guidance, with the exception of some “modest potential margin headwinds tied to a strong Taiwanese dollar.”
Looking ahead, Bryson anticipates a “modest increase in sales” in the fourth quarter due to “continued semi shortages” and “strong initial demand for the iPhone.” He added that TSMC could benefit from the current supply squeeze by increasing average selling price and expanding revenue and margin expansion this year or next.
Lait, whose Latitude Global Fund is up 18.3 percent this year, said that he uses a different strategy when it comes to price-to-earnings ratios. Traders closely monitor these ratios to determine whether a stock is overvalued or undervalued.
According to Lait, historically, the market has traded on 15, 16 times earnings for a “average, good” business.
“It is currently valued at 22-24 times earnings.” It’s considered normal. “We’ve been trained to believe that’s normal,” he explained. “Our [portfolio] trades on 14 and a half percent.”
Lait explained that he believes there is a significant risk of derating — when a company begins trading at a lower PE ratio — as a result of higher interest rates and inflation.
“I believe that is the greatest risk.” A small earnings miss, or a small stabilization, or a bit more choppiness around earnings from that input cost inflation, could drive a meaningful derating back — just in line with history, that would be a 30% drop at the market level,” Lait said.
Lait stated that, despite rising inflation, he does not expect a meaningful recession or a meaningful earnings recession, but that it is critical to focus on valuation.
“At the moment, I believe it is a blindness to valuation risk within someone’s portfolio that is leading them into higher growth stocks elsewhere, and we just think we have a competitive advantage doing it our way,” he added.
Stocks to watch
Lait said there were still plenty of opportunities in equities, citing British grocery chain Tesco as a “very, very excited” stock.
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“It’s only recently begun to show some of the growth that we’ve been anticipating for a couple of years.” It’s coming through; it was up 7 or 8% at one point yesterday, and it’ll probably do the same in the coming weeks,” he said.
Tesco, the UK’s largest retailer, exceeded earnings expectations on Wednesday with a profit increase of more than 16%. Despite ongoing supply chain issues, it raised its full-year earnings forecast.
“It’s not the fastest growing stock in the portfolio, but we believe it can grow cash supported earnings in the double digits for the next five years, especially with its new buyback program,” Lait added.
“I think it’s a fantastic, interesting investment, trading at 13 or 14 times earnings and yielding a sizable dividend… There’s a lot of upside potential, and you’ve seen the valuation upside from all of the PE bids and what’s going on elsewhere.”