Experts pay attention to FOMC meetings in order to help navigate the financial markets and their positions with more confidence. Our FOMC meeting cheat sheet will help equip you with everything you need to know about the Federal Reserve's key decisions and how they may impact your investments.
The Importance of FOMC Meetings for Investors
FOMC meetings are crucial in determining the direction of U.S. monetary policy. The decisions made during these meetings significantly influence interest rates and asset prices. By understanding the FOMC's actions, investors can make more informed decisions and better manage their portfolios.
Key Components and Terminology in FOMC Meetings
Three critical elements drive FOMC meetings and monetary policy: the federal funds rate, open market operations, and quantitative easing/tightening (QE/QT). The Federal Funds rate is the primary tool for conducting monetary policy and affects other interest rates in the economy. Open market operations involve buying or selling government securities, influencing the federal funds rate and the banking system's reserves. Quantitative easing entails large-scale purchases of government bonds and mortgage backed securities, aiming to lower long-term interest rates and stimulate the economy.
Economic Indicators to Watch
Stay informed by monitoring vital economic indicators, such as Gross Domestic Product (GDP), inflation rates (CPI and PCE), unemployment rate, labor force participation rate, average hourly earnings, and housing market indicators. These factors play a crucial role in shaping the FOMC's policy decisions.
Navigating the FOMC Meeting Schedule and Resources
The FOMC meets eight times a year, with meeting minutes released three weeks after each session. Four times a year, the FOMC releases its Summary of Economic Projections (SEP). Additionally, the FOMC Chair holds press conferences after scheduled meetings, providing further insights into the committee's decision-making process.
Understanding the FOMC's Dual Mandate
The FOMC operates under a dual mandate from Congress, which includes ensuring maximum employment and maintaining stable prices with a long-term inflation target of 2%. Striking a balance between these goals requires the FOMC to carefully consider various economic indicators and policy tools.
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The Impact of Forward Guidance
The FOMC utilizes forward guidance to communicate its future policy intentions. This communication method influences market expectations and long-term interest rates, enabling investors to better understand the FOMC's monetary policy approach.
Insights into FOMC Members and Voting Structure
The FOMC consists of 12 voting members, including the Chair, Vice-Chair, New York Fed President, and other regional Fed Bank presidents. Investors can gain valuable insights into these members' views on economic conditions and policy by following their speeches and comments.
Preparing for FOMC Meetings
To effectively prepare for FOMC meetings, one might consider reviewing recent economic indicators, assessing the impact of global events on the U.S. economy, studying FOMC members' speeches, monitoring market expectations for policy decisions, familiarizing yourself with the latest SEP and dot plot, and reviewing previous meeting minutes for context.
How FOMC Decisions Could Affect Your Investments
FOMC policy decisions can create market volatility and impact asset prices. By understanding the FOMC's actions, you can make more informed investment decisions and align your portfolio with your risk tolerance and market outlook.
The I/O Fund is a publishing company. The analysis, strategies, reports, activity and all other features of our service is provided for informational and educational purposes only, and should not be construed as personalized investment advice. Hedging is an advanced method of trading stocks, sudden losses can occur, and hedging should only be pursued under the supervision of your personal financial advisor.
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It may feel like the words “Google” and “lawsuit” are commonplace, but the trial in September carries enormous weight and is unlike the lawsuits of the past. Not only do we want to keep an eye on ad-tech names that could benefit should Google’s monopoly be broken up and the juggernaut come out weaker, but we also want to be prepared if the tech giant is able to hold off regulators.
Considering that Google is sitting on the world’s very best consumer data, which is not an exaggeration in the least bit, its ability to lead on artificial intelligence and large language models should not be underestimated. For our purposes, the company is far from sitting on its laurels and there’s a predictable path where the company competes in a duopoly with Microsoft.
Therein lies the issue. Google undisputedly has the world’s best consumer data, but did this grow to become part and parcel with operating a monopoly? The Department of Justice has asserted anti-trust violations against Google with the trial beginning in September 2023. The trial is expected to last ten to 12 weeks, although a lawyer for the DOJ told CNBC it could be as brief as five weeks.
Why it matters:
With Google and other ad-tech companies trading this low, one of two outcomes will happen. The antitrust outcome will be mild, and Google will be empowered to continue to dominate. Or, the outcome will require the ad properties to be broken up, leading to a weaker stance for Google. This could benefit smaller ad-tech players.
The Goal — Looking back:
A few years back, I analyzed the potential outcome of a government decision when the Pentagon was evaluating cloud providers. Clearly, this decision is far outside of anyone’s control and requires some speculation. At the time, I speculated Azure would be a winner. For a year or so, Microsoft did secure the Pentagon contract over the more-favored Amazon. This decision was ultimately reversed, and the contract was split between four tech companies.
The exact outcome of the Pentagon contract was not particularly important because the analysis led to my conclusion that Microsoft’s hybrid computing was a material advantage and this would be the path Nadella would most likely use to take market share from AWS’s heavily-slanted public cloud strategy.
I’m hoping for something similar, which is to acknowledge something very important is going on with ad-tech, which is Google’s antitrust case. This is not a headline to simply dismiss. It’s the first time the DOJ has brought a case of this kind against a technology company since Microsoft. If there are even minor cracks in Google’s monopoly, there could stand to be a stock or two that starts a new trajectory.
On similar note, Cambridge Analytica is what sparked my coverage on Facebook. Similar to Google’s antitrust case, it became apparent to me that Facebook was peaking in terms of its ability to monetize through third party data. I covered this extensively, for example here and here.
Brief Overview of Antitrust Case:
According to Lanier Law Firm, which is the litigation team for the State of Texas in the state coalition case, a primary argument against Google is that the company went above and beyond to become the default search engine on iOS devices by paying Apple $12 billion per year.
The lawsuit includes other deals that Google struck with Apple’s Safari browser, the Mozilla browser and Android device manufacturers where Google either paid up or imposed restrictions on Android device makers to strongarm having their suite of apps pre-installed on the home screen.
The company has already lost an antitrust case in Europe in 2018 with a $4.4 billion Euro fine for forcing Android manufacturers to pre-install Google’s bundle of apps on the device, including Chrome, Maps and the Play Store.
Google’s market share of Search is at 91% and the argument is being made this was accomplished through anti-competitive practices, especially since Google owns Android and had leverage over the many device makers that used this operating system.
In addition to being pre-installed and the default browser/search engine, Google also attempts to keep people on its search engine by using a website’s data on its page. For example, if you look up “Best Dog Breed” Google scrapes Wikipedia and puts the results onto the search page instead of sending you to Wikipedia. This is seen as anti-competitive as it takes a website’s data to profit from it, rather than directing the traffic to the rightful copyright owner, which is the function of a search engine.
Part of Microsoft’s antitrust case was based on Microsoft using its dominance on Windows to force a Microsoft Explorer to be the default browser. At the time, the decision was that default settings are anticompetitive.
The secondary argument filed by a 10-state group led by Texas, is that Google leverages its properties to be the buyer and the seller via its ad exchange. Per Lanier Law Firm, the Texas case states Google and Facebook “unreasonably restrained trade and harmed competition through an unlawful agreement to allocate auction wins and to fix prices in violation of Section 1 of the Sherman Act, 15 U.S.C. § 1”
This is where it gets very messy, and so I’ve dedicated a specific section below to break down these details. The purpose of understanding the minutiae is not to only determine if we should buy Google and when, but also what companies could stand to benefit if Google’s products are shutdown or broken up.
My long-ago analysis on Facebook pointed toward a conflict of interest in the company owning a third-party ad network called Audience Network while also being publisher. At the very least, the conflict of interest created a risk since Facebook was essentially siphoning oil from real estate the company didn’t own (iOS users). This was a serious, material risk for investors that played out over time (note: it certainly wasn’t immediate, it took four years from the first time I covered the topic).
If you’re a Meta investor, you’ll want to watch the CPMs on the company and make sure the erosion below is not permanent. Despite Apple only impacting third-party data, it’s unclear how much of that third-party data was informing its first party data. The unusually high CPMs that Meta charged points towards enhanced targeting – that in my opinion – was likely due to mixing both first-party data with third-party data. This means there will be an eventual erosion, over time, of the CPMs Facebook can charge even on its own applications.
Pictured above: Although subtle, there is an erosion to Facebook’s otherwise high CPMs. You can see that Nov 2022 made a lower high over Black Friday compared to the two previous years. Many factors could be at play, such as lower ad budgets, but it’s something investors should keep a close eye on.
Google currently does the same thing that Facebook used to do, which is to run an ad exchange that is undeniably a conflict of interest. The difference is that rather than renting real estate, like Facebook did with iOS, Google is a real estate tycoon. There isn’t a tech company that can kick Google off their turf because Google owns all of the turf – primarily Chrome, Android, Google Search, and YouTube.cBy conflict of interest, I’m referring to AdX, DoubleClick and DV360, collectively known as the Google Network.
Below, you can see Google Network is a $32 billion annual revenue stream. Not exactly peanuts.
To further the lawsuit, a 30-state coalition has issued a third claim that Google uses its monopoly to rip off smaller companies, such as Yelp, DoorDash, and Kayak. You can see evidence of this when Google Search returns flight searches powered by Google at the top, with a large embedded format, rather than producing a fair search result that includes competitors. Yelp has been in a battle with Google over this for over a decade. After Google Reviews were launched, Google pushed Yelp down the page in terms of search results.
The two search engine allegations are fairly straight forward. Most of us who use Google Search can reasonably understand those arguments.
The Messy, Blackbox that is AdExchange (AdX):
DoubleClick was acquired in 2007 for $3.1 billion. As author Tony Yiu points out on Toward Data Science, this was twice the amount paid for YouTube a year earlier. Google Network is a by-product of many acquisitions including AdMob for $750 million and AdMeld for $400 million, among others, yet DoubleClick truly set the supply side dominance in motion as the company owned 60% of the desktop publisher market at the time of acquisition.
DoubleClick allows Google to set a cookie on a website so that online publishers can better target visitors with ads. The DoubleClick cookie provides the time and date a user saw an advertisement, as well as a unique ID that identifies a user by their browser. Publishers are then able to auction inventory to advertisers.
DoubleClick was a major move by Google to expand beyond search advertising. This was the first time Google entered the market on display ads. As stated, DoubleClick owned 60% of the publisher market when it was acquired, which means Google would eventually profit from monetizing millions of websites.
This led to a concentration of power for Google, because with this advantage, it was able to grow quickly as a predominant ad server for publishers. Naturally, Google wanted to maximize this advantage, and so the company made the appropriate acquisitions to operate on the demand side (advertiser side) in addition to the publisher side.
Through a series of acquisitions, Google built DV360, which allows advertisers to use their own data to target customers across publisher inventory. Google always has strong ties to data, in this case powering DV360 with Google Analytics 360. In addition to this, Google’s AdX allows advertisers to create campaigns across Google-owned properties in addition to millions of websites from third-party publishers on the DoubleClick publisher side, as mentioned above.
An easy analogy here would be to compare it to a real estate transaction, since ads are transactional between a buyer and seller. In this case, Google was representing both the buyer and the seller, and in some cases brokered its own real estate to the buyers. You can imagine due to Google’s scale of doing millions of transactions a day, things might get unethical real quick.
Here’s how a Google executive put it:
“[I]s there a deeper issue with us owning the platform, the exchange, and a huge network?” the executive allegedly asked. “The analogy would be if Goldman or Citibank owned the NYSE.”
With that in mind, let’s continue because the depth of Google’s black box is quite deep.
The product AdSense further pools the data provided by publishers. When millions of websites join AdSense to pool data, Google can record more information on a person’s browsing history. It provides a complete view of the consumer for more enhanced targeting. Another area that Google allegedly monopolizes the market is that the company mixes its first party data with this third party data, but only in instances where Google will benefit.
The AdMob acquisition in 2009 provided a similar strategy as DoubleClick but on mobile. It deepened Google’s reach on the supply side for the mobile market. This, of course, was especially advantageous considering Google bought Android in 2005.
You can imagine, that the depth of Google’s data on desktop users and mobile users is deep (and likely quite dark). Meaning, Google knows more about you than you know about yourself. Now, take that depth of data and add the serious conflict of interest that can occur when Google bids against competitors.
Where Google (Allegedly) Went Wrong with AdX
Despite the allegations below that Google was unethical, I want to point out that antitrust could be harder to prove for AdX. This is because many corporations combine first-party publisher data with a third-party ad exchange, such as Amazon, Facebook, Disney and Comcast. Microsoft is building its ad exchange, as well right now, after acquiring Xandr from AT&T. However, Xandr/Microsoft’s strategy is to support the “free and open web” by adopting the Unified ID.
Point being, if the product AdX is found to be anticompetitive, it could have far-reaching implications for other companies. This wasn’t the case with Microsoft, as the company was rather isolated on its throne in the late 90s. With that said, Google is the worst offender in terms of the sheer advantages it has compared to other corporations with large media properties.
Here are some of the more unethical things Google is being accused of:
According to the lawsuit, there was a 65% drop in revenue if publishers chose to not use Google on the demand side. Advertisers are also stating this was a conflict of interest as Google restricted inventory in this case. This would be like a real estate agent refusing to show a house if they did not have both the buyer and the seller to double-end the transaction.
Google also allegedly circumvented waterfall auctions to prioritize their own bids on AdX. Waterfalls were prevalent throughout the ecosystem because they allow exchanges to be ranked by bids. Based on historical bids, if the ad exchange in the number one position doesn’t buy the inventory, it goes to the next ad exchange in the waterfall (the number two position).
Where Google may have manipulated the bidding is by allowing their exchange to meet only floor prices to win the bid, even when another exchange would have bidded higher in a waterfall-like auction. This would be like a real estate agent only presenting their Buyer’s offer to a Seller even if they knew they could get higher offers from another agent.
Due to DoubleClick and AdX waterfalls having the issues described above, programmatic header bidding was introduced to offer true, real-time bidding to increase publisher yield. It essentially increased competition by holding an open auction rather than a closed, blackbox auction that pushes inventory back and forth in an attempt to sell the inventory.
Per Digiday written in 2015: “One notable side effect of header bidding adoption is that it puts pressure on Google’s DoubleClick for Publishers ad server, which, through its dynamic allocation feature, lets AdX — but no other exchange — see and bid on every impression.”
That sentence and general understandingand general understanding of what AdX did to manipulate the waterfall process nicely sums up where Google could face trouble in a courtroom. According to the lawsuit, publishers saw 30% to 40% more revenue through header bidding by simply removing Google’s ability to manipulate the waterfall auction. I bolded “general understanding” because Google is so powerful that the ad ecosystem knew full and well that it was using its monopoly in anticompetitive ways but there was nothing any publisher or advertiser could do about it.
Google has tens of thousands of engineers and is a very advanced company, which is why the allegations are quite complex. The lawsuit points out that Google then later manipulated header bidding by allowing AdX to bid last. As long as AdX beat the previous bids, then it would win the bid. Going back to the real estate agent scenario, this would be like having multiple offers on a house, and the listing agent going to their exclusive buyers to reveal what the prices are to help the buyers win the bidding war.
Google is also accused of using more acquisitions for ad technology that would later be leveraged to subsidize bids. This means Google paid the difference on an advertiser’s bid in order to be the winning bid. In this case, Google simply increased its margin or cut in order to make up for the amount that was subsidized.
Google’s DSP called DV360 was also allegedly engineered to decrease bids from competing ad exchanges, including those who were using header bidding for a more fair auction process. This was done by setting the highest competing bid at the floor price while AdX was able to bid higher.
Google is accused of suppressing header bidding through covert mechanisms by reducing header bids by up to 90%. Meanwhile, Google’s own DV360 bid was not decreased. This was done even when Publishers attempted to set a lower floor for competing ad exchanges, meaning, Publishers were without recourse even if they agreed to a lower bid.
Conclusion:
Given the sheer impact a weaker Google could have on the ad-tech ecosystem, we wanted to do a deep dive and get in front of this. I believe this is the number one catalyst across ad-tech this year and we want our readers to benefit no matter the outcome. As the market can often do, there may be some price movements ahead of the trial, and if so, we will be watching for entries closely.
We offer an Advanced service with specific stock picks that may benefit from Google’s lawsuit and we also offer real-time trade alerts for all of our portfolio entries and exits. You can learn more about this service here.about this service here.
For reference to terminology used, please look at technical analysis under our resources section here. Regarding the charts below, the vertical tan shades represent time factors. These are inflection points where we have high odds of something significant happening. More times than not, (3/4 of the time), they mark a turning point in the trend. So, what matters is the direction we are trending into these periods. Regarding the vertical lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.here. Regarding the charts below, the vertical tan shades represent time factors. These are inflection points where we have high odds of something significant happening. More times than not, (3/4 of the time), they mark a turning point in the trend. So, what matters is the direction we are trending into these periods. Regarding the vertical lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave count are meant to provide context. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play
Broad Market
My primary perspective is that we are continuing to trace a complex corrective pattern in this ongoing bear market. For the non-Elliott Wavers, all that you need to know is that this pattern is not complete until we get a sharp 5 wave drop towards the SPX 3050 region. The only question I have is determining if we topped, or will we have one more push higher?
Do you see the wavy/overlapping pattern inside the red box? That could be counted as a corrective pattern in an ongoing uptrend. This would imply one more push to at least 4275 before the wheels fall off. If this plays out, we will remove our hedge (more below), and hold a high cash position.
1-2, i-ii
In Elliott Wave analysis, the 3rd wave is typically the largest and most powerful move in a trend. This is what you want to capture on the upside, and really avoid on the downside. That being said, there is a phrase called a “1-2, i-ii setup." This simply means that waves 1 and 2 are in place, and we are setting up for the heart of the 3rd wave move, usually on some gap. If you’ve ever heard of a cup and handle pattern, this is just a simplified version of a 1-2, i-ii setup.
Keeping that in mind, let’s take this one step at a time. In the picture above, look at the structure of the move off the October low. It is clearly 3 waves up. Whenever you see a 3 wave move, the vast majority of the time it is a corrective move in a larger trend; in this case, that trend is down. What follows a 3 wave bounce (B wave) is a 5 wave drop (C wave). So, this C wave will be a 5 wave move, which will necessarily develop into a 1-2, i-ii setup before really letting go.
Well, that setup is in place.
The above chart can be counted as a 1st wave down, 2nd wave up; followed by another 5 waves down and 3 waves up. I cannot stress the level of risk this setup presents us right now. Just because this setup is in place does not mean the market will take it. As long as price stays below the 4035-4067 region, this window will remain open. So, below this level and the risk in the markets remains quite high.
To simplify the risk levels, there are three final supports to monitor before the blue primary count is fully confirmed: 3902, 3835, 3808. Each level that gets taken by price increases the risk in the markets. Once we go below 3808, we should be in the heart of the 3rd wave drop pointing us towards the 3050 SPX region.
On the other hand, if the bulls can muster a rally that takes us through 4035-4067, then this window pointing us down will be closed, for now. What this means is that in order to drop us back towards that region, a new setup will have to develop, likely after we move to the 4275 region.
Now, let’s look at the red alternative scenario where we do break through the 4035-4067 region. The only structure that will take us there has collapsed into a low-quality pattern called a leading diagonal. Remember how I said that when you see a 3 wave bounce, the odds greatly favor it is a correction in a bigger downtrend? Well, look below at the bounce we are in. It’s only 3 waves.
The only bullish alternative is a rare pattern called a leading diagonal pattern, which is a messy, overlapping 5 wave pattern. The rule with leading diagonals is that you should not believe them until you get all 5 waves in place, and then see a bigger pullback that holds the low. So, this pattern, if it is playing out, has a lot to prove.
Macro
With the recent fall of Silicon Valley Bank (SIVB), followed by Signature Bank (SBNY), we saw the 2nd and 3rd largest bank failures in US history. In fact, the run on SIVB was the largest bank run in US history, with $2 Billion withdrawn in one day. Prior to this run, Washington Mutual was the largest run, with $16.7 Billion over 10 days.
According to the markets, the problem is not localized. The below chart is a handful of larger regional banks in the S&P 500 as well as the SPYDR Regional Bank ETF (KRE). This type of drop off is not the sign of a healthy stock, and we are seeing them across the board.
However, we learned over the weekend that the current banking crisis is not limited to US regional banks. Credit Suisse, one of the largest international banks, sold to their Swiss competitor, UBS, for a little more than $2 Billion (or $0.54/share). On Friday, it was priced more than $7 Billion dollars (or around $3/share). This will mark Europe’s largest bank merger since the 2008 financial crisis.
Regardless of the details, what this signals is that the current banking crisis is not a US problem, and not just a regional bank problem. This is more than apparent when we look through various charts within the financials sector.
BAC is being portrayed in the news in a position of strength. It was one of a handful of banks that bailed out First Republic, and has recently been mentioned as a potential buyer of Signature Bank. However, if we look at the chart below, this is a very concerning pattern unfolding.
First off, BAC is below its October low. More concerning, we can count a 5 wave drop from the 2022 high, followed by a 3 wave retrace that ended right before the current drop. If BAC breaks below $22.70, the COVID low will be in discussion.
MET is one of the largest insurance companies in the US. The chart below is telling me that this banking crisis is not localized to just Banks.
The above chart is showing zero bids as MET is in the process of breaking a major support zone. What is concerning, which can be seen on many charts right now, is that this drop is preceded by a clear 5 wave uptrend from the COVID low. We are at the completion of a large degree 5 wave pattern and are beginning a large degree correction.
MS is a very large investment bank as well as a robust wealth management firm. They recently acquired ETrade, which gets them into the retail space. Their chart is also closing on the lows after completing a clear bear pennant from the October lows. At best, this should play out as an A,B,C pattern, where the C wave that just stated is equal in length to the A wave.
If we are in the beginning stages of something larger unfolding, we would expect the FOMC to drop rates and begin a fresh QE program to support equities. However, considering all the problems unfolding, the FED Futures on what this week’s decision is sitting at 63% chance of raising rates by 25 bps!
This is probably quite shocking to most, considering the headline CPI number was celebrated by the equity markets. However, the bond market sold off sharply on the CPI news. What the headlines were not discussing was that the CPI print was actually much hotter than the YoY print was suggesting. Inflation is best measured on a sequential basis, not a YoY basis. What matters is the trend, not annual comparison. It’s much more important to see if inflation is improving from month to month, not year over year, when tracking the trend.
I prefer to take the 3-month annualized readings to get the best feel for the actual trend. When you add up the prior 3 month readings and annualize them, the number comes out to 4.08%, compared with last month’s reading at 3.4%. This is a concerning rate of acceleration, and marks the 2nd month in a row of an accelerated trend within the CPI data.
Even more concerning, we are seeing a similar acceleration in energy, core prices, core goods, shelter, as well as services, which has been the biggest concern regarding inflation. The reason why services is so concerning is because it accounts for ~85% of the US GDP and it is still expanding above its 12-month trend.
With an on-going economic expansion comes inflation, which continues to show up in the CPI numbers. There is no question the FED, short of a banking crisis, would have to increase their terminal rate well above 5%, considering both the resilience of the US economy and the stubbornness of inflationary pressures in the services sector.
So, if the FED does drop rates prematurely, we risk a replay of the 1970s, when that FED also dropped rates due to market pressures, leaving inflation intact to roar back repeatedly for over a decade. In light of this history, which Powell has alluded to multiple times as the primary guiding force behind their decisions, if they decide to drop rates soon, investors should be concerned.
I’ve been discussing the bullish posture in various futures. Another interesting chart to monitor is the 10-year yield. Remember, if the FED is about to drop rates, and a banking crisis is upon us, then bonds would be one of the primary assets to own going forward. This would mean that yields would fall, as inflation is no longer as much of a concern as deflation.
According to our analysis, the 10 Yr. Yield’s uptrend looks incomplete. The current consolidation looks like a 4th wave with a 5th wave targeting just over 4.5%. This would imply, like various futures, that inflation is not behind us.
Hedge
Our hedge signal flipped to buy on last Thursday’s rally. We decided to follow our risk levels to put the hedge back on while the signal is in buy. If we break above last week’s high, we will remove it and go in line with our signal. Considering the risk in the market, we are being more cautious. If our worries are justified, the signal in bear mode is quite sensitive, so it should flip back relatively close to where we are.
I/O Fund Positions
We added some cash back into NFLX, ENPH and TSLA. These are attempts to position for the possibility of the above red count playing out, so these new entries have stops. However, we are currently tracking crypto to add a heavy allocation towards (more below).
NVDANVDA
NVDA found a way through the $241 resistance. However, it still appears to be closer to the end of a move than the beginning of one.
NFLXNFLX
If NFLX breaks below $285, we’ll stop out of our 2% allocation from last week. Also, it will change the count, as one more high will become less likely.
AMDAMD
This move up in AMD has completed what can be counted as a leading diagonal. As a rule, we now need to see a 3 wave pullback that holds the October low. AMD is now a candidate for a stock that has bottomed, no matter what plays out. It is now over 80% off its low.
ENPHENPH
Enphase is a play on energy. Its breakdown last week was in line with the breakdown we saw in crude and natural gas. We are early to this thesis, but we still believe it is likely to play out.
Crude OilCrude Oil
GasolineGasoline
MSFTMSFT
That's quite a key reversal candle in MSFT from a key resistance level. This has given us 5 waves up in an ugly C wave.
TSLATSLA
This correction is starting to get too stretched to be a 4th wave. However, the count works best, like NFLX, with one more high. My primary analysis is that TSLA will go towards $92 before the larger drawdown is over.
BTCUSDBTCUSD
This chart is interesting. I’m counting this as a large degree 4th wave with a move towards $13,000 in the future. However, we also have 5 waves up off the low and an interesting divergence from equities. Our original thesis that Bitcoin is a path out of a failing centralized money system could be finally playing out, so we will give this thesis a chance. What we want to see from this high is a 3 wave retrace, not 5 waves down. If we see 3 waves down, we will likely add aggressively to Bitcoin, with a stop in place.
AEHRAEHR
ETHUSDETHUSD
ETH has a very bullish posture, which we will give the benefit of the doubt. The next pullback should be a small 3 wave retrace then a very big breakout to confirm
We thought it may be helpful to our readers to share our initial thoughts after the SIVB bailout. As we write this, CSFB has reported material weakness in its financial reporting so we’ll see if this will create further stress on the financial system.
In response to the SIVB collapse, the Fed had no choice but to take decisive action to further stem deposit outflows and the potential risks to the banking system. The Fed’s response was a comprehensive pledging of cash in exchange for all Treasuries, agency debt and mortgage-backed bonds without any discount being applied to face value. Commentators have described these actions as akin to quantitative easing on demand for the financial system.
Below is a chart of the Fed Funds rate dating back to the 1950s. As recent history shows, the Fed had embarked on a policy of ultra-low interest rates – brought on by the GFC and again by the Covid pandemic – that were unprecedented in scale and duration. This created unintended consequences and fueled asset bubbles and inflationary pressures throughout the economy.
Similarly, as the Fed aggressively raised interest rates in 2022, this has also created unintended consequences. The collapse of SIVB. While SIVB’s demise seems not to pose a systemic financial risk at the moment. Its overnight collapse is a reminder that the banking sector remains vulnerable to sharply rising funding costs after years of operating in a low rate environment.
SIVB’s demise has been well covered in the financial press, we’ll touch upon some salient details. There were red flags, a couple that were somewhat unique to SIVB.
Greg Becker, SIVB’S former CEO, served on the board of the Federal Reserve Bank of San Francisco until the day of the collapse. He had lobbied that that banks of SIVB’s size should not be subject to as much regulation as the mega banks
In 2018, a bipartisan bill was passed that exempted banks with $100 billion to $250 billion in assets – Silicon Valley's size – from requirements that included regular examinations of how they would fare in tough economic times, known as 'stress tests.'. The 2018 law also provided the Fed with more discretion in its bank oversight. The central bank subsequently voted to further reduce regulation for banks the size of Silicon Valley. In October 2019, the Fed voted to effectively reduce the capital those banks had to hold in reserve.
The bank had grown rapidly. Its assets quadrupled in five years to $209 billion, making it the 16th-largest bank in the country. And roughly 94 percent of its deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation's $250,000 insurance cap. That percentage was the second highest among banks with more than $50 billion in assets, according to ratings agency S&P. Signature had the fourth-highest percentage of uninsured deposits – which uncoincidentally also failed. Signature had large exposure to crypto clients.
According to analysis done by UBS. SIVB had 52% of its deposits from venture capital and private equity related businesses and funds. First Republic Bank, another California-based lender that dropped more than 60% in pre-market trading on Monday, only 8% of its deposits to those types of clients.
Ultimately SIVB’s risk management, or the lack-thereof, proved it’s undoing. It’s not uncommon for banks to have unrealized losses due to their bond holdings. According to Bloomberg, US banks had booked $620 billion in unrealized losses on their available-for-sale and held-to-maturity portfolios at the end of last year, according to filings with the FDIC. But SIVB’s investment portfolio had swelled to 57% of its total assets. No other competitor among 74 major US banks had more than 42%. It was this toxic brew of a very large unrealized losses on Treasuries and mortgage bonds combined with a concentrated depositor base that proved fatal.
This was exacerbated by SIVB’s failure to hedge the interest rate risk on these holdings and an upcoming credit downgrade. Once it was made known to the market that SIVB may raise equity to pre-empt the downgrade, this was the catalyst for deposits to be withdrawn which worsened their credit standing. It became a self-fulling prophecy.
So as technology focused investors, how do we assess the current situation?
Let’s start with the macro. I have written extensively on concerns over the broad market from both a technical and macro perspective. The latter namely due to the Fed’s inability to combat super-core inflation and the over-leveraged consumer. I and the rest of the team have been monitoring for further signs of weakness.
Financial Sector Earnings
Within the overall S&P 500 earnings, it is estimated that Technology contributes the most at about 25%, while the second largest is Financials at 19%. The S&P 500’s decline in the SPX has in part been driven by reductions in earnings for the Technology sector. The SIVB fallout could lead to a reduction in earnings estimates across the financial sector. These downgrades can be driven by a number of factors such as lending margins being squeezed as cost of bank deposits are still catching up with rate rises that have already happened, higher regulatory costs and higher loan loss provisions, just to name a few. This could be another headwind for S&P 500 earnings in the future.
Banks are a transmission mechanism for the economy. To the extent that is hindered, there will be a negative trickle down effect for the economy that are yet to be seen. Somewhat ironically, the SIVB collapse may help Fed Chairman Powell’s goal to reduce supercore inflation driven by the sticky services component through aggressive interest rate hikes. Albeit clearly not the way he intended.
Technically, the Financials ETF has broken down.
What will the Fed do in the next meeting?
Given the recent CPI data, the Fed has every justification to continue to raise interest rates, which we discussed here. However, will the SIVB failure give them a reason to pause? The futures market has the odds at a resounding no.
And the reason is that under the headline CPI number, we are seeing the 2nd month in a row of 3 MoM annualized acceleration. If you combine the prior 3 months and annualized them, the number comes out to 4.08%, compared to last month’s reading at 3.4%. Furthermore, energy, goods, core, shelter and services all showed similar accelerations.
How to invest in technology in current environment?
In the public markets, the technology sector was already facing headwinds as higher rates impacted valuation. Meanwhile those with consumer exposed businesses have also had earnings impacted. The SIVB fallout adds additional headwinds. SVB’s demise has revealed the extent of the damage rising interest rates might cause on companies and banks that had grown accustomed to years of cheap money. Startups are especially vulnerable to any systemic drop in confidence, given their reliance on investors’ faith in their long-term potential when profitability might be years away.
Private markets will face a tougher funding environment. There is a talk of ‘day-of-reckoning’ for the private equity/venture capital-funded universe and may force PE funds to mark down private books sooner than they’d like to.
Softbank is a good public and sentiment proxy for the private markets. Before the meltdown, Masayoshi Son’s investment powerhouse — which has poured more than $140 billion into names from WeWork to ByteDance Ltd. and DoorDash Inc. — had already been reeling from the post-pandemic economic downturn.
SoftBank, similarly central to the global VC arena, has lost around 7% or $5 billion of its value since news of SVB’s difficulties emerged. Its credit default swaps are surging for the second straight day, and speculation is growing on what asset sales might be ahead should SoftBank need to help out portfolio companies.
SoftBank sees little impact from SVB’s failure on its portfolio companies, a SoftBank spokesperson said, adding that the company expects no impact on its own finances. Most Vision Fund portfolio companies are cash-rich, the company said during its earnings call last month. However, if we look at the chart, the market disagrees, as it is ~63% off its 2021 high, and only ~32% from testing its COVID low.
Attributes of stocks that we are looking for
This past week, I/O Fund analysts held a webinar that discussed “How to Build a Defensible Tech Portfolio.” Although macro continues to throw curveballs, we believe a defensible portfolio can help alleviate any concerns.
Defensible means the portfolio should be overweight the bottom line. For tech investors, stocks that do not materially cash burn are ideal right now. Per Silicon Valley Bank’s CEO Gregory Becker: “While VC (venture capital) deployment has tracked our expectations, client cash burn has remained elevated and increased further in February, resulting in lower deposits than forecasted.”
Per the same Reuters report, Silicon Valley Bank is selling assets to position for higher interest rates and faster cash burn: “We are taking these actions because we expect continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients.”
Elevated cash burn is something the public markets will be very sensitive toward into the foreseeable future. We have found that expanding operating margins and GAAP profitability was rewarded last year, and we believe this is the best way to position for an unpredictable 2023. At the very least, while the FED raises rates, cash burn will continue and we believe it will surprise investors at times just how cash strapped the tech sector truly is. This is why we have built a defensible tech portfolio, as outlined in this webinar here.
We thought it may be helpful to our readers to share our initial thoughts after the SIVB bailout. As we write this, CSFB has reported material weakness in its financial reporting so we’ll see if this will create further stress on the financial system.
In response to the SIVB collapse, the Fed had no choice but to take decisive action to further stem deposit outflows and the potential risks to the banking system. The Fed’s response was a comprehensive pledging of cash in exchange for all Treasuries, agency debt and mortgage-backed bonds without any discount being applied to face value. Commentators have described these actions as akin to quantitative easing on demand for the financial system.
Below is a chart of the Fed Funds rate dating back to the 1950s. As recent history shows, the Fed had embarked on a policy of ultra-low interest rates – brought on by the GFC and again by the Covid pandemic – that were unprecedented in scale and duration. This created unintended consequences and fueled asset bubbles and inflationary pressures throughout the economy.
Similarly, as the Fed aggressively raised interest rates in 2022, this has also created unintended consequences. The collapse of SIVB. While SIVB’s demise seems not to pose a systemic financial risk at the moment. Its overnight collapse is a reminder that the banking sector remains vulnerable to sharply rising funding costs after years of operating in a low rate environment.
SIVB’s demise has been well covered in the financial press, we’ll touch upon some salient details. There were red flags, a couple that were somewhat unique to SIVB.
Greg Becker, SIVB’S former CEO, served on the board of the Federal Reserve Bank of San Francisco until the day of the collapse. He had lobbied that that banks of SIVB’s size should not be subject to as much regulation as the mega banks
In 2018, a bipartisan bill was passed that exempted banks with $100 billion to $250 billion in assets – Silicon Valley's size – from requirements that included regular examinations of how they would fare in tough economic times, known as 'stress tests.'. The 2018 law also provided the Fed with more discretion in its bank oversight. The central bank subsequently voted to further reduce regulation for banks the size of Silicon Valley. In October 2019, the Fed voted to effectively reduce the capital those banks had to hold in reserve.
The bank had grown rapidly. Its assets quadrupled in five years to $209 billion, making it the 16th-largest bank in the country. And roughly 94 percent of its deposits were uninsured because they exceeded the Federal Deposit Insurance Corporation's $250,000 insurance cap. That percentage was the second highest among banks with more than $50 billion in assets, according to ratings agency S&P. Signature had the fourth-highest percentage of uninsured deposits – which uncoincidentally also failed. Signature had large exposure to crypto clients.
According to analysis done by UBS. SIVB had 52% of its deposits from venture capital and private equity related businesses and funds. First Republic Bank, another California-based lender that dropped more than 60% in pre-market trading on Monday, only 8% of its deposits to those types of clients.
Ultimately SIVB’s risk management, or the lack-thereof, proved it’s undoing. It’s not uncommon for banks to have unrealized losses due to their bond holdings. According to Bloomberg, US banks had booked $620 billion in unrealized losses on their available-for-sale and held-to-maturity portfolios at the end of last year, according to filings with the FDIC. But SIVB’s investment portfolio had swelled to 57% of its total assets. No other competitor among 74 major US banks had more than 42%. It was this toxic brew of a very large unrealized losses on Treasuries and mortgage bonds combined with a concentrated depositor base that proved fatal.
This was exacerbated by SIVB’s failure to hedge the interest rate risk on these holdings and an upcoming credit downgrade. Once it was made known to the market that SIVB may raise equity to pre-empt the downgrade, this was the catalyst for deposits to be withdrawn which worsened their credit standing. It became a self-fulling prophecy.
So as technology focused investors, how do we assess the current situation?
Let’s start with the macro. I have written extensively on concerns over the broad market from both a technical and macro perspective. The latter namely due to the Fed’s inability to combat super-core inflation and the over-leveraged consumer. I and the rest of the team have been monitoring for further signs of weakness.
Financial Sector Earnings
Within the overall S&P 500 earnings, it is estimated that Technology contributes the most at about 25%, while the second largest is Financials at 19%. The S&P 500’s decline in the SPX has in part been driven by reductions in earnings for the Technology sector. The SIVB fallout could lead to a reduction in earnings estimates across the financial sector. These downgrades can be driven by a number of factors such as lending margins being squeezed as cost of bank deposits are still catching up with rate rises that have already happened, higher regulatory costs and higher loan loss provisions, just to name a few. This could be another headwind for S&P 500 earnings in the future.
Banks are a transmission mechanism for the economy. To the extent that is hindered, there will be a negative trickle down effect for the economy that are yet to be seen. Somewhat ironically, the SIVB collapse may help Fed Chairman Powell’s goal to reduce supercore inflation driven by the sticky services component through aggressive interest rate hikes. Albeit clearly not the way he intended.
Technically, the Financials ETF has broken down.
What will the Fed do in the next meeting?
Given the recent CPI data, the Fed has every justification to continue to raise interest rates, which we discussed here. However, will the SIVB failure give them a reason to pause? The futures market has the odds at a resounding no.
And the reason is that under the headline CPI number, we are seeing the 2nd month in a row of 3 MoM annualized acceleration. If you combine the prior 3 months and annualized them, the number comes out to 4.08%, compared to last month’s reading at 3.4%. Furthermore, energy, goods, core, shelter and services all showed similar accelerations.
How to invest in technology in current environment?
In the public markets, the technology sector was already facing headwinds as higher rates impacted valuation. Meanwhile those with consumer exposed businesses have also had earnings impacted. The SIVB fallout adds additional headwinds. SVB’s demise has revealed the extent of the damage rising interest rates might cause on companies and banks that had grown accustomed to years of cheap money. Startups are especially vulnerable to any systemic drop in confidence, given their reliance on investors’ faith in their long-term potential when profitability might be years away.
Private markets will face a tougher funding environment. There is a talk of ‘day-of-reckoning’ for the private equity/venture capital-funded universe and may force PE funds to mark down private books sooner than they’d like to.
Softbank is a good public and sentiment proxy for the private markets. Before the meltdown, Masayoshi Son’s investment powerhouse — which has poured more than $140 billion into names from WeWork to ByteDance Ltd. and DoorDash Inc. — had already been reeling from the post-pandemic economic downturn.
SoftBank, similarly central to the global VC arena, has lost around 7% or $5 billion of its value since news of SVB’s difficulties emerged. Its credit default swaps are surging for the second straight day, and speculation is growing on what asset sales might be ahead should SoftBank need to help out portfolio companies.
SoftBank sees little impact from SVB’s failure on its portfolio companies, a SoftBank spokesperson said, adding that the company expects no impact on its own finances. Most Vision Fund portfolio companies are cash-rich, the company said during its earnings call last month. However, if we look at the chart, the market disagrees, as it is ~63% off its 2021 high, and only ~32% from testing its COVID low.
Attributes of stocks that we are looking for
This past week, I/O Fund analysts held a webinar that discussed “How to Build a Defensible Tech Portfolio.” Although macro continues to throw curveballs, we believe a defensible portfolio can help alleviate any concerns.
Defensible means the portfolio should be overweight the bottom line. For tech investors, stocks that do not materially cash burn are ideal right now. Per Silicon Valley Bank’s CEO Gregory Becker: “While VC (venture capital) deployment has tracked our expectations, client cash burn has remained elevated and increased further in February, resulting in lower deposits than forecasted.”
Per the same Reuters report, Silicon Valley Bank is selling assets to position for higher interest rates and faster cash burn: “We are taking these actions because we expect continued higher interest rates, pressured public and private markets, and elevated cash burn levels from our clients.”
Elevated cash burn is something the public markets will be very sensitive toward into the foreseeable future. We have found that expanding operating margins and GAAP profitability was rewarded last year, and we believe this is the best way to position for an unpredictable 2023. At the very least, while the FED raises rates, cash burn will continue and we believe it will surprise investors at times just how cash strapped the tech sector truly is. This is why we have built a defensible tech portfolio, as outlined in this webinar here.
The bear market is not over. This has been our probable thesis since the start of 2023. With the 10-year rates breaking out to new highs, and on-going inflation reports showing a re-acceleration under the headline numbers, it was apparent that the FOMC would need to raise the terminal rate to further fight stubborn inflationary pressures. This realization marked the February top, which has since been intensified by the unforeseen collapse of two large regional banks.
We are open to the bullish narrative; however, it would require a clear and dramatic reversal in the monthly inflationary trends, coupled with no more banks coming under pressure. The needle the FOMC must thread is one of the most delicate in modern history. With inflation still elevated and showing little signs of decelerating in key areas, how much can the FED drop rates, short of a bank contagion? Either way, it does not look good for equities, and until we get signs of this bullish scenario playing out, we will remain cautious and defensive.
Broad Market Analysis
We have been warning our members since early 2023 that this market is unhealthy. Our automated hedge signal went to sell, and we have been hedged since early February; however, the warnings were present long before. We were seeing warning signs in Financials long before the current regional banking crisis. On February 22nd, we even posted a public warning about this sector flashing warning signals.
We were seeing a clear bearish pattern forming off the October low, which was confirmed over the last 2 weeks.
We were also seeing similar warnings in international markets. The reason this was concerning was that if we were on the verge of starting a new bull market, this would likely be signaled across the globe. This was not what we were seeing.
For example, the Canadian TSX has a long history of leading the US markets. This was a very clear bear pennant playing out, which has now been confirmed.
European markets have been relatively strong this year. For those watching, it was actually just a little behind US markets. In other words, the same bearish setup was playing out, just with a lag. So, while many were talking about a US breakout, we were seeing topping patterns in European markets, which did not line up with a new bull market forming.
So, where does that leave the US markets? From a technical perspective, the 2022 bear market does not appear to be over. We seem to be tracing a rather complex pattern, which suggests one more large degree 5 wave drop to complete the pattern.
These complex patterns tend to have shallow recovery rallies, much like we saw in July/August, and then again in October/January. Also, another key feature is that the length of each leg tends to be proportionate.
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For the first leg, which is marked “W” in the chart below, it broke down into 3 legs, marked A,B,C. Note how the C wave, which bottomed in June, is exactly 150% the length of the A. Regarding the 2nd leg of this bear market, which is marked “Y”, we should expect similar proportions.
Interestingly, if we apply the same measurements, from the recent top in February of 2023, 150% targets the 3050 SPX region. This lines up with several techniques pointing out the significance of this support region. If this pattern is playing out, we will loosely target this zone for some signs of a low being put in.
However, we need confirmation that this leg is playing out. The primary pivot will be 3765-3750. If we break below here, I would expect the drop to unfold rather rapidly. As long as we stay above this pivot, there is an off chance that we could see one more attempt at a bullish push higher, before the next leg lower.
Peak Inflation?
On Tuesday, the market celebrated a YoY CPI reading that was in line with expectations. While equities were up, long duration bonds on the other hand were down, which was a warning. This is interesting because what drives the price of long duration bonds is not the FED, but the growth and inflation outlook set by the bond market. With the FED trying to lower rates, and the CPI print coming in as expected, signaling inflation is cooling, you would think the bond market would rally with equities.
What the headlines were not discussing was that the CPI print was actually much hotter than the YoY print was suggesting. Inflation is best measured on a sequential basis, not a YoY basis. What matters is the trend, not annual comparison. It’s much more important to see if inflation is improving from month to month, not year over year, when tracking the trend.
I prefer to take the 3-month annualized readings to get the best feel for the actual trend. When you add up the prior 3 month readings and annualize them, the number comes out to 4.08%, compared with last month’s reading at 3.4%. This is a concerning rate of acceleration, and marks the 2nd month in a row of an accelerated trend within the CPI data.
Even more concerning, we are seeing a similar acceleration in energy, core prices, core goods, shelter, as well as services, which has been the biggest concern regarding inflation. The reason why services is so concerning is because it accounts for ~85% of the US GDP and it is still expanding above its 12 month trend.
With an on-going economic expansion comes inflation, which continues to show up in the CPI numbers. There is no question the FED, short of a banking crisis, would have to increase their terminal rate well above 5%, considering both the resilience of the US economy and the stubbornness of inflationary pressures in the services sector. This is why, in light of the troubles in the banking sector, the futures market is still priced in a 25 bps raise at a 50% chance.
What’s more concerning is that the current inflation readings were for February, which was done with Wheat and Energy commodities at subdued prices. If we look at these charts, from a technical perspective, they appear to be either coming to the end of their large downtrends, or in bullish postures, suggesting a bigger breakout is brewing.
Take gasoline, for example. It’s holding the ascending triangle pattern on bullish momentum.
If we see a breakout $2.8-$3 price point, we should see a sharp move higher, which would mean higher gas prices. The same can be said with Wheat, which appears to be coming to the end of a large degree correction.
These charts are suggesting a move higher on the horizon, which would not be good for future inflation readings.
Banks Matter
When the market bottomed on October 13th, 2022, it did so on the day that major banks began reporting their earnings for Q3, 2022. Interestingly, some of the larger banks surprised to the upside and even raised their 2023 guidance. What became apparent was that larger banks were thriving in the elevated rate environment.
Through various FOMC policies like 0% interest rates, operation twist, QE programs, etc., banks have not seen 30-year mortgage rates this high in a very long time. Being artificially suppressed, this affected the margins. So, this change was actually a windfall for banks that have been starved for years to make more money on the difference they take in for loans and then pay out on liabilities, also called net interest income (NII).
For example, JP Morgan in Q3 of 2022 reported NII of $17.6 billion, and guided for NII of $61.5 Billion for the year, beating expectations of $58 Billion. Even more astounding, JP Morgan announced that they currently have $1.2 Trillion in excess cash at the time. But, JPM was not the only bank reporting similar growth, we saw similar stories around the October lows from most major banks.
As a result, financials led the market higher into late November, which was signaling a stronger economy than most were anticipating. This was one of the primary reasons why we went on a spending spree in mid-late October. What’s important to note is that when financials are strong, the market tends to be strong, and vice versa.
For reference, there have been two bear markets that saw a greater than 50% drawdown in modern market history: 1929, 2008. They are extremely rare events that have one common theme running throughout each narrative – a banking crisis.
In each instance we saw a rare phenomenon that can be summed up as a loss of confidence in the banking sector. Each instance also saw the credit windows shut for even reasonably capitalized companies, which only intensified the accompanied recessions.
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It’s easy to dismiss the financial sector in today’s tech focused market. After all, financials only account for 11% of the total market cap of the S&P 500, with 3 sectors ahead of it. However, all companies depend on loans, and when banks get scared, the credit window shuts, which tends to lead to outsized bankruptcies. Bankruptcies lead to unemployment, which leads to less spending, which snowballs the process into a panic.
With the recent fall of Silicon Valley Bank (SIVB), followed by Signature Bank (SBNY), we saw the 2nd and 3rd largest bank failures in US history. In fact, the run on SIVB was the largest bank run in US history, with $2 Billion withdrawn in one day. Prior to this run, Washington Mutual was the largest run, with $16.7 Billion over 10 days.
According to the markets, the problem is not localized. The below chart is a handful of larger regional banks in the S&P 500 as well as the SPYDR Regional Bank ETF (KRE). This type of drop off is not the sign of a healthy stock, and we are seeing them across the board.
No one knows what will ultimately play out. We could see no further bank failures, accompanied with inflation continuing to trend towards the FED’s 2%. This would allow them the freedom to start a fresh liquidity cycle and rescue equities from any additional volatility. However, the above charts are quite telling and very unhealthy. They appear to be incomplete, and if they break below the recent panic low, expect the banking crisis to only intensify.
In conclusion, markets climb a wall of worry. This was the phrase that championed one of the greatest bull markets in US history from 2009-2022. After all, the market shrugged off Grexit, Brexit, the downgrading of US debt, two global slowdowns, China crash 1 and 2, as well as a global pandemic (!) Why would investors not believe it could shrug off a regional banking crisis as well as inflation?
However, the one common theme within the last bull market was that the FED was allowed to maintain an expansive liquidity cycle due to low inflation. Even in 2016, 2019 and 2020, the FED was able to start fresh liquidity cycles before the selloff lead to severe damage in the markets and economy. Today, the FED is aggressively draining liquidity from the system as a means to fight inflation, as shown in the below chart that compares liquidity in the system to the S&P 500
What’s troubling is that the aggressive actions taken by the FED are starting to affect the banking sector. However, these aggressive actions are simply not doing enough to quell inflation.
It could be argued that the FOMC will drop rates, start a new liquidity cycle and save the day. History suggests that this is not the case once the damage is done. It takes months for rate changes to filter into the economy, and once an aggressive hiking cycle breaks something, it tends to run its course in the equity markets before a bottom is found. The below chart compares the Fed Funds rate to the S&P 500. Note when the FED started lowering rates, which started a fresh liquidity cycle. Then look at how long it takes for equities to finally respond.
Maybe inflation will trend lower going forward, and maybe no more banks will have trouble; maybe, we are missing out on an opportunity to buy equities at lower prices just before a new bull market is about to start up. This is a very thin needle that must be threaded, and until we get evidence it is manifesting, we remain cautious.
Join us every Thursday, at 4:40 EST, when we host a webinar for our premium members. We go over various markets, outline what we are seeing and what we need to see in order to reverse our perspective. We also go through the charts of tech stocks and some cryptos that we are targeting to buy or trim. You can sign up here.
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The I/O Fund is a publishing company. The analysis, strategies, reports, activity and all other features of our service is provided for informational and educational purposes only, and should not be construed as personalized investment advice. Hedging is an advanced method of trading stocks, sudden losses can occur, and hedging should only be pursued under the supervision of your personal financial advisor.
2022 was rough — so rough it marks the greatest destruction of wealth in modern history with an estimated $57.8 trillion lost across all asset classes combined.
We’ve been accustomed to believe the inverse correlation to equities and bonds is universal. Since 1998, this relationship has held true, offering investors safety in bear markets with a rotation into bonds. This was not the case in 2022, as heightened inflation brought on a bear market in both asset classes.
According to a write-up by the Syz Group, 2022 smashed many records, including the only year in history in which both the S&P500 and the US 10-year Treasury bonds were down more than 10% each.
Certainly, if smart money struggled this much then so did retail investors. In fact, retail investors typically take the brunt of the losses in the stock market. According to a professor at the University of Oxford, “retail investors will always lose money because they lack the ‘education’ whereas financial professionals are well informed – that’s what they do.”
That’s a hard pill to swallow as retail investor communities swelled to a size not previously seen prior to Covid. Retail investors previously made up 10% to 15% of the market and now make up 25% of the market, according to Bloomberg Intelligence.
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This means the retail community was growing at the exact point in history that this investor type was most likely to get hurt in late 2021 and throughout 2022. According to Goldman Sachs, “retail net selling activity has accelerated over the past six months. In aggregate, selling over the past eleven months has completely reversed all the net buying in single stocks from 2019 to 2021.”
According to Goldman Sachs, retail investors have sold 1.5 times the amount accumulated in NDX 100 stocks, which indicates not only a complete reversal, but a complete reversal coupled with a steep loss.
Volatility is Driven by Machines
One of the primary culprits to the extreme volatility seen in recent years is caused by algorithms. Most newer investors envision a stock trading floor where market makers assist in trading stocks. The reality could not be further from the truth. In fact, those pictures of stock traders on the New York Stock Exchange floor are entirely for appearances. To truly envision how the stock market works, a more accurate picture would be of a colocation data center stacked with servers.
It’s true that quantitative easing caused too much liquidity, and in response, there was a knee-jerk reaction to quantitative tightening. However, it’s important to remember that machines were breaking records in both directions at the height of QE, as well.
Here’s an excerpt from an editorial I wrote in 2020 when the market was seeing a record number of limit up and limit down days:
“Nearly a decade ago, there was a flash crash that occurred on May 6, 2010. This “flash crash” caused the Dow Jones to drop 998.5 points (about 9%) within minutes, only to recover a large part of the crash later in the day. According to the Commodity Futures Trading Commission (CFTC), high frequency trading “did not cause the Flash Crash, but contributed to it by demanding immediacy ahead of other market participants.”
Flash crashes and flash rallies of 1000 points are now the new normal with sixteen occurring since March 1st. Four of these historical daily gains were above 9%. Trading curbs, known has circuit breakers, were hit four times last month.”
The editorial also discussed the prevalence of a “man plus machine” approach or woman plus machine:
“During the Q4 2018 sell-off, Guy De Blonay, a fund manager at Jupiter Asset Management stated 80% of the stock market is controlled by machines. In 2017, JP Morgan stated that “fundamental discretionary traders” accounted for only 10 percent of stock trading volume.
Billionaire Steven A Cohen’s hedge fund had to focus more on quant trading in 2017 when it lost money in most of its traditional trading strategies in that year, while its quant investors made money. For example, Steven Cohen’s $12-billion hedge fund, Point 72 Asset Management, is moving about half of its portfolio managers to a “man plus machine” approach.
According to Wells Fargo, robots will replace 200,000 banking jobs over the next 10 years. Citigroup has formed a lab to cross-train traders and developers for machine learning and artificial intelligence. The programming language, Python, is especially in high demand at leading banks, such as JP Morgan and Goldman Sachs.”
This creates a serious disadvantage for retail investors and those who do not have a team of Python developers to leverage quant systems that trade in a blink of an eye. Ray Dalio, the fund manager for Bridgestone, has openly discussed that the best approach to the modern-day stock market is what he calls “the man and machine.” His firm has 1,500-employees that use computer models to test hypotheses; which is just one of the many advantages hedge funds and institutions have over retailers.
According to Dalio, the ideal is to have an algorithm work alongside a portfolio manager for a customized approach to predicting the markets. Although the I/O Fund does not have a team of Python developers, this year we partnered with Vincent Duchaine of WealthUmbrella in order to close the gap between human-driven actions and emotionless machines. This marked an important turnaround for our firm as we gave up what I would call “retail idealism” which centers around the idea that holding a stock for a long period of time is retail’s only defense. This works during times of economic expansion, but where this can go (horribly) wrong is when a new, more challenging macro can change the outlook for any given company.
Note: For a Limited Time, I/O FundNote: For a Limited Time, I/O Fundis offering a $99/year Premium Newsletter plan that provides one actionable stock tip per month and analysis from a top performing, audited team. Click here for more detailsis offering a $99/year Premium Newsletter plan that provides one actionable stock tip per month and analysis from a top performing, audited team. Click here for more details
For example, the cloud sector is a favorite among retail investors yet has not been through a period of quantitative tightening. Most cloud companies were founded in 2010 or later, when funding was easy to secure. It did not matter if these companies were cash efficient or not, as the past decade has been marked with cheap money with over a decade of the Fed Funds rate at or near zero.
For our premium members, I wrote an earnings report in August on two stocks that were brutally beaten up entitled “It’s the Economy Stupid.” The analysis asked an important question: are these stocks down as a result of poor management, something unique in their financial profile — or because a weak economy is simply too hard to contend with?
Although retail investors were busy pointing fingers at specific stocks, if it was the latter, then all consumer stocks would eventually be affected. Fast-forward, and hundreds of tech stocks finished down 70%, and nearly every tech stock finished down 50%. This includes the indestructible FAANGs, with many trading at historic low valuations. In 2022, an investor would have to be in denial to focus on the poor performance of an individual company rather than acknowledge something much bigger was going on.
The point was to encourage our readers to let go of the idea that picking good stocks could save a portfolio in the tech industry and to instead fully embrace risk management tools.
Risk Management Tools
In April of 2022, the I/O Fund stopped relying on stock picks as the primary, offensive measure because this approach simply was not working in the new macro. After partnering with Wealth Umbrella on an automated hedge, the I/O Fund began to boldly hedge up to 100% of our portfolio, at times.
We pivoted to playing defense rather than offense. Those who watch team sports will understand this transition well, as the strategy changes from attempting to make money (or make a goal) to a strategy that prevents losses (or prevents a goal).
The first four to five months weighed on our returns, yet our portfolio performance in 2022 stands apart from all-tech portfolios that only played offense. In addition to being evident in our soon-to-be published performance results, we also believe the positive effects of this pivot toward playing defense will be seen throughout 2023 and onward.
Unlike many other all-tech portfolios and ETFs, we believe a more active stance is necessary for long-term tech investing. We also believe that the easy years of buy and hold are over, marked by the great growth cycle post-GFC, and that a more active approach will be necessary to survive, and even profit. As a result, we rotate our portfolio frequently, raise cash and actively hedge our portfolio with an automated signal.
In addition to hedging, real-time trade alerts are sent to our members the minute the hedge is on, or is turned off, or when the allocation changes in terms of percentages, such as 25% of our portfolio value, to 50% of our portfolio value, to 75% and so on.
Please reference “The Best of I/O Fund’s Newsletter in 2022” for More Information on Analysis the I/O Fund published last year relating to Technicals and the hedge and a few fundamental calls, as well.
For those who may not be aware, this is extremely challengingextremely challenging to do as it combines the two most advanced forms of portfolio management.
One of the most advanced forms of portfolio management is real-time trade alerts. This places immense pressure on a portfolio manager as the stakes are high to record what you do every second in real-time. To voluntarily choose to have the highest level of accountability in retail is nearly unheard of, yet registered fund managers are required to do this and file their stock trades.
Secondly, hedging up to 100% of a portfolio is also a large psychological hurdle, and traditionally a risky one. Markets spend the vast majority of their history in uptrends, for one. Secondly, the amount you can lose on a short is literally infinite, to where one’s downside risk is capped at 0 on the long side. To overcome these hurdles, we have spent considerable resources developing a “man and machine” signal with the help of Wealth Umbrella that is truly state of the art.
It’s only natural for retail services to want to ease the pressure of having to report in real-time. The stakes are much higher when what you do is recorded the minute the action is taken, but overall, having the highest level of accountability possible has made the I/O Fund much sharper investors.
Logging trades in real-time also places immense pressure on the analysts at the I/O Fund, as well, who are not allowed to simply choose a stock but must also determine the allocation for the stock. After recommending a stock, the analysts must help the portfolio manager actively manage the position, which can change at any time.
There is a reason most services do provide this level of transparency and activity. The more granularity that is offered, the more skill is required. Also, compare this to social media, where some investors will casually claim trades that were not logged in real-time.
Verified Returns
In addition to a lack of risk management tools, I believe a lack of verified returns in the retail space contributes to the losses this investor type experiences. Smart money is careful about who they consider a good investor — they do not take someone’s word they are a good investor; they make the investors or firms they follow prove it. Every single hedge fund has to report their returns, which reduces the chances of posturing.
Retail is not offered these checks and balances, and instead, this investor type follows many influencers and research sites who verbally state their performance without proper verification. Across the board, retail is offered a very low amount of accountability – this includes unverified month-end reviews, a list of stock tickers, unchecked screenshots, or other methods that are easy to manipulate. This widespread acceptance of loosely stating a stock performance is odd, to say the least, considering the finance industry is more inclined than any other industry toward deceptive practices.
How the I/O Fund Sets a High Bar for Accountability
Over the past three years, the I/O Fund has invested over $130,000 into accountability and transparency for our Members. When we launched in July of 2019, for the first year or so, we used a forum hosted by Tribe for our trade alerts, but by January of 2021, we had migrated to SMS and email tools that were the least likely to experience an outage for our real-time trade alerts. This costs us $40,000 per year.
In addition to this, we use an auditor from a large firm in San Francisco to mathematically review and verify the performance of our I/O Fund portfolio trading account and crypto account. The process is quite extensive and it takes up to four months to complete. This costs $4,500 per audit and we’ve completed four audits for a total of $18,000 spent on this process.
Note: For a Limited Time, I/O Fund is offering a $99/year Premium Newsletter plan that provides one actionable stock tip per month and analysis from a top performing, audited team. Click here for more detailsNote: For a Limited Time, I/O Fund is offering a $99/year Premium Newsletter plan that provides one actionable stock tip per month and analysis from a top performing, audited team. Click here for more details
Here are some things we could have done with $130,000 instead of being the only retail site to provide checks and balances to this extent:
Bought two Tesla Model Y SUVs and painted them with our logo (or even three Model Ys with the new tax credit)
Traveled the world for a year, all expenses paid, and instead, sent our members a picture from a Gondola in Venice
Bought a small yacht and sailed the beautiful Bay, and sent our members kitesurfing pictures
Joking aside, accountability is expensive but we feel it’s worth it.
Conclusion
I believe real investors take necessary steps to prove their returns, that they accept the pressure that comes with registering trades in real-time and that they do not expect anyone, under any circumstances, to lower their standards and accept an unverified number in regard to portfolio performance. Due diligence on stocks requires scrutiny, and this same level of scrutiny should be applied to the company you keep in the finance industry.
To put it simply, the I/O Fund was founded to bring the standards that smart money insists on to the retail investment class. We think retail will be empowered to outperform when their standards are higher on who they follow and what research they read, and when they refuse to accept a lower standard on transparency.
The I/O Fund is wrapping up our annual audit in the month of March, which is a month earlier than our audits were published in the past (you can access our previous audits including here and here and here). We look forward to adhering to the high standards that retail investors deserve. You can look forward to our 2022 performance being published by the end of this month.
Note: For a Limited Time, I/O FundNote: For a Limited Time, I/O Fundis offering a $99/year Premium Newsletter plan that provides one actionable stock tip per month and analysis from a top performing, audited team. Click here for more detailsis offering a $99/year Premium Newsletter plan that provides one actionable stock tip per month and analysis from a top performing, audited team. Click here for more details
The I/O Fund is a publishing company. The analysis, strategies, reports, activity and all other features of our service is provided for informational and educational purposes only, and should not be construed as personalized investment advice. Hedging is an advanced method of trading stocks, sudden losses can occur, and hedging should only be pursued under the supervision of your personal financial advisor.
China’s 2001 entry into the WTO marked the beginning of the golden age of globalization. This was the catalyst that led to the global outsourcing of domestic manufacturing capacity to lower costs regions in the world. As a result, world economies became more interlinked. In 2016, President Trump began his administration by imposing tariffs on China, one of the United States’ largest trading partners. This signaled globalization’s peak and the beginning of a shift downward. This shift has continued with the Biden administration and the passing of the Bipartisan Infrastructure Law (BIL) ($550B) and the CHIPS and Science Act ($53B). The legislative goal is to improve US economic competitive, innovation, and industrial productivity.
On August 16, 2022, Biden signed the Inflation Reduction Act (IRA). It directs new federal spending toward reducing carbon emissions, lowering healthcare costs, funding the IRS and improving taxpayer compliance. The IRA’s primary objective is to spur investments in US domestic manufacturing capacity. This most recent legislative action is another step toward the “Made in America” goal and increasing manufacturing national security.We have written about it and its key provisions here and here.
Here in Part One, we’ll go into more detail on the key characteristics of the IRA and the earnings impact by examining one company – First Solar (FSLR). Next week, in Part Two, we’ll discuss other companies that may benefit.
What is the IRA?
Based on an analysis by Mckinsey and Company , the IRA directs nearly $400B in federal funding to clean energy, with the goal of substantially lowering the US’s carbon emission by the end of this decade. The funds will be dispersed via a mix of tax incentives, grants and loan guarantees. Clean electricity and transmission will receive the highest funding, followed by clean transportation, including electric-vehicle (EV) incentives.
In the past, the US has generally relied on imports for solar equipment. This law will encourage more production at home with incentives for domestic solar panels and inverter manufacturing. It is also designed to support the construction of renewable electricity plats.
Who benefits from it the most?
The majority of the $394B in energy and climate funding will be in the form of tax credits. Corporations with US manufacturing capacity are the biggest beneficiaries with an estimated $216 billion worth of tax credits available. The tax credits are meant to provide an incentive for private domestic investment in clean energy, transport and manufacturing. Many of the tax incentives are direct pay, meaning they can claim their credit in that tax year and be paid the following year.
In addition to higher energy prices, the IRA’s corporate tax incentive has contributed to the Solar sector’s outperformance.
How does this impact earnings?
The IRA has created a tailwind for the clean energy sector. Companies are now just beginning to discuss the potential earnings impact in their most recent Q4 commentary. Some have provided more details than others.
From an investment perspective, the key is to identify companies with US based manufacturing capacity that can collect these tax credits and whose earnings will benefit in a meaningful way.
We’ve identified First Solar (FSLR) as one of the biggest beneficiaries of the IRA. Due in no part to the fact that they have provided the most visibility as to how the IRA will impact their earnings. In doing so, they have provided a useful investment framework to assess how other companies may benefit. We will discuss this next week and cover Enphase and Tesla, just to name a few.
We also want to emphasize that tech will see very few tailwinds this year, so it makes sense to take our time and to drill deep into one tailwind we have identified.
How does the IRA Tax Credit (IRATC) work?
This is how First Solar described how the IRATC will work.
“And finally, a few words on the Inflation Reduction Act. The IRA offers, amongst other incentives, production tax credits for solar modules and solar module components manufactured in the U.S. and sold to third parties. Although we continue to await guidance from the IRS and Treasury regarding these credits under Section 45X of the statute, based on our view of both the intention of the credit and the language of the legislation, we intend to begin recording a corresponding benefit in our financial statements in Q1 of 2023. Following consultation review with outside advisers, our auditors and the SEC, we expect to recognize these credits as a reduction to cost of sales in the period such modules and the integrated eligible components are sold to customers.”
In their 2023 guidance, they went on to say
“I’ll now cover the full year 2023 guidance ranges. Our net sales guidance is between $3.4 billion and $3.6 billion; gross margin is expected to be between $1.2 billion and $1.3 billion, which includes $660 million to $710 million of advanced manufacturing production tax credits under Section 45X of the IRA; and $110 million to $130 million of ramp and underutilization costs.
This results in a full year 2023 earnings per diluted share guidance range of $7 to $8”
FSLR’s guidance provides insight on the impact of the IRATC. To simplify the analysis, we’ve taken the mid-point and excluded the ramp-up related costs.
In the case of First Solar, the IRATC has a significant impact on profitability – gross margins double. Another way to look at it is that in addition to the estimated 2023 average sales price of $0.29 per watt, First Solar will receive $0.17 per watt in the form of the IRATC. This is how FSLR breaks down the IRATC:
“Given our fully integrated thin film manufacturing process, we expect that this guidance will entitle us to integrated tax credits for wafers, cells and module assembly, which we estimate will equal approximately $0.17 per watt for modules produced in the United States and sold to a third-party.”
First Solar has been advised to treat the IRCTC as a reduction in costs of sales. As a result, it’s important to focus on their growth in earnings per share. Assuming other companies adopt the same reporting standard, the same investment parameters will apply.
Consensus earnings are expected to increase 80% from 2023 to 2024. Comparing it to 2022 is not an apples-to-apples comparison as there was no IRCTC benefit in 2022 while gross margins were impacted by higher-than-expected logistic related costs. There were mainly penalty costs related to exceeding dock waiting times due to Covid supply-chain issues. FSLR has indicated that these and other costs will trend back down toward pre-pandemic levels over the course of the year.
Not every company will capture a similar level of profitability uplift. Generally speaking, those with higher domestic content can claim more of the IRATC. Companies will seek to capture as much of the IRATC as possible. And from an investment perspective, companies that have existing domestic capacity and can claim the IRATC in 2023 will be the stocks that benefit the most in the short-term.
FSLR provided insights on domestic capacity expansion as it relates to collecting the IRATC.
“… we believe that the intent of IRA is to create enduring long-term supply chains, which would therefore motivate and align the incentives to true manufacturing in the U.S., more than just final module assembly with all the build material being sourced from international locations.
And if everything lines up along those lines, then that sort of helps inform our view there as it relates to the inherent value of more domestic manufacturing, plus we want to make sure that, while we believe we're fully entitled to the vertically integrated manufacturing tax credit, to the extent that we can get confirmation through guidance from IRS and Treasury, that would be very beneficial as we think about factory expansion.”
The key word is “vertically integrated”. The more that a company’s US based manufacturing is vertically integrated, the more of the IRATC it can claim
Making of a National Champion
We’ll now take a closer look at FSLR and examine how they will benefit. But first let’s see how FLSR spoke about IRA after it was signed into legislation. This is what FSLR said in their Q322 call.
“I would like to discuss the U.S. policy environment, which has evolved significantly over the past quarter. As you may recall, the joint announcement from Senators Manchin and Schumer regarding the Inflation Reduction Act preceded in our last earnings call by just 1 day. Since then, we have seen the Act signed into law and First Solar had the privilege to be part of the White House event in September, celebrating the groundbreaking piece of legislation.
In our view, by passing and enacting the Inflation Reduction Act of 2022, Congress and the Biden-Harris administration has entrusted our industry with responsibility of enabling and securing America's clean energy future, and we recognize the need to meet the moment in a manner that is both timely and sustainable. Thanks to our strong foundation, including a repeatable, vertically integrated manufacturing template, proven technology platform and solid balance sheet, we were able to respond rapidly to enact — to act by accelerating the decision to expand our U.S. manufacturing base.”
“Broadly speaking, 2022 placed us on the cusp of significant growth in domestic solar manufacturing within our core markets.”
It goes without saying that IRA is an important piece of legislature. First Solar is positioning themselves as one of the National Champions to help IRA’s implementation. As we’ve seen internationally, National Champions typically get to provide input into and receive beneficial treatment from the government and other regulatory bodies. We believe the amount of IRATC visibility that FSLR has provided, in contrast to others thus far, is a reflection of that.
What does FLSR do?
FSLR manufactures solar modules based on thin film Cadmium Telluride (CadTel) photovoltaic (PV) technology demonstrated to have lower cost, superior scalability, and a higher theoretical efficiency limit over conventional technologies, like crystalline silicon (c-Si). Solar module sales represented 93% of total sales and the majority of sales were to developers and operators of systems in the United States. A few of its largest customers include Intersect Power, Lightsource BP, and NextEra Energy. FSLR will benefit as their clients have an incentive to build out their own capacity to capture the IRATC. This is how FSLR described the IRATC opportunity for its customers.
“The opportunity for everyone, whether you're the developer or whether you're the module manufacturer or whether you're the IPP or the utility who's going to own the generating asset over time, there's opportunity for everybody.”
“And so the question is, do you want to sort of secure your business plan and take risk off the table? And if you're willing to do that and do that at a fair price, then First Solar is a great option to do that. If you're trying to take some risk and you're wanting to find opportunities to avail yourself to potentially alternative supplies that maybe will still allow you to benefit to the maximum potential under IRA, then that's a risk that some may want to take and wait. But what we see right now is that we've got more than enough opportunity to engage. Yes, it's an item that is in some of our customers' thought process. But for the most part, most people aren't paying a lot of attention to it in that regard.”
Where does FSLR manufacture?
Currently, the US is 36% of their 9.8 GW manufacturing capacity. By 2024, this will expand to 50%. Total manufacturing capacity is estimated to reach 21.4 GW by 2026. FLSR will also benefit from India’s Incentive Production Scheme to encourage domestic based solar manufacturing.
Is there demand to this utilize this increase in capacity?
Below is the amount of GW has booked through 2/28/23. FSLR has booked 67.7 GW of future deliveries. Clients typically put up to 20% down payment to secure that order – the contracted backlog is 61.4 GW.
Q422 Investor Presentation
Regarding the contracted backlog, FSLR stated the following
“We had a total contracted backlog of 61.4 gigawatts with expected future revenue of $17.7 billion for a portfolio average base ASP of $0.288 per watt, before the application of potential adjusters”
Put another way, their contracted backlog is 6x their current manufacturing capacity. This is a product of FSLR’s customers preparing to build their capacity to capture the IRATC. This type of secular demand provides FSLR great visibility on future sales and pricing power. FSLR is sold out through 2025 (excluding India). FSLR’s focus is negotiating solely for 2026 volume and working with customers who are looking to secure multiyear contracts over the remainder of the decade. This is how FLSR described the current demand environment:
“We also began the year with a record contracted backlog, a significant pipeline of bookings opportunity and a robust demand in our core markets. This momentum is driven by our points of differentiation, including a unique CadTel technology, vertically integrated manufacturing process, domestic production, strong balance sheet and commitment to responsible solar, placing us in a position to respond to emerging opportunities, particularly those enabled by the rapidly evolving policy environment.
“After accounting for shipments of approximately 2.3 gigawatts during the fourth quarter, our future expected shipments, which now extend into 2029, are 67.7 gigawatts. Excluding India, and including our year-to-date bookings, we are sold out through 2025. We have, in recent months, pivoted from negotiating solely for 2026 volume to work with customers who are looking to secure multiyear contracts over the remainder of the decade.
From a commercial perspective, in 2022, we saw a precipitous shift towards long-term, multiyear module procurement. This record volume of multi-gigawatt deals spanning multiple years was driven by a combination of competitive pricing, competitive technology, agile contracting, shared values and trust in our ability to deliver the certainty that our customers are looking for. As a result, we had an excellent year from a bookings perspective, securing a record 48.3 gigawatts of net bookings in 2022. This was an increase of 30.8 gigawatts from our prior annual record of 17.5 gigawatts set in 2021. Our total backlog of future deliveries as of today's earnings call now stands at a record 67.7 gigawatts.”
“As it relates to converting the pipeline into future bookings, our record bookings in 2022 were driven by the favorable balance of near to mid-term available supply, aligned with customer demand for large volume multi-year procurement.”
“Our commercial strategy remains largely focused on supporting long-term multi-year customers who prioritize price and product availability certainty as well as ethical and transparent supply chains.”
This is how FSLR described the positive impact on profitability as they expand capacity to meet demand.
“I’d like to reiterate our approach to growth and gross margin expansion … this strategy includes our approach of contracting out our capacity several years in advance of production. The anticipated reduction of our cost per watt produced, the expected benefits from capacity expansion through scaling a largely fixed overhead structure in order to generate incremental contribution margin and our agile contracting approach would both provides the potential realization of incremental revenue and is expected to mitigate freight and certain commodity risks.”
Assuming, a return to pre-pandemic costs inputs levels (raw materials + logistics), the key drivers of earnings will be FSLR meeting GW expansion targets, ASP per watt and the IRATC combined with positive operating leverage. US pricing in particular may benefit from positive price adjusters that they can charge their customers based on the IRATC.
Can FSLR fund this?
One of FSLR’s competitive advantages is their financial position. Clients know that they are a financially stable partner. FSLR will not require external financing.
“Operationally, in 2023, we’re expecting to produce 11.5 to 12.2 gigawatts of modules, and after taking into account reductions in inventory, fell 11.8 to 12.3 gigawatts. From a capital structure perspective, our strong balance sheet has been and remains a strategic differentiator, enabling us both to weather periods of volatility as well as providing flexibility to pursue growth opportunities including self-funding our Series 6 and Series 7 transitions.”
“We ended 2022 in a strong liquidity position. And coupled with strong forecasted operating cash flows, modular advance payments and our existing India credit facility, we expect to be able to finance our current capital programs without acquiring external financing. We are evaluating putting in place our revolving credit facility to support jurisdictional cash management as well as to provide short-term optionality and expect to address more details on our capital structure and liquidity outlook at our Analyst Day.”
Sales vs EPS
Given the accounting treatment of the IRATC, it is important to identify companies whose earnings will benefit from the IRATC. Sales will still be important, but it won’t capture the IRATC benefits. Here’s a consensus snapshot of FSLR’s EPS and Sales.
Sales are still growing at a healthy rate due to capacity expansion while earnings are forecasted to grow at more than 2x that rate because of the IRATC. Recall that 2022 had no IRATC benefits and gross margins were severely impacted by logistic costs.
“Note from an earnings cadence perspective, we anticipate our earnings profile will be higher in the second half of the year, both due to contractual delivery schedules as well as the timing of first sales of our Series 7 products, which are forecast to begin shipping in Q3 of this year. This is forecasted to result in an increase in inventory at our distribution centers in the first half of 2023, which is expected to reverse in the second half of the year. Additionally, Section 45X credits, recognized, will increase after Q1, driven by both the timing of volumes sold as well as the inventory lag, whereby products sold in the early part of 2023 may have been manufactured in 2022.”
Given the recent rally after Q4, this timing effect may provide an opportunity to enter at lower levels.
How does valuation look?
Even after the recent rally, FSLR’s valuation is not demanding based on 2024 eps. Using 2024 EPS, price and multiple sensitivity indicates the valuation potential is between $275-325. We won’t start using 2025 EPS just yet.
How do the technicals look?
We aren’t the first to appreciate the FSLR investment case. However, as long-term investors we believe this case will play out over several years and the market will provide us better entry points.
Per Knox:
FSLR is completing a symmetrical 3 wave uptrend. Note how the length of the second push higher (C wave) is nearly identical the in percentage gains from the first push higher (A wave).
The $235 region will be the exact symmetrical target for this move, and it is pushing towards this important resistance zone on weaker momentum. We will be looking for some kind of pullback from this region.
For those looking for a riskier buy, I’d look for the $175-$145 region, if we get there. The safest place to buy is if/when it can breakout above the $235 region.
Conclusion
The Inflation Reduction Act is an important piece of legislature. Winners will emerge as a result. We’ve identified FSLR as a winner over the next few years.
In Part 2, we will apply the same IRATC investment framework to assess how other companies are positioned. As a sneak peak, Enphase has indicated they will capture a portion of the IRATC benefits but more likely toward the end of 2023 into 2024. Look for a follow up next week or so.
Regarding the charts below, the vertical tan shades represent time factors. These are inflection points where we have high odds of something significant happening. More times than not, (3/4 of the time), they mark a turning point in the trend. So, what matters is the direction we are trending into these periods. Regarding the vertical lines, black lines represent strong support/resistance, while dark red lines mark very strong support/resistance.
Elliott Wave count are meant to provide context. There is a pattern unfolding in real-time, one of which will play out. By monitoring price levels that are held/broken, it will help us figure out which one is in play
Broad Market
Last week we saw the market in extreme oversold conditions. As a result, we were expecting a short covering rally to target 4040 SPX, which is what we saw. However, what we were not expecting was a 125 point rally in two days that exceeded our target. Furthermore, the structure of the rally is a rather clean 5 wave move, which has added an interesting layer of complication into where this market can go.
As a result, I’m adding an alternative scenario to the larger picture, which we will start game planning for in this report. Before I dive into these scenarios, I want to be clear. Short of the FED starting a new liquidity cycle, which I see very unlikely considering the inflation data, coupled with the bullish posture in various food/energy commodities, I simply do not see the necessary support needed for a new multi-year bull market playing out. Long-term risk (6 months+), we are still quite defensive and will remain this way until new data changes this view. However, intermediate term risk (1-3 months) is quite different. There is now a potential +300 point move that could play out over the coming weeks-months, which we will likely position for, if confirmed.
– Primary (Blue) – we have either topped or are within 200 points away from topping. This will lead to a fresh leg in the bear market with a downward target towards SPX 3000.
– Alternative (Red) – We have just completed the 2nd leg within a larger B wave (bear market rally). This will lead to the final 3rd leg of the bear market rally, which is targeting +4400 SPX.
If we zoom into the structure of the bounce off the October 13th low, you can see on multiple time frames 3 wave moves in all directions. We assumed that the January rally was the C wave, which appeared to collapse into a weak diagonal pattern. However, the 5 wave rally off of last week’s low has opened the door to this alternative scenario potentially playing out. Over the next 2 weeks, I expect one of the 3 scenarios below to be confirmed. This wil define the intermediate-term risk. What will matter most of all will be HOW the market retraces in the coming days – 3 waves down or 5 waves?
If we retrace in 5 waves down, and take out last week’s low, then either blue or green is playing out.
– Blue – we have topped, and will continue to trend down until the selling pressure gives way to a strong trend.
– Green – we bottom before breaking below 3765, then turn back up in a 5 wave pattern. This will imply that we are going to the 4200 region before a bigger top triggers.
If we retrace in 3 waves down, then red will start moving into position.
– Red – The overlapping mess of a market we have experienced since the December top has been part of a very complex B wave pattern. B waves (and 4th waves) are treacherous, as they tend to whipsaw emotions, grind down investment plans and wear down investors. We typically do not see B waves take such a complicated form, but considering that sentiment is in the basement, as well as the resilient credit cycle in the economy (more below), this scenario should be taken seriously.
Let’s zoom in a little more to a 15 minute chart. This will help us set up parameters and expectations for the week.
Note how the 5 wave move off the low started from a slightly lower low than the previous drop. This could easily be an expanded flat correction, which would support the blue/green above. However, because it started from a fresh low, we have to consider red, and the potential for a large push higher before we see a bigger top.
We topped today right into our minor time factor (6-7). We were trending up into it, and so far, the drop is only 3 waves. This can easily morph into a 4th and 5th down, which should be settled tomorrow/Wednesday. If this 3 wave pullback holds, and we push to make another high, the red count will then become my primary, as we set up a buying plan for the following 2ndwave pullback.
Our Updated Game Plan
We currently have about 30% cash and are 100% hedged. If we see this 3 wave drop hold, we will look to remove some of our hedge for a gain. Also, if the odds start favoring the red count, we will look to deploy some of our cash. As of now, ~ 2.5% in NFLX, ~ 2.5% in TSLA, 1.5% in ENPH, and ~10% in QLD once we close our hedge, and the rest in cash. For long-term investors who do not want to be this nimble, nothing has changed. Whether we see a top already in, or one that happens within the next +300 points, we believe that this bear market is not over. This will remain our outlook until we see evidence to the contrary.
Macro
The Liquidity Cycle
The phrase, “wall of worry,” continues to get thrown around in 2023. The new bull market, like all bull markets, is climbing a wall of worry. This phrase was golden in the last 12 year bull cycle, as stocks shrugged off countless events that pundits were certain would end it all – Downgrading US debt, Brexit, Grexit, Global Slowdown, China Collapse (1 and 2), Taper Tantrum, The 2016 Presidential Election, COVID, etc. Nothing serious manifested, as all drops were quickly brought back to new highs, leaving bears in the dust.
However, the one common thread within all of these events that allowed for equities to shrug off the news and continue higher was that we were either in the expansive part of a liquidity cycle (2011, 2015-2016), or the FED started a fresh liquidity cycle (2019, 2020), which saved equities.
How important is the liquidity cycle for stocks? After the COVID collapse, we saw some of the most abysmal economic data on record. Literally, high frequency data was off the chart, and appeared to only be getting worse as we entered a recession. In response, the FOMC started one of the most aggressive liquidity cycles on record. In 2020, stocks went on to have a record year, while economic data continued to shock investors. Without a new liquidity cycle, I simply do not see a new bull market starting up, which is why this is so important to track.
The below chart compares liquidity to the S&P 500 over the last 15 years. When liquidity is being pumped into the economy, stocks are able to shrug off terrible events, even contractions within the economy. On the other hand, when liquidity is being drained, we tend to go through periods of volatility – 2018-2020, 2022-present – until a new liquidity cycle starts back up.
The Credit Cycle
Recessions happen when banks shut the credit window. As the FED increases rates to slow inflation, the cost to buy homes, cars, business expansions, remodels, etc. all go up as well. This is why manufacturing sees a relatively quick reaction to rate increases. Like dominoes, layoffs lead to less spending, which leads to more layoffs. Banks increase their standards for loans, making it more difficult for struggling businesses and consumers to stay afloat. This eventually gives way to a recession, which destroys inflation, allowing the FED to lower rates. We then start a new credit cycle.
The question we have to address today is – how close are we to a recession? Manufacturing is clearly in a deep contraction and has been for several months. However, 85% of our GDP comes from Non-Manufacturing (Services). Unlike Manufacturing, this segment of the economy is continuing to expand.
If we dive down into Non-Manufacturing reading from last week, it did tick down to 55.1, beating the consensus expectation of 54.5 (any reading above 50 marks expansion, while below 50 marks contraction). New orders, which measures future demand, increased to 62.6 from 60.4 a month prior. Within the report, inflation concerns continued to be the predominate theme. This can be seen clearly in the prices index, which ticked down to 65.6. This is clearly off the peak, but still very elevated.
A basic metric that I use is measuring the trend in ISM numbers to their 12 month exponential average (in blue below). The below chart blends the ISM number along with the new orders number. Note how Services is back above this moving average for the first time since later 2021. This is great news for those worried about an imminent recession, as the credit cycle appears to be more resilient than most expect.
This is not only a US story, as recent global PMIs show the exact same scenarios playing out. All major countries are showing a contraction in manufacturing; however, the only major country that is showing a contraction in services is in Brazil. In other words, the likelihood of a H12023 global recession is unlikely. Why this matters for equities is because equities tend to bottom while in the middle of a recession. This further supports the red or green counts from above.
Why This Time is Different
The credit cycle is ready to extend, while the liquidity cycle continues to contract. Without the liquidity cycle, it is only a matter of time before credit, equities and the economy continue to contract into a recession. Why we think it is a pipe dream to assume the FED will pivot and start a new liquidity cycle to support equities? In one word – inflation.
We’ve been conditioned to expect the FED to save equities when they go down too much. Many, including myself, were shocked to see the most dovish FOMC in history pivot into becoming one of the more hawkish in recent history. This is because of how harmful inflation is to an economy. There is a reason that inflation pressures are more important to fix over decreasing asset prices.
Most investors have never experienced inflationary environments, while very few have experienced inflation of this caliber. We have entered a new macro regime where systemic global inflation is at odds with one of the most indebted global economies on record – global debt-to-GDP ratio of 338%.
As inflation builds, the fixed yield on bonds becomes less attractive. So, yields go up until buyers are satisfied with the new fixed yield relative to inflation. This will increase the cost to service debts, which is bad news for countries with a debt-to GDP ratio over 100%. If this cost goes too high, the bond market fails to believe that the debt will ever get paid back, which can cause a fiscal spiral. This is what we saw in England in late 2022, and this is what we want to avoid in Japan in 2023.
Furthermore, while a bear market in equities affects some members of a society, inflation affects all members of a society, especially the middle and lower classes. And, if the 1970s taught us (and the FED) any lesson about inflation, it is that once the genie is out of the bottle, it is very hard to get it back in. So, addressing inflation is the primary concern of this FED. They have stated this time and time again, and we do not believe the story with inflation is over, yet.
The below chart shows the 5 year breakeven rate. This is the difference in yield between the inflation projections 5 years out and the 5 year nominal yield. In other words, it’s a market-based gauge of where inflation will be in 5 years. Since January of this year, the 5 year breakeven is up 60 bps.
This is further backed up by the breakout in the 10 year yield. The bond market is diverging from equities, which will require a resolution.
This makes sense considering that the Services segment of the economy continues to expand in light of an aggressive FED. It also makes sense considering the “Super Core” segment of the economy, which we discussed last week, has been barely affected by the current rate cycle. What concerns me is that the 5 year breakeven is up this much while energy and food prices remain subdued. This, in my opinion, is not being priced into the markets, except maybe the bond market, which is very bearish right now.
The below charts are the price action in crude and gasoline. They are weekly charts, and appear to be consolidating just before a bigger breakout.
Gas
Crude
Furthermore, food prices appear to be setting up a fresh push higher. Cattle prices have been in a sharp uptrend and not far away from making new highs. Anecdotally, most carnivores have probably noticed the increased price of steaks, hamburgers, etc., as a result. This has been offset by wheat prices going down. Wheat appears to be putting in a bottom, as we trend down on decreased momentum, and into a major cycle cluster this week.
So, my concern is where will the breakeven go if energy and food make a new leg higher? What will the odds be that the FED starts a new liquidity cycle if the above futures do breakout? Can the rally ignore a higher terminal rate and continued draining of liquidity from the markets? How likely will the consumer be to increase discretionary spending if we do see another leg higher with inflation, and another leg lower in equities?
We are seeing a resilient credit cycle at odds with a decreasing liquidity cycle. It is my belief that the liquidity cycle is the most important element to justifying a new bull market. Without it, the current uptrend is on shaky ground. The FED has more than enough data without energy and food prices to continue draining liquidity from the system. It has to get inflation from 6.5% down to 2%, and the Services sector is making this goal very difficult with the current rate in place. This is without food and energy prices breaking out.
Hedge
The hedge is trending close to a flipping to a buy. We will likely close some of the hedge for a gain after we see weakness into this week. There has been a stark difference between the signal’s performance in 2023 and my manual performance. We continue to believe the signal, though will drag on returns in choppy markets, will help any that follow it avoid deep draw downs like we saw in 2022. This signal will help us to invest for a shorter time period and still find the necessary protection from another drop – whenever that happens. We plan to close some of our hedge in the coming weeks for a gain, and the remainder when the signal flips.
I/O Fund Portfolio
We are still holding about 30% cash, which we will likely deploy half if the coming pullback is 3 waves. These will be temporary allocations, until the market can prove to us that a new bull cycle is starting.
NVDA
The divergences are quite strong on the larger time frames. However, when you look at the daily chart, note how the Composite Index found support above the moving averages, that are starting to point up. This supports another push higher, but a limited one. No matter what, we still only have 3 waves up off the low, so any breakout should be bought with a stop that increases with price. This is not where a LTBH portfolio goes in.
NFLX
This chart is the most supportive of the OMH red count. A move to $300 will trigger a buy from our end. A push to new highs will also more than confirm NFLX has put in a major low back in May of 2022.
AMD
AMD is not as strong as NFLX. If we do see another leg in the bear market, we will likely see a fresh low here, but not in NVDA. The upper targets are listed as we complete 3 waves up off the October low.
ENPH
This one continues to trade like an energy commodity. If energy breaks out, I expect ENPH to have another stellar year. We will likely add to this position, as its posture is much more bullish than many of the other names we track.
MSFT
This stock is key for me. Some FAANGs have topped – GOOGL, AMZN. MSFT is the 2nd largest weighting in the S&P 500, and the jury is still out on whether it has topped. As of now, it is about 7.5% away from making new highs. Also, this rally is giving a strong sell signal. If we break below last week’s low, then we can see this market get ugly.
Now, if we compare this chart to APPL, you can see more divergences. AAPL is currently 2.5% away from a new high. So, if in the coming (potential) rally, we see AAPL make a new high without MSFT, this is a big warning. But, if MSFT can breakout to new highs with AAPL, this supports the larger red count where we can push towards 4400+ SPX.
AEHR
For AEHR to get another high, it cannot break this channel to the downside. That’s a lot of room to drop, and could set up a great buying opportunity.
TSM
TSM is 12% away from new highs. The same divergences with the FAANGs should show up in semis if/when we do top out in a larger B wave.
TSLA
TSLA could be in a 4th wave that’s targeting $180. This will be one of the places we park cash if we get more confirmation.
MGNI
Crypto
Can we get one more high? The setup is there as long as we hold $20K
In conclusion, I remain in the long-term bear camp based on my technical and macro analysis. I simply do not see a FED chair who is so obviously concerned about his legacy starting up a fresh liquidity cycle in light of the recent inflationary data just released. If energy and food do breakout, this will likely be the catalyst to push the 10 year yield to new highs, and finally align the equity market with the bond market.
However, this does not mean the equity market is seeing something 9 months in advance that I am not. Maybe the recession will be shallow, maybe energy does not breakout and continues lower? Or, maybe sentiment needs to be fully reset before we drop to new lows. This is why I always say, “price is king.” It is the only metric that makes you money, and if it is running counter to a great macro thesis, I will abandon that thesis to follow price.
The set-up is there in the stocks presented for another push, some to new highs and some not. If the red count is confirmed, or looks like it is getting confirmed, we will close some of our hedge (wait for the signal on the rest), and deploy some of our cash for this move. If not, we are hedged and will continue looking down for better buying opportunities.
Given Nvidia’s recent rally after it’s Q4FY23 results, we’d thought it be helpful to provide a fundamental and technical view, as well as a brief follow up on the other two stocks we have discussed within this service – AMD, NFLX. Both of which are positioned to capture market share from their competitors. We wrote about it here, here, here and here.
As long-term investors, we firmly believe holding quality companies for at least 3 years is crucial. However, as you will see, there are times to buy, and times to take some gains. Last week we discussed why we are cautious right now based on our overall technical and macro view of the markets.
In summary, my current market outlook for 2023 has devolved since the start of the year. I have grown more bearish as time has progressed and remain rather cautious. Prompted by technical indicators that point to lower market index levels as the Fed’s fight against “supercore inflation” has proved to be difficult. Previously, I wrote about my concerns over the US consumer here.
I think that the market will provide me an opportunity to buy Nvidia, AMD and NFLX at lower levels.
First let’s take a look back at Nvidia. Below is a chart showing the buys and sells I’ve communicated to readers on a real time basis, which are moves we made in real-time. This is an example of how we actively manage a high quality position to help mitigate risk and boost returns. For reference, the percentage buys/sells are in reference to our portfolio value.
Fundamentally, we have written about the potential of AI in the past and potential beneficiaries of this secular trend. We identified Nvidia as a winner given its product offering and market position. The announcement of its H100 GPU in March 2022 to be available in 2h22 was a gamechanger. We wrote about that here.
However, in 2022 its cyclical gaming business was a significant earnings headwind. Nvidia Q3FY23 missed expectations mainly due to China related inventory write-downs, higher compensation expenses and excess inventory in the gaming channels. However, Nvidia’s gross margin guidance for Q4 suggested that the first two were isolated to Q3 and stated that gaming related inventory would be worked down in Q4. Importantly, H100 was gaining acceptance faster than expected. We wrote about it here. We bought shares the first trading day after the earnings release.
As we entered 2023, we assessed Big Tech’s capex plans and all pointed to the prioritization of AI related capex. This gave us further confidence that Nvidia was well positioned, regardless of the macro headwinds.
Nvidia recently announced Q4FY23 and full year earnings. Gross margins improved sequentially, earnings beat expectations and the Q1FY24 revenue guidance was better than consensus. Gaming showed sequential growth and the inventory situation was no longer an issue. Clear signs that earnings had bottomed in Q3. Critically, management guided to sequential growth in all 4 of its businesses and talked about the benefits of AI related demand on the company. Pointing to their March GTC conference as a key event where they will update investors.
Fundamentally, we continue to like Nvidia. Technically, after its recent rally we would wait and look for better entry points.
Regarding the technicals, we are seeing a 3 wave uptrend, which is a warning. It’s pushing higher on weakening momentum (divergence). So, big warning. I do believe that we could see one more, push we believe the time to buy is not now. Our buy zone is in green, and we must hold $138 on any drawdown, or the odds start shifting towards us seeing a fresh low.
Taking a look at AMD and NFLX.
AMD (hold)
We are seeing the same symmetrical 3 wave pattern off the October low. I can see AMD making one more run higher, but it should not be bought. I believe AMD will retest the lows in the coming months, which will set up a great buying opportunity. (hold/trim)
NFLX (hold)
Like NVDA, I believe THE low is in. However, like most stocks, the time to buy is not at these levels, unless one plans to be nimble. I do believe NFLX could set up for one more push to new highs, but after that it is due for a large retrace. We expect lower prices as we move into 2023, which will set up a great buying opportunity.
Conclusion
Given the macro backdrop, Winners and Losers will emerge within the technology sector. From a fundamental stock perspective, the team has been focusing on companies exposed to secular rather than cyclical growth with strong competitive moats.
Recent commentary from Big Tech indicates a prioritization of AI related infrastructure capex through 2023 and beyond. We continue to look for companies benefiting from AI or other themes that can withstand these macro headwinds. I believe Nvidia will emerge as a winner.
Meanwhile, AMD and NFLX are well positioned to capture market share from their competitors.
I believe that the market will provide us with better entry points in all three.
