The Week That Matters (8-12 April, 2024)
"When someone mentions free trade, keep an eye on your wallet." Murray N. Rothbard
History Rhymes
It was not that long ago when the average man in the street thought semiconductors were part time orchestra leaders while microchips were a kind of snack food. Today, it’s a very different world.
TSMC has become a household name (almost!). Media pundits talk lovingly about the latest semiconductor chip. Nvidia is everyone’s go-to-stock and semiconductor plants are being built all over the world. (Wait for Samsung’s announcement next week).
Without chips, the Victorian Age of technology that surrounds us would be a pipe dream. Semiconductors are the “brains” of the future, to quote Masayoshi Son, but it would be remiss to forget one fact. The semiconductor industry can be horribly cyclical.
Insatiable demand for a product - PCs in the 1980s, mobile phones in the 2000s, smartphones in the 2010s - lead to aggressive expansion by manufacturers. Sod’s Law dictates as soon as capacity catches up, the economy goes into recession and demand for the product collapses, resulting in massive overcapacity. The cyclicality of the industry can have serious economic and political consequences as well as having a huge impact on your stock portfolio.
The Example of 1985
Interestingly, one of the best examples of that took place in 1985. A mild recession in the computer market caused a horrific down year for semiconductors. Prices collapsed 60% and an immense amount of capacity found itself without sales to fulfil.
It was so bad that it caused Intel to exit the DRAM market completely, closing down 8 semiconductor factories and laying off nearly 3000 people. Texas Instruments saw revenues shrink 14% and National Semiconductor saw a 17% decline in revenue in addition to a stunning $117 million loss. By 1986 the American DRAM industry had consolidated from 14 producers in 1970 to just 3.
As is human nature, when things go wrong, people look for a scapegoat. And the US Congress quickly turned their attention towards Japan. Attitudes towards Japan in the 1980s were not what they are today. Japan’s cheaper and better cars were making a dent into the gold standard that used to be “Made in America.” Japanese capital was also making its presence felt from Los Angeles to New York.
The 1970s had undermined American confidence. And many people with influence were uneasy with an old enemy, Japan, taking market share from American companies. Some were outright racist about it.
Protectionism is American as Apple Pie
If the 1990s were the decade of globalization, it was in the 1980s when the foundations were laid for a more cooperative, outward oriented, and market friendly trade policy. And not everyone liked it.
Former US President, Donald Trump, might have surprised everyone with his contempt for “globalists”, but his rhetoric was nothing compared to what US politicians freely said in the 1980s. Globalization was, by and large, feared in Washington. It was not embraced.
In 1985, there was even a bill in Congress proposing sanctions (yes, sanctions!) against any country running a trade surplus with the US. Naturally then, given the fallout from the decline in the US chip industry, it was unsurprising that Japan’s semiconductor industry was accused of unfair trade practices and for not allowing access to its domestic market to the likes of Micron and Intel.
It was a highly political accusation, and only half true. Semiconductors had been seen as a strategic industry by Japan’s Ministry of International Trade and Industry (MITI) and had seen “over-investment,” the main claim against Japan. And it is true that 1985 was the peak of Japan’s mercantilist power, where Japan expanded its trade overseas rapidly while protecting its domestic market. It was a stretch, however, to argue that the success of Japan’s semiconductor’s industry in winning market share in the US was solely down to it using “predatory” methods.
The reality was the Japanese had spent two decades building cheaper and higher quality product than the Americans, through capital investment and smart bets on technology but, of course, that didn’t matter. US trade protectionism has a lineage dating back to the Founders and it was much easier to explain away the shortfall of the US semiconductor industry by saying Japan was dumping semiconductors below market prices. Japan’s competitive companies were a threat to what was still considered, with good reason, a growth industry for the US.
Yellen in China
It struck the author that the vibe of Janet Yellen’s visit to China this week had similarities to what transpired in the mid 1980s, especially as it was coordinated with the Japanese Prime Minister’s visit to the US. Chinese officials presumably watched Kishida’s surprisingly good address to Congress, with a certain amount of foreboding. The speech was a statement that the US and Japan’s alliance was stronger than it has ever been. It was a show of force to an economically troubled China, especially given what Yellen pushed for during her visit.
Janet Yellen warned China that Washington will not accept new industries in the US being decimated by Chinese imports. She argued that Beijing’s overinvestment has built factory capacity far exceeding domestic demand, while fast-growing exports of these products threaten companies in the US. Where has one heard that before?
The similarities are obvious. Like the Japanese semiconductor companies, Chinese companies are crushing it in strategic growth industries like electric vehicles, batteries, solar panels and green energy products. Of course, the Chinese government may have facilitated investment into them (didn’t Tesla get government money?), but the Chinese companies are delivering good, quality products at better prices. BYD seems to be doing very well everywhere (Charlie Munger was a bit special, wasn’t he? He bought it back in 2008).
There is another obvious similarity. The US is in as a strong position as it was in 1985. Yellen’s request for “balanced trade” will not fall on deaf ears in China despite all the noise. Chinese EV companies need the US market as do the battery and solar panel industries.
What was more interesting to the author though was Yellen’s concern about the threat of cheap Chinese products flooding the US market as the Chinese did in 2000 and in the early 2010s with Chinese steel. This is important to keep in the back of your mind this week as we get bombarded, as predicted last week, by the inflation fanatics, who have lost their mind over the recent CPI number. Inflation is an issue but it is not what keeps Janet Yellen up. The return of deflation (and slow growth) is what gives her nightmares.
Markets
This newsletter, a proud bull since September 2023, argued last week there was an increasing risk of a correction. The author sold most of his non-core positions. Unfortunately, it won’t matter. It will be a painful week for the longs.
The author will avoid mentioning the obvious risks but would suggest it might make sense to focus on what might make the market turn up after the impending sell off. There are two earnings that come to mind: ASML on 17th and MSFT on 25th. We need to see strong order growth from ASML, which we should get, and more evidence that MSFT is monetizing its AI strategy. Imagine if its implied revenue growth is closer to 20%?
Finally, the author would urge the reader to look for Goldman’s report on high operational leverage names. If the Middle East doesn’t derail a recovery, names with scale are the ones surely you need to buy. (The author has tried small cap names and it’s just not working). We live in a winner take most economy and scale ultimately generates incredible free cash flow. Doesn’t that lead to a stock like UBER?
As always, thanks for reading. I wish you the best with family, business and trading this week. I wish all my Muslim readers Eid Mubarak.
Praying for peace! Shlama/Shalom/Salam.
Mateen