🗞 We're About to Shift

WHILE YOU POUR THE JOE… ☕️
Tear the House Down

Analysts have recently downgraded Caterpillar stock ahead of its earnings release this season, and the reasons behind it align with what we expect for the rest of the connected industries. 📉 

We posted a short thesis for homebuilder stocks, focusing on Toll Brothers stock. As Caterpillar’s outlooks become bearish on weaker real estate and construction sentiment, it seems time is nearing to collect our payoff for this short pick.

By the way, congratulations on cashing in an over 23% return on Walgreens stock yesterday. That is, if you actually read our pitch as to why the stock was set to rally by double-digits on earnings. 🔥 

Speaking of winning views, let’s get on with today’s email 📧…

MASTERS OF THE UNIVERSE
The Goldman Effect

Goldman Sachs's earnings were released yesterday 📰, and if you know how to read them, you know that they spell bad news for the stock market.

Underwriting for equities brought the bank double-digit growth. At the same time, fixed income barely grew during the year.

This usually means that stocks are so expensive today that corporations can't resist issuing more stock to the markets and underwriting more deals using their expensive stock as collateral.

At the same time, the lack of activity in bonds tells me that the asset class might be on the cheaper end today. This is why we decided to get back into the $TLT bond ETF yesterday, which we also tweeted about: 👀 

More than that, Goldman reported rising provisions for credit losses, absolutely a warning sign to consider for deteriorating consumer environments.

They also ditched their initiative for consumer-driven digital products, especially with the Apple collaboration for credit cards.

As a last measure of what’s happening in the markets today, Goldman's sales and trading department brought on a record set of fees. Still, not all fees were made equal this quarter.

Most came from equities, as more transactions at the highs were made, with old businesses taking profits and new businesses chasing momentum. However, records were driven by commodities and fixed income.

To me, this means a simple, double-edged bet for inflation.

Betting on commodities like gold and oil is an inflationary view, but betting on bonds is a way to hedge the inflation bet while adhering to the new Federal Reserve's path to further interest rate cuts.

We happen to be doing the same thing. We also published our position in $USO just as oil hit $70 📈 a barrel yesterday evening, right before it bounced back up above $71 a barrel.

TRADE OF THE WEEK
Semiconductors in Trouble?

The semiconductor and chipmaking industry might be in trouble, which is something we’ve called for since last quarter. Still, this time, we’re doubling down after the Nvidia stock selloff. 📉 

If last quarter was bad, this one might be a total disaster, and here’s why:

ASML stock crashed by over 16% in a single day 😨 after reporting its quarterly earnings figure. While the quarter was not that bad, the future outlook was so negative that markets had no choice but to react.

Analysts and markets wanted to see roughly 5.4 billion Euros of booking orders for ASML chips this year.

But

Markets lost less than half, at 2.6 billion Euros only. The answer everyone is looking for now is whether this slowdown is going to spill over to names like Nvidia or whether this is only ASML-specific.

The answer is we don’t know, but there are signs to support the belief that it will spill onto other names in the industry.

Starting with the manufacturing PMI index trends for the past quarter:

Notice the Electrical Equipment industry and its New Order contraction showing a 3-month consecutive trend now. That places the odds highly in favor of looking into short positions within the industry’s value chain.

Knowing that the top of the value chain is found in supply materials, like semiconductors, we decided to look there and compare different names to find potentially bearish outliers.

Turns out, results are a little mixed:

Typically, we like to choose the outliers based on three metrics:

• Forward P/E ratios (PE2 column)

• Earnings growth rates (EG2 column)

• Forward PEG ratios (PEG2 column)

Nvidia trades at the most expensive forward P/E of 35.2x 📈, compared to the industry average of 20.2x. Markets typically have a good reason to pay a premium for stocks, but that doesn’t mean they’re always right.

This time, considering Nvidia’s 32.7% EPS growth forecasts compared to the second-most expensive stock ($AMD), it doesn’t look that attractive.

The PEG ratio confirms that Nvidia carries a 1.1x multiple compared to AMD’s 0.6x, which is nearly half.

Long story short, I think that Nvidia stock is a leader, but today’s price has priced in most - if not all - of the potential growth the stock could deliver in the next 12 months.

The overextension opens up a major weakness for Nvidia, and if they report a worse-than-expected outlook, like ASML, the stock is ripe for a huge selloff. 💥 

Where do we get in / out, though?

In my opinion, the ideal entry point for a short would be around $137.5 🎯 a share, which happens to be a low-volume node and cutoff point for Nvidia’s auction.

Can we get there before earnings? Maybe, maybe not. But if we do get there, I am more than comfortable buying some put options since we have a defined catalyst and risk profile.

Speaking of profiles, here’s the market/volume profile for Nvidia to show some potential exit points:

Same thing for the entry point at $137.5 for the short, but what about the exit levels?

Based on this, we want to go for the high-volume area (fair value) of roughly $122.75 👀. This would represent a 15-point decline, and since we’re using options, the profit potential will be significantly amplified.

But which options?

It’s not very clear yet, but there are two main distributions for put option picks around the $100-$120 area 🎯, so at least that gives us the reassurance that the market does expect the same exit levels we are also pointing to.

NOW GO AND MAKE IT HAPPEN
Level the Playing Field

To be a great investor today, you need to have information, collect it, and understand it in a way that lets you pick better stocks and trends to get behind.

Today’s book recommendation 📖 opened my eyes to where the future of the semiconductor industry might be headed, particularly around the US / China conflicts, and what role Taiwan plays in this battle.

To your success,

G. 🥃