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March 24, 2020

A new way of looking at market weakness

My basic assumption is that the world is at an early stage of a technology revolution, which is going to have a seismic impact on humankind. My grandchildren will grow to adulthood and beyond experiencing mind-blowing technological developments. This is driving what I believe will be the greatest bull market in history, with the Dow Jones Industrials index, currently around 20,000, reaching 100,000 and more.

Right now we have a massive interruption in the form of the Covid-19 virus and the impact it is having on the global economy. This is almost certainly a one-off effect. World leaders are accepting a worldwide economic slowdown, very possibly a dramatic one, as a price worth paying to slow the spread of the virus, make it manageable and save lives.

Most of us will agree that this is a good decision. It may have other benefits. In Zen they teach us that to achieve one objective we should pursue another. While Boris was trying to save the UK economy economy the virus spread and the economy began to tank. Now that he has accepted the economy as a casualty of war in the interests of beating the virus I think the economy will do better than expected and, even if that doesn’t happen, will recover more rapidly.

In a nutshell, making an absolute priority of targeting the virus, is a win-win for beating the virus and saving the economy.

My second belief, thesis, whatever is that the effect of the virus may be bullish for technology shares. If people are going to travel less and work from home more they will need even more ubiquitous and advanced technology so the tech boom rolls on faster than ever.

It is this belief that is changing my attitude to how we play the Nasdaq 100 and the periodic crashes it seems we have to endure. I used to think, when a crash was under way that the key thing was to wait for a buy signal and stand well clear until we had one. Inevitably, this meant joining the party after it had begun. Now I am considering a different approach.

In the chart above you will see two moving averages. The slightly longer dated, darker coloured one, is more gradual in its moves. The other, which as well as being shorter is momentum-weighted, weaves around it, sometimes dipping below.

My new theory is that on the assumption that the index is in a secular uptrend with a very long way to go shares are always worth buying and will be cheap, even oversold, when the more volatile moving average is below its steadier fellow. This is what on Wall Street they call buying on the dips.

If you look back in time it has always been a good idea to buy shares, when the more volatile average is below the less volatile average. This even applies to 2008, when the index had a massive fall; you win in the end, especially from stocks bought during the bear phase, as long as you hang in there and buy the right stocks and accept, on that occasion, massive volatility.

The practical conclusion from this is that now is a buying time for stocks, an opportunity to pick up shares at relatively depressed prices. The stocks to buy will be 3G stocks but I am slightly waiving the rules here. If the story and the fundamentals are outstanding I will be more relaxed on the chart pattern although I will be looking for signs of resilience and buyer interest.

In a nutshell, I am prepared to buy a share that is well off the peak, if the reason for the set back is entirely macroeconomic and not a sign of deteriorating fundamentals at the company.

This incidentally is why some people are describing the Coronavirus sell-off as creating some fabulous buying opportunities. It is having severe effects but they are temporary. There are no implications for companies except that some may take a severe short-term hit to profits. As and when the virus is tamed, goes into remission and/ or is fully discounted in prices, the bull market should resume, maybe surprisingly quickly.

Even if I am wrong and like the First World War, it lasts far longer than anyone initially expected, I still think technology companies will keep on growing and will either be relatively unaffected or even strengthened in their growth by the shift to a stay at home economy.

I see new highs ahead for the Nasdaq 100 and that could happen before the end of the year. There is even a chart name for the pattern I expect. It is called a bull hook. Shares rise strongly for an extended period, crash dramatically and then first recover back to the old peak and then set off on a new bull leg. If that is where we are the current buying opportunity would be a spectacular one.

Buy recommendation No.1 – Advanced Micro Devices (AMD) @ $45 Next figures: 16 April

Advanced Micro Devices (AMD) is a semiconductor business that has been growing strongly over recent years with strong growth projected to continue. This was a recent comment on the company by somebody who knows it much better than me.

“AMD said they are expecting Q1 2020 revenue to be at $1.8bn, which would be an increase of about 42pc year over year. This is expected to be driven by the strong growth of Ryzen, EPYC, and Radeon product sales. They are targeting a margin of 46pc for the quarter. How much of this will be changed by the coronavirus situation is hard to say. Being a large tech company they shouldn’t be affected too badly. This will depend on how the lockdowns in certain countries and states impact their manufacturing supply chain and their customer base. Looking at the entire year, AMD is looking to hit a 45pc margin for the entire year, which would be a 2pc increase year over year.”

The chart is one of the strongest in the market, with both my moving averages still heading higher. They have not been unaffected. Peak to trough in the last two months the shares fell by 38.8pc and they are still well below the February peak of $59.5.

AMD is both a management story and a semiconductor story. The CEO since 2014, since when the AMD share price has been climbing strongly, is a Taiwanese American called Lisa Su, who, by a remarkable coincidence, is related to Jensen Huang, the CEO of my other favourite semiconductor company, Nvidia.

Semiconductors are central to the technology revolution, which is why although often cyclical, shares in the best companies in the sector, are in strong secular uptrends, especially in recent years. The last earnings call, for Q4 2020, was on 28 January, so before the Covid-19 meltdown, nevertheless the company was in great shape.

This is what Lisa Su had to say:

“We delivered record annual revenue of $6.73bn and significantly increased both gross margin and net income as we successfully introduced and ramped the strongest product portfolio in our 50-year history. We grew clients and server processor annual revenue by $1.5bn in 2019 driven largely by the strongest demand for our 7-nanometer Ryzen and EPYC processors powered by our Zen 2 processor core. Looking at the fourth quarter, we ended the year very strong with quarterly revenue increasing 50pc year-over-year to a record $2.13bn, while also significantly increasing net income.”

This is a business absolutely on a tear. Be thankful that Covid-19 has given an opportunity to buy the shares at a steeply marked down price.

Buy recommendation No. 2 – Nvidia @ $244 Next figures: 7 May

Nvidia has long been not just one of my favourite semiconductor stocks but one of my favourite stocks. Jensen Huang, the CEO and founder, is just such an exciting and charismatic individual and Nvidia’s technology stands at the heart of so many key future trends. Video games, self-driving cars, data centres, parallel computing and any applications for graphic chips, where it is the world leader, give the company huge growth opportunities.

Earnings for Q4 2020 comfortably beat expectations and CFO, Collette Kress, made some very positive comments on prospects, again before the plague but still providing evidence of the great momentum within the business.

“Q4 revenue was $3.11bn, up 41pc year-on-year and up 3pc sequentially, well above our outlook, reflecting upside in our data centre and gaming businesses. Full year revenue was $10.9bn, down 7pc. We recovered from the excess channel inventory in gaming and an earlier pause in hyperscale spending and exited the year with great momentum.”

Last year was a tough year in the semiconductor industry, hence the reference to excess channel inventory, while 2020 had been shaping up as a much better year.

Warren Buffett is famous for liking to buy growth stocks when some external problem is temporarily depressing results. The virus-driven global shutdown looks like a perfect example of such an opportunity to buy semiconductor stocks, given their key role in the technology revolution, the central phenomenon of our times.

Stocks are rebounding strongly as I write. Could this be the start of a sustained recovery? I would say very possibly. There is plenty of potential for more scary headlines from the effect of the virus but I think that is priced into the stock market. Down days from now on should be buying opportunities unless the pandemic rages out of control. Paradoxically, the more ruthlessly Johnson’s government shuts down the economy to contain the virus, the better for shares, especially against the background of a massive injection of stimulus and liquidity into economies around the world. It’s almost like they are trying to send share prices through the roof to boost economic activity so I do think it is a time to be positive. We have had some serious fear; it may be time for a little bit of greed.

It was noticeable that Wall Street fell sharply in early trading yesterday, when Trump suggested easing up in the battle against the virus to save the economy. Hopefully he has now got the message that is absolutely not the way to go. Until the virus is beaten nobody is going to relax and the economy will be stuck in quarantine like the rest of us.

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