Chips Ahoy

The Nasdaq keeps finding new ways to reinvent itself. After a successful retest centered on the Trump tariff tantrum, markets were ready to run. The breakout in the semiconductor group has signalled that the persistent technology sector leadership is still intact. Following a strong earnings report season, and buoyed by the proposed Broadcom takeover of Qualcomm (now negated by an adverse CFIUS ruling) the chips are exploding, leading the charge to new highs.

The quick dissipation in the trade war allowed for investors to concentrate on what's working and to ignore Trump's trade policy circus. The semiconductor sector has always been perceived to be a hyper-cyclical group, and has traded at a substantial discount valuation. Chronic overcapacity at the peak of the demand cycle has consistently lead to a massive collapse in the chipmaking stocks in all prior cycles, leading to this PE discount. The recent strength in the sector is now being accelerated by analyst reports of "this time its different".

The internet of things argument is being used for a re-rating of the stocks. There are chips in everything. Every car made now has more computing power than a Gemini spacecraft. I have a chip for my guitar case to send a bluetooth read-out of the relative humidity. My Taylor 814CE thanks you, Qualcomm.

The pending move to 5G communication is seen as a driver for the next-gen chip demand wave. The 10 year analyst forecasts now circulating do not envision any slowing in that curve. Yesterday saw a $100 target on Micron from one analyst who has jumped out in front of a parade that is already well down Main St. The bullish pile-on is in full swing.

The parabolic move in the Sox is a mirror image of the previous tech bubble in 2000-02 (see chart below).

Not a comforting picture, given the complete round trip experienced in 2003.

Semiconductor Index 1999-2018

I've often thought that the markets always peak on a cyclical surge in materials, most notably copper. "Every bull market has a copper roof" was the first thing I learned when I got in the business. Maybe this time its silicon that is the prime candidate for roofing material on this current bull market house.

CPI

The last tame U.S. CPI report came out this morning, reinforcing the widely held view that inflation (ex food & energy 1.8% yoy) is stubbornly below 2%. As we lap the March reading next month, we will pick up a boost from the base rate effect. Remember, last year's collapse in cell phone package rates is baked in the next report, setting up an 'easy comp'. Last week's jobs report saw the market focus on the tame average hourly earnings component. I don't think a lagging variable like wage cost is where we should look for inflation. The 2-10 curve at 58bps is starting to flatten again.

The Trump Dollar

The Dollar index is weakening, setting up a Q2 run in materials. A complacent FED and a dysfunctional White House is not helping the 'reserve' currency. With Cohen and now Tillerson gone, the cause of the 'Globalists' in Washington is now lost. With the steel/aluminum 'trial balloon' completed, Mr. Art of the Deal will likely move to a full-on trade war with China. This is obviously not likely to inspire confidence in a currency that purports to represent an international standard.

As to fixed income, I'm still a seller of rallies, but the pause in the nascent bond bear was predictable, given how quickly crowded that view had become. Commitment of Traders data on Large Spec positions became extreme, creating the need for a much needed 'time correction'. Still, I believe for longer term rates, sideways is the new down.

My $1.2950 exit last week on USDCAD is looking better now.

Risk Model: 3/5 - Risk On

The reversal in the VIX was an important confirming signal for the recent retest sequence. Although now below the risk-on level, the AAII bull/bear ratio was disproportionately affected by the trade controversy. That should reverse on Thursday.

The market is seemingly impervious to any headline risk. I'm not arguing against the risk model, but after the recent lunacy emanating via twitter from the highest office in the country, I'm out of the U.S. market.

I'm also giving the materials until May to show me the money, but if they don't play out, I'm going to cash.