Mike Wilson Sees Semiconductor Stocks Correcting

Yeah, I think you were saying it earlier. I was listening to the show. There's somebody expecting a hike, someone expecting a cut, and we're on hold. This is what we gotta get used to: with the new chair probably not giving as much guidance, he's gonna allow the market to figure it out on its own and have these differing views. We're in that adjustment period now. I think that's one of the reasons why the market's been a little choppy or even correcting in the last month or so: we're getting used to this new regime, which is gonna be higher volatility in the bond market. But over time, what's gonna end up happening is the market's gonna settle down. It's actually more estimates or wider dispersion of estimates that leads to lower volatility in pricing over time, but we're in that adjustment period. So we think rates are lower ultimately, particularly at the back end. And by the way, we've talked about this on the show many times: new treasury secretary, new Fed chair, this new Fed Treasury accord to really anchor the back end. That's what they're focused on. You gotta get the back end down or at least anchored because you have so much debt to finance.

Yes.

Yeah, I think that's right. The market's pricing that now. So the good news is that we've already had that adjustment, and it started four months ago. This is why precious metals have traded really poorly. The day that was announced as a nominee, the gold market peaked, and that was a sign the dollar has been stronger. So once again, the market has really gotten ahead of this.

Yeah, that's our call, basically. That was happening at the beginning of the year, then we had Venezuela and then Iran. By the way, the market priced Iran before the invasion even happened, or the attacks happened because once again, it was pretty well signaled. So that's when the broadening trade stopped. It literally stopped the day that the attacks happened, and we had the big spike in oil and then the pricing of the Fed to hike rates. Since mid-May, when we reiterated the broadening call, we had a different view than most. We thought oil prices would come down, and that has allowed Fed pricing to stabilize and the broadening trade to reignite. Small caps have performed nicely, just had a massive quarter up by more than 20% on the Russell. We've seen the broadening trade in the performance of the equal weight S&P 500 as well.

Yeah, there's a symbiotic relationship between the spenders and the beneficiaries, and typically they trade in lockstep. A couple things we've been writing about for the last several months. Number one, CapEx to sales. That factor has been straight up since the big beautiful bill was passed. The government is incenting businesses to spend money today rather than later. That CapEx to sales factor has been driving a lot of stocks higher. It looks like it's peaking now. The hyperscaler stocks started to trade poorly about a month and a half ago into this idea. But that's not sustainable. You can't have the spender stocks trading poorly and the beneficiary stocks continuing to go straight up. Last week, Meta announced that perhaps they're gonna sell some excess capacity, maybe turn into a provider of capacity. That is a reason for these things to take a break. Also, peak rate of change on revision breadth. The memory stacks. Revisions have been spectacular, but they can only go so high. So all that's happening at the same time, and I expect the hyperscalers now to stabilize. That's what's going on in the last couple of weeks, and the semiconductor stocks are gonna correct. That's a good development. That doesn't mean the CapEx cycle is over, but that ebbing and flowing between the two is a natural governing factor because you can't have this divergence continue. It's unstable.

Well, we don't know for sure, but we've had three of these already, John. Since ChatGPT was announced in November 2022, we've had three of these mini cycles within the broader structural CapEx cycle. The market starts to question whether the return on capital is good enough to support this kind of CapEx. Then the stocks trade poorly, and the CEOs come out and say maybe we won't spend as aggressively, and then it ebbs the other way. That's the dance back and forth. There will be a time when the CapEx cycle exhausts itself, and we will have malinvestment. But we don't think that spending cycle is over because they just started raising capital in the credit market. So they're gonna spend it. We can have these mini cycles within the structural bull market of CapEx.

Well, it's doing it right now. We talk about it as a peak rate of change or trough rate of change, second derivative growth, and that's exactly what's going on. There are two things we're focused on. Earnings revision breadth for the semiconductor stocks is about 75%, which is as high as it goes. That's gonna roll over. It doesn't mean it goes negative, but the deceleration can cause those stocks to correct. The hyperscalers will benefit if the market perceives them as being somewhat CapEx disciplined, not doing willy nilly spending that drives free cash flow to zero or negative. Free cash flow expectations for some of those companies are going towards zero, which is why they've underperformed. So it's a back and forth stance. In the last week and a half, some of the hyperscaler stocks have started to trade better. That's a good sign that we're gonna have this little correction. This could last four, six, eight weeks, and then we'll probably have the next up cycle.

Well, these are high beta stocks. They can correct 30% to 40% in a bull market. Just look at the 200-day moving average. That's a really good gauge. These stocks are so extended relative to those moving averages. Those moving averages exist for a reason; they always return to them. Does it happen violently or gradually over time? We'll have to wait and see. But a 30% correction in these stocks is well within possibility. In fact, some of them already have corrected.

But that's part of our call too: we think this rotation is happening in a down tape. Unlike the correction we saw in precious metal stocks in January because they're a small part of the index. Energy stocks had a big correction after a great run in January and February. The market traded off a little bit because of the war itself. I agree with your premise: since these stocks are such a big part of the index, it's gonna be really hard for the index to make any upward progress until this rotation has happened.

Oh, yeah. We're not bearish on the year end. We're still 8,000 plus for year end, and we've had that call for quite a while based on the earnings story. The earnings story is very much intact. The fact that we're rotating now to some of these other areas almost confirms the thesis we've had all year: this is not just a tech story. The broadening story is the story that I think people have really underestimated - the rolling recession from a year ago, this operating leverage story, which is still very underappreciated.

Well, they have been. I mean, the money center banks and the capital markets banks really have been...

The regionals. They've started to perform, and that's been an area we've been highlighting. The yield curve is flattening still, having trouble re steepening. So I think that group could pause a bit. We took it off our list of favorites for the broadening trade this week. But ultimately, between now and year end, we think the banks are gonna do quite well because this is a strategy of the Treasury and the Fed: they want more lending going through the traditional lending sector. While the yield curve is flattening, loan growth is accelerating, and that's feeding the broadening story of the economy. This is a strategy of the administration: they want a privately driven organic economic expansion, and that's what we're getting. Even if the labor market isn't as robust as some hoped, that's also feeding the earnings story, because you're seeing revenue growth without a crazy need to hire, and that's the operating leverage story 101.