T.W.I.T. #4: On Return Dispersion and Breadth, TikTok Ban, Semi Bullishness and Video Games Strategic Importance

This week, besides return metrics, we look at breadth and dispersion of returns. Dispersion of returns is normally good news for skillful stock pickers, because it is easier to differentiate oneself when picking the right stocks. Unfortunately, that tells only half the story; when the proportion of stocks outperforming the index is low, so is the probability of making the right bets. This is the situation we are in in some areas of Tech as I will show below.

Performance Review

The S&P500 was up 2% for the week, ending flat on a year to date basis. From a sector standpoint, Internet outperformed; the QNET Index was up 7%, pushed up by Netflix which was up 8% on Friday. Semiconductors had a good week, with the SOX up 4%; Nvidia passed Intel in market value. Software (as measured by IGV or BUSSFTW Index) ended up the week up 3%, in-line with the broader IT sector.

From a factor standpoint, growth and momentum dominated Value. Large Cap Growth was the best combination of Size vs Value, small cap value had a poor week.

Dispersion and Breadth Favor Software

I have put together below the year-to-date statistics of cumulative returns, breadth and dispersion, across various sub-segments of the market. I measure breadth as the proportion of stocks delivering a return above the index return in any given period. I define dispersion as the difference between the average return of the top 50% of stocks in the index (as measured by return) and the average return of the bottom 50% of stocks in the index.

There are a few important take-aways from this table. First, Internet and Software are up a staggering 39%/31% year-to-date compared to SPX flat and S5INFT +19%. Second, the easiest place to pick stock has been Software, with a breadth of 51%, and a relatively high dispersion of 69%. Comparatively, picking stocks in Semis has been harder — breadth of 33% — and less rewarding anyway — dispersion of 28%.

Now, moving on to specific Tech news

Key Developments in Tech World

Semis

Steve Sanghi, the CEO of Microchip, sent a letter to customers that read bullish for the sector as the company will start charging a fee from August 1st to customers with expedite requests. The letter mentioned three factors contributing to the increase in the number and size of orders placed on. First, “Customers whose businesses have strengthened due to COVID-19 conditions (ex: “work from home” initiatives and Medical Devices)”. Second, “The recovery in May/June of some customers’ business which experienced a sharp decline in the March/April timeframe(ex: Automotive and some industrials). Third, “An erroneous expectation that despite not providing backlog visibility, orders placed with short lead times can be supported by slack in the supply chain”. Whilst the market took these points, especially the second one, as signaling a recovery in the weakest verticals, the move could also result from concerns about double ordering in the channel.

The two additional datapoints read bullish this week. Samsung pre-release and TSMC 2Q revenues above expectations suggest strength in Data Center, Memory and Smartphone end markets.

Internet

The big news this week after the two previous weeks of regulatory concerns came from the ban of TikTok. A border clash between India and China led the Indian government to ban all Chinese apps in India. Following in India’s footsteps, we learnt the Trump is looking into banning TikTok over privacy concerns in the US. That would be of great help for Snap and Facebook, as TikTok user base and engagement levels should threaten them once the Chinese company decides to monetize. It will be interesting to see whether Facebook can capitalize on the user behaviors that TikTok tapped into, in a similar way to what they did with Instagram. In a previous post I argued that TikTok posed the biggest threat to Facebook in the last five years.

Besides, the Information reported this week that Google and Facebook have seen the ad market rebound from April bottom, with ad spend and prices inching back to pre-pandemic levels. I continue to see the boycott concerns as overblown and that article seems to be confirming this view.

Software

SAP and PTC released earning that were well taken by the Street. As noted above, Software stocks have been so far the place to be in Tech land. However, I am not sure that leadership continues. Software, given its size in US GDP, is simply too big to remain insulated from a broader economic slowdown. But CIOs are often the last ones to learn that their budgets are being cut; so it is lagging indicator, not a leading one. Confirming this, I have read many broker surveys of IT buyers in the last week pointing to a decent amount of weakness ahead.

Video Games

The action was in M&A talks this week. Microsoft may be interested in the Warner Bros assets; buying them would depart from a strategy so far focused on small studios. We would also likely see reactions from other large Internet properties, most notably Amazon (which owns Twitch). Sony made a $250m investment in Epic and Tencent is reportedly interested in Leyou in Hong Kong.

All these corporate actions come against a backdrop of an upcoming console cycle, where the evidence so far for games point to increased pricing for the first time in many years. This article published on July 2 ndindicates that NBA2K21 pricing could increase by $10 to $70.

I am hoping to get the time to write a deep dive on game engines over the next few weeks. It is a fascinating topic and seems to me a strategic asset for the next decade as more of our time get spent in metaverses dominated by a few franchises. I came across a great article this week explaining why we will not see a “Netflix of Gaming”; the authors make points to that end. I quote: “Games that demonstrate mass appeal become platforms and spur the creation of new communities: all-encompassing experiences with social, competitive, and personal-status elements.”

That’s all for T.W.I.T. #4, Week 28 2020.

Originally published at https://kinesisinvesting.com on July 12, 2020.