China Trade Talks Overshadowed by China. And Trade: Taking Stock

(Bloomberg) -- One could argue the four biggest developments overnight and into early trading are actually the most inconsequential, and futures are responding in kind near flat.

First, confirmation that the U.S. was seeking the extradition of the Huawei CFO from Canada after filing criminal charges was widely expected (though the timing is less than ideal on the eve’s eve of U.S.-China trade talks). The usual suspects (suppliers like NPTN, LITE, ACIA, IPHI) still all fell on the news, however.

Second, a WSJ report that China was to offer more U.S farm product buys in U.S. talks echoes the report two Fridays ago that lifted markets. The problem there is that the sticking points on talks remain, notably that China is resistant to changes being demanded for structural reforms and cuts to subsidies for industries. This may not come as a surprise after it appeared a curveball was thrown late Monday with White House trade adviser Peter Navarro, author of "Death by China: Confronting the Dragon", being included among the negotiators (previous reports had not mentioned his name). Successful talks appear to hinge on whether the U.S. can convince China on monitoring mechanisms, as well as enforcement on IP issues.

The third and fourth issues -- the PG&E bankruptcy, which was telegraphed late last week despite a late attempt by an investor group Monday and Brexit developments -- were all expected, though they pose a fair amount of headline risk into today. Brexit votes begin at 2 p.m. ET and will center on one plan to place Brexit on hold and another plan that May prefers where they would renegotiate with Brussels.

Game Over (or at least on pause)

Even when its not about China trade its still about China and trade.

Gaming chipmaker Nvidia’s disastrous pre-announcement piggy-backed on even more ominous Caterpillar results Monday (its worst profit miss since 2008) to send shares down nearly 14% (after being down more than 18% at one point). For all the concern about China (both cited demand in the country for disappointing the Street) prompted by these two (circa $80 billion) multinational companies, the biggest surprise to me wasn’t that nearly $20 billion in shareholder wealth was erased, but that for the chipmaker at least, it wasn’t the biggest drop in shares the company had seen recently.

China Trade Talks Overshadowed by China. And Trade: Taking Stock

In November, when Nvidia reported its results, it lowered the same quarter’s outlook that it did Monday, Q4, to miss analyst expectations by $700 million, sending shares cratering. With Monday’s move, it was cut a further $500 million below the estimates (that had been reset near the company’s adjusted forecast), meaning that from November to late January, a collective readjustment of $1.2 billion in revenue was trimmed from expectations (only $3.4 billion was originally expected), accounting for nearly 35% of the quarter’s revenue. Citi analysts Monday wrote that they expect NVDA shares to fall to the $120-$130 range, Needham sees $100 or below, while Morgan Stanley downgraded their rating early Tuesday. Shares closed at $138.01.

Its no surprise then that its gaming chipmaker peer AMD fell in sympathy given the magnitude of events. After all, Nvidia CEO Jensen Huang cited an “extraordinary, unusually turbulent, and disappointing quarter.” Options were already pricing in an above average move for AMD earnings (11.9%) due post market today, which is further complicated by closing down 8% Monday. Granted, the two companies have differing fiscal years, and as a Stifel analyst wrote, AMD should be less exposed to the weakness Nvidia cited given its gaming cards are typically sold at lower price points.

The market is less discerning, with nearly identical gains (on a percentage basis) for two years -- AMD and NVDA were the SPX’s best performers from October of 2016 through September of last year, racking up gains of 355% and 322% respectively.

Apple’s earnings are ahead later today, where consensus is that revenue will continue to shrink, even after that major warning earlier this month. A report from Digitimes earlier indicated that Taiwan Semi’s (a supplier to Apple) suppliers agreed to cut their prices by 10%.

Apple services will be the focus, as they will likely disclose margin figures for the unit, which UBS expects in the low 60% range, Bernstein in the mid 60s, while RBC expects margins in the mid 50% range. This will be little consolation for the Apple watchers who craved the unit by unit detail in sales figures which Apple has ceased to provide. Bernstein is also looking for weakness in any other regions as "China only appears to account for half of the iPhone’s shortfall in Q1."

China Again?

The growth story, however, is real. Despite the market selloff in late 2018 that was at least partially attributed to the concerns (combined with the IMF cuts earlier this month), January’s Bloomberg Economics gauge confirmed that China was indeed slowing, and for the 8th straight month.

Investors have been at least partially ahead of this idea, with demand signals in commodities from crude to iron ore flashing concern. Even taking Monday’s action with Caterpillar serving as a wet blanket to the industrials sector (sector cohort MMM, with >30% of revenues from Asia just reported and trimmed their forecast), energy names underperformed with oil servicers among the biggest subsector laggards. Wells Fargo equity strategist Chris Harvey even detailed that the short interest in the energy sector is now at a new high. Morgan Stanley’s Wilson is now running for the exits, telling clients to sell the January rally after mixed earnings results, a failure to break S&P resistance and a struggle with the risk/reward.

Goldman Sachs analysts for their part still see the U.S. as the best place to see returns. In a Monday note they detailed expectations for a U.S. return of +14% to year-end 2019, closely followed by followed by Japan (+6%) and Europe (+5%), and Asia ex. Japan (+3%). And for all the fear of international exposure, the analysts led by David Kostin actually cited stocks with the biggest exposure overseas as those which have performed the best since November 2018.

Sectors in Focus Today

  • Containers and packaging names GPK (results just beat while adding a buyback program), SLGN and PKG as they report results ahead of peers like BMS, BERY IP and WRK later in the week. Citi analysts expected North American pulp prices to be under pressure for the period
  • Mega pharma names LLY, SNY, NVO, PFE as drug pricing hearings in the Senate and House get underway in Washington. The Senate begins at 10:15 a.m. ET. Pfizer results just hit the tape and their outlook is below expectations
  • Telecom as Verizon earnings are due shortly. They pre-announced their wireless subscribers earlier this month, but we’ll still be watching for 5G expansion details and perhaps some commentary on Apple and handsets (in a presentation at the Citi Global TMT conference, their consumer exec highlighted 20% of their new customers were taking the Apple music offering)
  • Electronics manufacturing names (JBL, BHE, PLXS), after Sanmina’s results blew out ests.
  • Life sciences names after Danaher’s results were mixed to slightly weak; ILMN reports post market, TMO reports Wednesday, while PerkinElmer is due Thursday
  • Auto parts makers after Autoliv cut its forecast and is plummeting early, watch shares of APTV, LEA, BWA and VC
  • Utilities (like ED, SRE) after PG&E confirmed it was to file for bankruptcy protection despite the late intervention by investors Monday

Notes from the Sell Side

Jefferies is out with calls on the asset managers, raising Blackrock (to buy) and downgrading AMG to hold. Analysts led by Daniel T. Fannon note that BLK is likely to bring "industry leading" organic growth while benefiting from secular investing trends. On valuation, BLK provides a "rare entry point", while AMG is also attractive. However, Fannon sees flow trends at the latter worsening before they improve this year, with an expectation of few near term positive catalysts.

3-D printer manufacturer Stratasys Ltd. is indicated to open higher by nearly 6% in early trading after Piper Jaffray raised the rating on on both SSYS and 3D Systems (DDD) to overweight. Despite the likely "challenging quarter" for DDD, analyst Troy Jensen expects strong direct sales with overall printing demand improving. He maintains his Street high PT while becoming the only bull on the name. For SSYS, he sees Q4 exceeding expectations on the demand front while growth assumptions are the "best we’ve seen in years." His raised PT to $31 becomes the Street-high there.

Tick-by-Tick Guide to Today’s Actionable Events

  • DPZ investor day
  • CWK, SONO lockup expiry
  • 8:30am -- VZ earnings call
  • 9:00am -- HOG earnings call
  • 10:00am -- PFE earnings call
  • 10:00am --Jan. Conf. Board Consumer Confidence
  • 4:30pm -- AAPL earnings
  • 4:30pm -- AMD earnings
  • 5:00pm -- AAPL earnings call
  • 5:30pm -- AMD earnings call

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