Shock Arrest Puts This Sector Under the Microscope: Taking Stock

(Bloomberg) -- The U.S. stock market, closed since Tuesday at 4pm, has 41 and a half hours of news to catch up on. In that time span, we’ve had a truncated futures session that went from a slight relief rally Wednesday morning on the sanguine China trade reports to what looked like a mini "Flash Crash" immediately at the open last night only to quickly recover for a modest decline, and are now back in the throes of a risk off meltdown (S&P futures down more than 40 handles) that appears to look like Tuesday all over again.

Europe and Asia markets tanked, oil is extremely volatile (down as much as 5% at one point) as OPEC meets, yields are down again (though it’s notable that the 2- and 10-year gap isn’t flattening for a change), and momentum darlings like Square, Roku and AMD are all tumbling somewhere around 4% in the pre-market.

Shock Arrest Puts This Sector Under the Microscope: Taking Stock

While I’m being very cautious to pin any one reason for the recent rapid movements in the tape, (see Wednesday’s Taking Stock for more on the innumerable reasons being blamed for the prior session’s selloff), it seems like everyone is taking the news of the Huawei CFO’s arrest as a potentially significant setback for U.S.-China trade relations.

Add the fact that Huawai isn’t just any tech company -- it’s overtaken Apple in smartphone shipments, targeting the top spot for 5G wireless networks, and may already be the world’s largest provider of networking equipment to wireless carriers -- and that this C-suiter isn’t just any CFO, but rather the daughter of the CEO and founder (and the potential next in line to take the throne), and anyone can see why the shock waves of the arrest are being cited for the heavy feeling in the tape this morning.

Some are pointing to the fact that the arrest came on Saturday, Dec. 1, or the same day of the Trump-Xi dinner and well before China struck a conciliatory tone in an attempt to pacify the skeptics. One could surmise that China presumably took all of this into consideration when making said consolations, but there’s no question that this new wrinkle wasn’t priced into a market that is very "shoot first, ask questions later" when it comes to the trade war.

The One Sector to Watch

While we may be looking at a repeat of Tuesday’s brutal session, there’s one sector that could bear watching more than the rest, and that’s the semiconductors.

This is mostly due to the impact to the supply chain from the Huawei arrest news, as it’s reminiscent of the ripple effects we observed when the ZTE ban was put into place earlier this year, but on a potentially larger scale.

Keybanc dished out a flash note last night after the Huawei news that listed nine chip stocks that may be at risk given their meaningful exposure to communications: Xilinx (30%), Analog Devices (20%), Maxim Integrated (20%), Silicon Labs (20%), Microchip (15%), Qorvo (~10% Huawei), Skyworks (~8% Huawei), Qualcomm (~5% Huawei), and Cypress (5%).

But there are other factors than the arrest that may play a factor in weighing down the semis today, starting with Lam Research’s CEO getting the boot for workplace misconduct, which appears to be a continuing worrisome trend in the industry after similar departures from top execs at Intel and Texas Instruments.

Additionally, there were cautious sell-side takes from Western Digital’s investor day, which included a slight downside bias to 4Q guidance and signals that conditions in NAND remain tough. Separately, Apple supplier Skyworks talked about "softening" in the smartphone market coming into the December quarter, though perhaps none of that is shocking to anyone at this point given all of the warnings from peers.

And the big semis bear on the Street, Morgan Stanley, is out with yet another negative note on the space this morning after hosting fireside chats with six companies, including Intel, Micron, and NXP Semi: "Not surprisingly, near-term commentary was on the cautious side given pressures on most end markets and a lack of visibility. While tariffs garner a lot of attention, the root issue of weak fundamentals is moderating demand and excess inventory."

But if this Huawei situation turns into another ZTE mess, and the U.S. starts to hold this over China as a bargaining chip in a drawn-out escalation of the trade war situation, I’d expect the gap between the Philadelphia Semiconductor Index, or SOX, and the S&P 500 to narrow even further. This is something that has happened ever since the October meltdown, as the two-year chart below shows.

Shock Arrest Puts This Sector Under the Microscope: Taking Stock

Elsewhere...

Outside of the semis, we’ll be watching these sectors for added weakness:

  • Trade proxies (Caterpillar, Boeing, Apple and the semis, as mentioned above) may extend their losses in reaction to the Huawei news; in this scenario, it’d be likely that defensive sectors like utilities, consumer staples, and REITs would continue to outperform the tape
  • Banks may be weak again after Citigroup’s CFO hinted at a profit target warning yesterday, a day after JPMorgan CEO Jamie Dimon spooked financials pads with comments that fourth-quarter trading results would be roughly flat year-over-year
  • Truck machinery stocks, like Cummins, Paccar and Navistar, may get hit on the weakest monthly Class 8 orders figure in recent memory; JPMorgan said it was the first y/y decline this year while Morgan Stanley said this was only the fifth instance of >10k underperformance versus seasonality since 2006
  • Pot stocks may continue to falter if they follow the downward spiral in Aphria, which has more than halved (Canadian shares plunged 15% on Wednesday) ever since Quintessential Capital’s Gabriel Grego took the stage to present his short thesis at a conference earlier in the week

Later Today...

And since yesterday was an unexpected market holiday, a lot of events did have to be delayed by at least one session, making today more jam packed with catalysts than usual. Key focal points include the homebuilders ahead of Hovnanian’s numbers (after TOL’s ~13% trough-to-peak roller coaster ride after Tuesday earnings), grocers into Kroger results, gold majors with Newmont Mining on tap to release 2019 guidance, semis with Broadcom earnings after the bell and more conference presentations rolling throughout the day from the likes of Nvidia, NXP Semi, ASML Holding, and Cypress.

Notes From the Sell Side

Stifel downgraded Facebook to a hold Wednesday midday, which counts as new since the market was on holiday and there was no impact on the share price (FB is down ~3% pre-market). The analyst sees long-term negative ramifications on the business due to all of the adversaries that the management team has created: "The political and regulatory blowback seems like it may lead to restrictions on how Facebook operates, over time." But most importantly, they add, "consumers and some employees seem to have grown disenchanted with the company." Note that 41 of 52 analysts still rate Facebook a buy.

Guggenheim initiated four big-name Internet/social media stocks. Buy ratings are given to Alphabet and Twitter (their $39 price target is well above the average of $33) while Facebook and Snap get neutrals. On Facebook, they expect challenges from privacy to regulation and monetization as weighing on investor sentiment.

JPMorgan upgraded Activision Blizzard to an overweight as current valuation gives little credit for options like King advertising: "We think investors are now overly focused on short term execution and growth, creating an attractive entry point for what remains a compelling long-term story driven by a secular shift to digital, extension of core IP to mobile, an expanding console and player base and continued innovation in live services."

Morgan Stanley said Europe and China provide downside risk to 2019 earnings across the autos and shared-mobility sector. "European (global) autos are in no man’s land," the analysts say, adding that "valuations are low relative to history, but we are too late in the cycle, and EPS downside potential too great to be too positive." They downgrade both Autoliv and Veoneer to an equal-weight within the broader outlook note.

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

  • Today -- HD hosts sell-side lunch in NYC
  • Today -- Court to hear appeal of TWX/T merger
  • 7:00am -- SCWX, THO, MIK, GIII, PLCE, PDCO, Dollarama earnings
  • 7:30am -- KR earnings (roughly)
  • 7:30am -- LB monthly sales
  • 8:00am -- COST monthly sales
  • 8:15am -- ADP employment change
  • 8:30am -- Nonfarm Productivity, Initial Jobless Claims
  • 8:30am -- TTC earnings
  • 8:30am -- VRSK investor day
  • 9:00am -- DLTH earnings
  • 9:00am -- MTOR analyst day
  • 9:15am -- HOV earnings
  • 9:30am -- BSX at Citi health care conference
  • 9:45am -- Markit PMIs, Bloomberg Consumer Comfort
  • 10:00am -- ISM Non-Manufacturing Index, Durable Goods, Factory Orders
  • 10:00am -- KR earnings call
  • 10:00am -- NEM 2019 guidance webcast
  • 11:00am -- DoE oil inventory data
  • 11:00am -- PRU guidance call
  • 11:00am -- HOV earnings call
  • 11:00am -- AGN, ISRG at Citi health care conference
  • 11:30am -- T at Barclays TMT conference
  • 12:00pm -- NXPI, ESTC at Barclays TMT conference
  • 12:15pm -- Fed’s Bostic on the economic outlook
  • 12:30pm -- VZ, ASML at Barclays TMT conference
  • 1:30pm -- CY, FTNT, EXPE at Barclays TMT conference
  • 2:00pm -- JPM, BA, T CEOs at Business Roundtable
  • 2:00pm -- Bombardier investor day
  • 2:00pm -- CSCO at Barclays TMT conference
  • 2:10pm -- BMY at Citi health care conference
  • 2:30pm -- LITE, FEYE at Barclays TMT conference
  • 2:45pm -- BX, QCOM CEOs at Business Roundtable
  • 3:00pm -- NVDA at Barclays TMT conference
  • 3:30pm -- WMT, IBM CEOs at Business Roundtable
  • 3:30pm -- BIDU at Barclays TMT conference
  • 4:00pm -- BLBD earnings
  • 4:01pm -- DOMO earnings
  • 4:03pm -- ULTA earnings
  • 4:05pm -- LULU, UNFI, AOBC, ZUMZ, DOCU earnings
  • 4:15pm -- AVGO, SAIC, COO earnings
  • 4:15pm -- CMI CEO at Business Roundtable
  • 4:30pm -- LULU earnings call
  • 4:30pm -- APRN at Barclays TMT conference
  • 5:00pm -- AVGO earnings call
  • 6:30pm -- Fed’s Williams holds discussion with Mervyn King
  • 6:45pm -- Fed Chair Powell gives welcome remarks at housing conference
  • 8:20pm -- Jaguars at Titans (-4.5)
  • Tonight -- IPOs scheduled to price: Moderna (MRNA), Mercantil Bank (AMTB), DiaMedica Therapeutics (DMCAD)

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