Welcome back to the Lumida Ledger. Here’s a preview of what we cover this week:

• Macro: Payrolls Beat, WLI Up, Bonds Oversold

• Markets: Capitulation in Utilities and Small Cap, but not Tech

• Company Earnings: Banks report this week; Earnings growth at 0%

• AI: Defense & Surveillance boom; The Economist on AI

• Digital Assets: Early Stage Crypto Venture; SBF Trial

Meltem Demirors and Ram interviewed Dylan Patel, who leads SemiAnalysis - a leading semiconductor research firm. It was a great conversation - if you care about NVIDIA, semiconductors or big tech, we encourage you to listen to the recording.

Reminder: we’ve talked at length about our CRE thesis. Our preferred CRE manager will close to subscriptions in the coming weeks. Reach out if you are a qualified client and you want to learn more.

_Macro

Mohammed El-Erian published a piece in the FT making the bear case:

That’s the emerging new narrative. Folks are turning bearish.

Take that with a grain of salt. El-Erian formerly was Co-CIO of Pimco. He was making the case for a ‘new normal’ of below trend growth post-GFC. That view didn’t work out as we entered the Roaring 2010s, and he didn’t last long at Pimco.

The point here is Consensus is turning bearish.

Meanwhile, leading economic indicators are turning up. Analyst earnings continue to trend up. We landed on a strong jobs report (see Lumida analysis here).

We still believe the economic direction is continued slowing - but the brakes from the Fed aren’t that effective when consumers and corporates have termed out debt, and there’s still stimulus working through the system.

The US Consumer is stronger than most think. Here’s a tweet on Consumer Spend trends which shows renewed signs of life.

Twitter

There are weak areas - such as low-income consumers. But the services part of the economy continues to grow and take share from the cyclical part of the economy.

On ‘higher for longer’, this chart does a great job visually depicting how markets have digested ‘higher for longer’.

There’s still a few cuts priced in, but we’ve come a long way.

We believe bonds are oversold. As we’ve stated before, yields are in ‘price discovery’ amidst a period of accelerated issuance. We could certainly see a ‘scare’ if yields hit 5%.

However, those would be buying opportunities in a world of declining growth and inflation.

Price drops due to short-term technical considerations eventually give way to fundamentals.

_Markets

Friends Don’t Let Friends Do Crowded Trades

In January, investors loaded up on defensive Consumer Staples on recession fears.

Staples include food & beverage (Pepsi, Molson, and Clorox). Consumer Staples this week showed signs of capitulation.

So much for ‘Defensive Sector’ Lesson: there is no safety in herds.

This past week, the Staples Sector plunged 2.1% for its worst day since January, despite less pressure from long-term rates compared to the last couple of days.

Relative to the S&P 500, Staples are at 52-week lows and have lagged the broad index by 12% over the past year.

Various Sectors in the Market Are Going Through Capitulation

Rate-sensitive utilities were crushed as rates went up. The price of oil has dropped 10%+, and energy stocks also dropped but continue to outperform.

We pointed out in a post this Monday that ‘the vibe is changing’. Hedge funds for the first time are starting to accumulate instead of short. And, now, we had the first week with tech stocks finishing up.

We are seeing a shift back to the ‘technology up’ regime. That means energy, which has done quite well these past two months, likely underperforms.

Semiconductors present an excellent entry.

Take a look at this beautiful chart from our friends at Barclays.

The chart decomposes what is driving sector performance - changes in multiple or changes in earnings.

Notice Energy has experienced the most multiple expansion in the last few months. Does that mean sell energy? No. Energy is still the cheapest sector on a valuation and earnings growth adjusted basis. And we want to avoid capital gains tax. But it does mean wait for dips before adding.

On the other hand - take a look at Semiconductors - one of our other favorites.

At long last, Semiconductor stocks are down 10%. And earnings growth expectations for this sector is the highest across all sectors. That’s what we want to see folks.

The market was dumping semis and tech this past two months, and yet earnings are going up. We believe now is the time to start legging into semiconductors.

We still don’t have a full capitulation in the US equities market. And we may not get that. If we do get it, we can identify that and will let you know.

So our approach is to start legging into the most oversold sectors where there is value.

Here’s a basket of semiconductor stocks we like. We are still continuing to refine this list.

We were joined by the inimitable Meltem Demirors and interviewed Dylan Patel who leads SemiAnalysis - a leading semiconductor research firm.

Notably, although semiconductors have been pummeled the last two months, these stocks have done well. That’s not a basis for our selection, but the relative strength versus the peer group of stocks we did not select is encouraging.

Now, one needs to be careful about approaching this basket thoughtfully. For example, we like ARM - we wrote about our thesis here - but it’s too expensive and trading just above its IPO price. If there was no lock-up this stock would be trading down.

Because semiconductor stocks are volatile, investing in this model portfolio with a Direct Indexing strategy we believe can generate a few additional points of tax alpha. We use sophisticated portfolio analytics to craft a portfolio with the appropriate portfolio weightings.

We still have more work to do in semiconductors - especially small cap names that are undercovered but play critical roles in the ecosystem.

We’re also excited about the CoreWeave IPO next year, which we believe will do well.

On Technology stocks, we are bullish for Q4.

However, as always, the expression matters. We prefer ‘capex receivers’ and are sensitive to valuation and earnings growth. If you’re following us closely, you already know what we like.

Our Brief Thoughts on The Market

1) VIX at 20

2) Drudge Report indicator triggered

3) Utilities capitulated [ and may present a good buy for income oriented investors ]

4) Small caps wrecked

5) Gold oversold

5) Apple downgraded

This all paints a picture of capitulation.

However, we have not seen a capitulation in Technology. The Meta Connect/AI narrative has saved QQQ thus far.

We are surprised how tech stocks have held up in the face of a 4.8% 10-year yield, and we don’t see an ‘all clear’ capitulation sign here like we saw in October of last year.

Should we get a sell-off early in the week, we believe those would represent opportunities to accumulate.

In the presence of uncertainty, we would start legging into semiconductors since they’ve sold off, and as we showed above, they also display the highest earnings growth.

History suggests the upcoming earnings season is a catalyst for the largest tech stocks.

The largest tech stocks have outperformed the equal-weight S&P 500 in two-thirds of earnings seasons since 2016, typically outperforming by 3% over the season.

Earnings estimates are projected to be flat for Q3, but show growth in Q4.

Given the forecast for 0% earnings growth, we expect a positive but muted rally to finish the year.

We remain of the view this is a correction in a bull market and we are in the last chapter.

Note that earnings week is starting this coming Friday with a focus on the banks. Markets statistically do better during earnings season.

We expect the large GSIB banks, including JP Morgan and Morgan Stanley, will do well.

_{Company Earnings}

Levi’s beat earnings by ~4% but missed revenue by ~2%. We wrote a thread here.

~$1.5 Bn in total revenue, up ~13% QoQ & flat YoY

Stock: Down 3% post-results in after-hours

Inventory levels increased by ~6% YoY but aim to be below prior year levels by year-end

FY 2023 revenue growth guidance revised from ~2% to flat to 1% YoY

Cuts full-year sales forecast, citing weak sales of its denim at department stores & big-box retailers.

However, direct-to-consumer up 14%; E-commerce up 19% YoY

Note: E-Commerce sales are up 19% YOY at the expense of physical retail.

_AI

We believe the disturbing and tragic events in Israel will lead to accelerated investment in AI for Defense & Surveillance.

Humans in charge of monotonous but mission critical functions just can’t be trusted.

That will spur spending from governments and the beneficiaries will be the Silicon layer.

On the consumer side, this article in the Economist caught our attention:

Their point is that mobile phone sets are less needed in the new world of AI.

That would place pressure on Apple where MacBooks and iPhone are already experiencing YOY decline.

But, the Economist gets it wrong.

The Phone is not at risk. We need mobile, light weight, and multi-modal compute. That’s called ‘smart phones’.

What's at risk is SAAS.

We don't need Dashboards. AI can build dashboards.

Take a look at these publicly traded SAAS firms.

How many of these firms are at risk? If AI isn’t the customer of your product then aren’t you at risk?

_{Digital Assets}

Grayscale took steps to convert Ethereum trust (ETHE) to an ETF.

That’s consistent with our thesis:

1. Bitcoin will get approved for an ETF conversion (in 2024)

2. Ethereum will soon follow

3. ETHE has wider discount, and correlated to BTC, so own ETHE

The last time we bought ETHE was in August after that panic liquidation.

We don’t like chasing green candles, and Digital Assets has had a strong run.

Talking about liquid Digital Assets is great… but it pales in comparison to the return (potential) from early stage crypto venture.

Consider Dragonfly. The Aptos launch was successful, but a dud in terms of valuation. No matter - Dragonfly will return the fund. Seed investors get the best valuation and token warrants.

Instead of figuring out what macro rates will do for the price of Bitcoin or Ethereum, the return on capital is highest with early venture.

Consider this post from Nick Tomaino. He published his funds Distributions (Cash) to Paid-In-Capital. 5X+ returns on Fund - taxed at long-term capital gains.

And there are funds with 20X returns or 10X back-to-back returns.

The real money in crypto is made via early-stage token warrants.

In Q1 ‘24, we expect to deploy to additional crypto venture funds and are doing a light survey now. There are hundreds of crypto funds.

The work resembles Indiana Jones in the Last Crusade where he is gingerly jumping from one stone to the next - avoiding a minefield.

Crypto venture investing is hard. Example: There are many VCs sitting on positions that are ‘unexitable’ because the portcos are not compliant. So they show attractive unrealized returns on capital (MOIC), but low cash distributions.

And there are many, many distinct themes.

Here’s just a few:

• TradFi - DeFi crossover

• Crypto Gaming

• Crypto Apps for Crypto Natives

• L1 & L2 bets

• Infrastructure

• Tokenization - has many sub-variations (capital markets, RWA, royalties, etc.)

• Compliance

In crypto, the sheer volume of funds and lack of access to fund returns on databases like Preqin make it harder. There are also VCs with skeletons in the closet - back-channel and background checks matter.

Here’s a crypto lunch this week with Ram, Serge Kadassjian (Sixth Man Ventures), Alexander Knopp (Phaedrus Ventures), and Raghav Chopra (Tephra Digital).

The insight from these conversations is invaluable and we believe gives us an edge in staying ahead of the curve.

So, for those that are tracking our views on Digital Assets, keep in mind you can choose the game you want to play.

The better games to play are in Alternative Investments, and early stage crypto venture.

Reach out to us if you’d like to learn more.

Lastly, Justin and Ram did a ‘What’s On Your Mind’. These are short 30-minute videos with instant reactions on various items and how we’re processing them.

We discuss: SBF trial jury selection, venture investing, and how to offset income with passive losses

Work with us: we are are looking for a client associate to help us with sales and client service support. Send referrals here.

Meme of the Week

Quote of the Week

“Develop a passion for learning. If you do, you will never cease to grow." - Anthony J. D'Angelo

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