Monday Digest

Posted 18 January 2021

Outlook: new leadership brings fresh optimism to the US
There remains a broad consensus within investment markets that this year will see a strong economic rebound as mass vaccinations finally put an end to the pandemic – even if we have to wait until the second half of the year to see it. Ahead of Wednesday’s inauguration of Joe Biden as the 46th President of the United States, there is also a widespread expectation that the new administration will usher in a more sustained recovery than the faltering US growth displayed over the last quarter of 2020.

The hope is that Biden will be able to deliver on his campaign promises of substantial, but also structurally beneficial, fiscal stimulus. If he can, it would amount to a rebuilding of US crumbling infrastructure towards a better, greener future. Some even see this as the opportunity for a re-run of Franklin D. Roosevelt’s New Deal, credited with having put an end to the crippling depression of the 1930s. The Biden administration’s announcement last week of an immediate fiscal support programme worth an additional $1.9 trillion, seemingly reaffirmed those hopes, and explains why US and global stock markets enjoyed another week of positive returns, despite the COVID-19 pandemic hampering economic activity everywhere.

However, the support programme did not contain any notable elements of fiscal investment into sustainable infrastructure, focusing instead on overcoming the household and business income gap that lockdowns are inflicting, and on ramping up vaccination to a huge scale. The (potentially more contentious) investment plan will only come in February. While markets might want to see that right away, the deal on the table allows for rapid bipartisan approval now, and consensus-building later. Coming after Donald Trump’s erratic and divisive leadership, there is a palpable sense of urgency for immediate, decisive action from the incoming administration.

Meanwhile, as the UK continues to grapple with the worst second-wave public health pressures of anywhere in Europe, bedding down the post-Brexit trade framework is also making life difficult for businesses, who are struggling with the lack of meaningful preparation time they were allowed. Not surprisingly, the UK stock market lagged its global peers once again last week. However, with a strong rebound of global growth, and potentially a green infrastructure rebuilding effort around the world firmly on the 2021 horizon, UK stocks could still come good in the near term. The UK market’s domination of distinctly cyclical sectors and global companies, together with having been unloved because of Brexit uncertainties, is making investments in UK large caps (FTSE100) still one of the more promising likely sources of portfolio returns during 2021.

The many faces of Tesla: Tech, green investment, carmaker or just another bubble?
Investment flow data shows that Tesla has been the darling of retail and selected institutional investors over the last year. As the global economy fell into its deepest recession on record, Tesla’s stock climbed 800% and now has a market capitalisation of around $820 billion, making it by that measure 50% of the entire global car industry. Despite only being admitted to the S&P 500 weeks ago, Tesla has already overtaken Facebook to become the fifth largest company in the index. At its lofty price, Tesla dwarfs all its major competitors combined, despite producing a fraction of the cars they do. Having shipped just under 500,000 units last year – Tesla’s highest-ever sales figure – in 2020, the market valued the company at around £1.6 million per every car it sold.

However, saying Tesla is expensive is not the same thing as saying we expect its stock price to come down soon. For one, many of the factors underlying its massive expansion – an extremely accommodative financial environment, a supportive political and social backdrop (with an emphasis on green technologies) – are still present. Tesla has leading-edge technology in both the design and mass manufacturing of electric vehicles, as well as a big foot in the door of the self-driving market. Analysts estimate that the Tesla Model 3 sells at a profit margin of around 30%, which is a matter of factors higher than the average of its combustion engine competitors.

Traditional car manufacturers are desperate to crack the electric market – many have devoted vast resources to developing and rolling out new products. When burgeoning technologies arrive, newer companies often have the edge, being unburdened by the legacy of old tech. With governments, businesses and the investing public all striving towards sustainable alternatives, it is not unreasonable to think a company without a gas-guzzling history might end up winning out. Even if Tesla can fight off more experienced manufacturers, it may not be able to do the same to new entrants. Apple and Google have already announced intentions to launch into the electric and self-driving car markets (Google’s self-driving car company Waymo is indeed perceived as one of the leaders in the sector), and with their immense resources and technological know-how, they are well placed to make a sizable dent in an already crowded space. Essentially, while Tesla’s justification may not be wrong, it is nonetheless speculative.

Tesla is certainly no sure thing, but its valuation is based on more than just faith in an impulsive billionaire. The company has a lot going for it, but if an industrial carmaker is to remain the darling of the stock market, it has to start selling more cars and make more profit soon.

A bull in a (micro)chip shop
With most of the developed world stuck at home, it has been a good twelve months for chipmakers. Consumption of just about everything digital shot up last year – from remote working and learning to servers and gaming. TSMC, as with others in the semiconductor business, had a part to play in all of it. demand for semiconductors during the pandemic has been so strong suppliers cannot keep up. Talk now is of a global shortage of microchips, affecting the automotive industry in particular.

More advanced cars need more (standard) chips, but manufacturers have been reserving capacity for their bigger tech customers and their needs for more sophisticated, higher profit chips. The shortage has left car manufacturing crippled, with Volkswagen, Nissan and Honda all forced to cut production. Problems are so pronounced that TSMC called it their “top priority” to solve shortages for carmakers. But solving it could be a tall order. The chip industry at large is seeing shortages in every area, with analysts expecting supply gaps to last into 2022. Underlying these shortages are many technical issues. For example, scaling up chip production is slow and expensive, and access to the raw materials is limited. With demand for 5G phones and high-tech gear sky-rocketing, chipmakers have invested in equipment to make newer and better chips which they can sell at higher margins.

For governments, the chip supply issue is now a national security issue. Over the last four years we have seen private technological superiority become an explicit point of national security in the context of US-China tensions. China, it should be said, is some way behind in chip production technologies, and has to rely on TSMC for most of its supply. But even in the US, there are serious concerns that it may be left without a leading chip manufacturer to count on. With governments around the world investing heavily in the wake of COVID, technological infrastructure is one area likely to see a big boost. With chip design and production now also a cause for national security concern, we could well see chipmakers receiving subsidies in the post-pandemic recovery. In addition, the coming ‘green revolution’ in tech needs plentiful supply of chips – for everything from electric cars to newer, less energy-intensive servers. Even without fiscal expansion, chipmaking is sure to see more investment.

We are seeing a convergence of underlying trends which point to chip demand outpacing supply for the near future. So, while the pandemic has become a welcome catalyst for ever-more digital capability and convenience, we cannot expect the past decade’s trend of technology improvements – without price increases – to persist. With global chip-making industry operating at full capacity, and still demand outstripping supply, producer pricing power is as strong as it has ever been.

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