BRENF - The 'Big Short' Is Shorting Semiconductors: Why High Yield Will Pummel Tech

2023-11-16 10:00:00 ET

Summary

• Michael Burry recently opened a $47 million short position against the semiconductor sector, indicating a bearish outlook for tech stocks.
• Meanwhile, we believe that high yield stocks are poised to soar.
• We share several reasons why we think that high yield will pummel tech moving forward.
• We also share some of our top picks.

Michael Burry - commonly referred to as "The Big Short" - recently opened a $47 million short position against the semiconductor sector via put options against the iShares Semiconductor ETF ( SOXX ). This move combines with a number of other metrics that indicate the future outlook for semiconductor stocks - and the tech sector ( QQQ ) at large - is bleak, while the outlook for defensive high-yielding stocks is quite strong. In this article, we will explain why we believe that high-yield stocks are poised to pummel tech moving forward.

Why Semiconductor & Tech Stocks Are Poised To Underperform

Semiconductor and technology stocks have had a monster year, driving the S&P 500 ( SPY )( VOO ) higher in the process:

However, there is a growing body of evidence that suggests underperformance may be in store for semiconductor and technology stocks moving forward, including:

1. Yield Dynamics : The equity risk premium is currently quite thin, indicating that investors are not being adequately compensated for the risks associated with equity investment compared to the safer treasury yields. Historically, a 300 basis point gap is expected, but at the moment it is much narrower. In fact, in some sectors - particularly tech - there is actually a negative spread between equity earnings yields and bond yields. While this can potentially work in a high-growth environment, economic indicators are pointing to slowing growth and some of the biggest names in tech such as Apple ( AAPL ) are seeing growth flatline right now.

2. Monetary Policy : The Fed's hawkish stance and positive real interest rates suggest a tightening monetary environment. In particular, the Fed's focus on weakening the labor market implies that - while interest rates are likely at their peak - they will likely take a cautious approach to rate cuts, which could lead to a continued challenging environment for growth stocks like technology and semiconductors.

3. Mean Reversion : The semiconductor and technology sector has outperformed this year, with the SOXX ETF appreciating by over 48% and QQQ not far behind. However, this performance may not be sustainable, especially in an environment where bond yields exceed tech earnings yields by a large margin and economic growth is slowing. Moreover, the tech-rich S&P 500 is currently overvalued based on the Mean Reversion model.

4. Michael Burry's Short Position : As already stated, Michael Burry's significant short bet of $47 million against the semiconductor sector is a bearish indicator given that he is known for generally being correct with his high-conviction market bets.

5. Broader Market Sentiment : Moreover, "Bond King" Jeffrey Gundlach's recent comments about leading sectors during market highs being the worst performers during recessions with a specific reference to large and mega-cap tech stocks point to a potential downturn for the tech sector. Indicators, suggests a cautious approach towards technology stocks.

Overall, the current earnings yield and interest rate dynamics, monetary policy outlook, market performance trends, and notable recent comments and moves from seasoned investors like Burry and Gundlach point towards a bearish outlook for semiconductor and technology stocks in the near future.

Why High Yield Stocks Are Poised To Outperform

Meanwhile, the outlook for defensive high-yield stocks, particularly those in sectors like Real Estate Investment Trusts (REITs) ( VNQ ) and utilities ( XLU ), appears to be quite strong for several reasons:

1. Economic Slowdown Indicators : Recent economic data suggests a cooling economy, evidenced by clear signs that inflation and job growth are cooling. In particular, the Federal Reserve's preferred personal consumption expenditures price index and the lower-than-expected headline CPI number in October 2023 indicate a deceleration in inflation. This trend, coupled with weaker job market data — including a rise in the unemployment rate and a decrease in real wages — points to an economic slowdown.
2. Potential Shift in Federal Reserve Policy : Given the cooling economy and inflation, the Federal Reserve is likely finished raising interest rates and it appears likely that interest rates will begin falling in the not-too-distant future, making high-yield, defensive stocks - which have been pummeled by rising interest rates recently - more attractive.
3. Defensive Stock Characteristics : Moreover, defensive stocks, like REITs and utilities, are known for their stable, contractual cash flows, which become more appealing to investors during economic downturns.
4. Mean Reversion : While tech stocks appear poised for a valuation mean reversion lower in the coming months and years, high-yield stocks appear poised for a valuation mean reversion higher moving forward. This is because many REITs, utilities, and other infrastructure stocks are trading at cash flow and dividend yields that imply they are significantly undervalued relative to their history.

Investor Takeaway

Tech stocks are clearly very expensive relative to their history and current interest rates. As leading economist David Rosenberg recently pointed out in an interview:

The arithmetic is so daunting that if you think that the stock market is where it should be right now, to make it make sense from a yield perspective with the mean reverting to the historical average, the 10-year Treasury Yield would have to collapse to 1.5%. Everything I'm looking at: the home affordability ratio, that's a mean-reverting ratio that has to include lower interest rates in the coming year, the equity risk premium has to include lower rates in the coming year or so, all roads lead to lower bond yields... I think that the long bond is going to be the place that you want to have money in for the next 12 months.

In other words, the earnings yield on tech stocks is so low right now relative to interest rates, that either tech stocks are going to have to crash, bond yields are going to have to crash, or some combination of the two will have to take place. Given that many defensive high-yielding bond proxy stocks like triple-net lease REITs ( WPC )( O )( NNN ), utilities ( AQN )( NEE ), and yield cos ( BEP )( BEPC )( AY ) are so beaten down from high interest rates, it is highly likely that these stocks will soar along with soaring bond prices in the coming months while the high-flying technology sector underperforms as the economy contracts, inflation vanishes, interest rates plummet, and valuations revert to their historical means.

For further details see: