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Takeaway: Early warning signs in the semiconductor space suggest it’s appropriate for investors to rotate out of Taiwan here.

Snapping our immediate-term TRADE line of support recently, the iShares MSCI Taiwan ETF (EWT) is now breaking down alongside what was one of our favorite ways to play our 2Q Macro Theme #StructuralInflation on the long side – semiconductor stocks (SMH). Recall that in our 6/3 research note titled, “BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA”, we preferred Taiwan over most other international equity markets at that time due to its exposure to the “anti-CapEx cycle” (i.e. M&A):

  • “It’s worth noting that the Tech sector accounts for a whopping 46% of TAIEX market cap, with semiconductors alone accounting for 23%.”
  • “Not surprisingly, the benchmark Taiwan TAIEX Index has registered a +0.83 correlation with the MSCI World Semiconductors GICS Level 3 Index in the YTD, which is up a bit from the +0.80 correlation registered over the trailing 3Y.”
  • “Indeed, it would seem that getting the semis cycle right is really all investors need to have a handle on to get market beta right for Taiwanese equities.”

Now, we are getting increasingly negative on the global semiconductors space amid signs of frothiness throughout the industry. Per a research note from this morning via Hedgeye Semiconductors Sector Head, Craig Berger:

  • “We note Atmel's Memory shipments have grew 13% QOQ in 2Q14 and are guided to grow double-digits again in 3Q14.  We have not seen  consecutive double-digit growth quarters in Atmel's memory business even once in the last thirteen years of history (though mid-2009 came close).”
  • “Semiconductor Upcycle now means Modest Downcycle Reset later. In short, when the sector is in the throes of an Upcycle (even a modest one), then there will inevitably be a revenue/earnings estimate reset process that could play out over three to nine months (modest Downcycle).”
  • “Currently, chip customers are feeling more confident about global macro conditions, and are modestly replenishing chip and finished goods inventories to higher levels.”
  • “Now, chip lead-times are starting to expand and supply is tightening, which could either increase in magnitude from here or begin to fizzle out into early 2015.”
  • “Either way, even if there is not 'too much' inventory in the supply chain, some chip firms' shipment levels could be 5%-15% above real end consumption levels.”
  • “This drives chip firms to have to 'reset' estimates at some point in the future to 'normalize' shipments with end consumption levels.”
  • “Conclusion: This Upcycle is getting long in the tooth. Chip stocks have spent 256 weeks in Upcycle Trends versus only 26 weeks in a brief Downcycle (most of 1H11). Only one Upcycle in history has been longer (1 at 272 weeks).”
  • The two most similar (i.e. muted) Downcycles were in 2006 and 2011, lasted 24 weeks and 26 weeks, and with Chip stocks falling by 21% and 32% peak-to-trough, respectively.”

CLICK HERE to view a brief, ~7 minute video with Berger and Hedgeye CEO Keith McCullough delving deep into these industry dynamics.

***If you’re not yet receiving what some of our customers are already labeling as the best semiconductors research on the Street, please email to learn more.***

Jumping back to Taiwan, we see that the island economy is clearly mirroring the semis Upcycle. Specifically, looking to just about every single relevant high-frequency growth data point coming out of Taiwan, we see that economic activity in Taiwan is accelerating on both a sequential and on a multi-duration trending basis!


Is this is as good as it gets, however? The market is certainly starting to have that debate.  While our GIP model continues to portend a positive growth outlook for Taiwan here in the third quarter, it is also calling for a sharp deceleration into Quad #3 for the fourth quarter.  


In the context of the aforementioned quantitative signals and this readily identifiable roadblock within our intermediate-term TREND duration, we think it’s best for investors to step aside and book the gain in Taiwan here.

In the spirit of keeping score – win, lose or draw (though we tend to avoid the latter two options w/ our country-picking) – the EWT ETF has appreciated +2.2% since our JUN 3 note. That compares to a sample mean of +2% for the 24 country-level ETFs we track across the EM space and a -0.6% decline for the S&P 500 SPDR ETF Trust (SPY). Annualizing those returns would result in a +12.5% gain for the EWT vs. a -3.4% decline for the SPY.



Darius Dale

Associate: Macro Team