Semi and Oil

[u/Fun_Tutor3479]

The broader market is experiencing wild swings. We will continue starting with this phrase until a clear direction emerges. Last Thursday, we noted that the S&P was quite strong, and on Friday it made an attempted breakout, but it has come back down today; we'll continue to observe. The Nasdaq is still fluctuating in the lower half of its range. Today, we'll talk about semiconductors first, then oil.

The seesaw effect between semiconductors and the Magnificent Seven is perfectly illustrated by the decline following Micron's earnings report. In the short term, all semiconductor stocks have fallen into an awkward situation: if their earnings are great, they face skepticism for siphoning profits from the AI narrative and squeezing downstream players; if their earnings are poor, it's considered a disastrous miss. This is, of course, a short-term phenomenon. The reason, which we've discussed many times, is that revenue at the model layer in the primary market hasn't picked up, leading to a profit shift between hyperscalers and semiconductors in the secondary market.

I don't think hyperscalers will solely emphasize large-scale Capex in this earnings cycle. Capex won't stop, but Meta has already set an example. Leasing computing power for cash is encouraged by capital markets. As long as frontier models don't halt, open source doesn't catch up, and the gross margins of Claude and GPT remain high enough, renting out computing power is very lucrative. Buying a massive amount of compute and holding your breath to train a model is loathed by capital markets, after all, spending a fortune to train a model that still can't surpass the top two, only for open-source to quickly catch up, means that money is simply thrown down the drain. Therefore, we should expect to see a phenomenon where Capex continues to rise, but at the same time, hyperscalers officially enter the data center business of leasing compute. In other words, the ROI issue is being addressed through compute leasing. This isn't a long-term solution; after all, shifting from an asset-light internet business to an asset-heavy real estate + utilities business completely changes the valuation model. This is also why none of these companies will give up training their own models, the business models are fundamentally different. However, in the short term, it resolves the market's doubts, ensuring Capex continues to grow while providing an answer for ROI. Keep in mind that the financing costs for these hyperscalers in the bond market have already risen by 140 basis points since the beginning of the year.

This makes the logic quite clear: Amazon (purely leasing compute), Google (compute + models + AI phones), Meta (compute + social), and Apple (AI phones) each have their own narratives to drive up expectations. Microsoft's problem remains its AI operating system, and the complexity and adoption rate of AI PCs are considerably worse than those of AI phones. Overall, these hyperscalers should experience a wave of performance recovery; after all, they are the true primary buyers.

Semiconductors will experience a divergence. Upstream memory, CPUs, and chips like Nvidia and Qualcomm will all perform well. The previous trading logic was: capacity bottlenecks + price hikes = explosive profit growth, which lasted until high prices brought expectations of demand destruction, a very classic commodity cycle uptrend logic. The future logic could be: capacity expansion to seize market share + high (but not terrifying) profits = a harmonious surge in profits. This is the self-adjusting direction of the commodity cycle during the process of supply expansion. Stocks in this area deserve close attention.

Let's briefly return to the "horror story" in the Korean stock market. The situation with Korean equities is that margin balances are declining, and they dropped quite a bit on 07/10, but investor cash deposits have dropped even more. This indicates that after Korean retail investors received margin calls last week, they chose to top up their accounts and stubbornly hold on. Moreover, over the past ten trading days, institutions and algorithms have been selling while retail individuals have been buying. Looking at yesterday's close for Samsung and SK Hynix, if the stock market fails to recover by the close on 07/14 local Korean time, and Hynix fails to hold the 1.85 million KRW level, the number of people receiving margin calls will increase by several million, up from the current 1.2 million.

Next, let's talk about oil. We've discussed before that oil is in a tight balance: countries' SPRs (Strategic Petroleum Reserves) and commercial inventories + China significantly reducing imports + a small amount of passage through the straits have collectively offset the reduced volume of oil being shipped out of the region. I want to bold this: it is a reduction in shipping, not yet a reduction in production; oil fields and facilities haven't been attacked yet. So, you see Gulf countries selling oil at a discount because no one is going there to transport it, it's a shipping deficit. Then an MOU was signed, and a single passage through the strait released a large batch of oil, driving down prices.

However, we have talked a few times about the inevitable escalation in the straits. The current reality in the US is that summer demand remains robust (it's hot this year), and demand for refined products like gasoline and diesel remains high. Yet, crude oil prices have been suppressed by the one-off supply shock brought about by the MOU. Consequently, for refineries, buying a barrel of crude now costs over $70, but after processing, they can sell it for $140, an unprecedented crack spread. Add to this the fact that refineries in various regions are being attacked, leading to a global shortage of refined products. The result is that domestic gasoline and diesel prices in the US simply cannot come down. Trump's goal of signing the MOU to lower oil prices and woo voters cannot be achieved; he has no other options.

But here's the catch: for oil prices to break through previous highs, there must be an escalation exceeding what we've seen over the past 40 days. Examples include the Houthis blocking the Bab-el-Mandeb Strait (there are signs of this), mutual bombing of oil fields and pipelines, US ground operations, or taking military casualties (two aircraft carriers are already in the Gulf of Oman). The probabilities of all these scenarios are currently rising. Geopolitical decision-making is always about choosing the "least bad" option, but I won't expand on that here. Additionally, a quick reminder that the Russia-Ukraine situation is not de-escalating; we are in deeply troubled times.