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Separate the Noise from Fundamentals

By Scott Chan on February 12, 2018

Last week was a rough one for the market. Monday was particularly bad. It was a mini “Black Monday.”

In percentage terms, the S&P 500 experienced its biggest drop since 2011. In absolute terms, the 113 point decline was the index’s largest one-day fall ever.

Concern that inflation may accelerate and possibly cause the Fed to raise interest rates quickly sparked the correction. But, automated computer trading and margin calls made the selling much worse.

Stay the Course

If you are a daytrader, Monday was a big deal, but for most investors who stay the course, in the long run the decline should turn out to be just a blip.

Fundamentally, the economy still looks good and the chances of a recession in the next 12 months look slim. Although there is a chance that inflation could slow the economy, that risk does not warrant the scale of the Monday sell off.

This brings us to this important lesson: when investing, one must separate the noise from fundamentals.

What do we mean?

Fundamentals matter much more in the long run than day-to-day price movements. If Monday’s fall was caused by an event that has lasting economic implications, such as a major bank failing (think financial crisis), or if some important economic data suggested that a significant slowdown was happening, then it’s time to make some moves.

Last Monday’s stock drop was scary, but it was likely just noise. The market was due for a correction and modern trading techniques made the situation much worse. The risk that the Fed could raise interest rates faster than previously expected is enough to cause a pause in the rally, but should not be enough to cause the market to enter a bear market.

At some point we will have another recession, but given the current strength of economic data a recession is unlikely in at least the next 12 months.

A Game Changer

And sometimes, the fundamentals for an industry can change dramatically. For instance, the semiconductor industry is known to be cyclical. Companies in the industry have experienced cycles of feast and famine.

But in recent years the improvements in technology has fundamentally reshaped the industry and helped it to become less cyclical.

The growth of the Internet of Things, artificial intelligence (AI), and even blockchain have greatly increased the demand for computing power and chips. The advancement in these technologies is a tide that lifts all boats in the industry.

Chip designer Nvidia (NASDAQ: NVDA) has enjoyed explosive growth in its share price thanks to leadership in self-driving cars and other areas of AI. Taiwan Semiconductors (NYSE: TSM), which manufactures the chips for Nvidia and other chip companies, is seeing strong demand. Even companies that supply the equipment to manufacture chips, like Applied Materials (NASDAQ: AMAT) and Lam Research (NASDAQ: LRCX), have joined the party.

As you can see in the chart of VanEck Vectors Semiconductor ETF (NYSE: SMH), stocks in the industry have enjoyed a very strong two-year run. The recent dip indicates a correction after a heated run.

For someone who has not bothered to research why semiconductor stocks have rallied some much, the recent decline may suggest the start of the next down cycle, and he/she may decide to get out. But to someone who realizes that advances in technology have increased the demand for chips, the correction looks like a buying opportunity.

The fundamental outlook for the semiconductor industry still looks good and the valuation looks reasonable. The stocks in SMH are trading at less than 15-times projected forward earnings. This is lower than the S&P 500 (18 times).

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  1. avatar
    Rudolph Millan Reply February 13, 2018 at 4:03 PM EDT

    I pay for a subscription. I strongly resent all the spam you are sending me disguised as investment advice. A premium service should be free of advertising. Your incessant efforts to grow your revenue by splitting up the investment environment into ever increasing sub-categories is unseemly, and has me considering whether the benefits of continuing to subscribe outweigh the efforts I have to put in to sort out all the advertising noise you are subjecting me to.