The “Routation” Continues

Yesterday we offered up the term “routation” to explain how major indices could get hit hard even when other market metrics imply otherwise.  After the requisite attempt at “buy-the-dip” during the pre-market and as the regular session opened, the selling in megacap technology resumed soon afterward.  As of now, we see again declines in key indices, but also note only a modest bias to declining stocks over advancers, and value stocks remain roughly unchanged even as growth stocks trade lower.

It was interesting to tune into a general news program last night to hear them describe markets as mixed.  Frankly it wasn’t incorrect, because the Dow Jones (INDU) rose even as the S&P 500 (SPX) and Nasdaq Composite (COMP) were down sharply.  I’m not sure how many readers would agree with that assessment, since so many undoubtedly have portfolios that are more closely correlated to SPX and the Nasdaq 100 (NDX) than INDU, but as long as people continue to view INDU as a valid market measure (I don’t, by the way), it was not necessarily wrong. 

The culprit today, as it was to some extent yesterday, is Taiwan Semiconductor (TSM).  We noted that tech stocks suffered from a bout of unintentional political bipartisanship.  There were reports that the Biden administration would be cracking down further on the sale of advanced semiconductor technology to China while Trump mused about having Taiwan pay for its defense.  Neither was a plus for TSM, whose ADRs plunged by nearly 8% yesterday. 

They seemed to get a reprieve today when TSM reported solid EPS of $1.48, well above the $1.40 analyst consensus, and raised revenue guidance.  The news was released after trading closed in Taiwan, where shares closed about -2.4% lower, so the roughly 4% jump in the ADRs pre-market was viewed as welcome news both for the stock and for the industry.  Nvidia (NVDA) shares bounced back 3% pre-market too, as did a wide range of other tech stocks. 

But then, after a quick bounce right around 9:30 EDT, TSM began to fade.  It bounced off unchanged levels around 9:48 and then was down for the day at 10:36. By midday, the drop in TSM was nearly 3%, with other tech stocks helping drag SPX -0.8% and NDX -0.9%.  So much for that post-dip bounce.

Today’s reaction in TSM once again raises a concern I've expressed more than once recently.   It is quite possible, if not likely, that expectations for the tech leaders have gotten so high that it is becoming increasingly difficult to impress investors, even if they beat on a wide range of metrics.  This is probably the issue with TSM today.  It’s possible that political worries may be offering a bit of a negative backdrop, but the fact that the decline only began after a positive start puts more weight on my belief that investors have set too high of a bar for their favorite stocks. 

This type of behavior could be a huge headwind as we begin to expect key tech stock earnings in the coming days.

I would be remiss if I didn’t point out an interesting wrinkle that is specific to TSM ADRs.  Because there is a limitation upon the amount of ADRs that can be created and the demand for this company from international investors is so high, TSM ADRs trade at a significant premium to the ordinary shares.  The vast majority of major company ADRs trade roughly in synch with their ordinary shares.  There might be slight differences resulting from mismatches of trading hours and currency fluctuations, but the TSM premium is both long-lasting and extraordinary.  This provides an added risk to holders of TSM – you are not only buying a highly valued semiconductor stock, you are paying a premium well above what local investors pay.  That leaves ADR holders susceptible not only to a decline in the shares themselves, but also to the risk that the premium could shrink if foreign investors rotate en masse away from this stock specifically or semiconductors in general. 

The recent jump in the Cboe Volatility Index (VIX) from about 12.5 to the current 15.86 tells us that investors have reassessed the potential for volatility over the coming 30 days.  Considering the earnings concerns that we raised above, and, oh yeah, a consequential FOMC meeting on the 31^st, that reassessment seems rather appropriate.