Buy U.S. Tech After Broadcom Warning Defines the Trade War’s Scope

Hilary Kramer

Hilary Kramer is an investment analyst and portfolio manager with 30 years of experience on Wall Street.

Think of the glass that’s either half empty or half full. Present Wall Street with a binary scenario and many investors automatically will assume absolute disaster.

That’s the “risk off” mentality driving talk about the trade war. For months now, a lot of great global stocks have factored in an all-or-nothing outcome when it comes to China.

Apple Inc. (NASDAQ:AAPL) and a few dozen smaller technology companies have effectively sold off on the rumor that their sales to China will drop to zero. If future developments restore that market, they’ll rally in relief.

But for reality-based investors, where the scenarios really get interesting is when we can define an impact somewhere between 100 percent disaster and 100 percent relief. Once we have that number, we can gauge which stocks are priced for a disaster that won’t happen and which still have room to fall.

We can make money in the market. And that’s what Broadcom Inc. (NASDAQ:AVGO) gave us last night with its warning that losing sales in China will knock $2 billion out of its revenue over the next six months.

AVGO management isn’t speculating in the dark. They’re constantly talking to their sales teams, key customers and even competitors to get maximum clarity on where the business is headed.

When they provided the $2 billion figure, it almost certainly reflects the best guidance they have, maybe setting the expectations bar a little low to cushion their future results. Even so, anyone who really knows the company knows that it’s far from disaster.

Wall Street has reached a tentative consensus that AVGO sells about $12 billion a year in chips to Chinese data centers and other customers. That amount is half of the company’s overall sales, and it is nothing to take lightly.

When the trade war started heating up late last year, the most vocal bears argued that as much as 65 percent of the Chinese business was at risk. That’s an $8 billion hit, which is pushing AVGO down to $210.

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Now that we know that the real impact will only be half as intense, those dismal levels are off the table in anything but a fleeting market storm. Sooner or later, the fundamentals will cut through even the worst sentiment and AVGO will bounce back to roughly these levels.

I think the stock is fairly valued now or even a little cheap if we see a resolution to trade talks soon. In the meantime, we know how much China hurts this company.

Extrapolating that pain across the rest of the “China crisis” stocks on my screen will create plenty of opportunities over the next few months. If you’re not on my Gamechangers’ list yet, it’s actually an exciting time to start.

In the meantime, of course, we’ll stick closer to home as we hunt high-growth technology stocks. True blue-sky business models are a whole lot more attractive than companies facing Chinese clouds.

Speaking of the cloud, we’ve done well on U.S. business solutions providers in recent months. Coupa Software Inc. (NASDAQ:COUP), ServiceNow Inc. (NYSE:NOW) and Ultimate Software Group Inc. (NASDAQ:ULTI) have been huge winners for us. Click here to sign up for GameChangers now.

And I’m not alone. These companies do most of their business outside China, along with a staggering 80 percent of the Nasdaq.

The China threat is real, but the numbers are exaggerated. Chip makers are reeling but most of the names you hear about are only $1 billion companies, barely 1/1000 the size of an Amazon.com Inc. (NASDAQ:AMZN) or Microsoft Corp. (NASDAQ:MSFT).

AVGO is one of the biggest, but it barely has 1/10 the market cap of either of those giants. Its $2 billion in lost sales won’t slow the NASDAQ at all, even if you multiply it across all the other chip makers in a similar position.

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CANNABIS CORNER

It is relatively easy to recognize that an all-new industry like legal cannabis will create long-term wealth. The hard part is making sure your portfolio remains open to emerging winners, while pivoting away from companies that clearly aren’t going to end up dominant players.

No marathon route runs on a straight track. There will be twists along the way and investors need to follow the flags if they want to reach the finish line.

In the world of cannabis, that means keeping your eyes open as we navigate a competitive landscape that’s extremely fragmented now but ultimately will consolidate around the most successful business models.

Corporate life is all about this process of testing ideas against commercial reality. Sometimes new ideas disrupt everyone’s assumptions, pushing leaders to the back of the pack while innovators make their big moves.

In cannabis, we’ve already seen a few waves of innovation shake up Wall Street’s assumptions about how this industry is going to evolve. Five years ago, for example, commercial-scale production still was a fantasy and none of the current Big Cannabis farmers were prominent on the market map.

Back then, a lot of investors thought the boom would come from lax enforcement on existing small-scale growers in Vancouver and other jurisdictions. People weren’t even thinking of industrial agriculture.

That “cottage” scale implied a competitive gold rush with entrepreneurs crowding into the market to tap a bit of newly liberated consumer demand. Investors imagined a kind of dot-com boom with thousands of start-up shops, each raising a few plants instead of running a few websites.

In that kind of world, the farms are too small for direct outside participation. Investors looking for a taste naturally shifted up the supply chain to focus on the companies that support small-scale producers.

After all, if this was a gold rush, the people who were really going to make money were the mining equipment stores, right? So, Wall Street bet big on gardening equipment, high-efficiency lighting systems, anything that someone who wanted to start a clandestine indoor farm would want to buy.

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Scotts Miracle-Gro Co. (NYSE:SMG) doubled in price between 2014 and 2016. Investors couldn’t stop whispering about the fact that this yard supply company also sold hydroponic gardening systems perfect for indoor cannabis.

Management loved the attention and ultimately paid $600 million to acquire all the hydroponic product manufacturers they could find. In theory, they were the face of the cannabis boom, with an emerging monopoly on the “mining equipment” of the green gold rush.

But then the marathon route turned. Canada, with the second-largest land area on the planet, started moving toward industrial-scale farms. Venture capitalists provided plenty of money to buy cheap acreage and build massive greenhouses.

The cottage entrepreneur can survive the competition, but for now, giants like Aurora Cannabis Inc. (NYSE:ACB) have the upper hand. They’re growing as fast as the venture capitalists can hand them cash.

Aurora, in particular, can drop a 30-acre facility anywhere on the planet to boost production and squeeze local rivals. And we don’t hear so much about cottage growers anymore.

We also haven’t traded SMG lately. Hydroponic sales are declining, and the balance sheet stretched to chase a business that has peaked for the time being. It’s going to need to pivot to industrial sales or come up with a different strategy to remain relevant in a Big Cannabis world.

But this was a key stock once. It made my subscribers money. The world keeps changing. Investors who want a good position at the finish line need to change with it.

We’re adding the most relevant cannabis stocks of today to the Marijuana Millionaire Portfolio in Turbo Trader week by week. Success is always a moving target.

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