The Monday Report

Welcome back.

As the global trade landscape continues to evolve, one of the most significant and contentious issues at play is the ongoing tariff wars. Among the industries facing substantial risks, the semiconductor sector—comprising companies integral to the production of microchips—is particularly vulnerable. In this issue, we examine how the shifting dynamics of tariffs are expected to affect chip investors and why caution is warranted.

The Landscape of Tariff Wars

In recent years, geopolitical tensions, especially between major players like the United States and China, have escalated into trade disputes that have seen tariffs imposed on a range of goods, including semiconductors and their key components. These tariffs are designed to penalize countries for trade imbalances and perceived unfair practices. However, the consequences extend far beyond the immediate effects on national economies, particularly affecting industries reliant on international supply chains—such as the semiconductor industry.

The Impact on Semiconductor Companies

Semiconductor manufacturing is a global endeavor, with companies sourcing materials, assembling products, and selling to markets worldwide. Tariffs imposed on microchips and raw materials disrupt these processes, leading to:

• Increased Production Costs: The imposition of tariffs raises the cost of imported goods and raw materials. This, in turn, can squeeze profit margins for semiconductor companies, especially those operating in a competitive market where price sensitivity is high.
• Supply Chain Disruptions: Tariffs often lead to delays in production and shipping, as companies adapt to new regulations. Disruptions in the supply chain can result in a shortage of key components, creating ripple effects throughout industries reliant on chips, such as automotive, consumer electronics, and telecommunications.
• Reduced Profitability: With production costs rising and supply chains becoming less efficient, semiconductor firms may see reduced profitability. Investors who are heavily reliant on short-term gains could be hit hard by these changes.

Effects on Chip Investors

For investors, the semiconductor sector presents an attractive opportunity due to the increasing demand for chips in emerging technologies like AI, 5G, and autonomous vehicles. However, the tariff wars introduce a level of unpredictability. Here’s why:

• Volatility in Stock Prices: Tariffs can cause fluctuations in the stock prices of chip companies, particularly those with a heavy exposure to affected markets. Investors may witness heightened volatility, making the sector riskier for those seeking stability.
• Uncertainty in Long-term Growth: While the long-term growth potential of the semiconductor industry remains promising, tariff wars threaten to undermine this trajectory. Investors must account for the risk that political instability may slow global expansion efforts.
• Shift in Investment Strategies: Given the risk of tariff-induced disruption, many investors are shifting towards a more diversified portfolio. By balancing semiconductor investments with other sectors, they can hedge against the impacts of tariff wars on individual chip companies.

What’s Next for Chip Investors?

As trade relations continue to fluctuate, chip investors must stay vigilant and consider strategies that minimize risk. Key steps include:

• Monitoring Trade Developments: Staying informed about ongoing trade negotiations is crucial. Any change in tariff rates or the imposition of new restrictions can significantly affect semiconductor companies’ operations and profitability.
• Diversification: Spreading investments across different sectors, rather than relying solely on the semiconductor industry, can offer a safety net in case of ongoing tariff challenges.

Seeking Opportunities in Emerging Markets: While tariff wars may hurt short-term profitability, long-term growth opportunities can still be found in emerging markets. Investors should consider companies adapting to new global dynamics, including those with a strong presence in regions less impacted by tariffs.

Conclusion

The ongoing tariff wars present substantial risks for chip investors. Increased production costs, supply chain disruptions, and volatility in stock prices may undermine the potential for short-term gains. However, by staying informed, diversifying investments, and being strategic about emerging markets, investors can better navigate these uncertain waters.

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PORTFOLIO UPDATE:

Industrials (XLI) March 2025 $145 Puts

In a December 5th alert, it was discussed the potential impact of trade dynamics on the industrial sector. Based on insider perspectives, a recommendation was made to puts on the Industrial Select Sector SPDR Fund (NYSE: XLI).

Insights from machinery, aerospace, and transportation stocks suggest that forward earnings are more likely to decline rather than rise, particularly given the current fiscal outlook that was under President Joe Biden’s administration.

Despite revenue growth forecasts for the industrial sector showing a 1% contraction in 2024, analysts remain overly optimistic for 2025. The combination of a weakening global economy, ongoing challenges with Chinese product dumping, and a strengthening U.S. Dollar Index creates a bearish environment for XLI.

Recommendation: Hold the XLI March 21, 2025 $145 put option.

Materials (XLB) March 2025 $97 Puts

On November 7th, it was recommended for puts on the Materials Select Sector SPDR Fund (NYSE: XLB). With materials, including chemicals and steel, historically suffering during recessions, insiders point to a clear risk of price and volume declines.

China’s steel overcapacity, particularly in light of slowing construction, suggests further steel dumping onto international markets. Additionally, chemicals, particularly those used in plastics, are seeing oversupply, adding further pressure to the sector.

Recommendation: Hold the XLB March 21, 2025 $97 put option.

Consumer Staples (XLP) March 2025 $83 Puts

On October 3rd recommended puts on the Consumer Staples Select Sector SPDR Fund (NYSE: XLP). The recent surge in XLP, driven by investor demand for defensive assets, seems misguided based on the latest insights. Many companies are reporting pressures from middle-income consumers, who are increasingly looking for value and making trade-offs in their purchasing decisions.

This behavior threatens the pricing power and profit margins of consumer staples companies, which have depended on price hikes for growth. Moreover, a hot economic recovery could push Treasury yields higher, making XLP’s current low dividend yield less attractive. A continued recession-like environment would similarly squeeze profit margins.

Recommendation: Hold the XLP March 21, 2025 $83 put option.

Consumer Discretionary (XLY) January 2025 $185 Puts

On September 5th, it was suggested puts on the Consumer Discretionary Select Sector SPDR Fund (NYSE: XLY). As reported by insiders, much of the portfolio is concentrated in Amazon and Tesla, two companies with significant exposure to global supply chains and discretionary spending.

Amazon’s overexpansion in its fulfillment operations, paired with the risks of an oversupplied data center market for AWS, suggests possible challenges ahead. Similarly, Tesla’s overhyped prospects for becoming a robotics and AI leader are driving its stock price to unsustainable levels. Despite its challenges, Tesla continues to attract speculative interest, driven by external factors such as Elon Musk’s support for President Trump.

With disappointing retail sales and potential hurdles from tariffs, the consumer discretionary space remains highly vulnerable.

Recommendation: Hold the XLY January 17, 2025 $185 put option

Disclaimer:

The information provided in this material is deemed reliable; however, we do not guarantee its accuracy or completeness. The opinions, estimates, investment strategies, and views expressed herein reflect our judgment based on prevailing market conditions and are subject to change without prior notice. These perspectives and strategies represent the author’s assessment based on current market conditions and may be revised without notice. You should carefully evaluate your personal needs and objectives prior to making any decisions. For further guidance on how this information may apply to your specific situation, it is recommended that you consult with your advisor.