Regime Change

Arjun Balaji joined us to talk the most exciting developments in biotech, the US’s changing healthcare policies, and Australia’s secret one child policy

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We are now nearly two weeks post the election of Donald Trump.

In markets, it seems we are going through a regime change. These are the hardest periods as an investor, as they new regimes can last for a while. The previous regime ran from the beginning of 2023 to basically the election, the better part of two years.

The winning trades were big tech, semiconductors, healthcare, and some independent growth stocks.

However, most software and small and mid cap tech significantly underperformed, as well as the vast majority of stocks in major indices (the ‘narrow market’.)

We got part of this right and part of this wrong.

We were right on semiconductors and had some wins in growth, notably in healthcare. But at various times we owned software and fintech which didn’t perform.

Since June/July semiconductors peaked, and are now down 21%, and this would look a lot worse without Nvidia. A number of prior best performers have collapsed, notably Elf, Celsius, and Transmedics.

The election of Donald Trump has accelerated these moves and has added a few new winners and losers.

Elon Musk is perhaps the biggest individual beneficiary. As a detour from electric cars, catching spacecraft in flight, cofounding OpenAI, and experimenting with neural engineering, he had a real impact on the election, drive the Amish to vote at the polls.

They were upset by Government intrusion into their lifestyle over matters like unpasteurized milk.

Musk is now perhaps the second most powerful man in the world, the one who Trump invites on the phone with other world leaders.

Elon Musk’s companies are heavily reliant on government. Tesla benefits from green policies around the world, and SpaceX’s first customer was the US Government, though Starlink will eventually dwarf those contracts.

The Biden administration attacked him through the courts wherever possible, for example, suing for not hiring refugees and illegal immigrants at SpaceX, even though it is against the law to hire non-US citizens (even Australians, apparently).

Now the tables have turned, and Musk can be assured of Government support, and other business leaders are already treating him very differently too. 

At Twitter/X an advertiser boycott had a collapse in revenue, even as users and usage increased. Now executives at companies like Disney and IBM are re-engaging.

Tesla will also benefit from tariffs, as the cheapest competition is from China, which will be the main target of Trump’s trade policy.

Semiconductors

There are three issues with semiconductors. 

Firstly, other than other than Nvidia, Taiwan Semiconductor, and a handful of datacenter plays, the industry has disappointed. 

Revenue growth has been slow or negative, profits weak, and most companies had sold off substantially before Trump’s election. 

Smartphones and PCs are still in a slump and seem unlikely to return to an annual upgrade cycle.

The industry hopes AI features will encourage consumers to splash out.

This would also shift the burden of inference away from datacenters and onto consumers and their own devices, but I don’t think consumers care. 

Secondly, from an investment perspective, semis were just too red hot and overdue for a reset - a reminder of why they have been one of the most successful sectors in our lifetimes, but also the most cyclical.

Thirdly, many are heavily reliant on the revenues from China, like ASML, and these will be under US attack. Semiconductors manufactured outside the United State may have new tariffs, which will encourage manufacturing to return to the US, but will also reduce industry profitability. 

Thirdly, there is a question mark over the path of capex.

The hundreds of billions of semiconductor capex is being decided by a small number of tech CEOs like Sundar Pichai and Satya Nadella, as well as founders like Elon Musk and Mark Zuckerberg.

If all semiconductor spending is downstream of these decision makers, they themselves are downstream of their own research labs.

There are early reports that the latest investments have not led to incremental improvements in language models. We may have reached a local peak, perhaps now that models have been trained on all available books and the web. Perhaps the next improvement will come from an algorithmic breakthrough, rather than the application of more and more power.

Applying more compute at inference is improving results and the user experience, but if training reaches an asymptote, spending is going to be materially lower than it would be otherwise.

This is an empirical thing, we’ll just have to find out.  

Which puts the tech leaders in a tight spot as they make the call on whether to build 10x larger clusters. If just one continues to invest - and it pays off - this would be a mortal threat to the others. Noone can risk being a generation behind in the latest computer modality.

Finally time for SMID cap growth?

A major winner of the new regime is small cap tech. This used to be our primary hunting ground but has been heavy going for the last few years. This sector that lost most of its value in the crash of 2022, and many of those leaders are still down over 70% (Square and Sea Ltd come to mind). 

These companies have slowed from the hypergrowth of the lockdown era, but still have billions or tens of billions of dollars of revenue, which offers plenty of value for a strategic or cost-focused financial buyer.

In the United States, acquisitions by big tech were blocked by Lina Khan, which along with a closed IPO market, locked the major exit routes. Trump’s appointee will be less radical. 

Reopening these companies to M&A would unlock a huge amount of liquidity for both public market investors and the VC funds that hold vast portfolios of private companies with similar profiles. 

And at some point, the IPO market may even reopen.

Big tech is less exciting. Valuations are rich and the Republicans have no love for firms that vote almost entirely democrat and systematically censored and deplatformed them. It wasn’t so long ago that Trump was banned from Twitter, Facebook and YouTube.

Healthcare

There is a lot of anger in the incoming administration towards the medical establishment, which made substantial errors of judgement during the COVID period, and silenced and censored scientists at Harvard, Stanford and Oxford who ended up on the right side of history.

There is a certain amount of Stolen Valor when it comes to science, with bureaucrats stealing hard won scientific credibility to make political decisions around, for example, who is allowed to leave their house. 

The core of science is subjecting ideas to the harshest possible criticism to get closer to the truth, not censoring critics. When you’re right, there’s no need... But let’s return to topic.

The FDA will be reformed by the new administration, and it’s certain they will try to cut medical spending. Drug pricing is a political issue for everyone, and is misunderstood by voters and politicians.

How radical will the new administration actually be? We don’t know, but investors are right to be cautious. 

There may be some good. My personal hope is that advertising is banned, as these costs are shared by everyone without improving health outcomes. And perhaps patients will be given more choice around experimental treatments. In an ideal world, timelines would be reduced, but that may be hoping for too much.

Summary

So with a new range of winners and losers, I’m focusing my attention on new small cap growth opportunities, which are likely to be different to those that worked the last two years. 

We still have a large positions in semiconductors, but will manage this risk carefully and systematically. This could change in the near future. 

The future path of the heavily regulated healthcare industry is unclear, but changes are unlikely to be so radical as to change outcomes at the stock level. Performance will still mostly be driven by the outcomes of clinical programs rather than politics. But something to watch.

Since the election Australia has traded relatively independently of the United States, which is perhaps not too surprising given the root cause is a political changing atmosphere in the United States, though the AUD sold off.

US yield have risen substantially, and if inflation picks up rate cuts both here and overseas will be off the table.

However, the good news is that for the first time in a number of years, after a multi-year bear market, small and midcap tech may once again be one of the very best places to invest. 

Michael