Market Pulse
Friday, September 6, 2024
Welcome to this week's Market Pulse, your 5-minute update on key market news and events, with takeaways and insights from the Sidekick Investment Team.
Our three stories this week:
1. Unlocking Value: Intel’s Turnaround Plan
2. Mind the Gap: UK Bond Spreads Rise
3. Threading the Needle: China’s Economics Risks
It’s important to note that the content of this Market Pulse is based on current public information which we consider to be reliable and accurate. It represents Sidekick’s view only and does not represent investment advice - investors should not take decisions to trade based on this information.
Last week, reports surfaced that Intel is putting together a comprehensive turnaround plan to address the company’s recent struggles. While details of the plan are still unconfirmed, the primary focus appears to be offloading non-core assets and slashing overall costs. CEO Pat Gelsinger is expected to present the plan to Intel’s board later this month.
The company has already announced a substantial cost reduction target that, combined with subsidies and partner contributions, could add around $40 billion of incremental cash to the company’s balance sheet through the end of 2025.
But the most obvious place to look for unlocking value is the company’s foundry division, which manufactures chips for both Intel and external customers. Intel’s dual role as both a chip designer and manufacturer is extremely costly and highly unusual for the industry. Most competitors focus on one role or the other, such as TSMC and GlobalFoundries in manufacturing or Nvidia and AMD in designing.
It’s no secret that Intel is already preparing to split the two divisions after the company began separately reporting the financial performance of its foundry division earlier this year. But while we think that the two divisions are worth more separately than together - for a variety of reasons, the most important being the conflict of interest with their potential foundry clients - we are less optimistic about the timing of such an important move.
Instead, the current turnaround plan likely involves selling smaller divisions. One possibility is spinning off Altera, a company that Intel acquired back in 2015. Altera specialises in FPGA chips, which have declined in importance relative to GPUs in recent years. Altera alone could fetch anywhere between $12 to $27 billion according to our analysis. Other options include cancelling Intel’s planned $30 billion manufacturing plant in Germany, a project already struck by repeated delays or selling down a stake in Mobileye that is currently worth close to $9 billion.
Last week’s news could be a positive first step in helping realise Intel’s full potential. As we have outlined previously, Intel’s low valuation relative to chip industry peers offers substantial upside if the company can engineer a turnaround.
Note: We hold Intel and Nvidia in our Flagship portfolio
In a sign of the diverging economic paths between the two countries, the ‘spread’ between interest rates on UK and US government bonds continues to grow. Last week, this gap rose to a one-year high of 0.18 percentage points, with UK rates above the US. While less severe, spreads have also been growing between the UK and European peers.
When it comes to financing public spending and supporting growth, higher rates are generally considered to be less advantageous. In this instance, though, the UK appears to be a victim of the country’s own unexpected success. After emerging from a shallow recession at the start of this year, the UK economy has proven far more resilient than anticipated, notching continued growth in 2024. With stronger growth comes less need for rate cuts.
At the same time, higher UK rates are also reflective of stubborn inflation, particularly in the services sector. In comparison, the US continues to receive good inflation news, with the Fed’s preferred measure falling to 2.5% in July. As a result, the BoE may not have a choice in keeping rates higher for longer relative to peers.
Considering the balance of risks in the UK right now, we see relatively higher rates as a mixed blessing. Although certain inflation categories remain elevated, price increases have moderated overall. The unemployment rate, meanwhile, has slowly ticked higher over the past year.
Higher rates give the BoE less room to manoeuvre in a resurgent inflation environment. Crucially, though, they also allow for more firepower to support the economy if labour markets begin to decline more significantly.
In the latest potential warning sign for the country’s economy, the People’s Bank of China (PBoC) made a substantial $56 billion purchase of Chinese government bonds last week. The move should give the central bank greater control to engineer the yield curve after repeated warnings about falling yields have been ignored by traders.
The PBoC’s concern over declining yields appears to be largely related to financial stability. China’s recent economic troubles, including a slow-moving property crisis and a stagnation in consumer spending, have led to increased purchases of government bonds among financial institutions. At least one Chinese economic official has stated that current low yields “show a tendency towards some degree of bubble”.
If this bubble were to pop and bond prices were to crash, yields would rise sharply. This could threaten the solvency of China’s banks in a similar mechanism to last year’s regional banking crisis in the US.
A decline in consumer spending and retail sales, however, also points to the need for lower rates to induce greater spending and less saving. With manufacturing data also showing some evidence of a chill, the PBoC will need to thread the needle between low rates to support economic growth and high rates to forestall financial instability.
For investors, China’s economic woes are a source of persistent uncertainty. Financial data from the country is hard to parse and frequently of questionable reliability. The global impacts of the world’s second-largest economy, however, are too large to ignore.
Both the U.S. and European economies remain tightly linked to China by trade, especially in terms of high-value electronics and energy supply chains. Moreover, fluctuations in Chinese demand frequently drive global commodity prices. As a result, the threat of financial instability or economic slowdown in the country is an underappreciated source of potential risk – especially in such an uncertain global economic environment.
Please remember, investing should be viewed as longer term. Your capital is at risk — the value of investments can go up and down, and you may get back less than you put in.
