Shane Obata, portfolio manager at Middlefield Capital

FOCUS: Global and technology stocks

MARKET OUTLOOK:

One of our highest conviction investment themes entering 2024 was that high-quality stocks would continue to outperform, given a still challenging interest rate backdrop. That is exactly what has transpired thus far, as evidenced by the Nasdaq 100 returning more than nine per cent year-to-date and Goldman’s non-profitable tech basket dropping 13 per cent as of the end of the first quarter of 2024. While we are expecting upside risk to lower quality names when the U.S. Federal Reserve starts cutting rates, we continue to believe that outperformance could prove transitory and that this is largely a “big get bigger” market.

The key takeaway from the fourth-quarter earnings season was the broadening out of the AI theme. While we continue to have high confidence in early leaders, such as Microsoft and Nvidia, we have been pleased to see tangible benefits from other AI beneficiaries such as Salesforce and Dell. The more companies that show momentum in AI, the more durable the theme will become. Another important development has been the emergence of early indications that AI is paying off for adopters. One great example was from Klarna, the European payments company, which noted that its AI assistant – powered by OpenAI – is handling two thirds of the company’s customer service chats and resolving problems in just two minutes, compared to 11 minutes previously. It will be very important to see more evidence of returns on investment to support the massive amount of spending that is currently going into AI.

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TOP PICKS:

Alphabet (GOOGL NASD)

Alphabet has been a significant laggard relative to Magnificent Seven peers and especially AI leaders year-to-date and over the past six months. While we believe this is partially justified given the lacklustre Gemini launch, we continue to believe that investors are significantly underestimating the company’s AI capabilities. Google has all of the right requirements to lead the world in AI. They just need to get their act together and we think they will, because the stakes are simply too high to lose the AI arms race.

Even in our bear case, Google is undervalued at current prices. If the company fully matures and becomes a “consumer staple” then it should trade at a mid-20s multiple vs around 21x at present.

Micron (MU NASD)

Micron is set to benefit from a revival in the memory industry, after a long and drawn-out post-COVID-19 hangover. The company’s profitability is inflecting higher after a sustained period of weakness that saw the company endure negative EPS revisions for 17 consecutive months. Actions around supply discipline from the major players, such as MU have rightsized inventories, are allowing for renewed price increases. This combined with the incredible demand for high-bandwidth memory should allow for continued margin expansion for quarters to come. As noted by the CEO, Micron is sold out of HBM capacity for all of fiscal 2024 and the majority of 2025.

Micron is in the early stages of an EPS upcycle. Given this and supported by excess demand for HBM, we do not think the stock is expensive at current levels.

Taiwan Semiconductor Manufacturing (TSM NYSE)

Taiwan Semiconductor Manufacturing is the world’s most important semiconductor foundry, manufacturing chips for a wide array of industries and companies, such as Nvidia. Like many other diversified semiconductor companies, TSM has been enduring weakness in select end markets, such as smartphones. Even so, there are bright spots in other parts of their business, mainly in AI-related applications. This division is expected to grow at nearly 30 per cent for 2024. We still believe that we are early in the AI investment cycle. As such, there is upside to TSM estimates, especially if and when the handset market recovers.

TSM trades at a significant discount to other AI plays, such as NVDA. We foresee better-than-expected EPS growth and multiple expansions as we move through 2024.