By K C Ma and Zachary Gunn
After significant upbeat quarterly earnings reports, many tech stocks, including Intel (NASDAQ: INTC), Advanced Micro Devices (NASDAQ: AMD), Nvidia (NASDAQ: NVDA), and Micron Technology (NASDAQ: MU) have failed to make meaningful breakouts. In fact, most of the tech stocks have traded at a significant discount from their newly raised target prices. A causal look further revealed that the discounts have been pervasive across many sectors. It is this pervasiveness that piqued our interest to look for the common thread which has driven the recent stock price movements.
Let’s first go over our thought process: We started with pinning our interest on one obvious group of market participants, institutional investors, who are known to be the most influential party in the market to affect stock prices. We wanted to see if their changes in stock ownership were related to the recent stock price movements on the stocks in question.
A Stock Effect?
In this regard, we collected the weekly institutional ownership for AMD, MU, Nvidia, and Intel from company’s 13f filings (Bloomberg). At this point, the actual timing of the institutional investment vs. the reporting of the investment positions requires some clarification. Since institutions are required to file their holdings within 45 days after the end of each calendar quarter, the investment positions obtained from a company’s 13F filings could easily lag the actual times of the trades by a maximum of 75 days before the end of the calendar quarter end. As a result, we assumed that the actual investment decision was made 38 days (mid-point) prior to the quarter end.
Keeping the timing difference in mind, the historical institutional ownership of these 4 companies are displayed in Figure 1. At the first glance, we were surprised by the similarities in institutional ownership changes over time among the four stocks. It appears that institutions decided to increase their investments simultaneously in Q1 and reduced the investments in Q2. The timing decisions cannot be more “coordinated” as if institutions have timed their decisions on the tech stocks almost perfectly. Simply because there are 4 different large-cap stocks involved and hundreds of the institutions hold the stocks, we immediately ruled out the possibility of manipulations. On the other hand, it does suggest that there is a common reason which drives the institutions to make very similar timing decisions on the tech stocks.
A Sector Effect?
The next likely reason for the common changes in institutional holding on these stocks is that it may have been a result of the institutional sector rotation strategy. Or, these stocks were affected by the same industry factors which led the institutions to make the same timing decisions. In order to see if the changes were a result of the changes in institutional tech sector allocation, we proceeded to examine the changes in institutional ownership for each of the 5 major sectors, Basic Materials, Industrial, Technology, Financials, and Utilities. We selected the largest 5 companies in each sector and computed the average institutional ownership each week for the same time period. The ownership history of the five major sectors is displayed in Figure 2. It is to our surprise that the sector institutional ownership followed virtually the same time path. More importantly, it appears that the US institutions increased their investments in all sectors in Q1, and decreased their holding in Q2. In other words, institutional ownership in the 4 tech stocks dropped not because institutional investors reduced their investments in tech sector, but they reduced their investments in all sectors.
Why Was There A Market Effect?
The above evidence naturally follows to a logical conclusion that there must have been some common market-wide reasons to drove all institutional investors to act the same fashion. Some clues for the common reasons can be identified by the common timing of the increases (Q1) and decreases (Q2) of the institutional ownership. Since these were the market factors which affect all sectors, we identified the passing of tax cuts in late November of 2017 as one of the reasons which motivated institutions to increase their investments for US-based companies. Similarly, since the Trump administration fired the first shot with the $25 billion tariffs around March 1st, the same US-based companies are potentially exposed to retaliation tariffs or a trade war. It is not surprising that the same institutions would have reduced their investment in order to reduce the trade risk.
U.S. Tax Cut Benefit and Trade War Risk
If the above argument seems plausible, the institutional money has to come from and go to some “counter party.” And if tax cut benefit and tariffs risk were behind the institutional investment decisions, the “counter party” may be companies which did not benefit from US tax cuts and will not be hurt by US or retaliation tariffs. If you buy our reasoning, the obvious “counter party” will be companies that are foreign-based and with a non-US business country where they generate their revenue from.
US-Based Companies and Foreign-Based Companies
To see if our “hypothesis” holds any water, we identified the five largest U.S. traded, foreign-based companies with a non-US business country in each of the five sectors we looked at before. Following the same procedure, we computed their historical institutional ownership over the same time period. In Figures 3-7, we compared the institutional holdings between US-based and foreign-based firms in each sector.
The results are striking! In all sectors, there is a remarkably clear pattern that institutions have increased their investments in the US-based stocks at the expense of the investment in foreign-based stocks, an obviously rational strategy to reap the US tax cut benefit. They have reversed the investments to avoid the trade related risk in Q2.
While the evidence may not be “irrefutable,” we have provided strong findings to support the following assertions:
- Institutional investors have raised their stakes in Intel, Nvidia, AMD, and MU early 2018 and subsequently reduced their holdings in early Q2.
- The same changes in institutional ownership are observed for all US sectors.
- There is an indication that the institutional investments have been rotated between foreign-based companies and US-based companies within the same sector.
- The rotation within the sector was motivated by reaping US tax cut benefit and reducing trade war risk.
Intended and Unintended Consequences
Finally, we can’t avoid being practical about our findings. If the intent of U.S. tax cuts were to create jobs at home and as a result institutions increased their investments in US-based firms, at the expense of their investments in foreign-based firms, then we seemed to be on the right track.
Similarly, if the intent of the newly imposed tariffs is to create jobs at home, and as a result institutions increased their investments in foreign-based firms, at the expense of their investments in US-based firms, we are clearly on the wrong track.
Disclosure: I am/we are long NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.