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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Sunday, June 27, 2021

Long Netherland Semiconductor Stocks v/s Short Netherlands - 25 Index

by Century Financial in Investment Insights

Long Netherland Semiconductor Stocks v/s Short...
Long Netherland Semiconductor Stocks v/s Short Netherlands – 25 Index

*Trading in financial markets carries risk and can result in loss of capital
*This performance is only observed with historical backtests and not traded by the company

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The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.

Risks & Assumptions
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The flyer is based on thematic investment theme currently present in the markets i.e. semiconductor shortage. The past performance of the 3 mentioned Netherlands stocks has hugely overshadowed the performance of the broader Netherlands stock index primarily based on this theme.
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Going ahead, should the market dynamics for semiconductor change, these stocks may diverge from their past observed historical performance & the index may outperform these stocks.
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Trading pairs is not a risk-free strategy. The diculty comes when prices of the two securities begin to drift apart, i.e., the spread begins to trend instead of reverting to the original mean. Dealing with such adverse situations requires strict risk management rules, which require the trader to exit an unprofitable trade as soon as the original setup has been invalidated.
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The amount /figures indicating returns do not include applicable transactions and holdings costs which may be incurred by the investor.
Rationale

Major end users of semiconductor industry are facing a dicult time in handling the current crisis facing the industry. Carmakers have slashed their production; PlayStations are getting harder to find in stores & even the core internet broadband providers are facing long delays for internet routers. The main component required in these sectors is often referred to as integrated circuits which is the tiniest part mounted on any motherboard or chip board. Some of the major reasons for the current industry crisis include – abnormal chip demand on back of WFH theme boom, stockpiling by major PC makers from as early as 2020 start even before the pandemic started & draught suered by Taiwan causing water shortage at its key processing plants.

Just this year alone, the shortage is expected to wipe out $ 61 billion from the carmakers sales with major chip makers including Samsung & TSMC warning about serious imbalances in the system.

How long will the current semiconductor shortage last?

An industry report by Gartner expects the current industry crisis to last till at least mid of next year i.e., June 2022. This is based on active stockpiling by major Chinese 5G smartphone maker Huawei as well as huge backlog of requirements from other industries including wireless device makers, aerospace, military, automotive, etc. Some of these industries operate in Just in Time environment like the automobile sector. Consequently, the overall lead time is expected to normalize over the course of next year.

How does the long Netherlands semiconductor stocks v/s short AEX – 25 index fit into this picture?

As seen from the chart, Netherlands -25 index was largely rangebound between Oct’2016 to April’2020 period post which the index fell on account of pandemic related downfall.

AEX 25 Index ( Duration : 2016 to YTD | Source : Bloomberg) AEX 25 Index ( Duration : 2016 to YTD | Source : Bloomberg)

AEX 25 index v/s 3 Netherlands Semiconductor stocks (Duration : 2016 to YTD | Source : Bloomberg) AEX 25 index v/s 3 Netherlands Semiconductor stocks (Duration : 2016 to YTD | Source : Bloomberg)

Macro View on ASML Holdings, BE Semiconductor Industries & ASM International

ASML Holding is in the Semiconductor Equipment Wafer Fabrication Industry with the company reporting EPS growth of 40.6% last year. The current year EPS estimate are topping above 56% range. The stock has become one of the top investor plays for riding the current semiconductor shortage wave. Key customers such as Intel and Taiwan Semiconductor Manufacturing are boosting capacity, fueling demand for ASML's gear. ASML has scored double-digit sales and profit growth the past four quarters. The Dutch company easily beat views with Q1 earnings that soared 264% on account of 90% jump in sales. The steeper than expected recovery in demand for semiconductors, amplified by the Covid-induced lower investments of the industry in 2020, has created significant upside to the semiconductor demand shortage.

BE Semiconductor announced last month of its plans to boost its operations in USA & Taiwan as majority of its top customers look to ramp up investments for further inventory buildup in this sector. Similarly, Q 1 earnings for ASM International showed strong growth outlook for the year ahead with increases seen in growth as well as the gross profit margin estimates. The company’s normalized net earnings for Q1-2021 was Euros 125 million, 43 million Euros higher than previous Q4-2020 estimates.

Historical Performance of AEX Index, ASML Holdings, BE Semiconductor Industries & ASM International

Historical Annual Returns

AEX Index ASML Holdings BE Semiconductor Industries ASM International
Current Weightage in the Index as per the market cap basis 21.21% 0.50% 1.20%
2016 10.6% 31.9% 72.7% 18.8%
2017 13.2% 36.9% 120.6% 32.4%
2018 -10.5% -5.4% -47.4% -35.9%
2019 26.0% 94.5% 88.4% 176.7%
2020 2.7% 50.0% 42.8% 78.0%
2021'YTD 14.4% 40.0% 46.4% 47.6%
Cumulative Yearly Returns 56% 248% 323% 318%
Average Yearly Returns 10% 46% 60% 59%

Historical Performance from 01/01/2020 to 02/06/2021

AEX Index ASML Holdings BE Semiconductor Industries ASM International Average of 3 Stocks
Cumulative Daily returns 1.63% 17.19% 6.68% 24.04%
Historical Average Return/Trade 0.0044% 0.0464% 0.0180% 0.0650%
Absolute Price Returns from 01/01/2020 to 02/06/2021 ( Holding Long positions over this period) 18.24% 109.47% 160.44% 103.51% 124.47%
Strategy Trade

For example, the strategy would involve going long on the 3 semiconductor stocks with combined investment exposure of € 100K while at the same time going short on AEX – 25 index with € 100K exposure. Accordingly, the investment amount allocated to each stock would be € 33,333K.

Based on the below observed historical performance, the pair would have probably given Net P & L of € 106,233.33 since January’2020 start till date i.e., 106.23% return.

Historical P & L Performance on Pair : Long ASML,BE Semiconductor & ASM International v/s Short AEX Index

Investment Exposure Per Stock € 33.33K
Index € 100,000
Long 3 Stocks P & L Short AEX Index P & L Net Pair P & L
€ 124,473.33 € (18,240.00) € 106,233.33
Risks and Assumptions for Back-tested trading strategies
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The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
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The strategy might suffer from look-ahead bias which occurs due to the use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
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The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data & Prices as of: 02/06/2021 (European Market Close)

Arun Leslie John
Chief Market Analyst

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