A trading opportunity built on 5G expansion

Day trader Michael Taylor is worried about inflation proving sticky but is still finding trading opportunities, including a telecoms testing specialist

October 13, 2021

by Michael Taylor

I don’t believe that inflation is transitory. Maybe I’m wrong. But an economy is a series of moving parts and transactions. Each transaction affects the other. Increased spending means more transactions and more economic growth. Decreased spending means fewer transactions and a shrinking of the economy – or recession.

Ever since the global financial crisis, quantitative easing has been used to increase spending and this has led to asset value increases. But there is now talk of tapering. This is a slowing in the rate at which a central bank would bring new assets onto its balance sheet under a quantitative easing policy.

Let’s assume this happens. There is less spending. The number of transactions shrink. The cost of capital goes up because the potential returns are decreased. Prices for services and products rise, inflation increases. This is all basic rationale so far. But now let’s consider the fact that supply chains have been skewered. Products and raw materials now have shortages and longer lead times. This leads to delays, decreased spending and decreased transactions. If households find their costs are going up or spending power decreasing, or both, then they’ll also contribute less to the economy. There is certainly lots to worry about.

Inflation risks

For the first time in my life, inflation is a very real prospect. Luckily, that doesn’t mean you can’t make money. What it does mean is that we may not have a rising tide that floats all boats, and some stocks will sink or even go bust. How many bang-average businesses were kept alive by furlough and other grants? At some point, the debt comes due.

My goal for the next quarter is to position myself in high-beta names that do not correlate with the market. I have no interest in the indices because they’re only bellwethers of what most stocks are doing and typically I hold positions in fewer than 20 stocks. The wider market is of little interest to me because most stocks are rubbish. Plus, the FTSE 100 is not getting hit as heavily as overvalued US tech because of its strong commodities weighting.

Another goal is to reduce my holdings to 10 stocks or fewer, which I am making progress on. Cash has been raised as stops have been hit with the capital not redeployed. This is because my trades are becoming ever more short-term on liquid stocks and so I’d like to have 10 names that I believe offer the best risk/reward in the market.

A telecoms testing opportunity

One stock that I have entered a position in is Calnex Solutions (CLX). It’s relatively new to the market (IPO October 2020) and it provides test and measurement hardware along with software solutions that check the standards and test the performance of telecommunications infrastructure. Basically, it tests networks. The 5G network is expected to be a key driver of growth for Calnex due to datacentre expansion along with bigger networks.

The company is renowned worldwide and has an advantage because it already dines at the table of big network operators such as Vodafone, Verizon, Nokia, Google, Facebook and more. These companies need the best in the business and so there is a risk that standards slip at Calnex leading to it being replaced, but so far Calnex has kept its customers happy and business is booming. This is evidenced by the fact that the top 10 customers in terms of revenue have on average a nine-year relationship with Calnex.

The business is profitable and cash-generative, nd has a relatively fixed cost base. This means it benefits from operational gearing because as more kits are sold, the percentage of profit rises. Looking at Chart 1, we can see that the stock came storming out of the blocks after a few weeks, more than doubling in the space of two months. All-time highs are excellent because everyone is in profit and there are no desperate sellers.

But big moves can mean extended periods of sideways trading. This is because the stock needs to cool off after a sustained move. No 400m sprinter can keep up that pace forever; they need to recover. This is no different after explosive bursts in stocks.

Moving down to Chart 2, we can see how the stock has performed since.

I’ve marked three arrows on the chart. The first was in February this year when the company announced it was trading ahead of expectations. We saw heavy volume in the stock, along with a gap up and a sell-off. This told me that some shareholders were using the volume as an opportunity to exit or take some profit off the table. We can see since that period there wasn’t sufficient buying power to take the stock to further highs and instead for the rest of the year it drifted lower. The bottom two arrows show the 200-day exponential moving average (pink line) being tested. Both times the stock rallied, confirming this is support for the trend.

In recent months we’ve seen the stock trend upwards and start to move towards the resistance line I’ve drawn on the chart at 130p.

I’ve entered half a position early before this resistance (I am long Calnex) because the company announced on Tuesday that earnings are running materially ahead of expectations – meaning the company’s revenue and profits will beat the consensus expected earnings.

My stop-loss for this position is around 90p – this means that it’s below the 200 EMA, meaning the trend will have been broken and also below the most recent lows. Remember, you can use my position size calculator on my website to calculate your risk on trades.

Should the stock break the 130p level I’ll scale this up to a full position. There is no guarantee of a breakout, but the chart is looking as thought it is strengthening so I’m happy to take the risk of entering early.