When it comes to chipmaker Micron (NASDAQ:MU), the investment thesis on MU stock is exceedingly simple. You want to own Micron stock when the music is playing, and you want to avoid it when the music isn’t playing.

What exactly does that mean? The semiconductor industry, and especially Micron, are notoriously cyclical. They are driven by supply-demand economics which constantly fluctuate between eras of low supply and high demand, and eras of high supply and low demand.

The music is playing for Micron when supply is low and demand is high. We had that era for 2016-17 and through the early part of 2018. Demand was robust from growth markets like data-centers, artificial intelligence, and Internet-of-Things.

Meanwhile, supply was constrained because new demand required more complex chips, and those new complex chips weren’t being produced at scale yet. As such, the music was playing loud and clear. Micron’s revenues and margins roared higher, and Micron stock went from $10 in 2016 to $65 earlier this year.

But, around June of 2018, there were signs that the music slowing. Namely, next-gen chip supply was finally ramping to levels that were sufficient to offset demand, and demand was cooling due to lower corporate capex spend at the end of a decade long economic expansion.

Net result? Revenue growth at Micron is cooling. Margins are deteriorating. Profits are on the verge of peaking. And, MU stock has dropped 40% off its 2018 highs.

This sell-off isn’t over. The music still isn’t playing for Micron stock, nor does it project to start playing again any time soon. As such, MU stock will remain weaker for longer.

The Music Is Slowing

The situation at Micron always boils down to simple supply-demand fundamentals in the company’s core DRAM and NAND markets. When those supply-demand fundamentals are favorable and project to remain favorable, MU stock does well. When those supply-demand fundamentals are weak or project to be weak, Micron does poorly.

We are currently in an era where the supply-demand fundamentals are strong today, but project to get weaker over the next several quarters.

Due to higher interest rates and tariffs threatening global economic growth, companies around the world are cutting back on capex and reducing semiconductor spend. At the same time this demand is cooling, supply has expanded dramatically over the past year. As such, Micron’s core DRAM and NAND markets are presently characterized by falling demand and rising supply.

Those dynamics are typically unfavorable for Micron. They cause revenue growth to go negative, margins to compress, and earnings to wipe-out. The result is huge and sustained weakness in Micron stock.

Just look at the long term stock chart for Micron. You have big rallies (which are fueled by improving supply-demand dynamics), and you have big sell-offs (which are fueled by deteriorating supply-demand dynamics). Right now, we are in the midst of one of those big sell-offs.

But, compared to prior sell-offs, this one really isn’t all that bad. In 2015-16, Micron dropped more than 60% from peak to trough over the course of 12 months. In 2006-08, Micron stock lost more than 75% of its value over the course of 24 months. During the Dot Com crash, MU stock lost more than 80% of its value in about three years. Today’s sell-off is simply a 40% drop over five months.

That means one of two things. Either this time is different, or the sell-off isn’t over. I’m always hesitant to say this time is different. And, current fundamentals imply that the music will continue to slow for Micron over the next several months. So long as this music continues to slow, MU stock will remain weak.

Further Weakness Is Ahead

The bull thesis on MU stock rests on one big feature: valuation. Micron trades at just 3X trailing earnings. That is way too cheap, and so now is the time to buy, according to the bulls.

But, investors should ignore that argument. Valuation is meaningless here and now. Cyclical stocks like Micron tend to have attractive valuations at the peak, and huge valuations at the bottom.

That is the nature the cycle. When earnings are next to nothing and growing, valuations are big but fall as earnings grow. Meanwhile, when earnings are huge and dropping, valuations are small but rise as earnings fall.

So, let’s put aside the valuation argument for a second. What truly matters here and now is gross margins. This metric is the tell-all for whether or not the music is playing. Rising gross margins imply demand is outstripping supply, and that the music is playing. Falling gross margins imply supply is outstripping demand, and the music is slowing.

Right now, the outlook for gross margins is dour. At the midpoint, gross margins are expected to drop 300 basis points sequentially next quarter. About 75 basis points of that is tied to tariffs. The other 225 basis points is tied to lower chip prices due to rising supply and falling demand.

With rates going up and the tariff headwind seemingly only getting worse, the outlook for demand to bounce back over the next few months is unfavorable. Meanwhile, chip capacity has already been built out, so big and rising supply is here to stay. Thus, gross margins at Micron should drop for the foreseeable future, and as they do, MU will remain weak.

Bottom Line on Micron Stock

The music has stopped playing for MU stock, and that means it is time to stay away. Eventually, the music will come back. But, current economic trends imply that the music won’t start playing again any time soon.

Until it does, Micron stock isn’t a buy.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.