Semiconductors: A Wide-Reaching, Cyclical Industry with Secular Markets

What are Semiconductors?

Many stay-at-home trends have fallen out of favor with consumers and investors, alike. One can point to Peloton (PTON) or Robinhood (HOOD), or even Netflix (NFLX) as examples of businesses struggling to recapture the robust growth they experienced during the pandemic. A bit ironically, it’s not the popular pandemic-driven trends that have begun to show long-term secular momentum, but rather solutions to the pervasive challenges that opened up across global supply chains and created such turmoil for companies.

The global economy had never experienced an event like the coronavirus pandemic. A decade-plus of heavy supply chain offshoring and corporate cost-saving measures was stressed by COVID infections, COVID lockdowns and shifting demand trends. While a range of industries were impacted, many bottlenecks could be traced back to the supply chain surrounding a single electronics component, called a semiconductor.

A Google search for “semiconductor” can make one’s eyes gloss over the different elements and technical properties it entails, but the basis is that everything which includes electronics contains semiconductors, and increasingly more of them. Key trends like autonomous vehicles, internet of things (IoT) and 5G are driving the exponential demand trends.

Not all semiconductor companies are created equal; different companies serve different parts of the supply chain and a diversified customer set. Semiconductors are classified into a small number of categories, including microprocessors (brains of an electronic device) and memory chips (information storage). The semiconductor supply chain consists of mining companies which extract the raw materials, equipment producers that sell chipmaking equipment and integrated device manufacturers that design, manufacture and sell chips. There are also foundries and fabless companies – fabless companies contract with foundries to produce and supply their chips, which the fabless company designs.

While broad demand appears secular, shifting demand trends have created some headwinds in the ability for companies to keep up with elevated expectations.

Cyclical Exposure and Near-Term Demand Slowdown

The VanEck Semiconductor ETF (SMH) is down -20.62% year-to-date, compared to the S&P 500 -8.98%. The geopolitical risk for semiconductors is substantial. Taiwan controls near 66% of global chipmaking market share, while South Korea controls the next largest share 18%. For the most advanced semis, Taiwan accounts for 92% of production.

The Asian economy is very dependent on technology exports. A shift from outsized demand to outsized supply could mark an end to the decade-long bull market in semiconductors. Global bit growth and Asian exports, according to Bloomberg, are historically correlated with the global economy – signs are beginning to show that elevated inventories are having rapid effects on industry sales growth and profits.

Global Bit Growth¹

Weaker demand than supply undermines outlook for chipmakers

Intel (INTC) missed earnings expectations and cited “the sudden and rapid decline in economic activity” that led to -22% y/y sales in Q2, largely due to lower PC and smartphone demand. Advanced Micro Devices (AMD) also lowered their forward guidance due to the PC demand slowdown, but their data center segment grew +83% y/y. Nvidia (NVDA) blamed their earnings shortfall on weaker-than-forecast gaming revenues, down -33% y/y. And lastly, Micron’s (MU) CEO warned “we see further weakening in demand because of adjustments broadening outside of just consumers to other parts of the market, including data centers, industrials and automotive.” Net net, certain end markets remain under pressure, like PCs and gaming (big stay at home beneficiaries). While MU also called out data centers, industrials and automotive slowdown, the relative strength remains. 

Despite the near-term slowdown, triggered by shifting demand trends, inflation and Fed tightening, semiconductor companies are staying committed to long-term expansion plans. These expansion plans are supported by still tight capacity, a large total addressable market and U.S. government investment. At some point in the longer-term future the expansion plans, along with an economic slowdown, will certainly lead to higher supply trends and, likely, lower prices. 

The CHIPS Act Beneficiaries are Broader than just the Semiconductor Producers

The U.S. CHIPS and Science Act, signed by the White House last week, provides a total $52 billion for U.S. companies producing semiconductors and 25% in tax credits for investments. Like most fiscal policy windfall investments, this bill could wind up funding company excesses. However, the basis is to encourage capital spending on new U.S. plants and equipment – Micron, AMD and Intel are a few names that have committed to growing U.S. capacity as a result of the bill’s passage. Additional U.S. capacity supports U.S. jobs, U.S. national security, and a broad number of customers that can more efficiently access chips in the U.S. and build a U.S. supply chain around the semiconductor plants.

This week, China announced rationing of power supplies that would impact semiconductor manufacturing facilities’ ability to operate. This further emphasizes the U.S. motivation for investing in domestic supply chain capacity.

These are multi-year expansion projects that will surpass any near-term macro headwinds and cross-pollinate benefits to a variety of industries. Increasing the U.S. capacity to fabricate semiconductors supports jobs, industrial production and reduces reliance on Asia. While companies are connected to semiconductors in varying degrees, semiconductors touch so many parts of the economy that securing greater capacity benefits long-term economic activity and national competition.

Semiconductor companies are viewed as a leading indicator of economic demand. As global economies continue to slow and supply chains ease, this will be a very important group to watch.

Stephanie Link: CNBC TV Schedule

Source

1. Bloomberg (chart)

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors. All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice. This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.