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Home Companies Large-Cap

Navigating the Volatility: The Resilience of U.S. Semiconductor Stocks

byLiliana Vida
July 18, 2024
in Large-Cap, Mid-Cap, Semiconductors, Small-Cap
Reading Time: 4 mins read
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Understanding Market Dynamics and Strategic Investment Picks in the Face of Geopolitical Uncertainty

The semiconductor industry has long been a cornerstone of technological advancement, powering everything from smartphones to advanced AI systems. However, recent geopolitical tensions have introduced significant volatility into the market, as evidenced by a recent 5% correction in the Philadelphia Semiconductor Index (SOX). Despite this, historical trends and strategic investment opportunities suggest that the sector remains robust and poised for recovery.

Geopolitical Turbulence and Market Response

Recent geopolitical developments, particularly concerning China and Taiwan, have played a pivotal role in the recent market downturn. The imposition of equipment restrictions on China and the increasing possibility of conflict in Taiwan have collectively contributed to a 6.8% drop in the SOX, markedly outpacing the broader market’s decline of 1.4%. This drop is notable but not unprecedented; it marks the 26th instance of a 5% or greater decline in the SOX over the past decade. Historically, the index has demonstrated resilience, rebounding by an average of 19% and 28% over the subsequent three and six months, respectively. This pattern suggests that while volatility is a concern, it is not necessarily a long-term detriment to the sector.

Market Rotation and Fundamentals

The current market rotation away from semiconductors and technology stocks towards value and small-cap stocks appears to be more driven by short-term positioning rather than fundamental changes. The semiconductor sector, particularly in areas like artificial intelligence (AI), remains a stronghold of capital expenditure. Leading companies such as Nvidia (NVDA), Broadcom (AVGO), and Advanced Micro Devices (AMD) are backed by robust balance sheets and proven revenue models. Conversations with industry leaders, such as AVGO’s management, indicate a multi-year investment horizon among top U.S. cloud providers, underscoring the sustained demand for cutting-edge semiconductor technologies.

Conversely, other sectors within the global economy are experiencing slower growth. Inflation, ongoing global conflicts, and post-pandemic adjustments have dampened consumer and enterprise demand across various segments, including PCs, smartphones, telecommunications, and industrial applications. This dichotomy highlights the sector-specific nature of current market dynamics and suggests that the rotation away from semiconductors may be short-lived and not reflective of underlying strengths.

The Indispensable Role of Taiwan

Taiwan’s role in the global semiconductor supply chain cannot be overstated. Despite the geopolitical risks, there is no viable substitute for the advanced foundries and comprehensive ecosystem present in Taiwan for at least the next five years. Companies like Intel (INTC), Texas Instruments (TXN), and GlobalFoundries (GFS) may have seen relative outperformance recently, but they remain deeply intertwined with Taiwan’s semiconductor landscape. Any assumption that these companies can fully insulate themselves from Taiwan-related risks is likely short-sighted.

Strategic Investment Picks

In light of the current volatility, focusing on companies with strong fundamentals and high profitability is essential. For computing and AI, Nvidia (NVDA), Broadcom (AVGO), and Arm Holdings (ARM) stand out. KLA Corporation (KLAC) remains a top pick in semiconductor capital equipment, while NXP Semiconductors (NXPI) and Analog Devices (ADI) offer solid prospects in the automotive and industrial semiconductor sectors. For investors looking at attractive valuations, ON Semiconductor (ON) and Micron Technology (MU) present compelling opportunities with their ~15x CY25 price-to-earnings ratios. Additionally, small-cap companies like Camtek Ltd. (CAMT) and Nova Measuring Instruments Ltd. (NVMI) offer quality exposure to the increasing complexity of chip design and assembly.

SOX vs. SPX: A Comparative Analysis

The recent 5%+ decline in the SOX is significant, but it’s worth noting that such movements have historically been followed by substantial rebounds. On average, the SOX has outperformed the S&P 500 (SPX) in the periods following these declines, with the SOX rising by 28% over six months compared to the SPX’s 16%. This performance underscores the resilience and growth potential of the semiconductor sector, even in the face of short-term disruptions.

China: A Complex Landscape

The U.S. government’s restrictions on semiconductor equipment exports to China have created a complex landscape for the industry. Despite these challenges, reports indicate ongoing high-tech production within China, driven by companies like Huawei and SMIC. The U.S. may tighten restrictions further, particularly targeting non-U.S. firms like ASML and Tokyo Electron. While these measures could impact global chip manufacturing activity, they also highlight the sector’s adaptability and the potential for reshoring and increased domestic investment in the U.S.

Long-Term Outlook: Semiconductor Cycle Analysis

The semiconductor industry is currently in the third quarter of what is typically a ten-quarter upturn cycle. Past downcycles have shown increasing trough levels and longer periods of negative growth, but they have also been followed by extended periods of robust year-over-year growth. According to the Semiconductor Industry Association (SIA), the current upturn is expected to continue through mid-2026, driven by sustained demand across various technological sectors.

The semiconductor industry faces significant volatility due to geopolitical uncertainties, but its fundamental strengths and historical resilience offer a compelling case for strategic investment. By focusing on high-quality companies with robust profitability and capitalizing on attractive valuations, investors can navigate the current turbulence and position themselves for long-term gains. The sector’s critical role in global technology ensures that it remains a vital component of the broader market, capable of weathering short-term challenges and emerging stronger.

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