Chip squeeze tests sector’s resilience
If you’ve been in the market for a new car, smartphone, or home appliance this year, you may know firsthand how the global chip shortage is wreaking havoc on supply chains.
Our reliance on semiconductors has never been more apparent: The supply crunch has shuttered auto factories, hindered electronics manufacturing, and threatened to push up consumer prices across the board.
As the world emerges from the pandemic with a voracious appetite for chips, demand is outweighing supply, presenting some interesting considerations for investors eyeing the semi space.
The digitalization of the economy was well established before the pandemic, but with the world-wide shift to working, learning, and consuming from home, the technology that makes it all possible became that much more critical. Demand for chips that power laptops, tablets, gaming devices, smartphones, and the cloud surged during the pandemic, and manufacturers struggled to keep pace. The problem became more acute as the global economy reopened and previously dormant industries sprang back to life—as did their need for semiconductors.
For example, automakers paused production at the onset of the pandemic, which bumped them to the back of the fulfillment line. Accordingly, the chip shortage has hit the auto industry especially hard, and car makers have once again had to temporarily idle factories and curb production.
Unfortunately, there are no quick fixes. Only a handful of companies actually manufacture physical chips—most “chip makers” are really chip “designers” who farm out the physical production to other firms. Two companies alone are responsible for manufacturing more than two-thirds of the world’s chips.1
Switching existing production lines from making one type of chip to another isn’t easy because of differences in equipment. Chip makers can only increase existing capacity incrementally, and it typically takes at least two years—not to mention billions of dollars—to get a semiconductor plant (called a “fab”) up and running. Also, even after a fab is built, a chip can take months to make, depending on how advanced it is.2
Semi stocks at a glance
When your product is in demand and supply is tight, prices tend to rise—including your stock price. That was the case for many chip stocks at the start of this year, when the effects of the semiconductor shortage were really becoming apparent. The PHLX Semiconductor Index℠ (SOX℠), which tracks the performance of chip-related companies, outperformed the S&P 500® (SPX) as well as the tech-heavy Nasdaq Composite (COMP) in the first quarter of 2021.
In fact, as the chart shows, the SOX has, with the exception of 2018, outperformed the major US indexes over the past five years, as advances in automation, smart devices, and artificial intelligence have picked up speed.
That said, the semiconductor sector also tends to be more volatile than the broad market. The SOX has retreated amid the larger rotation away from tech, and in recent weeks, for example, chip stocks have fallen more than either the S&P 500 or the Nasdaq Composite.
With demand remaining high and little additional capacity expected in the short term, the current shortage is likely to last through 2021. Longer term, though, some of the trends fueling this demand may be more permanent than others. Investors interested in the semiconductor space may want to consider a few themes:
- End-market demand: Cloud and computing chipmakers benefitted from the switch to remote work and learning in early 2020, while more cyclical semis, such as those tied to cars, outperformed in the second half. Over the next five years, Morgan Stanley’s Global Investment Office expects strong growth for automotive, industrial, and consumer chips.3
- Fab expansion: Some key players have committed significant investments to build out fabs, positioning themselves for increased manufacturing capacity in the future, and the potential to gain market share.
- Supply-side exposure: Regardless of where end-market demand picks up or cools off, one area of the industry that may continue to gain steam is semi suppliers. These companies provide the highly specialized tools, equipment, and chemical components needed to make chips and build fabs.
Unlike semiconductors, which are made in pristine, controlled environments, semi stocks aren’t immune to the twists and turns of the broader market. Investors should make sure that any decisions reflect their individual goals, timelines, and risk tolerance before putting any chips on the table.
- CNBC, “2 charts show how much the world depends on Taiwan for semiconductors,” 3/15/21, https://www.cnbc.com/2021/03/16/2-charts-show-how-much-the-world-depends-on-taiwan-for-semiconductors.html
- The Wall Street Journal, “Why the Chip Shortage Is So Hard to Overcome,” 4/19/21, https://www.wsj.com/articles/why-the-chip-shortage-is-so-hard-to-overcome-11618844905
- Morgan Stanley Wealth Management, “Semiconductor Outlook: Putting Our Chips on the Table,” 3/10/21
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