Tepid Demand Threatens Chip Stock Rally

A rally in semiconductor stocks over the past three months may be in danger of faltering as demand concerns have darkened the outlook for the industry.  Warnings of disappointing sales from bellwethers, such as Taiwan Manufacturing Co (TSM) and Samsung Electronics, threaten to derail the recovery. Also, the latest monthly sales data from the Semiconductor Industry Association came in below seasonal trends. 

The Philadelphia Stock Exchange Semiconductor Index ($SOX) has risen for five straight sessions through Thursday, the longest rally in 3 months.  The index is now up +29% from its 2-1/2 year low in October and has lifted stock valuations above their long-term average.  Goldman Sachs said, “for chip stocks to move significantly higher from here, there’s got to be a sustained recovery in the second half of the year.”

The semiconductor industry is the most cyclical part of the technology sector.  Chip stocks surged at the height of the pandemic as demand for chips used in everything from laptops to cars skyrocketed.  However, the market reversed as the pandemic eased, and chipmakers are now scaling back their capital spending plans on waning chip demand. Goldman Sachs predicts 2023 will be a “correction year” for chip stocks as the auto and industrial end markets follow memory and PCs in seeing a slowdown in growth.

Analysts have been cutting their earnings estimates for chip stocks.  According to Bloomberg Intelligence, semiconductor earnings are expected to fall -16% this year while revenue drops -4.4%.  Six months ago, the consensus was for profits to rise +5.9% and sales to be up +7.4%.  The Philadelphia Stock Exchange Semiconductor Index is trading at 18.4 times estimated earnings even after slumping by more than -30% last year.  That is still above the 10-year average of 16.4.  Should earnings estimates drop further, that would make stocks appear even pricier by reducing the denominator in the price-earnings ratio.

Chip makers can bolster their profitability by cutting spending.  However, that does not bode well for the companies that make the equipment to produce semiconductors, such as Applied Materials (AMAT) and KLA Corp (KLAC).  Wells Fargo Securities sees 2023 as a “choppy” year for those companies and recommends a “defensive positioning,” citing the prospect of another leg down in estimates in the second half of this year.  The market so far is ignoring signs of weaker chip demand, and Goldman Sachs said, “there is a lot of hope, but limited evidence that we’ll see a significant recovery.” 

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