Is It Time to Sell Semiconductor Stocks?

The winning spree for semiconductor stocks and exchange-traded funds (ETFs) has continued unabated in 2023, as suggested by the 221% year-to-date gain for sector standout Nvidia (NVDA). More broadly, popular chip ETFs such as the VanEck Semiconductor ETF (SMH) (up 55.3%) and the iShares Semiconductor ETF (SOXX) (up 55.7%) are comfortably outperforming even the healthy 44% advance in the Nasdaq QQQ Invesco ETF (QQQ) since the start of the calendar year.

So what's behind the breakout rally in the chip space in 2023? Is it sustainable? And should investors book profits now after this massive rise?

AI Boom and Supply Chain Issues

There are two primary reasons for the meteoric rise in semiconductor stocks this year - the boom in the Artificial Intelligence (AI) space and ongoing supply chain disruptions.

As AI enjoys rapid mainstream adoption among corporate consumers and everyday users, AI-related stocks have been an obvious beneficiary of the positive buzz. One of those names is NVDA, which designs and sells graphical processing units (GPUs) - a type of processor that's ideally suited for the heavy demands of AI computing. 

Nvidia recently became the first chip company to achieve a $1 trillion market cap, and investor optimism over the company's strong AI footing was backed up by a solid earnings report and outlook in its latest quarterly results.

The AI juggernaut is showing no signs of slowing. According to a report by the McKinsey Global Institute, generative AI can add productivity value to the tune of $4.4 trillion annually with widespread value addition in the banking industry ($200 to $400 billion annually) and consumer goods sector ($400 to $660 billion annually) just to name a few. Further, the compound annual growth rate (CAGR) of the AI chip market is expected to hit 22.2%, launching the industry from $12.9 billion in 2022 to roughly $62.5 billion in 2027. 

However, not every semiconductor stock is outperforming this year. U.S.-listed shares of Taiwan Semiconductor (TSM), the company that actually manufactures Nvidia's AI-tailored chips, are lagging the broader QQQ so far in 2023. 

TSM could apply pressure across the rest of the sector with its latest move, too. The company recently announced a $2.9 billion investment in an advanced chip packaging plant in Taiwan to help meet continued strong demand for AI chips globally, addressing a supply imbalance that has persisted since the onset of COVID.

The global chip shortage in 2021 and 2022 - sparked by pandemic-related supply disruptions and exacerbated by increased demand as the auto industry shifted increasingly toward automation - provided a steady underpinning of support for semiconductor stock prices during that time. In fact, in 2022, the global semiconductor industry registered its highest-ever chip sales of $574 billion.

As a result, the gradual easing of supply chain bottlenecks becomes a potential headwind that could weigh on chip stocks. In fact, this one-time supply shortage could be poised to turn into a supply glut soon, according to some analysts.

Sandeep Deshpande, Head of European Technology at J.P. Morgan, recently wrote, “We’re nearing the end of the supply crunch after more semiconductor capacity came online in 2022 … Looking ahead, we don’t predict any major constraints.” The report, released prior to TSM's newly announced investment, further cited that there could be an oversupply in the short term.

Final Takeaway

It can be argued that the market for AI chips will continue to grow as use cases expand across a myriad of products and services globally. Chip manufacturers are expected to benefit from robust demand, barring any company-specific operational issues or wider geopolitical tensions. This makes investors' exposure to this burgeoning space all the more critical for the well-being and growth of their portfolios.

However, as long-term supply chain issues continue to ease and more production comes online to meet demand, prices of outperforming semiconductor stocks like NVDA and associated ETFs like SMH and SOXX could reasonably be expected to come under pressure, at least in the short term. Further, any weakness in the global economic outlook could also prompt a slowdown or decline in these outperforming chip names.

Taking all this into account, I would recommend investors book partial profits to lock in some of the rally on standout semiconductor stocks so far in 2023, while leaving open some exposure to additional long-term upside.