What Lies Ahead for Semiconductor ETFs: Boom or Gloom?

Semiconductor stocks and ETFs have been fluctuating lately. On one hand, this group has been benefiting from the increasing demand for artificial intelligence (AI) hardware. On the other hand, occasional concerns about a potential demand slowdown are emerging.

Semiconductor giant NVIDIA NVDA hit a record stock close on Monday, only to dive 4.7% on Tuesday and rise 3.1% again on Wednesday. In addition to NVIDIA, other AI chip and hardware companies like Arm ARM, Qualcomm QCOM, Broadcom AVGO, Super Micro Computer SMCI, Astera Labs (ALAB) and Micron MU have seen their stock prices rise last week.

The PHLX Semiconductor Index has risen 4.3% over the past five days (as of Oct. 14, 2024), outperforming the S&P 500, which climbed 2.5% in the same period. This positive trend in AI chip stocks has been aided by strong AI hardware spending.

ASML’s Lowered Outlook Raises Concerns

But the warning from Netherlands-based chipmaker ASML this week halted the rally. ASML’s shares dropped the most since 1998 in Europe this week after the manufacturer of the world’s most advanced chipmaking machines cut its outlook due to sluggishness in areas beyond AI. It lowered the top end of its guidance range for 2025 total net sales to €35 billion ($38 billion) from €40 billion.

Should You Worry About ASML’s Outlook?

Investors should note that ASML has a near-monopoly on critical tools used by TSMC, Intel, and Samsung Electronics to make advanced chips. Per some analysts, the weaker outlook of ASML probably reflects some overcapacity at chip factories. It doesn’t necessarily indicate chip doom.

Increased AI Spending From Tech Giants

Major tech companies like Alphabet GOOG, Microsoft MSFT, Amazon AMZN, and Meta META are expected to continue significant AI infrastructure spending into 2024. Goldman Sachs projects that mega-cap tech companies will collectively invest $215 billion in AI capital expenditures next year and $250 billion in 2025, as quoted on Yahoo Finance. NVIDIA, in particular, is poised to benefit from these investments.

Semiconductor Industry Outlook

According to JPMorgan analyst Harlan Sur, the semiconductor industry is projected to grow by 6% to 8% in 2024, per the above-mentioned source of Yahoo Finance. Sur believes semiconductor and equipment stocks will continue to rise, especially in anticipation of better supply-demand balance in the second half of 2024 and 2025 and better earnings trends this year and in 2025.

What Are Other Silver Linings?

The Semiconductor Industry Association (SIA) announced lately that global semiconductor sales hit $53.1 billion during the month of August 2024, marking a year-over-year increase of 20.6% and a sequential rise of 3.5%. Regionally, year-over-year sales were up in the Americas (43.9%), China (19.2%), Asia Pacific/All Other (17.1%) and Japan (2.0%). However, Europe was a dampener.

If this was not enough, in the decade following CHIPS enactment (2022 to 2032), the United States is projected to more than triple its semiconductor manufacturing capacity — the highest rate of growth in the world during that period — according to a May 2024 SIA-Boston Consulting Group report.

The report also forecasts that the United States will increase its share of advanced (less than 10nm) chip manufacturing to 28% of global capacity by 2032 and capture 28% of total global capital expenditures (capex) from 2024 to 2032. If there had been no CHIPS Act, the report estimates that the United States would have secured only 9% of global capex by 2032.

Potential for an AI Investment Slowdown

Despite the current enthusiasm, some analysts caution that AI chip stocks may be in a bubble that could burst once the Big Tech’s massive AI infrastructure spending slows. Unlike AI software, which is sold on a subscription basis, hardware is a one-time sale, meaning demand would wane at some point of time.

Recent earnings reports from Google, Microsoft and Amazon have shown lesser correlation between their high levels of AI spending and actual returns, leading to a drop in their stock prices over the summer. Some analysts, including D.A. Davidson’s Gil Luria, believe that AI infrastructure spending could peak as early as next year, indicating a potential slowdown in capital expenditures, as quoted on Yahoo Finance.

Bottom Line

Against this backdrop, investors can play semiconductor exchange-traded funds (ETFs) for exposure to the entire industry, and not just the AI boom. These ETFs include VanEck Semiconductor ETF SMH, iShares Semiconductor ETF SOXX, First Trust Nasdaq Semiconductor ETF FTXL and SPDR S&P Semiconductor ETF XSD. These ETFs have lower company-specific concentration risks and are up around 46.8%, 23.2%, 16.9% and 8.9%, respectively, in the year-to-date frame.

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