FTXL - FTXL: A Pullback Would Provide Better Buying Opportunity

2023-09-21 10:23:00 ET

Summary

• FTXL owns a portfolio of semiconductor stocks and tracks the Nasdaq U.S. Smart Semiconductor Index.
• The semiconductor industry's inventory correction may not be over yet, and investors may want to wait for a pullback before investing.
• The semiconductor industry is expected to grow rapidly in the long run, but FTXL's valuation is currently high, posing downside risks.

Introduction

The semiconductor has been through inventory adjustments for about a year now. Is this inventory correction over now? Should investors be taking advantage of this opportunity to invest? In this article, we will analyze First Trust Nasdaq Semiconductor ETF ( FTXL ), and provide our insights and suggestions.

ETF Overview

FTXL owns a portfolio of 32 large-cap semiconductor stocks in the United States. The fund basically tracks the Nasdaq U.S. Smart Semiconductor Index. Stocks in FTXL's portfolio should be able to ride on several important technological trends. In fact, the semiconductor industry is expected to grow at a rapid rate of 9.18% annually through 2030. However, the semiconductor industry's inventory adjustment may not be completely over yet. Given macroeconomic uncertainties and the semiconductor industry's rich valuation, we think investors may want to wait for a pullback before initiating a position.

Fund Analysis

FTXL has rebounded in 2023

FTXL suffered from a significant decline in 2022 but has since recovered most of its losses in 2023. In fact, the fund has rebounded by 28.5% since the beginning of 2023 and has rebounded by nearly 50% since its fund price reached the trough in mid-October of 2022.

Inventory correction may not be over yet

The semiconductor industry has been going through inventory adjustments since 2022. As can be seen from the chart below, some companies such as Nvidia ( NVDA ) have substantially reduced their inventories. However, most other companies still have inventories well above their historical levels.

Below is a chart that shows the inventory to sales ratios of the three major global semiconductor countries: South Korea, Japan, and Taiwan. While inventory to sales ratio has dropped substantially from the high reached in 2022, it is still well above their historical average. Hence, we think this inventory adjustment may still need more time to reach the end.

Semiconductor industry should continue to expand rapidly in the long run

Although stocks in FTXL's portfolio may still need to go through some inventory correction in the near term, the semiconductor industry is expected to grow rapidly in the coming decade. According to Proficient Market Insights , the global semiconductor market size is expected to reach $1 trillion by 2030 from $607 billion in 2023. This represents a compound annual growth rate of 9.18%. The rapid growth in the semiconductor industry is expected to be driven by artificial intelligence, electric vehicles (including autonomous driving vehicles), Internet of Things, industrial automation, cloud computing, metaverse, etc.

Valuation is rich now

As we have mentioned earlier in the article, FTXL has delivered a total return of nearly 50% since reaching the trough in October 2022. As a result, its valuation is not cheap. Below is a chart that shows the average valuation of semiconductor stocks in the S&P 500 Index. As can be seen from the chart below, the current forward P/E ratio is above 25x. This is towards the high end of its historical valuation range. Hence, its valuation is quite rich now.

Given the fact that we are in a monetary tightening environment and that the Federal Reserve's rate hike cycle may not be over yet, this high valuation may be subject to downside risks. In addition, the Federal Reserve is also shrinking its balance sheet. As liquidity dries up, it is difficult to support this valuation unless the Federal Reserve reverses its policy. Therefore, we think investors may be wise to wait for a pullback.

Investor Takeaway

FTXL is expected to benefit from several important long-term secular growth trends. However, the semiconductor inventory adjustment is likely not over yet and its valuation is quite rich now. Given macroeconomic uncertainties (e.g., a possible recession) that might continue to weaken semiconductor demand, and a tightening monetary policy, there may be substantial downside risk ahead. Hence, we think investors should wait for a pullback before initiating a position.

Additional Disclosure : This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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