WOLF - Semiconductors Winners And Losers Heading Into Q2 2023

2023-04-04 04:18:57 ET

Summary

• Semis are headed into Q2 with momentum on their side for various reasons, although some are in a better position than others.
• Expectations are high and semis have been positioned accordingly, but a high bar means the risk of falling short goes up.
• Tailwinds have the upper hand over headwinds, which has paved the way for the rally, but things could change towards the latter part of 2023.
• Semis are most likely heading higher in Q2 due to the current environment, but the outlook beyond Q2 looks a whole lot murkier.

Semiconductor stocks have outperformed thus far in 2023, probably a lot more than many had expected. Furthermore, semis look poised for more gains with several tailwinds in their corner. However, while the short-term setup looks bullish, there are some risk factors out there that could cause problems towards perhaps the latter part of 2023. Why will be covered next.

A strong rally amid a rough environment

If some people were wary of semis heading into 2023, then they had reason to. Virtually all semis incurred major losses in 2022, way more than other sectors. The industry is still in a downturn with the semiconductor market forecast to shrink in 2023 for the first time in years. However, not everyone was as down on semis.

For instance, a previous article concluded that semis could still do well in 2023 despite the headwinds. The article noted how monetary policy by the Federal Reserve became more dovish towards the end of 2022, which was likely to continue in 2023. Fed tightening was arguably the biggest headwind for semis in 2022 and its absence could lift semis and tech in general, something that has happened before.

So while semis face a number of headwinds, there are also a number of tailwinds counteracting these headwinds, paving the way for a much better performance from semis than would otherwise be possible. This conclusion turned out to be the right one as semis have outperformed YTD. The iShares Semiconductor ETF ( SOXX ), for example, has gained 27.8% YTD, ahead of the 20.5% YTD gain for the Invesco QQQ Trust ( QQQ ). In comparison, the SPDR S&P500 ETF ( SPY ) has gained 7% YTD. Semis have outperformed in 2023, the opposite of what happened in 2022.

Furthermore, the charts suggest there's more to come. SOXX is in an uptrend with higher lows and higher highs. Note how SOXX seemed to be having trouble getting through the $420-440 region the last two months, which happens to be the same region where SOXX was sent packing last August. That is until a few days ago with SOXX closing above the aforementioned region. If charts are anything to go by, then SOXX looks poised to break higher after being held down for months.

Still, not all semis have done quite as well. A breakdown of SOXX's individual stocks shows this as much. SOXX includes Nvidia ( NVDA ), Texas Instruments ( TXN ), Broadcom ( AVGO ), Advanced Micro Devices ( AMD ), Qualcomm ( QCOM ), Intel ( INTC ), Lam Research ( LRCX ), Micron ( MU ), Analog Devices ( ADI ), ON Semiconductor ( ON ), Applied Materials ( AMAT ), KLA Corp ( KLAC ), Microchip ( MCHP ), NXP Semiconductors ( NXPI ), ASML ( ASML ), Marvell ( MRVL ), TSMC ( TSM ), Monolithic Power Systems ( MPWR ), Skyworks ( SWKS ), Teradyne ( TER ), STMicroelectronics ( STM ), Lattice Semiconductor ( LSCC ), Entegris ( ENTG ), Qorvo ( QRVO ), Wolfspeed ( WOLF ), United Microelectronics Corporation ( UMC ), Silicon Laboratories ( SLAB ), MKS Instruments ( MKSI ), ASE Technology ( ASX ) and Synaptics ( SYNA ). The table below shows the gains or losses for all 30 stocks.

Source: iShares

Who was hot and who was not among semis

It's not always the case, but in this instance, the clear winner by a landslide is NVDA with a 90% YTD gain, well ahead of runners-up AMD and STM. On the other hand, NVDA is about flat based on its performance for the past 12 months. On that basis, the front runners are LSCC, ahead of ON and STM. The stocks heading into Q2 2023 with the most momentum are INTC, AMD and NVDA.

In contrast, unlike the other 29 constituents in SOXX, WOLF is the only one not to have gained with a loss of 5.9% YTD. KLAC and MKSI have also turned in a lackluster performance YTD. WOLF is still below where it was a year ago, unlike some of the other names above. Nevertheless, WOLF is not the number one laggard in that regard. SYNA, MKSI and MRVL have the most work to do to get back to where they were 12 months ago.

Fed policy may have been the most important factor behind the recent rally, but semis have benefited from other tailwinds. For instance, STM and ON have benefited as leading suppliers of automotive chips, which is the one market segment that continues to hold up during the current semiconductor downturn. In addition, the introduction of chatbots like ChatGPT and others has raised interest in companies perceived to benefit from increased use of AI applications.

It's therefore no coincidence that stocks like AMD, INTC and NVDA have the most momentum heading into Q2 2023 as all three stand to benefit from increased investment in HPC. NVDA in particular looks to be in a strong position with investors flocking towards AI plays due to NVDA's leading position in server GPUs, which are needed for AI applications. This looks set to continue in the near term.

Why semis are not without risks

The near-term setup looks favorable for semis as a whole. With Q2 2023 upon us, the charts suggest the most likely direction for semis is up. Stocks like ADI and NXPI, for instance, are in bullish patterns. Others like INTC and TXN seem to have broken out or are close to it. Furthermore, Fed policy is likely to remain a tailwind for semis and tech in general.

This belief has only gotten stronger with the recent failure of several banks, which has led many to believe the Fed will be reluctant to tighten further due to the risk of inflaming the financial crisis. The Fed itself is suggesting that the rate hike cycle is almost done . And while the Fed does not see any rate cuts in 2023, there are quite a few who believe that option is still on the table and many who expect one or more rate cuts in 2024 according to federal funds rate projections . With all the above in mind, there are grounds to be bullish on semis.

However, while there is reason to be bullish on semis, it's also worth noting that expectations are high, perhaps too high, which could become a problem since it raises the odds of results falling short of expectations. Many semis have reported big drops in sales and profits in their most recent reports, but most were able to avoid punishment because investors paid more attention to what potentially lies ahead. Besides Fed easing, a major reason why semis are getting bid up is because of expectations that H1 2023, if not Q1 2023, will mark the bottom in terms of the recent downturn in semiconductor demand.

A number of companies, including a bellwether like TSM, have called for a rebound in chip demand in H2 2023. The semiconductor market is currently experiencing severe stress, but a rebound in H2 is expected to make up for it, a major factor why forward projections call for the semiconductor market to contract by a relatively modest amount in 2023.

For instance, the most recent forecast from WSTS sees the semiconductor market contracting by 4.1% YoY to $556.6B in 2023. The recovery is expected to gather steam the following year with many expecting 2024 to be a very strong year for the industry. Some forecasts see the market growing by more than 16% YoY in 2024 to set a new record high.

Markets are pricing in this expected return to growth and semis have rallied in part due to this. This has allowed a number of companies to avoid getting punished for what were disappointing results. The list includes MU, whose recent quarterly earnings and guidance fell way short of expectations, but who was able to offset it all by issuing a rosy long-term outlook.

The risk here is that the recovery fails to arrive as expected, which could trigger a selloff because valuations in many instances have become elevated in an environment where stock prices are going up, even though earnings are going down. Quite a few semiconductor names are arguably overvalued and very much so if there is not a fairly quick return to growth as expectations call for.

Investor takeaways

Q1 is done and Q2 is upon us. While Q2 will probably not see the pace of gains from earlier in the year, semis are still most likely heading higher in Q2. Semis can count on the backing of a number of tailwinds. Whether it is Fed policy or the perception of it, the charts or an expected turnaround in the semiconductor market, semis have been a favorite in 2023 thus far and that looks set to continue, at least as far as Q2 is concerned.

Individual stocks could also see increased investor interest due to AI. If someone is picking stocks based on some long-term growth story like AI, then NVDA is likely to be at the top of the list for this reason. If someone is also interested in stocks with momentum, then stocks like INTC and AMD are likely to fit the bill. Others may be more interested in stocks that have lagged far behind and may be due to catch up to the rest of the sector. In this case, SYNA and MRVL are worth looking into.

On the other hand, some may be more wary of the recent rally in semis. Those who want to limit their risk exposure may be interested in long/short pairs as they offer a potential payoff if the market goes up, but also if the market goes down. Potential combinations include AMD/INTC, but also TSM/UMC and SWKS/QRVO. Whatever the approach, semis offer something for pretty much everyone.

With that said, while it will probably not be an issue in Q2, semis may be setting themselves up for disappointment later in the year. Most semis are priced for a rebound in semiconductor demand starting in H2 2023, but there is not much evidence one is indeed coming, at least at this point. The most recent report from MU, for instance, suggested more like the opposite. The market could be underestimating the severity of the current downturn.

It's possible that the downturn could get worse instead of better as expected. Automotive chips, for instance, remain in strong demand, but there are signs automakers, especially in the EV segment, are starting to see car demand taper off. A number of companies have slashed prices to drive demand, which is not a good sign.

Note that earnings projections for most, if not all semis, in the next 12 months assume there will be a rebound in the semiconductor market starting in H2 2023. If this turns out to be incorrect, valuations for semis will have to be revised. Forward projections may be too optimistic, especially with regard to 2024. Keep in mind that 2024 will not have the benefit of trillions of global stimulus and massive inventory building, especially in China, two factors that greatly contributed to the boom in chip demand in recent years.

It can also be argued that while the latest chatbots utilizing AI are useful in the sense that they can help improve productivity and an evolutionary improvement in comparison to how things are done right now, they are also overrated in terms of what many mainstream people perceive them to be capable of versus what they are actually capable of. For example, they are perceived to be able to write programming code when retrieving and slightly modifying previously written code written by someone else, whether correct or not, is a more accurate description of what they can actually do. A bubble could be forming in the AI space, if there isn't one already.

More importantly, the general expectation, certainly after the recent bank crisis, is that it is only a matter of time before the Fed lowers rates and many tech names, including semis, have been positioned accordingly, but stickiness in inflation could turn out to be the wildcard that throw things off. The Fed could find itself stuck between a rock and a hard place in the sense that they stand to lose regardless of what they do. If they ease, inflation runs amok and if they don't, the economy goes into a tailspin.

The good news is that monetary changes in policy come with a lag and need time to filter through. No easing is expected from the Fed in the near term and the industry is not expected to recover until H2 2023. Semis should not have to worry about either not happening in the short term, at least in Q2. Once Q3 gets nearer, it may be time to reassess.

Bottom line, a lot is expected from semis and the bar has been set high. While this does not necessarily mean semis have to fall short, it does increase the odds of it. The reality is that with the exception of the automotive segment, the semiconductor market as a whole, particularly the memory segment, is not doing well. There are other potential headwinds out there. For instance, U.S.-China tensions as to who controls what in the semiconductor space remain unresolved.

The market has looked past current problems, but that could always change if the cavalry in terms of the Fed and an industry revival does not come to the rescue. Still, as long as the Fed policy is perceived to be turning dovish and the expected recovery is not yet due, semis can continue to defy the current headwinds and continue to go higher. But don't be surprised that by the time 2023 is done, it turns out that most of the 2023 gains are already in.

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