Overview
As the old Wall Street saying goes, stocks climb the wall of worry. A bullish cycle usually advances amid doubts and concerns, but ends when the sky is clear, as prices often run ahead of fundamentals.
The current rally in global semiconductor stocks emerged from the depth of pessimism in October 2022, and marched on through worries about high inventories, macro weakness and the tapering of Covid-induced demand. Now, with fundamentals improving and concerns receding, could we be approaching the end of a bullish journey?
This week’s Chart Room examines where we are in the semiconductor cycle, based on technical and fundamental analysis by Fidelity International. We think the easy “buy everything” phase has ended, and the party is well into its second half, warranting more caution ahead.
We have created a trend line for the Philadelphia Semiconductor Index (SOX) by averaging 11 previous cycles since 1996. The current cycle since October 2022 overlays well with the rising part of this reference line, but we are also nearing its peak. On average, a bullish cycle extends for about 19 months and the current one is entering its 18th month.
On the fundamental side, two important worries remain for investors as share prices climb. First, the current recovery is almost entirely driven by the price increase of semi products, not by growth in sales volume. Second, capital expenditure rose to record highs at many semi companies in recent months, fuelling concerns about overcapacity.
We think the first worry will recede over the coming quarters with rising shipments for smartphones, personal computers and servers, as new artificial intelligence features boost demand for these products. The advancement of AI technology in general is fuelling long-term optimism about the semi industry. For the second worry, while the overall capex-to-revenue ratio remains elevated, some of the largest semi companies have started cutting back on their investments.
Weakness in global auto sales, including electric vehicles, has been a drag on the semi rally, but this is partially offset by an increase in the number of chips used in each car. On balance, the automotive impact on the semi cycle appears to be much smaller than that of personal devices and servers.
For now, these two worries are still limiting the valuation of semi stocks, implying that their rally has more room to run. Current share prices suggest investors are optimistic but not yet euphoric. In the next few quarters, if the worries melt away and euphoria kicks in, it may be a good time to start selling before the party ends.
