We have been fielding an awful lot of investor questions about semiconductor cycles recently. We just did a podcast episode of the Circuit with Ben Bajarin about this subject, and he is getting the same questions (You should subscribe). It turns out semiconductors are a cyclical business. We have actually been having the same discussion for three years now, it’s just that now we are having the “things will get better” some day conversation, while in 2022 we were having the “things are going to get worse” conversation.
For investors, this cycle is proving harder than usual to navigate. Past cycles tended to see a much higher degree of correlation among all the semiconductor segments. The economy goes into a recession, demand for everything decreases – phones, PCs, cars. Semis inventories go up, financials falter and then stocks decline. This time the cycle is not really being dragged by the economy, which may or may not be entering into a recession. Instead, the industry is dealing with the after effects of the pandemic. In 2020 and 2021, demand for many things went up just at the same time supply dried up because of the lock-downs. It turns out that all that demand was just future demand pulled forward, and we are now paying the price for that.
As a result, this downturn is very much staggered by market segment. Chips for PCs, then mobile phones, started falling in 2022. By comparison, demand for autos remained solid until recently. Or more precisely, supply of auto semis remained constrained. We spoke to people as recently as two weeks ago who did not think semis were in a downturn “because it is still so hard to get parts for cars”. The supply shortages are almost entirely gone, and automotive, industrial and analog semis are now poised to re-encounter gravity.
Unfortunately, there is a decent chance that the recovery in semis may not be as staggered and we may have to wait for all categories to show signs of improvement before the sector starts to recover more broadly. Just as analog semis stocks are coming under pressure, there is no sign of buyers lining up to plow back into PC and phone semis. As we noted last earnings season, most companies in those sectors are expecting a recovery of their financials in the second half of the year, but our sense is no one has a high degree of conviction on that timing. And if we had to guess, very few companies will raise their hand to commit to that timing this quarter.
Set against all this is the underlying theme that “semis are showing up in ever more places”. The notion that strong fundamental demand for semis should underpin long term support for semis stocks is both true and misleading. When we were on the sell-side, defending a stock, if we ever had to revert to the argument that “You should buy this stock because of secular trends”, we had already lost the conversation. There is no question that semis will continue to grow for a long time, with semi content growing in everything. That being said, those fundamentals can take a long time to be fully reflected in company financials.