Taiwan Semiconductor (TSM) is the world’s largest and most advanced chip manufacturer.
Last week, they said they’ll increase the supply of microcontrollers for the auto sector by 60% – before the end of the year.
That surge in production begins now and should ramp up over the coming months, helping to tame inflation…
The shortage of computer chips has been a leading cause of inflation this year. By some measures, it’s responsible for about half of the jump in the oft-quoted Core CPI inflation measure. That’s not surprising, considering there are semiconductors in everything from toasters to cars these days.
Shortages slow down production and push up prices. So, it’s reasonable to expect that as supply increases, price pressures will ease. That’s a big part of the reason the Federal Reserve is so committed to their view that inflationary pressures will be “transitory.”
The chip sector is not just a supply story though – demand also surged as the lockdowns eased… It seems like everyone wanted a new car or kitchen appliance at the same time. Lead times for production have stretched out to months for the most in-demand items. But, that’s unlikely to continue much longer as supply increases.
After all, not everyone buys a new house or remodels their kitchen every year. However, the pandemic accelerated buying decisions for a lot of people.
There’s a good chance that the surge in supply will occur right around the same time that demand peaks. That’s because the one thing investors seem to have forgotten over the last decade is the cyclical nature of the tech sector. It has booms and busts… and we just had a major boom.
So, now we’re due for some weakness. Once the production of semiconductors ramps up, it should bring prices down.
This past year, stocks like Nvidia and AMD have been enjoying an unprecedented demand from investors and inflated prices due to supply shortages. But that may be coming to an end…
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Because most software companies adopted the subscription business model, people forget that the tech sector is cyclical.
For example, you used to buy a new version of Windows every few years. Now you pay for it every month with Windows 365. Adobe used to charge thousands for Photoshop, now they sell subscriptions. That change of business model smoothed out the cycle for software companies.
But, no one is selling subscriptions to chips… meaning semiconductors are still very cyclical.
Demand for chips is still rising. The automotive sector is a significant new growth engine, and the consumer electronics sector is only getting stronger.
The important thing to remember, however, is that bull markets don’t end because demand evaporates… they end when supply increases so much that it overwhelms demand.
And the announcements of big increases in supply, like Taiwan Semiconductor made last week, are warnings that the bull market in chips is rapidly maturing.
Regardless, lower prices for chips is good news for other parts of the tech sector… For example, the companies buying chips for data centers will see their costs go down, the automotive sector will be able to manufacture more cars, and appliance manufacturers will finally be able to catch up with their backorders.
[In last Friday’s edition of Eoin’s Insights, I went more in-depth on inflation in the automobile sector and semiconductors. So, if you haven’t already, just click here to watch it.]
As we look at the composition of the main stock market indices, software companies have much bigger weightings than hardware companies like semiconductor producers. That’s because software is a higher margin business. That suggests the recent weakness on the Nasdaq won’t last for long as the next cycle brings a boom to tech.
However, the risk has risen substantially that the run of outperformance for semiconductor shares is over.
The spike in volatility on Monday set up a buying opportunity in the tech sector outside of chips. As inflationary pressures moderate and fears about imminent Fed tightening subside, the large-cap tech sector is bouncing nicely.
Amazon and Apple are both bouncing from the region of their previous peaks. So, a simple way to play this trend of continued strength in the tech sector outside of semiconductors is through the Schwab U.S. Large-Cap Growth ETF (SCHG).
All the best,
Eoin Treacy
Co-Editor, Market Minute
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