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Semi Stocks peaked weeks ago & drifted down Where do we go from here?

Robert Maire

Semi Stocks peaked weeks ago & drifted down... Where do we go from here? Up, Down or Sideways... Business remains strong but is that good enough?

Semi/Semi equipment stocks peaked on June 8th and have been down/sideways since then after a very strong and very long run. Given how much the stocks have appreciated over the last few quarters, we need to wonder and look at where we are in upside versus downside risk.

Without a doubt, business remains very strong and the overall business outlook over the next several quarters also appears strong but is that good enough to keep the stocks on an upward trajectory or is all the goodness already "baked in" to the stock price, and then some?

This discussion is therefore about investor sentiment and not strength of current business or future outlook.

Have investors and markets signaled the end of what has been a doubling of the value of many companies of the last year?

There are many factors to consider and unlike objective financial reports and future projections investor sentiment is subjective in nature.

"Second order derivative trading"...
Tech stocks and Semi stocks are all about growth and rate of growth. Over the last several quarters, the rate of quarter over quarter growth had been increasing, seeing ever larger jumps in quarterly business.

While business remains very strong, we think the rate of increase, or second order derivative is slowing and as such removes the motivation of "momentum" buyers or "fast money" that may have helped much of the rapid share price increase.

To be clear, a minority of investors are "mo" guys, but they do add a lot of "froth" to the market and can drive valuations very quickly. If we were a "mo" investor, we might look upon the recent pullback as a sign that the easy money has been made.

Are the stocks "GARP" or just growth stocks?

While we are certainly in the growth phase it is unclear that prices are still "reasonable" (GARP= growth at a reasonable price) as multiples for volatile tech stocks which had traditionally traded at a significant discount to the market now trade more in line with market multiples and therefore may no longer be a "relative" , "reasonable" price.

When looking at the traditional volatility that caused these stocks to trade at a discount to the market, we see less volatility overall, however the sharp drop, for no really good reason, after June 8th reminded investors that these still remain as volatile as ever.

How much of a discount to apply as well as compared to what benchmark is an open issue for the stocks.

In essence , its likely that "GARP" investors may have less motivation as valuations are not as "reasonable" or attractive as before....even company executives sheepishly admit in private that their stocks have ballooned beyond expectations....

Rotating in or out of tech?
The market always sees investors rotating in or out of a sector depending upon generalized market perceptions. We have seen a great rotation into tech over the last several quarters with semi stocks leading the charge. This has all been for good reason; memory pricing is strong, iPhone 8 anticipation is high, AMD and Nvidia have great new stories etc; etc;. Couple this with hopeful views on business friendly legislative agendas and potential return of overseas cash makes for an industry hitting on all cylinders.

Currently there appears to be a rotation out of the energy sector as oil prices and other issues have proven to be a negative impact on those stocks. This could be a help to tech stocks as there are not a lot of other sectors to go to that have worked as well so we could see that help shore up some of the recent weakness. But on the other hand, investors could be wary of the recent weakness as a negative sign rather than an opportunistic sign.

As good as it gets?
Its unclear to us that things can get that much better in the semiconductor space. Business is great and everybody is in high gear. Profits and revenues are at record levels with much of the industry struggling to keep up. We don't see business getting much stronger, much faster, from here (but that could always change...).

Memory, especially 3D NAND, remains super strong but we are likely on the downside of the Iphone 8 semi curve. TSMC has bought most of the tools it needs for 10nm and we are a little early for 7nm. Intel is sluggish on semi spend. GloFo while not a huge spender likely has a hit with its AMD relationship.

Our recent channel checks indicate continued strength in business but the rate of growth has clearly slowed (hence our second order derivative comments)

Is the multiple expansion story played out?
We have seen P/E multiples expand as the argument has been made that the industry is less cyclical and more stable (and some analysts go to extremes and say no longer cyclical--we don't agree) and therefore deserve a higher, closer to market or beyond, multiple. Indeed we have seen multiples expand. Whether this is simply due to higher stock prices or whether investors have bought into the less cyclical argument is unclear but the bottom line is that P/E ratios have increased as the long rally has not just been driven by better business but better valuations as well.

The question at hand is whether multiples can still expand from here or do the stocks asymptotically slow down as we only have upward earnings revisions to drive them.

Do fundamentals trump market sentiment
We keep coming back to the fact that business remains strong and at least in the near term, continues to look upward in the future. Perhaps investors will wait for fundamentals to slow before considering getting out of the stocks or getting more cautious on them...but then again it would probably be too late by then.....

Resistance points
We have seen some points of resistance in the stocks. For LRCX $150 seems to be a critical price point while KLAC dances around the psychological $100 price point. AMAT in the low to mid $40 range seems to be another battle ground.

Given the rapid rise in stock prices it would not be unreasonable to expect some consolidation and reformation of ownership base at these levels or slightly under.

What do we expect for Q2 earnings and Semicon West

Unfortunately, there are fewer and fewer big cap analyst meetings at the SemiCon show to define an overall industry trend. We will have the smaller cap companies speaking at the show and we think everybody will be universally positive. There is no real reason for companies to get any more positive than they already are so in general the only surprise would be if someone got more cautious.

The same goes for Q2 earnings which will be released n a similar timeframe as SemiCon West. We expect companies to meet or beat with continued better guide but just not as large a quarterly increase Q3 over Q2.

But this expectation is already well baked into the stock prices so its going to be hard to get an upside surprise.

Upside versus downside risks
While we have no indication that the industry is about to roll over or any other event that would cause a sharp drop off we remain concerned that the stocks are priced to perfection with little chance of an upside surprise and more of a risk related to anything other than continued great performance.

Right now it feels like the downside risk is higher than the upside risk given how far we have come in stock prices.

On a very simplistic basis we have to ask the question; "Are these stocks worth close to twice what they were a year ago?", "Has the industry grown that much?"

Investors likely "twitchy"
Given the sharp drop we saw in the stock prices after June 8th its clear that investors can change direction quickly. There is obviously a desire to "lock in" profits given the run that we have had. Momentum works in both directions as it picks up speed when the stocks are on their way up or down and others jump on board after sensing the direction of the thundering herd.


Business remains great but the stocks have had an issue. The correlation coefficient between business performance and stock price is not +1 and sometimes feels more like -1. Historically, markets have been a pretty good indicator of future business performance.

The recent stock performance could be just a temporary hiccup in the market that will correct or it could be a more definitive trend in the stocks.

Investors should likely look at the stocks in this sector that have seen the greatest rise as they seem to have the most vulnerability to downside if the turn becomes permanent.

Some of the smaller cap, derivative plays in the market have had outsize stock performance that may be at risk. Taking some money off the table may be prudent.

We see little news at Semicon or in Q2 reports that will be a strong catalyst and we think much is already known and built in to stock prices. Remember, its all about "expectations" and expectations are already pretty high.

We would get even more selective in looking for stories with 3D NAND exposure as spending is the strongest there. However, we would not be surprised to see a "digestion" period given the huge slug of equipment that has shipped into this space over the last couple of quarters. Sometimes we wonder if they even have enough space to put it all in.

On a broader tech stock basis, summer has tended to be a slower, weaker season and things generally warm up again into "back to school" and new Iphone release season.

Maybe investors are already at the beach focusing on their tans.........See you at Semicon

About Semiconductor Advisors LLC
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This is just a pause in a fast moving revolution. AI/ML, smart cars, automation of everything(medical, robotics, all transportation), manufacturing(3d printing of everything from parts to buildings), semis to augment drugs and bodily control functions and all areas of nanotech are still in the early stages and picking up speed. Just look at the continuing revolution semis and semi technology have brought to the financial markets. Organizations of all types are in a race in this area for those that fall behind will be relegated to the dust bin of history. This is just a brief pause in a trend that is will be picking up speed for a long time to come. Massive changes in education and training are coming as traditional training and multi year degrees are rendered obsolete by the accelerating pace of change. This is also fraught with danger the repercussions of those that refuse to change as needed, such as government workforces that are rooted in slow changing fixed/rigid structures that they will make everyone else pay for their refusal to keep up. There is as much opportunity as danger and we will see both. Hopefully we will have the wisdom to see us through this great change and make sure the benefits are broadly spread for this will lead to the best outcome. Widespread, cost and time efficient training on a subscription for life basis will be the key for only an intelligent, trained and informed population can make intelligent decisions.
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My view is that tech stocks might be on hold for the next few months. The run for the 6 months of the year was great, with many tech stocks up 20%, 30%, even 50% in some cases. I think it's just a case of the market needing some time and maybe even a bit of a correction to digest those gains. Yes these markets are all growing quickly, but for the most part they aren't growing 50% a year, at least you can't expect them to grow that fast sustainably. In the longer term, I think the better quality names who innovate with new products to meet the demands of the market will continue to do very well.
My view is that tech stocks might be on hold for the next few months. The run for the 6 months of the year was great, with many tech stocks up 20%, 30%, even 50% in some cases. I think it's just a case of the market needing some time and maybe even a bit of a correction to digest those gains. Yes these markets are all growing quickly, but for the most part they aren't growing 50% a year, at least you can't expect them to grow that fast sustainably. In the longer term, I think the better quality names who innovate with new products to meet the demands of the market will continue to do very well.

I agree. Semiconductor M&A is certainly on a pause as compared to 2015 and 2016 for just that reason, valuations are sky high. 2018 however should be another big growth year. AI is infecting everything and that will boost silicon content significantly. I also think the semiconductor ecosystem will do well (foundries, EDA, IP, Services). Many more systems companies are doing chips and they buy more tools (system level stuff) and actually equip their designers with the maximum versus the bare minimum that some fabless companies do. I'm not mentioning names but engineers from certain companies complain much more than others about under tooling and penny pinching.