After the powerful rally this year in computer chip manufacturer shares, these companies now have little room for error. Investors have built a strong bullish case for the sector that went through a big sell-off in 2018.
The Philadelphia Semiconductor Index, which includes some of the world’s largest chipmakers such as Intel Corporation (NASDAQ:INTC), NVIDIA Corporation (NASDAQ:NVDA) and Advanced Micro Devices Inc (NASDAQ:AMD) has surged about 45% in 2019, far exceeding the S&P 500's 24% rise this year. The index hit a record high on Nov. 11.
Chipmakers have been at the forefront of the technology boom, beneifting from the exploding use of smartphones, surging investments in cloud computing, data centers and gaming cards. But investors shunned them last year as they became caught in the crosshairs of the trade battle, which hurt demand and made it tough for these companies to expand in China.
With U.S.-China trade tensions easing and the U.S. Federal Reserve standing ready to cut borrowing costs if the economy faces a slowdown, some investors see further upside in semiconductor stocks. In our view, however, chasing the rebound at this stage of the cycle is dangerous. There are still many unknowns that could quickly unravel these gains.
First, the U.S. and China trade deal very much remains a work-in-progress and investors know very little about the details that might favor chipmakers. Wall Street continues to pin its hopes on a breakthrough in U.S.-China trade negotiations after the U.S. President Donald Trump said on Friday that a trade agreement with China was near.
Earnings Uncertainties
Chinese President Xi Jinping, however, didn’t provide a similar, strong signal. Instead he said, Beijing also wants to land a deal but would “fight back” if necessary. If a trade agreement doesn’t go through or terms of the deal don’t meet investors’ expectations, the shares of chip companies could get burned badly as this sector is among those which benefited the most.
The second biggest risk that investors in chip stocks face comes from the uncertainty about future earnings. In the latest quarterly earnings reports, chipmakers sent very mixed signals.
Nvidia, the industry's biggest maker of chips for computer graphics cards, early this month reported quarterly sales that topped analysts’ estimates, but the company offered a weak forecast, suggesting demand for gaming graphics chips is recovering slower than predicted.
Texas Instruments (NASDAQ:TXN) in October said “most markets weakened further,” in the third-quarter and gave a fourth-quarter revenue forecast that trailed the lowest estimate on Wall Street. Texas Instruments is considered a bellwether for the chip industry because of its broad customer base and geographic reach.
These warnings have so far failed to temper investors’ bullish mood about semis. According to analysts’ consensus forecasts, the third quarter likely marked a bottom of the industry’s down cycle. Growth will then continue to accelerate. By the third quarter of 2020, semi earnings are expected to expand faster than software companies.
Bottom Line
Investing in chip stocks after the powerful rally this year doesn’t make sense, especially when threats to their growth haven’t fully subsided yet. Any negative development on the U.S.-China trade negotiations, more bad news on the Chinese economic front, and a possible slowdown in U.S. expansion are some of the headwinds that call for avoiding semiconductor stocks in general.