The technology is cool but James Bevan warns that the current cycle for semiconductors is long in the tooth.
Commentators on Radio5Live recently stated that the new highs posted by US equities reflected Mr Trump’s popularity – but the reality is that polls conducted by the Washington Post and ABC News showed that Donald Trump is the least popular incoming president of the past 40 years by a large margin and we need a richer analysis as to why US equities have popped up and on what lies ahead.
For now, I remain bullish on stocks. Weekly and monthly measures of consumer confidence are up since Election Day, and Markit’s flash M-PMI was 55.1 in January, its highest since March 2015, whilst the average of the three available business conditions indexes from the Fed regional surveys for NY, Philadelphia and Richmond is up from 0.5 during October to 14.0 during January, the highest since November 2014. There’s now a risk that sentiment may be too bullish. The Investor Intelligence Bull/Bear Ratio has exceeded 3.00 for seven consecutive weeks.
Chips
James Ayre and I have discussed that in terms of sector issues, recent developments in autonomous cars, robotics, and artificial intelligence have captured the imagination of tech investors. One way they’ve played the future is by investing in the manufacturers producing the semiconductor chips that will run all of these new technologies.
The S&P500 semiconductor industry index gained 42.9% over the past 12 months through to close on Tuesday’s last week and semiconductor equipment industry shares were up 72.4% over the same period. Semi stocks have also been boosted by M&A activity and hopes that semiconductor revenues growth will pick up to the mid-single-digits this year.
Gartner expects a 7.2% year on year (yoy) increase in worldwide revenue to $364.1bn in 2017 after 2016’s growth of just 1.5%yoy. The projected acceleration in sales isn’t from traditional areas like cell phones and computers, which are now in a replacement cycle rather than genuine growth, but rather from new areas like self-driving cars, the internet-of-things, and cloud computing.
JPMorgan estimates that the total available market for semiconductors used in semi autonomous and fully autonomous cars will reach about $7.3bn by 2025, with compound growth of c62.5% per annum starting in 2017. That estimate assumes that semi autonomous and fully autonomous cars together will make up about 15.7% of a projected 109.6 million light vehicles produced globally, with the total cost of chips per vehicle reaching $400 to $500 a car, up from $300 to $400 from advanced driver assistance systems (ADAS). The total world market for automotive semiconductors grew to $30.3bn last year, and is expected to reach c$41bn in 2020.
Analysts expect the S&P500 semiconductors industry to grow revenue by 8.9% this year and 4.4% in 2018. The industry’s forward profit margin has increased by 4.2ppts to a record high of 24.2% since the beginning of 2016. As a result, earnings are thought to grow 15.9% this year and 8.3% in 2018. Net earnings revisions have been positive since the second half of 2016, with readings of 15.6% in January, 17.1% in December, and 15.6% in November. The S&P500 Semiconductors industry’s forward earnings multiple has ranged between 10x and 20x over the past 20 years, with the exception of the 1999-2000 Tech bubble when the multiple was much higher. With a forward P/E of 15.2x and earnings still growing, this industry looks like it still has room to head higher.
Long in the tooth
But there are risks of over-optimism. Apart from fundamentals, the semi industry has benefitted from M&A with small companies specializing in some of the new technologies being bought by larger competitors. Semiconductor M&A has topped $240bn over the past two years (Dealogic data) but the pace of M&A will likely slow as the best companies have been purchased and those with the ability to do a deal have already done so. That means that whilst an acquisition premium remains in smaller stocks, this premium may dissipate. So as ever careful stock selection will be key.
For the sake of completeness, some investors are playing semis by investing in the S&P500 semiconductor equipment industry, composed of companies that make the equipment to manufacture the chips. But the S&P 500 semiconductor equipment industry cycle is typically short and the current cycle is long in the tooth, having begun in 2015. Earnings are at record levels, as are margins, and while the technology being developed seems awfully cool, the numbers are warning that there have been better times to buy this particular industry.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
*CCLA is a supporter of Room151
