Chip stocks haven't been immune to the volatility that has roiled broader markets in 2022. But Julien Nono-Womdim, a semiconductor analyst at TD Asset Management, told Greg Bonnell why some investors are taking a more bullish view of the sector this year.
Transcription
Greg Bonnel: After a difficult run, semiconductor stocks posted solid gains at the beginning of the year. But will this performance continue? Many tech companies are warning of a more difficult economic environment. Joining us now with others is Julien Nono-Womdim, semiconductor analyst at TD Asset Management. Julian, it's a pleasure to have you back on the show.
Julien Nono-Womdim: Hi Greg, I've provided a chart to illustrate this. The SOX index is actually up 15% year-to-date, which is quite substantial, or 10% better than the S&P 500. More interesting, however, since the lows were formed in mid-October of last year, it's almost 30%, significant enough for a three-month run. I'd argue that what's happening is that last year, global PMIs started to decline. And as it stands today, most countries in the world are at or near contraction levels in terms of economic growth. And there's optimism that we'll return to growth in the coming months. And this should be constructive for the industry.
Greg Bonnel: Okay, so this is a—is this a classic example of the market being a forward-looking tool? Why are you talking about PMI? Production managers think things are getting weaker. Get warnings from central banks that the economy may slow down in the future. And you get—I have to add one more. Get warnings from big tech companies about job cuts and cost reductions. And then there's the semifinals rally. Is it a forward-looking game?
Julien Nono-Womdim: It's definitely a forward-thinking play. Perhaps we'll go back to last year. Semiconductor performance in 2022, from an industry perspective, was very good. It wasn't until the third and fourth quarters of July that fundamentals began to deteriorate. Even so, the sector has accumulated a 35% decline for the year. The market's frontrunners saw fundamentals deteriorate last year. And this year, the market is trying to do the same in the opposite direction, trying to anticipate good news.
Greg Bonnel: Now, we're also in the middle of earnings season. I don't think we've heard from all the semi-names. You'd know better than me, but what have we heard so far?
Julien Nono-Womdim: Well, so far, it's been a reflection of what the market is telling us. The fundamentals are poor. Fourth-quarter earnings were in line with expectations. But Q1 will get worse. The second quarter is also expected to get worse. This is happening across all end markets. Perhaps, with the exception of automobiles, there are some trends alongside electrification and EVs that are supporting the group. However, the fundamentals are weakening. But companies are optimistic. They believe that by the second half of this year, we should see a resumption of growth, helped in part by the reopening in China. What I would say is that earnings estimates for the sector peaked in June 2022. And since then, we've seen a 30% contraction in earnings estimates. This is the largest estimate revision in over 10 years. And so the market is starting to look further ahead, and so are companies. And they remain optimistic about the future.
Greg Bonnel: Is that the biggest risk here? Couldn't the negative optimism manifest itself in the second half of the year?
Julien Nono-Womdim: This is certainly a risk. If you think about the Great Financial Crisis, earnings estimates fell by 100%, or even 30%. Think about the early 2000s. Earnings estimates fell by over 60%, almost 70%. So the market is looking at bad news from the front end. But of course, it's a dynamic adjustment. And as we analyze Q1 and Q2 reports, we'll get a better picture of what the next 12 months will look like, and the market will adjust accordingly.
Greg Bonnel: OK, we're talking about semiconductors. Obviously, these tiny chips are found in many things, and increasingly in the things we use every day. And artificial intelligence? A lot of stocks are in Microsoft, its investment in ChatGPT. I always refer to GDP… reported economics. But ChatGPT. All this buzz around. What could this mean for the semifinals?
Julien Nono-Womdim: Well, to put it into context, ChatGPT is a chatbot, an AI-powered chatbot where people can ask questions and get very detailed answers. The technology has been around for several years, but this is the first time it's been made available to the general public. And I think from a semiconductor perspective, it bodes well for the entire industry. These models that ChatGPT is based on are computationally intensive. And then OpenAI, the company that created ChatGPT, is the first company, I think, to use more than 10,000 GPUs, which are the chips that Nvidia manufactures for training purposes. If you think about memory, this is another area that will be in high demand, as you'll need more data to feed into the models.
Greg Bonnel: Does it take 10,000 processors for ChatGPT to talk to me like a human? Because I'm not saying I'm smarter than it, I'm just using one brain—one brain.
Julien Nono-Womdim: It takes a lot of calculation, Greg. It certainly does. And historically, the semiconductor industry, believe it or not, has actually done a very poor job of forecasting long-term growth because there are always these end markets opening up. And if we're talking about chatbots, which over time can help companies interact with their customers, there are other applications in healthcare, which you and I have already discussed. There are open avenues for semiconductors to continue to grow. And I think this is another example that there will be opportunities within the industry to benefit from these structural growth drivers.
Greg Bonnel: So this is the future here and now. We know that cloud computing is a big and important part of the market. Think about Microsoft. And what do people want to know? They want the health of the cloud. Microsoft warned us earlier this week that, for example, they're seeing a slowdown, some caution among their customers. So, what could that do for chip demand in the short term?
Julien Nono-Womdim: In the short term—and we're starting to see this, as I mentioned earlier—demand for chips will certainly decline. However, there's a challenge and a struggle between existing demand and future demand. You mentioned ChatGPT. This is driving growth in the data center world, which is really the goal of cloud data center hardware. There will be some cyclicality. And I think it's important to contextualize that semiconductors are more industrial than software. They are the lifeblood of the economy. And when the economy contracts, demand for semiconductors declines. When the economy is growing, demand increases. And this is reflected in higher CapEx spending by companies. And so, in the short term, you're right that the cloud slowdown will impact semiconductor demand.
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