Why semiconductors could be the comeback kings of 2023

Where do we see investment opportunity in 2023?

We are bullish on two types of assets: those that could help investors weather an economic downturn, and those whose prices already reflect that outcome. We think semiconductor stocks fall squarely in the second camp.

After the sector boomed in 2020 and 2021, propelled by a surge of consumer and corporate investments in technology, 2022 brought a swift and severe reversal. Excess inventories, increasing geopolitical tensions and rapidly shifting consumption patterns spurred an almost 50% peak-to-trough decline. But we think the worst is over for the $600 billion semiconductor industry, even as stocks have priced in the effects of a coming recession. We believe there are two reasons early 2023 presents an attractive entry point for investors: first, the growing power and scale of technology and other secular (structural) forces in the economy; and second, cyclical factors, such as the business cycle and market pricing.

Here to stay: Smarter smartphones, games and EVs

We turn first to long-term forces. Simply put, semiconductors are key components in a wide range of products, applications and services—valuable assets whatever the phase of the economic cycle. Most semiconductors are complex products dependent on a serpentine supply chain. Only a relatively few companies can claim the design and manufacturing expertise to produce the most advanced chips. Chipmakers clearly benefited from the past decade’s rapid evolution in cell phones and consumers’ seemingly insatiable appetite for more memory, faster processing speeds and more functionality.

But some observers may still underappreciate the significance of the transition from hardware memory storage to cloud computing, the exponential growth in the gaming industry, and connectivity and technology’s penetration in consumer durable products, from automobiles to thermostats. All this likely translates into strong, sustained demand for semiconductors.

Semiconductor units increasing over time
Even as shipments fell last year, semiconductors grew more powerful

Source: WSTS. Data as of October 14, 2022.

We think these structural forces will continue to boost the semiconductor sector over the next several years. Consumers still have high expectations for technological upgrades to their smartphones and computers, while companies are still investing heavily in digital transformation and cloud computing. Major players in the space require greater computational power, scale and efficiency to enhance their artificial and machine learning capabilities. Electric and next-generation automobiles can typically require twice as much chip content as traditional vehicles.

Finally, we note a global push by government policymakers to develop more resilient and secure semiconductor supply chains. The push comes in the wake of the worst months of a pandemic that exposed significant vulnerabilities in those supply chains. In the coming years, we think a range of upgrades could provide substantial support to the industry.

In the United States, the recently enacted CHIPS Act will spur investment in semiconductor research, and will develop and subsidize domestic production. Outside the United States, the European Union, Japan, Korea, India, Taiwan and, of course, China have prioritized the semiconductor industry. Still, despite government support, it will take quite some time to reconstitute a global semiconductor supply chain.

Cyclical opportunity: Weaker economic growth, better prices

While these structural supports have been in place for a while, cyclical forces have challenged the industry over the past year. In 2022, semiconductor companies contended with the most aggressive Federal Reserve rate hiking cycle in decades. They also grappled with suddenly bloated inventories (the effect of changing consumption patterns), China’s Zero-COVID policy (which has been recently lifted) and continued uncertainty over the U.S.-China relationship.

Investors pummeled semiconductor stocks in 2022. But partly as a result, we think the entry point today looks attractive.

Semis underperformed the broader market in 2022
After steep declines in 2022, the entry point for semiconductor stocks looks attractive

Sources: Bloomberg Finance L.P., J.P. Morgan Private Bank. Data as of December 30, 2022. Past performance is not a reliable indicator of future results. It is not possible to invest directly in an index.

We compared the recent downturn in semiconductor stocks to seven previous episodes. Looking at price moves, earnings expectations and P/E multiples, the industry now seems close to a cyclical bottom. The median peak-to-trough price decline has been -30% versus -46% in this episode. The median earnings estimate revision has been -23% versus -24% in this episode, and valuations bottomed at a 13x forward price-to-earnings multiple versus the median of 13.1x.

Semiconductor price corrections, trough valuations and earnings revisions in previous cycles
Historical data suggests that semiconductor stocks are close to a cyclical bottom

Sources: Bloomberg Finance L.P. Data as of December 2022.

If, as we expect, the U.S. economy goes into recession in 2023, that could likely put a damper on semiconductor sales. But China’s reopening could provide a boost. Government incentives and more investment in capacity could benefit semiconductor equipment vendors.

Historically, after semiconductor stocks hit a bottom, they tend to perform strongly in recovery. In the one- and three-year periods following a cyclical bottom, semiconductor stocks have delivered median returns of 40% and 95%, respectively.¹ That seems a signal worth heeding.

Conclusion

In 2023, investors will likely face a demanding environment as companies and consumers manage the consequences of a historic global central bank rate hiking cycle. Recession may be unavoidable. With that backdrop, as investors, we like to be assertive in areas where we feel we are being appropriately compensated to take risk. We think the semiconductor industry is among the top of that list. Given the repricing that has already occurred and the prospective returns that could be supported by friendly government policy, we think you should consider taking a close look at semiconductor stocks.

Let’s talk

Your J.P. Morgan team is here to discuss how our views on equity markets, including semiconductor stocks, might fit into your financial plan.