Semiconductor shortage – Super size me.

This cycle is going to be bigger than normal.

• The balance between supply and demand in semiconductors has always been tricky to get right, but the pandemic has made the situation a whole lot worse which is what I suspect is at the heart of the current problems.
• The main reason why semiconductors are cyclical is because the factories that make them take a long time to build and require huge capital commitments.
• This means that supply is fixed and tends to go up or down in jumps as opposed to demand which ebbs and flows much more smoothly.
• Hence, there is often a degree of imbalance in supply and demand which creates the price fluctuations that are often seen.
• Consequently, the semiconductor companies spend a lot of time trying to forecast demand so that they can ensure that their capacity (or their bookings with the foundries) is as closely matched to demand as possible.
• The financial consequences of getting it wrong can be significant.
• The pandemic created some of the largest disturbances in demand that have ever been witnessed and so it comes as no surprise at all that forecasting demand went completely out of the window.
• The automobile industry has been the worst affected as demand for vehicles completely collapsed in H1 2020 and then recovered much more quickly than anticipated in Q3 2020.
• Back in the middle of 2020, I was more optimistic than average for short-term automotive demand given the reticence of people to use public transportation, but demand bounced back even more than I had anticipated.
• This caught the semiconductor companies unawares because the sudden collapse in automotive orders allowed them to switch capacity (which takes some time) to producing semiconductors for consumer goods.
• These have benefitted strongly from the homeworking, homeschooling and quarantine entertainment trends meaning that there was no capacity available for the automakers when demand came back more quickly than expected.
• This uncertainty has also caused device makers to increase the amount of inventory that they carry which has further exacerbated the current shortage.
• All of these things have recently coincided which, combined with how long it takes to build new capacity, is why there is such a shortage at the moment.
• Consequently, the outlook is that the shortage which is most acute in automotive but spreading elsewhere is likely to persist for at least a few more quarters.
• This will very likely then be followed by a slump as demand normalises and everyone decides to run down their inventories back to historic norms as they feel the cost of keeping working capital.
• Many in the industry think that inventories will never return to historic norms given that COVID is not going anywhere and the high level of trade tensions between the USA and China.
• This view is typical of a new situation but once one has worked out how to deal with it, the normal way of doing things tends to re-emerge.
• This is why I see COVID becoming no more problematic than Influenza (which it appears to have replaced) used to be and that everyone will go back to the office, school and move back into the cities in time.
• Hence, this is setting up semiconductors for a larger-than-usual cycle because just as demand is very strong now and inventories are rising, the downward slope on the other side is likely to be just as big as things normalise.
• There is a big dip coming but I think for at least 2 more quarters, the outlook in this sector is going to be very strong.