Semiconductors – Supercycle pt. IV

Three canaries burst into song.

• While the semiconductor companies are announcing record capital investment plans, there are signs that demand for components is starting to soften, highlighting the possibility that the semiconductor supercycle is beginning to peak.
• For the last year, demand and supply have been badly out of balance thanks to the coincidence of three factors:
  • First, the pandemic: The pandemic accelerated digitisation which combined with the economic recovery led to demand from end markets being sustainably stronger than expected.
  • Second, Supply chains which have been in complete disarray since the pandemic began to end.
  • This has led to longer turnaround times meaning that there has been less product available to meet the higher demand.
  • Third, Inventory stocking: The combination of geopolitical tensions with China and now Russia / Ukraine has led many manufacturers to stock up on components.
  • This will enable them to weather future shortages and uncertainty more effectively but has also added to the demand being experienced by the component manufacturers and semiconductor makers in particular.
• This combined with the geopolitically-driven desire to diversify leading-edge semiconductor manufacturing away from China’s sphere of influence has led to blistering increases in capital expenditure from the large manufacturers.
• TSMC and Samsung are both spending more than $40bn each this year while Intel is going to spend around $33bn on building new capacity.
• The danger with semiconductors is that the profile of supply and demand are rarely synchronised because supply is very lumpy (fabs) while demand is smooth.
• These levels of spending are likely to require that demand continues to grow rapidly to soak up all of the supply when it begins to come on stream over the next few years.
• The problem with this is that there are signs of demand beginning to soften which, if not reversed, will cause the supply-demand balance to swing wildly into oversupply.
• These canaries are:
  • First, TSMC: Mark Liu, Chairman of TSMC has stated that TSMC can see demand beginning to soften for TVs and PCs around the world but especially in China.
  • China is not a huge surprise as China’s draconian Covid-zero policy is crippling the economic recovery especially as Omicron appears to be through the safety net and looks certain to rip through the Chinese population.
  • The silver lining here is that China’s population is pretty well vaccinated and although Chinese vaccines are very poor at stopping symptoms, they are quite good at keeping patients out of hospital reasonably effectively.
  • Hence, I suspect that Omicron will put an end to Covid-zero meaning that China should open up towards the end of this year.
  • The softness is not just from China but, at the moment, TSMC still has more demand than it can cope with and so the short term outlook remains very good.
  • Second, Japanese Semiconductors are seeing signs that the inventory building that began as the pandemic was beginning to wind down is coming to an end.
  • These companies are now more comfortable with their stock levels and will purchase less in future as they buy just for end demand as opposed to end demand and inventory restocking.
  • This is a sign that I have been looking out for and suspect that it is signalling that demand growth is slowing.
  • Third, inflation: 1 out of 3 US dollars and 1 in 4 British pounds in circulation were printed since the pandemic began.
  • The problem is that it is impossible to print value and so the value of the money in circulation is now adjusting downwards.
  • This is the main reason for the inflation spikes that are being experienced pretty much everywhere.
  • Furthermore, the system is so indebted that central banks are not in a position to combat inflation properly which in many cases would require interest rates of 9% or more.
  • This would collapse both the stock market and the real estate market and therefore is political suicide meaning that high inflation is probably going to be around for several years.
  • This is how I suspect the pandemic is going to be paid for and the result of the lower purchasing power of the fiat currency in the hands of consumers will result in lower-end demand.
  • Most smartphones and consumer electronics are replaced before the end of their useful lives meaning that there is space for the replacement cycle of consumer electronics to lengthen.
  • Consequently, as the value of fiat currency falls against fixed assets, nominal prices will continue to rise which will hurt demand over the next few years.
• There are now three canaries singing in the coal mine signalling that the peak of the semiconductor supercycle currently being enjoyed is close.
• I think that as supply comes on in 2023, the balance may well tip towards oversupply and begin a downturn that is likely to be every bit as large and steep as the up leg has been for the last 18 months.
• My degree of caution on the semiconductor cycle is growing and I would continue to only be involved in the fabless sector (which does not own factories) where Qualcomm and MediaTek look both good value and relatively risk-free.