That sound you hear is the air coming out of the chip sector. Global industry sales grew five percent in the third quarter versus the year-earlier quarter, down from a growth rate of 12 percent in the second quarter. In response, the PHLX Semiconductor Index has slid more than 15 percent since Labor Day.
And we may not have even hit bottom. Analysts at Merrill Lynch believe the current slowdown in chip demand may continue into the spring, ahead of an expected upturn in the second half of 2019.
Nick Kalivas, senior equity product strategist at Invesco, points to recent earnings reports from firms such as Texas Instruments that suggest excess industry inventories need to be worked off. And he notes the slowing economy in China is hurting demand for chips in the near-term, though a resolution of the current trade spat between the U.S. and China would help sector sentiment.
Still, the current industry downturn is likely to be much more muted than previous industry cycles. That’s because there are so many new areas of technology that are driving chip demand.
Take autos, for example. Popular hybrid vehicles contain more than $900 worth of chips, according to McKinsey & Co., or three times more than in a traditional vehicle. And advanced navigation systems, enhanced safety technology and autonomous driving will boost chip content even higher.
The Internet of Things, big data analytics, artificial intelligence and 5G telecom networks are also expected to drive chip demand higher during the next few years.
“The next growth cycle will see a rise in demand for more powerful and efficient chips, especially with the expanded integration of augmented and virtual reality technology,” says Tom Bowles, research director at Defiance ETFs. “Looking further down the road, quantum computing and other game-changers will inject tremendous growth into the semiconductor industry.”
Current Reality
Investors may already be looking past the current trough, as witnessed by recent fund flow action in the VanEck Vectors Semiconductor ETF (SMH). The leading chip ETFs offer clear contrasts in terms of their industry approach, enabling investors to target a favored part of the sector.
For example, the Invesco Dynamic Semiconductors ETF (PSI) has greater exposure to small- and mid-sized chip makers. And that focus has often paid off when the chip industry’s biggest players pursue growth-through-acquisition strategies.