Equity View: Unwind Semiconductor Short Trade

Summary

• We are unwinding our long S&P 500/short semiconductors trade.
• Since we recommended it a year ago, the SPX has outperformed by 26%.
• We think the inventory problems that have hindered semiconductors will clear in coming months.
• Meanwhile, many tech companies focused on corporate technology needs are thriving as companies upgrade systems to capitalise on cloud computing and data analytics software.

Market Implications

• We may be slightly early, but we prefer to look for opportunities to go long semiconductors.

Introduction

We are unwinding our long S&P 500/short semiconductors trade (Chart 1). We expressed this trade using the SPY ETF for the SPX and SOXX ETF for semiconductors.

We entered this trade over a year ago, on 06 October 2021. Since then, SPY has outperformed SOXX by 26%.

Semiconductor equities have underperformed largely because several large consumer-facing companies found themselves with too much inventory.

Companies that make electronic consumer goods such as PCs, smart TVs, and game consoles stockpiled chips when supply-chain problems left them unsure they could meet demand for their products during the pandemic lockdowns. When the economy opened in earnest this year, demand for electronic products collapsed as people returned to the office or shifted spending to services and travel.

That in turn forced semiconductor manufacturers such as Micron Technology (MU), Intel (INTC) and Qualcomm (QCOM) to cut production.

Inventory Problems Correct Eventually

Meanwhile, ongoing earnings reports make clear the pain in semiconductors is focused on companies that make products for consumer electronics.

Tech and semiconductor companies that focus on industrial companies have been mostly thriving. Companies have been eager to upgrade their technology, largely because of the labour shortage and a need to automate processes as much as possible, but also to capitalise on new data analytics software and cloud computing facilities.

These include, among others, Microchip Technology (MCHP), Aristo Networks (ANET), Lattice Semiconductor (LSCC), On Semiconductor (ON), Arrow Electronics (ARW), Cirrus Logic (CRUS), and CCC Intelligent Solutions (CCCS). Many of these are smaller companies and hardly household names.

But the inventory problems dogging some of the big companies will clear in time, and the opportunities that these other companies are exploiting will grow and become more important.

We may be a bit early in exiting this trade, but we prefer to look for an opportunity to go long SOXX.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)