September proved to be a volatile month – in line with historical seasonality – and October is starting on a similar note with tech especially under pressure. What lies ahead for the markets for the rest of Q4 and where are the buying opportunities today?
In our view, the recent, quick 8% pullback means that parts of tech like semiconductors are better bought than sold.1 More broadly, positive seasonality and rebounding growth fundamentals should be on the markets’ side in Q4.
A buying opportunity for semiconductors
My advice to investors since early September has been to lighten up on expensive tech ahead of headwinds arising from the potential for higher rates and a fiscal policy trifecta of higher corporate taxes, higher taxes on foreign earnings, and higher capital gains.
Indeed, since September, the Nasdaq is down -7.35%, semiconductors are down -6.5% and the software sectors are off -6.5%, in contrast to energy, which is up +14.7% and the COVID travel recovery basket, which is +3.75%.2 While I still like positioning for more upside in energy and for an ongoing recovery in travel, technology is no longer an overbought and overcrowded sector and the risks of higher rates and the tax trifecta are now better priced.
Hedge funds have been selling Info Tech and Communication Services since May (though buying continued in software). Tech funds saw their first outflows since June 2021 as investors loaded up on financials and energy instead.3
As a result, the forward PE multiple on the S&P 500 Info Tech sector fell to 23.5x from 27x, though it remains above the five-year average of 20x. One subsector within tech – semiconductors – looks increasingly attractively priced, however. At a 17.14x forward multiple, the semiconductor sub-sector is just above its five-year average of 16.29x and all signs point to robust growth ahead.4
Demand for semiconductors likely to extend through Q4 and beyond
Semiconductors benefit from robust secular and cyclical demand and pricing power amid lower-than-average inventories. Semiconductor sales grew 31% year over year in August, for example, with average selling prices growing +12% year-over-year.5 Looking ahead, key drivers of semiconductor demand – 5G smartphone units, 5G base stations deployment, cloud capex, and the auto industry – are all expected to show substantial growth.
- Cloud/hyperscale capex is forecast to grow 18% this year followed by 15% to 20% growth in 2022.6
- Unit growth in 5G smartphones is expected to more than double this year and increase another 40% next year.7
- 2H21 U.S. telecom capex should grow 13% over the first half of 2021 and 2022E should rise another +9% YoY.8
- Auto production should return to growth of 2% this year and 9% in 2022.9
Stronger global growth is likely to provide another catalyst for the semiconductor market. Consensus estimates call for an acceleration in global growth from 5% in the third quarter to 5.6% in the fourth quarter, with emerging markets leading the charge at 7.1%.10
A decline in COVID cases should help drive this growth – and should help relieve the supply chain woes that have plagued the semiconductor industry, among others. Fewer COVID cases and fewer workers in quarantine should mean that ports can reopen, factory operations can resume, and truck drivers can turn up for work again. This should help ease supply chain bottlenecks in Q4 and beyond.
Q4 could also bring a beginning of the much-needed inventory restocking cycle as the inventory-to-sales ratio is woefully low and industrial production and new orders will have to pick up to rebuild them. The semiconductor industry restocking should continue for several more quarters, offering further support.
Finally, the fourth quarter is also a historically strong period for semiconductor demand. This is due in part to the holiday season, which produces strong sales of consumer electronic products that require semiconductor chips.11 Couple this with a continual rise in overall global demand for semiconductors and this seasonal pattern looks as though it will hold true this year.
In our view, this valuation, positioning, and growth catalyst setup, coupled with a seasonally strong period of demand for semiconductors, provides an attractive point for investors to selectively add to this sub-sector after the recent pullback.
(1) Source: Bloomberg, as Oct 5, 2021.
(2) Source: Bloomberg, as Oct 5, 2021.
(3) Source: Goldman Sachs Prime Services, as of October 1, 2021.
(4) Source: Bloomberg, as Oct 5, 2021.
(5) Source: Bank of America Research, October 4, 2021.
(6) Source: JPMorgan Research, September 20, 2021
(7) Source: JPMorgan Research, September 20, 2021
(8) Source: Bank of America Research, October 4, 2021.
(9) Source: JPMorgan Research, September 20, 2021.
(10) Source: JP Morgan Research, October 1, 2021.
(11) Source: World Semiconductor Trade Statistics, August 2021.
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