ETF Overview
Invesco PHLX Semiconductors ETF (NASDAQ:SOXQ) owns a portfolio of large-cap semiconductor stocks listed in the U.S. markets. The fund seeks to track the investment results of the Philadelphia Semiconductor Index. Stocks in SOXQ’s portfolio should continue to enjoy favorable industry fundamentals as the semiconductor industry is set to grow at a rate of 6.6% annually through 2030. However, the semiconductor industry is going through a period of inventory correction and that may last through the first half of 2023. In addition, the economy remains uncertain as the aggressive rate hikes last year may tip the economy over to a recession. Hence, we think investors should wait on the sidelines.
Fund Analysis
The semiconductor industry has been faced with strong headwinds in 2022
The semiconductor industry has greatly underperformed the broader market in 2022. While investors who owned S&P 500 Index funds have endured a total loss of 18.11% in 2022, investors who owned SOXQ endured almost doubled the loss of the S&P 500. The total loss of 35.6% was abysmal. This was brutal but not totally surprising as the S&P 500 Index consists of a combination of stocks from different sectors. Some sectors such as the energy sector in the S&P 500 Index have actually benefited while many other sectors such as consumer staples, communications, and utilities sectors suffered much less of a degree of losses in 2022. On the other hand, the semiconductor industry, a subsector of the technology sector, has faced strong headwinds.
Prior to 2022, the world was having chip shortages in almost every application ranging from the MCUs used in thermometers to chips used in computers, mobile devices, etc. due to the pandemic and people working from home. As a result, semiconductor companies benefited greatly. However, this trend has quickly reversed in 2022 as the economy reopens. Except the auto industry which was still facing shortages for most of the time in 2022, chip shortage quickly turned into a chip glut. Hence, most semiconductor fabs and IC design houses have accumulated a lot of inventories. As can be seen from the chart below, inventory level surged for most of these companies in 2022.
In addition to an inventory correction, semiconductor stocks have also faced challenges due to the Federal Reserve’s efforts to fight against inflation. The aggressive rate hikes last year caused multiple compressions in semiconductor stocks. Hence, stocks in SOXQ’s portfolio also declined greatly.
Several secular growth trends should fuel the industry’s growth in the future
Despite headwinds endured in 2022, the semiconductor industry’s long-term growth outlook remains favorable. In fact, the global semiconductor market is expected to grow from $456.79 billion in 2022 to $772.03 billion in 2030 according to Precedence Research (see chart below). This represents a compound annual growth rate of 6.6%.
The favorable secular growth trend is supported by growth in a wide range of end use applications such as artificial intelligence, electric vehicles, Internet of Things, AIoT (Artificial Intelligence + Internet of Things), wireless communication devices, automation, cloud and servers, etc.
Diversifying the supply chain will also benefit semiconductor equipment companies.
The supply shortage during the pandemic has caused governments and companies in the United States, Japan and many nations in the European Union to take actions to address the issue. The goal is to make their domestic industrial capacity more self-sufficient. While full self-sufficiency is likely unattainable, de-risking and diversifying the supply chain is already underway. Taiwan Semiconductor (TSM) is currently building its 5nm fab in Arizona and has announced to further expand its base by investing $40 billion to build a 3nm fab. Besides its investment in the U.S., TSM is also already committed to invest in Japan. There are also rumors that TSM will also invest in Germany. This trend in diversifying the supply chain will spur up investments and we expect semiconductor equipment companies to benefit.
Should you own SOXQ now?
Semiconductor stocks have rebounded handsomely in 2023 year-to-date. As the chart below shows, SOXQ delivered a total return of 19.3%. This was much higher than the S&P 500’s return of 6.7%.
The question is whether it is still okay to invest in 2023. At the moment in the beginning of 2023, we are likely still in the midst of an inventory correction. As CEO C.C. Wei of TSM stated in the latest conference call in January, this inventory adjustment in the first half of 2023 will result in a healthier level of inventory. According to C.C. Wei, whether the recovery will be a V-shape or U-shape is still uncertain at the moment and remains to be seen. Many semiconductor fabs such as Intel (INTC) have also announced layoffs recently in order to control costs.
We think investors should consider two important factors when it comes to investing SOXQ in 2023. First, inventory correction is likely going to last another quarter or two. The recent surge in semiconductor stocks may already reflect investors’ optimism that the end of the tunnel is not too far away.
Second, besides inventory concerns, investors need to also consider the macroeconomic environment in 2023, which is highly uncertain. The aggressive rate hikes by the Federal Reserve in 2022 have the potential to tip the economy towards a recession. Once a recession hits, the recovery will likely not be one of V-shape but U-shape. A U-shape recovery may mean semiconductor stocks will be rangebound at best. Hence, share price gains may be limited.
Considering this risk, we think investors may want to wait for further signs of clarity. We suspect that once recession fears mount, share prices of semiconductor stocks will likely fall further. At that time, it might create a much better buying opportunity.
Investor Takeaway
SOXQ will continue to benefit from long-term secular growth trends and hence is a good investment choice for long-term growth investors. However, stocks in its portfolio are going through a period of inventory correction. While this inventory correction may not be far from over, a recession may soon follow. Given these uncertainties, we suggest investors wait on the sidelines.
Additional Disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.
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