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Microchip Technology Is Telling the Market Something Important

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Microchip Technology has grown markedly more confident in its third-quarter sales in just the past month. The chip maker has thousands of customers in several highly cyclical industries and the positive announcement, which caught the attention of analysts, can only be a positive signal for the global economy and the market.

Microchip shares rose 6.29% to $110.20 Tuesday. The S&P 500 fell about 0.2%.

Microchip said the company now expects quarterly revenue to be between $1.281 billion and $1.288 billion, with the midpoint firmly higher than that of the prior guidance of $1.244 billion to $1.298 billion. The company said it has seen more bookings for chips than expected in December and that the strength is seen across geographies and segments. Microchip makes microcontroller and mixed-signal chips for automotive and industrial companies and data centers around the world.

Importantly, management said in the pronouncement, “Microchip is seeing strength coming from all major geographies including the U.S., Europe and Asia, as well as several major end markets including data center, industrial and automotive.” Those are highly cyclical industries. The strength indicates strong end-market demand, as companies producing items like automobiles and industrial machines may be expecting slightly higher demand. The breadth of the strength -- ranging across major economies around the globe -- also doesn't hurt.

The strength makes sense. Before the U.S. and China agreed to a phase one trade deal, investment strategists were quick to note that businesses were uncertain about demand, as the direction of tariffs were also uncertain. With phase one in the books, many expect business confidence and spending to pick up, a trend that may be showing up in Microtechnology’s announcement.

Still, while Microchip’s announcement can be viewed as a positive signal, there are a few caveats.

Several chip makers are seeing upward revisions from analysts, as chip pricing seems to be moving up from its bottom, so the industry’s expected return to revenue growth will be partly a result of an easy comparable in 2019. In late 2018, the semiconductor industry experienced an oversupply of chips, pushing prices and volumes way down.

Also, Microchip isn’t as large as it seems. While Microchip is a $26 billion (by market cap) company, that’s 5 times its expected 2020 revenue ($5.2 billion), which isn’t a cheap valuation.

But all told, Microchip is a fairly sizable company serving cyclical businesses, across the major economies of the globe. Its demand is ticking up, a positive indicator for the economy and for stocks.

Some strategists do see room to run for U.S. stocks, as the expected date of a recession has been largely pushed back past 2020 and expectations for economic growth have ticked up in the past few months.

Still, some are getting wary of the recent rally. The S&P 500 rose 27% in 2019 and the average stock trades at above 18.5 times next year’s forecast earnings, higher than the 10-year average of below 16. Monday, Canncord Genuity Strategist Tony Dwyer said he’s looking for a market correction, although he would view that as a buying opportunity.

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