U.S.-China tensions are flaring up again, but semiconductor stocks outperformed an already-strong market Monday. And there is solid reasoning based on industry fundamentals.
The latest on the U.S.-China political spat, which now ranges far beyond economic sanctions and into the realm of military threats, is that China is threatening to put U.S. companies on its unreliable entities list, restricting those companies from doing business in the country. The White House is restricting sales of U.S. semiconductor products to Huawei, China’s premier technology giant. That’s in order to block the country from obtaining U.S. software and other intellectual property.
Still, the iShares PHLX Semiconductor ETF (SOXX) - Get Report rose as much as 4.75% Monday, beating the S&P 500’s gain of as much as 3.27%. One thing is clear for the short-term: the economic optimism boosting stocks Monday was far overpowering the potential China headwind.
Federal Reserve Chairman Jerome Powell said he thinks the economy can exhibited a fast recovery from the Coronavirus-induced recession. Plus, hopes of a vaccine hitting the market are slowly turning to a reality.
Semiconductor stocks have already performed in-line with the S&P 500’s 32% rise since its March 23 bear market low. Much of the industry is cyclical and the market is pricing in a cyclical upturn soon. And some stocks in the industry are closer to growth, with data center sales somewhat tethered to cloud spending from businesses and electric and autonomous vehicle makers demanding chips in volume. Investors have certainly tilted towards growth in many short periods of time since late March.
Weigh this against the minimal drag the U.S.-China spat would have on U.S. semiconductors and it isn’t a surprise investors are still willing to pay up to own these stocks.
Huawei chip purchases represent only about 5% of the global semiconductor market, according to research from Alliance Bernstein analyst Stacy Rasgon. In 2019, Huawei bought roughly $20 billion of chips, a drop in the bucket for each individual U.S. chip maker compared to their annual revenue steams.
“The direct impact of the growing sanctions on the industry, while not fun, is not critical in and of itself,” Rasgon wrote in a note. He did say, "the risk of escalation and retaliation remains the broader structural worry; there are already increasing concerns over potential retaliation (with some ominous news flow around China activating their so-called "unreliable" list in response), and further US action seems entirely possible (especially in combination with other recent actions including further tightening of export controls and incentivisation of US semi manufacturing).”
Tariffs on chips coming into the U.S. would pressure costs for chip makers and. Some large semiconductor makers with global manufacturing footprints have had success moving some part of their operations out of China, but moving is never exactly easy.
Holistically, many SOXX components are taking at elevated valuations. Nvidia (NVDA) - Get Report, a growth component of the fund, is trading at 42 times 2020 expected earnings per share for the next twelve months, compared to recent 5-year highs of just above 30 times. Qualcomm (QCOM) - Get Report, which has elements of both growth and value in its earnings stream, trades at 23 times next year’s EPS. That’s also high compared to its history.
Some risk elements to these stocks: fading economic optimism in the short-term, a second wave of virus infections in the U.S. or China and some drag on revenue or profit resulting escalated trade tensions.