Technology
Communications equipment stocks broke out of a long-term downward sloping trend-line on the back of productivity improvement this summer, powered by a marked productivity improvement. Indeed, our productivity proxy, defined as sales/employment, is growing rapidly. These trends were supportive of profit margins, and at least a modest valuation re-rating from washed out levels. Nevertheless, our confidence that a major bullish trend change has occurred after years of underperformance has been shaken. The budding reacceleration in top-line growth has hit a snag. New orders for communications equipment have rolled over relative to inventories. Investment in communications equipment has dipped. The telecom services sector has scaled back capital spending (third panel), suggesting that final demand will continue to soften. It will be difficult for companies to maintain high productivity if revenue growth stagnates. Consequently, the most likely scenario is that relative performance is entering a base-building phase rather than a new bull market, warranting a reduction to benchmark weightings. The ticker symbols for the stocks in this index are: BLBG: S5COMM - CSCO, MSI, HRS, JNPR, FFIV.
As a long duration sector, technology has struggled since Treasury yields began to surge. This likely marks the onset of a major trend change. Tech pricing power has nosedived and domestic deflationary pressures are likely to intensify as the U.S. dollar appreciates, particularly against the manufacturing and tech-sensitive emerging Asian currencies. While the tech sector and the U.S. dollar have typically been positively correlated during the initial stages of a currency bull market, history shows that this relationship becomes untenable the longer currency appreciation persists. In the final phase of the past two U.S. dollar bull markets, tech stocks have abruptly reversed course, rapidly ceding the previously accrued gains. Apart from a loss of competitiveness from currency strength, the new anti-globalization trend is bad for tech as it has the highest foreign sales exposure. Tech sales growth is already sliding rapidly toward negative territory, with no reprieve in sight based on the contraction in emerging market exports, as well as U.S. consumer and capital goods import prices. The bottom line is that there is no rush to lift underweight tech sector allocations.
Highlights Portfolio Strategy If the Fed is about to begin interest rate re-normalization in earnest, then investors should heed the message from historic sector performance during tightening cycles. The tech sector remains vulnerable to tighter monetary conditions. Downshift communications equipment to neutral and stay clear of software. The OPEC supply agreement reinforces our current energy sector bias, overweight oil services and underweight refiners. Recent Changes S&P Communications Equipment - Reduce to neutral. Table 1 Feature Chart 1Why Is Equity Vol So Low? The equity market has been in a remarkably low volatility uptrend in recent weeks, powered by hopes that political regime shifts will invigorate growth. Signs of economic life have also played a role. The risk is that investors have pulled forward profit growth expectations on the basis of anticipated fiscal stimulus that may disappoint. In the meantime, the tighter domestic monetary conditions get, the less likely equity resilience can persist, especially in the face of rising instability in other financial markets. Volatility has jumped across asset classes, with the bond market leading the charge. The MOVE index of Treasury bond volatility has spiked. Typically, the MOVE leads the VIX index of implied equity market volatility (Chart 1, second panel). Currency and commodity price volatility has also picked up. It would be dangerous to assume that the equity market can remain so sedate. If the economy is about to grow in line with analysts double-digit profit growth expectations and/or what the surge in some cyclical sectors would suggest, then a re-pricing of Fed interest rate hike expectations is likely to persist. Against this backdrop, it is instructive to revisit historic sector performance during past Fed tightening cycles. If one views the next interest rate hike as the start of a sustained trend based on the steep trajectory of expected profit growth embedded in valuations and forecasts, then it is useful to use that as a starting point rather than last year's token 'one and done' interest rate hike. Charts 2 and 3 show the one-year and two-year average sector relative returns after Fed tightening cycles have commenced. A clear pattern is evident: defensive sectors have been the best performers by a wide margin, followed by financials, while cyclical sectors have underperformed over both time horizons. To be sure, every cycle is different, but this is a useful frame of reference for investors that have ramped up growth and cyclical sector earnings expectations in recent months. There has already been considerable tightening based on the Shadow Fed Funds Rate, a bond market-derived fed funds rate not bound by zero percent (Chart 4, shown inverted, top panel). The latter foreshadows a much tougher slog for the broad market. The point is that tighter monetary conditions can overwhelm valuation multiples and growth expectations. Chart 212-Month Performance After Fed Hikes Chart 324-Month Performance After Fed Hikes Chart 4A Blow-Off Top? The violent sub-surface equity rotation has presented a number of rebalancing opportunities. The defensive health care and consumer staples sectors have been shunned in recent weeks, with capital rotating into financials and industrials. As discussed previously, the industrials and materials sectors cannot rise in tandem for long with the U.S. dollar. These sectors should be used as a source of funds to take advantage of value creation in consumer discretionary, staples and health care where value has reappeared. Chart 5It's Not A ''Growth'' Trade Indeed, the abrupt jump in the cyclical vs. defensive share price ratio appears to have been driven solely by external forces, i.e. the sell-off in the bond market, rather than a shift in underlying operating profit drivers. For instance, emerging market (EM) equities and the cyclical vs. defensive share price ratio have tended to move hand-in-hand (Chart 5). The former are pro-cyclical, and outperform when economic growth prospects are perceived to be improving. Recent sharp EM underperformance has created a large negative divergence with the U.S. cyclical vs. defensive share price ratio. The surging U.S. dollar is a growth impediment for many developing countries with large foreign debt liabilities, and the lack of EM equity participation reinforces that the recent rise in industrials is not a one way bet. As a result, our preferred cyclical sector exposure lies in the consumer discretionary sector, and not in capital spending-geared deep cyclical sectors. A market weight in financials, utilities and energy is warranted, as discussed below, while the tech sector is vulnerable. A Roundtrip For The Tech Sector? After a semiconductor M&A-driven spurt of strength, the S&P technology sector has stumbled. As a long duration sector, technology has borne a disproportionate share of the backlash from a higher discount rate, similar to the taper-tantrum period in 2013. Then, bond yields soared as the Fed floated trial balloons about tapering QE. Tech stocks did not trough until yields peaked (Chart 6). In addition, a recovery in tech new orders confirmed that the sales outlook had brightened. Now, the capital spending outlook remains shaky, and tech new order growth is nil (Chart 6). Meanwhile, tech pricing power has nosedived (Chart 6). Domestic deflationary pressures are likely to intensify as the U.S. dollar appreciates, particularly against the manufacturing and tech-sensitive emerging Asian currencies. Tech sales growth is already sliding rapidly toward negative territory (Chart 7), with no reprieve in sight based on the contraction in emerging market exports, as well as U.S. consumer and capital goods import prices. Chart 6Tech Doesn't Like Rising Bond Yields Chart 7No Sales Growth True, tech stocks have a solid relative performance track record when the U.S. dollar initially embarks on a long-term bull market (Chart 8). Why? Because tech business models incorporate deflationary conditions, investors have been comfortable bidding up valuations in excess of the negative sales impact from a stronger U.S. dollar. Nevertheless, history shows that this relationship becomes untenable the longer currency appreciation persists. Chart 8 shows that in the final phase of the past two U.S. dollar bull markets, tech stocks have abruptly reversed course, rapidly ceding the previously accrued gains. Apart from a loss of competitiveness from currency strength, the new anti-globalization trend is bad for tech as it has the highest foreign sales exposure. The bottom line is that there is no rush to lift underweight tech sector allocations. In fact, we are further tweaking weightings to reduce exposure. For instance, software companies are worth another look through a bearish lens. Software sales growth is at risk from pricing power slippage amidst cooling final demand (Chart 9). Chart 8Beware Phase II Of Dollar Bull Markets Chart 9Sell Software... The financial sector is an influential technology sector end market. On the margin, financial companies are likely to reduce capital spending on the back of deteriorating credit quality. Chart 9 demonstrates that when financial sector corporate bond ratings start to trend negatively, it is a sign that software investment will stumble. A similar message is emanating from the decline in overall CEO confidence (Chart 10), which mirrors the relentless narrowing in the gap between the return on and cost of capital (Chart 8, bottom panel). Even C&I bank loans, previously an economic bright spot, are signaling that corporate sector demand for external funds and working capital are softening, consistent with slower capital spending. Against a backdrop of fading software M&A activity, we are skeptical that the S&P software index can maintain its premium valuation (Chart 11). Chart 10... Before Sales Erode Chart 11Not Worth A Premium Elsewhere, the communications equipment industry will have trouble sustaining this summer's outperformance. Communications equipment stocks broke out of a long-term downward sloping trend-line on the back of productivity improvement. Chart 12 shows that after a period of intense cost cutting, wage inflation was negative. Our productivity proxy, defined as sales/employment, is growing rapidly. These trends are supportive of profit margins, and at least a modest valuation re-rating from washed out levels. Nevertheless, our confidence that a major bullish trend change has occurred after years of underperformance has been shaken. The budding reacceleration in top-line growth has hit a snag. New orders for communications equipment have rolled over relative to inventories. Investment in communications equipment has dipped (Chart 13). The telecom services sector has scaled back capital spending (Chart 13, third panel), suggesting that final demand will continue to soften. It will be difficult for companies to maintain high productivity if revenue growth stagnates. Chart 12Productivity Strength... Chart 13... May Be Pressured Consequently, the most likely scenario is that relative performance is entering a base-building phase rather than a new bull market, warranting benchmark weightings. Bottom Line: Reduce the S&P communications equipment index (BLBG: S5COMM - CSCO, MSI, HRS, JNPR, FFIV) to neutral, in a move to further reduce underweight tech sector exposure. Stay underweight software (BLBG: S5SOFT - MSFT, ORCL, ADBE, CRM, INTU, ATVI, EA, ADSK, SYMC, RHT, CTXS, CA). Energy Strategy Post-OPEC Production Cut Chart 14Energy Stocks Need Rising Oil Prices The energy sector continues to mark time relative to the broad market, but that has masked furious sub-surface movement. We have maintained a benchmark exposure to the broad sector since the spring, but shifted our sub-industry exposure in October to favor oil field services over producers, while underemphasizing refiners. OPEC's recent agreement to trim flatters this positioning. Whether OPEC's announcement actually feeds through into meaningfully lower production next year and higher oil prices remains to be seen, but at a minimum, supply discipline should put a floor under prices. Rather than expecting the overall energy sector to break out of its lateral move relative to the broad market, we continue to recommend a targeted approach. The energy sector requires sustained higher commodity prices to outperform, and our concern is that a trading range is more likely (Chart 14). OPEC producers suffered considerable pain over the last two years as they overproduced in order to starve marginal producers of the capital needed for reinvestment. U.S. shale producers slashed capital expenditures by 65% from 2014 to 2016, and the International Oil Companies (IOCs) cut capital expenditures by 40% over the same period. Chart 15 shows that only OPEC has been expanding production. That has set the stage for limited global production growth, allowing for demand growth to eat into overstocked crude inventories in the coming years. OPEC's decision to trim output should mitigate downside commodity price risks, providing debt and equity markets with confidence to increase capital availability to the sector. With a lower cost and easier access to capital, producers, especially shale, will be able to accelerate drilling programs. The rig count has already troughed. The growth in OECD oil inventories has crested, which is consistent with a gradual rise in the number of active drilling rigs. As oversupply is absorbed, investment in oil field services will accelerate, unlocking relative value in the energy services space (Chart 16). Chart 15OPEC Cuts Would Help... Chart 16... Erode Excess Oil Supply This overweight position is still high risk, because it will take time to absorb the excesses from the previous drilling cycle. There is still considerable overcapacity in the oil field services industry, as measured by our idle rig proxy. Pricing power does not typically return until the latter rises above 1 (Chart 17). Companies will be eager to put crews to work and better cover overhead, and may accept suboptimal pricing, at least initially. Meanwhile, if EM currencies continue to weaken, confidence in EM oil demand growth may be shaken, eroding valuations. Still, we are willing to accept these risks, but will keep this overweight position on a tight leash and will take profits if OPEC does not follow through with plans to limit production. On the flipside, refiners will not receive any relief in feedstock prices, which should ensure that the gap between Brent and WTI prices remains non-existent (Chart 18). That is a strain on refining margins. Our model warns that there is little profit upside ahead. That is confirmed by both domestic and global trends. Chart 17Risks To A Sustained Rally Chart 18Sell Refiners Chart 19Global Capacity Growth Refiners have continued to produce flat out, even as domestic crude production has dropped (Chart 18). As a result, inventories of gasoline and distillates have surged, despite solid consumption growth. In fact, refined product output is about to eclipse the rate of consumption growth, which implies persistently swelling inventories. There is no export outlet to relieve excess supply. U.S. exports are becoming much less competitive on the back of U.S. dollar strength and the elimination of the gap between WTI and Brent input costs (Chart 19). Moreover, rising capacity abroad has trigged an acceleration of refined product exports in a number of low cost producer countries, including India, China and Saudi Arabia (Chart 19). Increased global refining capacity is a structural trend, and will keep valuation multiples lower than otherwise would be the case. The relative price/sales ratio is testing cyclical peaks, warning that downside risks remain acute. Bottom Line: Maintain a neutral overall sector weighting, with outsized exposure to the oil & gas field services industry (BLBG: S5ENRE - SLB, HAL, BHI, NOV, HP, FTI, RIG), and undersized allocations to the refining group (BLBG: S5OILR - PSX, VLO, MPC, TSO). Current Recommendations Current Trades Size And Style Views Favor small over large caps and growth over value.
After a semiconductor-driven, M&A related relative performance surge, the S&P technology sector has stumbled in recent weeks. The sell-off bears some similarities with the taper-tantrum period in 2013. Then, bond yields soared as the Fed floated trial balloons about tapering QE. As a long duration sector, technology bore the brunt of the backlash from a higher discount rate. Tech stocks did not trough until yields peaked. Moreover, in that period, BCA's Capital Spending Indicator had firmed while tech stocks were being sold off, signaling that corporate sector tech demand would soon improve. A recovery in tech new order confirmed that the sales outlook had brightened. Now, the capital spending outlook remains shaky, and tech new order growth is nil. Meanwhile, tech pricing power has nosedived. Deflation pressures are likely to intensify as the U.S. dollar appreciates. The bottom line is that there is no rush to lift underweight tech sector allocations.
Feature Today’s Insight is a Special Report written by BCA’s Senior Technology Strategist, Brian Piccioni. Brian discusses the reasons for ongoing M&A in the semiconductor industry, and the investment implications. We trust you will find this report insightful and informative. Semiconductor Consolidation Makes Sense But Changes Little We have written extensively about our stance against financial engineering through M&A in the high tech sector.1 However, we view the semiconductor space as somewhat of an anomaly. Unlike most tech goods, a large portion of semiconductor products generate revenues for many years, even decades, after they are first released. Although most of the development costs of these devices are depreciated in the first few years after introduction, price deflation continues. This means that for most such devices, margins do not rise to a very high level. In addition, incremental costs may be associated with "die shrinks" (making smaller devices with the same function), and changes in IC packaging, as the cost of the package can be more than the semiconductor itself. In addition to the inherent benefits of buying a company that makes a product line with long duration revenues, most semiconductors are sold through the same channels and have similar, if not identical, customers. This can allow for the rationalization of sales and marketing efforts. On the surface it might appear there is an opportunity for economies of scale in manufacturing, but these can prove elusive. It is often not worth the effort to consolidate manufacturing for an acquired company due to large differences in manufacturing processes. This is especially true since it would require an investment in R&D for a catalog of mostly dated products. These products would have to be "re-qualified" by customers, as there is no guarantee parts produced in a different factory will function the same as the old one. While most high tech M&A destroys shareholder value, that is less likely to be the case when two mature semiconductor companies combine (Chart 1). However, industry consolidation is not likely to lead to pricing power or unusual profitability post consolidation because: Semiconductor buyers are reluctant to adopt a product made by only one vendor; There is a powerful push for the adoption of technologies based upon Open Standards in order to avoid semiconductor vendors having too much power over customers; and For the most part, with the exception of leading edge process technology used in CPU and commodity memory devices, semiconductor expertise is well understood and widely available, as are the tools for the development of new devices. Total Intangible Asset Writedowns And Restructuring Charges As A Percent ##br##Of Assets By S&P 500 Tech Sub-Sector, 2000 - 2016 Semiconductor Buyers Are Reluctant To Adopt A Product Made By Only One Vendor Large device manufacturers always had an aversion to single sourced semiconductors but exceptions were made when there was a critical need or simply no other choice. For example, if you are going to design a PC you are either going to use a single-sourced device from Intel or AMD. Things changed after the "Dot Com" bubble when equipment manufacturers found themselves unable to ship finished products because a single-source vendor had declared bankruptcy and the parts were no longer being made. Even when a single source part is specified, an effort is made to ensure there are substitutes available. This hedges against the possibility the part may no longer be available and also reduces vendor pricing power. Powerful Push For The Adoption Of Technologies Based Upon Open Standards Open standards are standards where form, fit, and function, are both defined and easily referenced. The standard itself is typically inexpensive to license and any related Intellectual Property is available for license on "fair and equitable" terms, meaning that the price is reasonable and the same for all licensees. Open standards have a long history in the semiconductor industry. The market for certain devices such as memory chips would likely have never developed if every vendor had a different way of doing things. Nevertheless, companies such as Intel were able to establish a proprietary standard CPU architecture and profited handsomely as a result. Similarly, purported abuses by companies such as Rambus and Qualcomm have resulted in all players being leery of patent suits. It is now very difficult to get manufacturers to accept a new standard unless it is open. Difficult To Benefit From Competitive Advantage, Even For Largest Players The components sold by most small semiconductor companies do not require cutting edge process technology or expertise. The largest companies such as Intel, Samsung, and TSMC may have an advantage due to their process R&D, but competition among themselves limits returns. In addition, there are very few "must have" products nowadays, and consumers and businesses can typically decide to simply not purchase a new PC, video game, etc., if prices get out of hand. Industry Consolidation Will Not Fuel Growth As we have frequently noted, semiconductor industry growth has slowed to GDP plus or minus a few points (Chart 2). The industry operates within the context of chronic high price deflation, meaning many more units have to be sold each year just to keep revenues flat. Some end markets allowed for the sale of higher value-add components with increased functionality, offsetting some of the deflation. However, the era of hyper growth in PCs, networking gear and smartphones is in the past. This places downward pressure on pricing through the value chain. Chart 2Semiconductor Industry Growth Has Slowed, ##br##Now Near GDP Growth Rate Loosely speaking the industry can be separated into commodity semiconductors and proprietary ones. Commodity devices are exact functional equivalents to devices sold by multiple vendors. Examples might be discrete devices such as transistors and diodes, memory chips, logic devices, and so on. The competition in commodity semiconductors is so extreme that for some products package costs can be similar to the cost of the semiconductor itself and saving a small amount of plastic or using slightly thinner leads influences profit margins. The product life of many commodity products extends to decades. The market for proprietary semiconductors is somewhat more complicated than for commodity devices. Intel is the prototypical example of a company that makes mostly proprietary devices, though Qualcomm, Xilinx, and others exist. Some companies such as Texas Instruments are a sort of hybrid, offering both commodity and proprietary products. It would be a mistake to assume that proprietary vendors have no competition, because substitutes are typically available. A smartphone vendor can select a high end ARM-based microprocessor from Qualcomm, make its own, or buy from any number of licensees selling similar devices, depending on the market segment and price range it is targeting. This has the effect of limiting the price of a proprietary device and the associated margins. As with any M&A transaction the opportunity arises to take associated restructuring charges, write-downs, and all manner of "one-time" items which can make "non-GAAP" earnings look better than before. Similarly, management may decide to cut costs by reducing R&D and other expenses to improve near-term performance at the expense of long term results. Company managers typically highlight "synergies" and "complimentary businesses" when selling their latest M&A transactions. Nevertheless, it is rare that the combination of two semiconductor companies actually amounts to something greater than what the two were apart. Instead, what tends to result is a mix of products and activities with varying degrees of margins and growth potential. Like any overly diversified portfolio, the combined companies are more likely to grow at the same rate as the industry than to become high-tech powerhouses. In summary there is no reason to believe that organic revenue growth will arise as a consequence of any particular semiconductor M&A transaction and it is far more likely that revenue growth and margins will trend towards the mean for the industry, setting aside the impact of "non-GAAP" adjustments. Why Is There A Buyer's Panic? As we have shown, in most cases industry consolidation will not provide much in the way of operational leverage to the consolidator's results. Similarly there is little reason to believe that companies which remain independent will be affected positively or negatively from the trend.2 This raises the question of why these transactions are occurring at such a frenetic pace. Most likely the answer has more to do with capital market trends than objective business decisions. Investors have elected to reward high tech companies for financial engineering on an equal footing with organic growth (i.e. innovation), and the capital is very cheap nowadays (Chart 3). As we have addressed previously, increasingly imaginative "non-GAAP" financial presentation means that overpaying for an acquired product line is better for the bottom line than developing it in house, so managers are focusing more on financial engineering than actual engineering. Cheap capital and less-than-rational capital markets mean that companies become acquirers or targets. As companies get larger, the targets need to be large enough to "move the needle" with respect to financial impact. This goes all the way down the food chain as mid-cap companies buy small-cap companies and large cap-companies buy mid-cap companies. There are a finite number of target firms for any given company and this creates a sort of "buyer's panic" which stimulates the buyers to move quickly before the target is acquired by a rival (Chart 4). As acquirers get bigger they become the targets of larger acquirers, as they are now large enough to provide the illusion of growth. Chart 3Capital For Financial Engineering Is Cheap Chart 4'Buyer's Panic' In Semiconductor Industry Non-S&P 500 Semiconductor Companies Are Also Targets Unless the cost of capital rises significantly or investors suddenly get concerned about actual operating results rather than "non-GAAP" performance, consolidation will continue until there is a relatively modest number of large semiconductor companies. As we explained above, this does not mean these companies will have superior margins or revenue growth. Indeed we believe the end of the consolidation period will have negative impact for semiconductor industry valuations because: Opportunities for financial engineering of revenue growth and managing "non-GAAP" earnings will be limited; Balance sheets will typically be highly leveraged; and Valuation premiums associated with M&A activity will disappear. Until the consolidation phase runs its course investors should be able to profit by assembling a portfolio of smaller names since these are more likely to be acquired. This is a major reason we have most of the smaller members of the S&P 500 Semiconductor sub-index rated Overweight. Table 1Summary Of Potential Semiconductor Targets We have identified 14 additional small semiconductor firms that are not included in the S&P 500 as likely targets (Table 1). This list is not exhaustive but represents companies which are both likely to be acquired and large and liquid enough to be investible. We selected the most attractive companies based on the Price-Earnings-to-Growth (PEG) ratio, which attempts to adjust valuation for growth prospects. These companies, which have a PEG ratio close to or below 1, are bolded in Table 1 above. We are adding these 10 companies to our Overweight list, and will track these recommendations as an equally-weighted index (Chart 5). Chart 5Small Semiconductor Companies Should ##br##Outperform Due To M&A However, due to the "buyer's panic" described above, companies that appear expensive or exhibit deteriorating financial performance are also potential acquisition targets. As such, it is important to note that our recommendations in this sub-sector are not driven by company fundamentals. Alternatively, investors might consider playing consolidation through the iShares PHLX Semiconductor ETF (SOXX). The structure of this ETF limits the weight of each constituent to approximately 8%, effectively overweighing smaller firms. Brian Piccioni, Vice President Technology Sector Strategy brianp@bcaresearch.com Paul Kantorovich, Research Analyst paulk@bcaresearch.com 1 Please see Technology Sector Strategy Weekly Report, "Tech Company Red Flags Part 2: Intangible Assets And Restructuring Charges," dated July 12, 2016, available at tech.bcaresearch.com 2 That would not be the case if, for example, Hynix and Samsung, two major DRAM manufacturers, were to merge which would be problematic for the #3 player Micron. However, we doubt regulators would permit such a merger.
The technology sector has spiked higher of late, supported by the merger premium in semiconductor stocks. However, the fundamental justification for the recent valuation expansion remains shaky. Tech sales growth remains non-existent. A dearth of new order growth and the ongoing contraction in Asian exports warn that it is premature to position for a recovery in top-line performance. That is confirmed by the impending corporate sector retrenchment, as the steady narrowing in the gap between the return on and cost of capital warns that business investment on tech goods will stay sluggish. Consumer spending on tech has been the lone bright spot, but even that has mostly been moving in line with overall consumption in recent years, not enough to deliver sales outperformance. As a result, fading recent tech strength makes sense, given vulnerability to a valuation squeeze.
While the corporate sector has run up debt levels and is struggling to generate profit growth, consumers have rebuilt their savings and are enjoying the benefits of a positive wealth effect. The increase in real wage and salaries growth is supporting consumer income expectations, according to the latest consumer confidence survey (top panel). The implication is that consumption-oriented plays should be well positioned to deliver profit outperformance. Consumer finance stocks provide an attractively valued play on this theme, as does the S&P data processing index. The latter is levered to total transaction volumes, and a healthy consumer should translate into positive sales momentum. We are overweight both indexes.
The frenzy in semiconductor stocks has reached an overshoot phase. Relative performance had been buoyed by a flurry of M&A activity, but that has since waned without a similar response in share prices. If fundamentals return as the main driver, then a setback is probable. Our concern is that the inventory overhang continues to linger. Our proxy for global semiconductor inventories continues to grow, albeit at a slowing rate. Still, the semi sales-to-inventory ratio is deep in negative territory, which is typically deflationary and a harbinger of semiconductor profit contraction (bottom panel). That is confirmed by ongoing sluggishness in Taiwanese and Korean export and export price growth (second panel). The implication is that the surge in semi stocks is vulnerable to an abrupt reversal and an underweight position is warranted. The ticker symbols for the stocks in this index are: BLBG: S5SECO - INTC, QCOM, TXN, AVGO, NVDA, ADI, MU, SWKS, LLTC, MCHP, XLNX, QRVO, FSLR.