semiconductor industry

After a difficult previous year marked by market volatility and economic difficulties, the US stock market has experienced a strong recovery since the start of the new year. This recovery was driven by several key factors: the resilience of the technology sector, growth in the semiconductor industry driven by the development of AI, the expected pause in Fed rate hikes and the assessment of future rate cuts in late 2023 amid lower inflation.    The technology sector, which includes leading companies in innovation and digital transformation, has played a critical role in the market's resurgence. Industry giants such as Apple, Amazon, Microsoft and Alphabet have achieved significant stock price gains as they continue to innovate and provide products and services that meet changing consumer demands. The development of artificial intelligence technology has been a major catalyst for growth in the technology sector.   The semiconductor sector has also been one of the growth drivers of the markets. Companies such as Nvidia and AMD are experiencing strong demand for their advanced chipsets, which are vital for AI applications. The widespread adoption of AI technology across sectors has made semiconductor companies key drivers of innovation, contributing to their stock prices and overall market recovery.   The market was also supported by the expected decision of the Fed to pause its rate hikes. This pause in monetary policy tightening has helped to maintain the thesis of an end to the tightening cycle as early as H2 2023. 

Prioritise quality companies. If an investor needs to take a defensive stance, it is worth turning to quality stocks, as their robust balance sheets and stable cash flows should insulate them from unforeseen downside risk. With this in mind, many of the largest technology and Internet stocks meet these criteria, while exposure to highly cyclical sectors and companies with excessive leverage should be kept to a minimum. Thus, in order to increase the resilience of your portfolios, you should focus on high quality companies, strong dividend payers and also not forget about regional diversification, as lower valuations and a weaker US dollar can also make global stock markets outside the US attractive.   The general understanding is that the market is likely to come out of the correction this year with expectations of a continued recovery in the second half of the year and a return to a bullish trend. This recovery is expected to help recoup portfolio losses from 2022.   However, there are several factors that pose risks to the market in the near future. These risks include the potential for a bear market, which could be triggered by inflation statistics such as the PCE index and strong labour market conditions. Another risk is the narrow scope of the current rally, where only some sectors have shown growth while others, including cyclical, defensive and growth sectors and assets such as bonds, have remained weak. There is also uncertainty about the timing and severity of a possible recession this year. The market is now looking at the likelihood of a moderate recession, which is already factored into current expectations and prices.   Once there is more clarity on these risk factors, portfolio allocation can be adjusted accordingly, considering both bonds and stocks, with a focus on the second half of the year and recovery of losses incurred in 2022. Two scenarios were considered for such an adjustment:   Scenario No. 1, the positive outlook, sees the market rising and breaking through significant resistance levels of 4200-4300 in the SPX index, which would lead to a rally. In this case, it would be prudent to increase long positions. Risky stocks should be held until they reach the most likely level of local recovery, and then locked in. For positions that still have potential, they should be held. The portfolio as a whole should then be rebalanced, creating a new balanced structure with a 25% allocation to cyclical assets, 35% to growth assets, 10% to protection and 30% to bonds.   Scenario #2, the negative outlook, assumes that the market continues to decline either from the current level or below 4100. In this scenario, protection should be strengthened by using inverse ETFs and reducing long positions (using stop losses) until the target stock is reached. This approach aims to minimise further drawdown until the correction is finally resolved in 2023.   The US stock market has thus experienced a strong recovery since the start of the new year, supported by a resilient technology sector, growth in the semiconductor industry due to AI development, a strong Q1 2023 reporting season, a pause in the Federal Reserve's rate hike, expectations of future rate cuts, lower inflation, a resilient economy, a smooth economic landing and a debt limit increase. While risks are still present, a focus on longer-term investment strategies can help investors benefit from the market's upward trajectory and continued recovery in 2H.  

The emergence of advanced AI systems such as GPT-4 from OpenAI is by far the most surprising event this year, turning everything upside down. The AI-hyped rally has pushed the US equity market to new extremes, and the benefits and risk of this new technology is hotly debated. AI will also become an arms race between the US and China.   The rollercoaster year continues Going into 2023, pessimism had the upper hand, but China’s reopening optimism and early talk about AI released animal spirits, causing semiconductors, luxury and mega caps to rally double digits by mid-March. The banking crisis, led by the Silicon Valley Bank failure and takeover of Credit Suisse, reignited the calls for a recession, and the market began pricing an aggressive 150 basis points in rate cuts by the end of the year. The thinking was that the economy would finally crumble. What happened instead was a new twist on this year’s rollercoaster. Around the same time of peak pessimism around the economy and bets of aggressive rate cuts, OpenAI released its GPT-4 AI system, and the year was never the same again. Every company related to AI saw its shares take off in an AI speculative fever in an echo of past bubbles. Our semiconductor theme basket was up 17.5% by mid-March and by mid-June the basket was up 39.8%. Even more impressive, the bubble theme basket went from being up 8% to 37.8% during that same time period.      Data on the US economy is still showing economic activity below trend growth but is also not showing recession dynamics, and earnings estimates have increased substantially, especially in Europe, since the Q1 earnings season started in mid-April. US financial conditions peaked in late March at levels that can still be characterised as loose given the economic backdrop and have fallen ever since to levels that are close to the loosest since March 2022, before the interest rate shock began to tighten financial conditions significantly. The previous rate cuts before year-end have been almost priced out. In other words, as markets enter Q3, the direction of forces are pointing more towards upside risks to inflation vs current market expectations and higher policy rates rather than the ‘back to low inflation and rates’ scenario.   While the AI hype has undoubtedly unleashed animal spirits and growing optimism around the boost to productivity, it has also created a growing risk to the US equity market. Valuations on the US equity market are back to the highest levels since April 2022 and with the free cash flow yield on the S&P 500 down to 3.9%, the market is beginning to look a bit more stretched. While it is too early to call for an overall bubble, the semiconductor industry is clearly showing bubble-like behaviour, and equity valuations on semiconductor stocks are the highest since 2010, measured on the 12-month forward EV/EBITDA metric. Another risk that has come back, and something we thought would never happen again, is US equity market concentration. The rally this year has been carried by a narrow group of mega caps, as the emerging AI technology is expected to deliver the highest economic gains for the large technology stocks. The deeper issue is that the US equity market has moved to an index weight concentration we have never seen before, with the 10 largest stocks weighing 30.4% of the S&P 500 and the Herfindahl-Hirschman Index to a level 40% above the market concentration during the dot-com bubble peak. This makes the US equity market more fragile and sensitive to fewer risk factors. As a result, we have moved to a negative view on mega caps and overweight the long tail of equities vs mega caps.     The main question for global investors is still whether to reduce exposure to equities. Global equities measured by the MSCI All-Country World Index have a dividend yield of 2.3% and an estimated buyback yield of 1.2%. If we add expected real rate earnings growth of 2.2%, then the long-term expected annualised real-rate return on global equities is 5.7%. By comparison, global investment grade debt has a yield-to-worst of 3.8% but subtracting the 10-year inflation expectation of 2.5% takes the long-term expected return on investment grade bonds down to 1.2% annualised. In other words, if the investor wants to maximise long-term wealth, an overweight exposure to equities is still the most prudent.

Korea: Exports rebound for the first time in thirteen months Exports rebounded in October, driven mainly by solid vehicle and machinery exports, along with signs of improvement in chip exports, suggesting that global demand conditions are holding up well. However, the weak manufacturing PMI hints that the expected export recovery will only be modest.   Exports gain suggests global demand conditions remain healthy October exports rose 5.1% YoY (vs -4.4% in September, 6.1% market consensus) on the back of solid car (19.8%) and machinery exports. We also see some signs of improvement in chip exports as their decline moderated to -3.1% from the recent low of -44.5% in January 2023. We believe that Korean chip makers benefit the most from the recent strong demand for AI investment, and chip exports will likely rebound by the end of the year. Also, the recent rise in oil prices has boosted petroleum exports, which registered an 18% gain.  Despite growing concerns over the slowdown in developed economies, Korean exports suggest that global demand remains robust and is even recovering in some sectors. The robust exports to the US (17.3%) signal that resilient private consumption and investment may be sustained at least in the near term as EV cars, mobile devices, and machinery gained the most. However, exports to the EU declined (-10.7%) on the back of weak steel and machinery exports.  Imports dropped more than expected in October, falling by -9.7% (vs -16.5% in September, -2.1% market consensus). The recent rise in global commodity prices hasn't had much impact yet but will come through more meaningfully in the coming months. This will likely narrow the trade surplus despite the recovery in exports.    Exports rebounded but the trade surplus narrowed in October   Manufacturing PMI edged down in October The manufacturing PMI fell to 49.8 in October (vs 49.9 in September), staying below the neutral 50 level for a sixteenth consecutive month. Output and new orders gained compared to the previous month, which is a good sign for exports in the near term. However, a high level of inventories and heightened tensions in the Middle East probably dragged down other subindexes such as inventories, employment, and supplier deliveries. We expect the semiconductor industry to continue to recover with robust demand, but other consumer goods manufacturers may face strong headwinds in the near future.