Chips shortage: a cause for concern?
2 November 2021
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This article is personal perspective of the author and not Gate Capital. It is shared to stimulate thinking; it is not advice. If the situation is appreciated, the reader may choose to skip directly to the “take stock” section at the end of this article.
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Clarion call: alarmist or insightful?
Shortages drive up prices and create confusion, if not panics; and on occasions, calamities. One of the insidious effects of the (mis-)management of the Covid pandemic has been to seriously disrupt global Supply Chains, for everything. A disruption that continues to rumble on; fuelling inflationary pressures.
The semiconductor chip is now at the nexus of this vortex; with potentially profound impacts on associated companies, consumers and citizens. Concerns have been raised with regard to the chip shortage since March 2021: old news or is the dynamic playing out? Industry participants speak of an amelioration within 1-2 years, not months. For CEOs, the chip shortage and its cascading effects remains a Top Qudrant concern: cluster priorities 2-3-1 (see Chart 1).
Chart 1: CEO’s Keywords (source: IOT)
This article is personal perspective of the author and not Gate Capital. It is shared to stimulate thinking; it is not advice. If the situation is appreciated, the reader may choose to skip directly to the “take stock” section at the end of this article.
$1-Dollar chip for $500+ billion crisis?
There is already a very real shortage of semiconductors chips. The danger is that these chips are now found in nearly every product and service that makes up our modern digital world. Semiconductors are now a fundamental element of our daily and future lives. Arguably after air, water and food come, chips.
The Semiconductor industry itself, at USD 500 billion, is relatively small; but its indirect influence is huge. Consider that 60% of the World’s population are connected to the Internet. That percentage is a proxy (and possibly an under-estimate) of semiconductors’ economic overall economic impact.
Is a shortage of $1-dollar chip possibly threatening a global crisis of over USD500 billion? Some commentators have a more sanguine perspective.
In a digital world, chips are the lifeblood of production, so it is no surprise that the global shortage is having widespread impact. To date, the Automotive industry has been hardest hit. It for nearly 10% of total chip demand and relies on Just-In-Time practrices. It has been estimated that YTD, the industry has sufferd a USD 60 billion loss, directly attributable to the chip shortage. Chrysler has repoorted that its performance is down 30%. The Automotive industry is one of the central pillars of the global economy. In parallel, the knock-on effects to related industries and sectors as well as to Logistics providers and the myriad elements that make up the world’s intricate Supply Chain continue to cascade out. Such a development has potentially severe consequences for consumers, corporations, citizens and investors.
Anecdotal evidence.
The digital world contains gigabytes of information; almost any supposition can be supported. One needs to asses, decide and then act, or not. Inflation has arrived, but for how long?
Regardless of its duration, the “facts” on the ground are reinforcing the fact of Inflation.
A crown of broccoli at Waitrose, that was £1.00 a year ago, now retails for £1.40.
New car prices, already rising pre-Covid, have risen further (by 14%); if available. In the same period, Used car prices have increased faster (by 24%). In some case used car prices exceed those of new models.
Mattress prices have increased 35%.
With a post-Covid, WFH world; the demand for remodelling/renovation has jumped. “Utter catastrophe” in the building trade with material shortages, failing builders, extended scheduled and rising cost.
A NVIDIA graphics card, that cost USD 399 in 2020, now retails for USD 1,266.
Cargo port discharge delays have doubled in the last 6 weeks.
Delivery times have been extended to consumers from days to months. JIT systems and associated logistics have been seriously disrupted. “Free delivery” is a casualty. “Next day” in our digital, near instant gratification, service-oriented world is currently no more
Such effects and delays will have detrimental knock-on effects on corporate profits and growth prospects. Only so many costs can be passed on and even with pent-up demand unmet that demand may evaporate with time as consumers postpone and avoid non-essential spend. Some observers opine that matters will be resolved with time, 2023.
The already frothy market valuations of the Equity markets will come under pressure; especially for the Tech FAANGS. Michael Burry (of “Big Short” fame) has made his concern clear and public. He remains a cautious investor as he rotates Scion’s investments out of Tesla and ARK.
The focus of concern is now on the facilitating chips themselves and the companies that are engaged in their production.
This storm may be prolonged, with chip-infused companies exposed.
This economic as well as process disruption to semiconductor supply has been given additional jagged edges by the combination of several forces, which reinforce the current cascading momentum of disruption.
Semiconductor sector: As all other industries its goes through periods of undulating development. The Semiconductor industry has seen periods of 5x growth as well as 4x declines. The transition into a digital world with automation, algorithms, the development of blockchain, 5G roll-out, and increasing AI, etc are all driving an insatiable demand for better-faster-cheaper chips. Moore’s Law still prevails; yet the complexity, flawless performance, cost of supply for <5nm chips is immense; and not easily scalable.
Structural. The pre-Covid backlog of demand remains. Other factors include: the bespoke nature of chips and their applications; the highly concentrated number of production ‘foundries’ (the Top 3 account for 80%); the long lead times (3-5 years to bring new capacity on-stream); near full production capacity (already close to 100%); their limited locations (over 75% are in Taiwan).
Political. The bellicose posturing of China; (versus Taiwan); the recent drive by the US to support “diversity of supply,” as well as unknown implications of the questionable Digital Sales Tax (DST) initiative by governments will add to the miasma of doubt.
Capital markets. The World (and Investors) have seen scares, booms and bust before in the Semiconductor industry. Yet, many Tech companies have seen stratospheric increases in value (10-20x) most of which have occurred in the last half decade; all predicated on growth prospects (and results). As of today, many observers fear these valuations are not sustainable.
The chip shortage could well herald a “Tech stock shock”: affecting the FAANGS (the users of Tech) more than the Semiconductor firms themselves (producers). Industry, consumers and Society would suffer in such a situation.
The World has been subjected to a roiling series of crises since the Credit Crunch of 2008; and has not really had a chance to catch its breath. The concerns with Climate Change will just add further angst and uncertainty.
A scenario.
So, assume a medium-term world of shortages and price increases for things with chips. A form of hoarding or advanced purchasing could further fuel this dynamic. The imposition of a DST as well as a global corporate tax may well add a further destabilising factors and inflationary pressure. The timing of Rate hikes and Tapering actions will have their effects. Price increases are likely to be passed onto consumers; who by and large are voters. Inflationary pressures and consumer-voter dissent could well increase
The traditional stalwarts of the Tech sector, as well as those firms infused with Tech (in order to operate: so most manufacturing, logistics and service firms) could all suffer a valuation correction to varying degrees. The more resilient equity stocks will be those of companies which do not invest in technology (ie: Google, Amazon, Tesla) but which supply the technology: the foundries and their supporting firms.
In such circumstances of: a highly inflated equity markets; accelerating Inflation; the continuing pandemic repercussions; as well as political (mis)management of the economy suggest an unusually volatile investment environment.
Respected professionals and pundits have aired their concerns. ‘Y2K’ was not the calamity predicted and the Cassandras of the ‘Sub-prime” crisis were ignored for over 7 years. Recent market corrections (aka collapses) have ranged from 5-30%, with durations extending from months to years.
The obvious and predicted trigger points of change are rarely the ones that matter in reality. Usually something innocuous or unexpected is the spark.
Investors should take stock.
Technology, as an investment sector will remain important; yet the darlings of the past may not prove the safe havens they were. An Investor may consider looking at the ‘shovels’ rather than the ‘mines’ (viz: ASML vs AMD; TSM vs AAPL).
There are many Tech stocks that make up the sector. The following is an initial list of publicly quoted companies, in alphabetic order, that are at the front end of the industry. They warrant consideration in light of a Tech Stock Shock.
[Im]partial, alphabetic, list:
(Amazon), AMD, Apple, Applied Materials, ASML, Broadcomm, EPAM, Global Foundries, (Google), Intel, Lam Research, KLA, Marvell, Micron Technology, Nvidia, NXP Semiconductors, Synopsis, Taiwan Semiconductors Manufacturing, Texas Instruments, Tokyo Electron.
An Investor, with any investment asset, can then decide (if and when), to: do nothing; or rebalance; or seek-out alternative assets; liquidate and/or; re-enter at a later date.
For what it is worth, one can find Michael Burry’s portfolio here.
Just one sector, but oh so vital.
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Justin Jenk is a business professional who enjoys discovering and connecting dots.
