View from the Street: When the chips are down…no one knows what’s coming next

@IainGibson

View from the Street: When the chips are down…no one knows what’s coming next

Philadelphia. Home to the Eagles (American football), the 76ers (basketball) and the, er, Phillies (baseball). The birthplace of the Declaration of Independence, Kevin Bacon and fictional heavyweight champion Mr Robert Balboa. It is also the home of a stock index that this week offered a glimpse into the potentially rocky – see what I did there? – road ahead.

Celebrating its 25th anniversary this year, the Philadelphia Semiconductor Index (SOX for short) is a capitalization-weighted index that consists of tech companies “primarily involved in the design, distribution, manufacture, and sale of semiconductors”. A semiconductor, as its name suggests, is a piece of material that conducts current and is used in the creation of chips. The SOX includes huge companies that you will know – think Intel and Qualcomm – as well as equally huge ones you might not be aware of, such as Cirrus Logic and Mellanox.

Each index member packs its own punch and the importance of these companies cannot be underestimated. Whether they operate at the raw semiconductor end or at the final chip placement end, their products drive nearly everything we use nowadays from the smartphones in our pockets to less obvious examples such as hairdryers and fridges. Their reach is pretty much unparalleled and stock is always in high demand from both institutional and retail investors.

There is another reason for the index’s profile, however. The general view among analysts is that the performance of a company plugged into the semiconductor space is usually a strong indicator of wider economic trends, either current or imminent. The SOX can be analysed as a marker of numerous inclinations, such as consumer demand for smartphones or whether businesses are investing in new hardware. When I worked in the Middle East, several clients had substantial stakes in a number of semiconductor/chip companies, ranging from the US to Taiwan, so watching the performance of the SOX was a regular habit. A good week solicited smiles, a less-than-satisfactory seven days was often met with a grimace or sharp intake of breath.

You can probably guess where this is headed. As detailed neatly by the Financial Times, this week has seen a number of SOX members sound the alarm. Big hitters such as Texas Instruments, STMicroelectronics and AMD all gave less than stellar revenue projections on their latest quarterly earnings, leading to falls in their share prices ranging from 8-30%. These developments had been preceded by equally poor projections from AMS, an Austrian chipmaker which is a supplier to Apple. Weaker demand and falling prices were cited as key drivers, as well as uncertainty stemming from what looks to be a long and bitter trade war between the US and China. ‘Soft demand’ was the buzzword of the day.

And so the contagion spread. Every single stock on the SOX fell and thus the index took a battering, dropping by as much as 10%. At the time of writing, the SOX is still down nearly 20% from two months ago when it was riding on a high, having doubled its performance since summer 2016.

What will happen next? Wiser, and certainly richer, people than me don’t yet have an answer. There are legitimate questions being posed, such as whether the SOX companies are merely catching up with the wider market retrenchment we have seen in October, rather than acting as a harbinger of a significant future downturn. Perhaps we are seeing chip stocks return to the cyclical nature that some hoped had been banished by a strong performance over the past two years. One thing’s for sure; when the alarm is sounded by an industry that serves as the backbone to how most of us live our lives and as a bellwether of wider economic sentiment, we need to listen very carefully.