A reader complained yesterday that we have been too negative. While we aren’t going to go crazy and have a whole positivity day, we will take the time to outline the bull case for the industry on which we have been most negative: semiconductors.
1. The bad news is known. When we started harping about oversupply, it was the farthest thing from anyone’s mind. Like Heisenberg’s uncertainty principle, the act of observation can alter the experiment.
2. The market is ignoring the fundamentals. Related to point 1, the market knows about the bad fundamentals and doesn’t care. Often this means that the bad news is sufficiently well known to be priced in. This is of course the weakest reason, as the market ignored the fundamentals in 2000 as well.
3. Demand may be ready to pick up. Double-digit growth from a tech distributor for the first time in a long time should not be ignored. The Vista hoopla has passed, now the nuts and bolts work may be beginning.
4. Supply and demand will soon realign. For the first time since 2005, orders for new equipment grew at a slower rate than semiconductor end demand. The longer this situation continues, the healthier it will be for future industry sales, pricing and profit margins.
5. The game has changed. Forget private equity buyers. For the first time a semiconductor management team decided it was more important to take capital out of the industry than to add more. This is a sea change in semiconductor management-think, and the strong positive reaction from investors ensures that the wave will continue to build.
There. That wasn’t so hard, was it?
Lest you think we were going soft, we hereby balance our above enthusiasm for semi stocks with our more customary caution. The five reasons to avoid semiconductor stocks right now include:
1. The fundamentals will get worse before they get better. While supply indications grew slower than demand in April, the turn followed 16 months of too much capacity being ordered. As that capacity comes on line, the inventory situation will worsen and margins will get hit more. It is not at all certain that estimates reflect this.
2. It is May. Sure, sell in May and go away is a cliche. Things often become cliches for a reason.
3. Demand? What demand?
4. Valuations are too high because investors are hoping for more premium buyouts. They will happen, but not to every name in the sector.
5. The last bear may no longer be standing.
Food for thought.