The chip supply chain
After the episodic but effective sanctions seen during Trump's presidency to deny Chinese 5G plays of advanced semiconductor components, there should be more sustained actions by the new administration in concert with European allies, for a redefinition of the supply chain.
This has also become urgent as a result of the COVID-led supply-chain crunch impacting the automobiles sector with more than $60 billion of losses this year, and now propagating to engulf other sectors including electronics equipment and 5G gear.
As a result, there should be grass-roots level impact on chip plays comprising the iShares PHLX Semiconductor ETF (NASDAQ:SOXX), including the fabless ones, or those with no foundry in the U.S, after having outsourced chip-making to the Far East.
For this matter, SOXX follows the PHLX Semiconductor Sector index, a capitalization-weighted index composed of the 30 largest companies primarily involved in the design, distribution, manufacture, and sale of semiconductors.
Figure 1: First 14 holdings of SOXX.
For investors, in a capitalization-weighted index, individual holdings are weighted according to their relative total market capitalization, with higher market caps like Texas Instruments (TXN) carrying a greater percentage of weights.
On the other hand, the Direxion Daily Semiconductor Bull ETF (NYSEARCA:SOXL) tracks the same index, but at three times accelerated mode, before fees and expenses.
Those who have been used to the impressive gains of the Direxion's fund should be on the watch-out for a period of uncertainty due to the central role played by the likes of Taiwan Semiconductor Manufacturing (TSM) in the chip ecosystem, and developments by Intel's (INTC) as well as Biden's proposed infrastructure plan includes $50 billion for the American semiconductor industry
The recent announcement by Intel's (INTC) new Chief Executive, Pat Gelsinger, to invest $20 billion in Arizona to expand the group's semiconductor production capacity is in line with the United States' aim to strengthen its strategic sectors. With a turnover of 76.5 billion dollars expected for the year, huge free cash flow, Intel is investing in growth in a $100 billion market.
At the helm of the group since February this year, the new CEO has an ambitious investment project to strengthen the "Made in USA" brand. Thus, to benefit from economies of scale, two new factories will be built in Arizona, at the Chandler site. In contrast with the past, Intel is dedicating its best resources to the endeavor, including creation a whole new business unit to lead the foundry project, reporting directly to the CEO.
It also plans other production sites in the United States and Europe.
There are indications that big clients like Microsoft (MSFT), Amazon (AMZN) and Google (GOOG)(GOOGL) after becoming wary of the chip shortage forcing them to adapt to the supply side, are preferring Intel's more on-demand proposal for tens of millions of processor cores to service their massive cloud infrastructures.
There is strong support in the U.S. semiconductor industry as Intel's plan is seen as promoting a more balanced supply chain for chip components essential for all the latest innovations, ranging from 5G, AI, IoT to electronic circuitry in combat aircrafts.
While demand for these components explodes, the United States produces only 12% of the electronic chips in the world, against 37% in 1990. Having become very dependent on TSMC factories, the country fears seeing its supply threatened by China's instance towards the Taiwanese island off its coast.
Figure 2: High-level view of supply chain including TSMC, at the very heart.
Source: Built by author.
Consequently, there are real risks of the U.S. or its allies being deprived of vital components in a context of rising international tensions, with a shortage of semiconductors quickly crippling part of the economy.
Being realistic, the United States is one of the most expensive places to manufacture electronics in the world and Intel itself does not have capacity to satisfy its own demand and has to expand its use of third-party fabs. Also, there are strong competition dynamics within the semis ecosystem and it is unlikely that Advanced Micro Devices (AMD) will ship its chips from Intel.
No one knows for sure how things will be in two years' time, but the only certainty is that the chips ecosystem will not be the same again with the state now becoming a more active participant.
Share price actions - SOXX
SOXX was up nearly 2.9% in the first week of April after being up 2.4% on March 31, with all 30 holdings posting gains for the session.
However, a deeper analysis of the three-months price performance reveals that not all stocks have appreciated by the same amount. Of the 30 stocks, 15 are down 10% or more from February 16, when SOXX had hit its previous all-time high.
Now, one of the stocks to have been underperforming since that time is TSM, hit by news of the Biden administration trying to adjust the supply chain. As a result, the company which was previously in a dominant position and had pricing power could become more of an ordinary player in the chip ecosystem.
Figure 3: Share price performance.
The Taiwan-based company accounts for more than 50% of chips manufactured globally as many fabless U.S. semiconductor plays outsource their entire manufacturing to it.
Looking further, TSM also has a plan to open a factory in the U.S. by 2024 for producing 20,000 wafer per month, as part of a $100 billion investment plan spanning three years. This makes the company aligned with U.S. aims of a more balanced supply chain.
Latest developments, including the U.S. government taking steps to "mend the cost differences" between Taiwan and the U.S, could also see a factory emerging on American soil rapidly.
Exploring further, Samsung (OTCPK: OTCPK:SSNLF), which already has a factory in Austin, also plans to spend $116 billion in over a decade to expand its foundry business.
This will be good news for companies like Qualcomm (QCOM) and AMD, who instead of having to revive foundry activities can count on a growing number of partners they can outsource chip-building to, while at the same time mitigating the longer East Asian route in their risk-assessment plans.
Still, the initial beneficiaries in the short term should be microchip equipment makers Lam Research (LRCX), Applied Materials (AMAT) and ASML NV (ASML). The latter's state-of-the-art EUV machines are used by TSMC, Samsung, and Intel and purchase orders takes roughly two years for delivery, coincidentally the time frame announced by Intel for implementation.
Together, with Intel, ASML's share price have witnessed the most gains for the last three months, dragging SOXX in their steps. Now, with nearly 30% exposure to foundry plays, Intel and TSM as well as chip equipment suppliers, the ingredients to fuel further upside in the iShares ETF are there.
Share price action - SOXL
As for SOXL, it has been up by a whopping 29% in the last 5 days. The three times bullish ETF has been up more than 700% since the beginning of the year and this is the reason why some investors seeking for growth have entrusted the Direxion fund with their money.
On the other hand, its path from the third week of January to the beginning of March as shown by the dark blue line has been something of a roller-coaster ride, fluctuating widely with the share price gaining or losing 30% to 50% within a matter of days.
Figure 4: Share price performance.
Now, SOXL is a leveraged ETFs seeking a return that is 300% of the return of its benchmark index for a single day. As per the issuers, the fund should not be expected to provide three times the return of the benchmark's cumulative return for periods greater than a day.
This is the reason, that for less experienced investors, it is not advisable to adopt a buy-and-hold strategy with SOXL. Its three-month path shows that the direction seems to be dictated more by TSM, especially at times when the "uncertainty" factor weighs more. However, on an overall basis, the fund has returned a 38% performance, more aligned to Intel's.
Now, this figure (38%) corresponds to much less than the 300% rise in the value of SOXX, rising by 16.64%.
SOXL's appreciation = 38% < 16.64 x 300% or 49.92%
The reason is because of the compounding effect induced by highly leveraged ETFs whereby the daily ups and downs synonymous of volatile markets result in more losses, in contrast with a period when there is a more gradual and smooth upside. Hence, it is better traded on a day to day basis and for this purpose, there have been several days when the ETF has risen by 10%.
Applauding, the recent move by the new U.S. administration, the Semiconductor Industry Association has said that Biden's spending program would invest in U.S. workers in semiconductor, manufacturing and innovation - three cornerstones of America's future strength.
While views may diverge for overall infrastructure spending and some conservatives say the industry should not be subsidized, there is broad bipartisan support for supporting the semiconductor industry, including from Republican lawmakers who view China's heavy spending to build its chip-making capacity as threatening the U.S. lead in advanced chip technology.
Hence, many investment strategists have included chip-makers on their list of companies that could benefit from the Biden plan, not only through direct support but also indirectly as a result of more spending on wireless broadband and green energy.
Exploring further, there are alternatives to SOXX and SOXL, constituted by the likes of the First Trust Nasdaq Semiconductor ETF (FTXL) and the ProShares Ultra Semiconductors ETF (USD) respectively. The latter provides two times bullish exposure to the Dow Jones U.S. Semiconductors Index. However, the big advantage of the funds I covered in this thesis are that the net assets under management (AUM) are very high as well as the average daily trading volume.
Figure 5: Comparison of key metrics.
Source: Seeking Alpha
Intel’s leveraging on external foundries by creating a new business unit called Intel Foundry Services is “too strategic to fail”, with the company already having an inside-out knowledge of silicon platforms and packaging.
Looking beyond, there should be effervescence in the semiconductor industry, propelling SOXX to new heights, $485 by the end of this year, based on a 7.7% year-over-year growth forecast by the IDC.
As for SOXL, two years is a long time and for those who like to trade the ETF, it should be impacted by news about the global chip shortage prolonged by fab activities being paused in turn hitting consumer electronics. Also, after such a vertiginous rise, a fall to the $35-36 would be an opportunity to buy.