Challenges And Opportunities In The Tech Selloff

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Summary

  • Is the tech selloff overdone?
  • Which semiconductor makers may benefit from the U.S. CHIPS Act?
  • Kim Parlee speaks with Jim Kelleher, Director of Research and Senior Technology Analyst at Argus Research.

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Technology stocks are having their worst start to a year on record as markets react to inflation, rising interest rates, and continuing supply chain problems. But is the selloff overdone? Kim Parlee speaks with Jim Kelleher, Director of Research and Senior Technology Analyst at Argus Research.

Transcript

Kim Parlee: Joining me now, Jim Kelleher. He's Director of Research and Senior Technology Analyst at Argus Research. Jim, it is great to have you with us. Thanks for taking the time. I don't want to spend a lot of time talking about what's happened, because I think we've all witnessed. It's been tough for tech in the past little while. But I know that you had a presentation today, and you were talking a bit about why you think the upcoming year could be different. So maybe tell me what you're seeing and what's interesting to you.

Jim Kelleher: Good evening, Kim. And thanks for having me on. Well, what we're noticing is that unlike in past sell-offs in the market, the tech sector fundamentals are holding up. The stocks, obviously, are not holding up. The market is rotated away from growth and towards cyclical, towards inflation beneficiaries, like energy, and toward interest rate sensitive. But the fundamentals have not really deteriorated all that drastically. And in fact, we expect tech earnings to rise this year and tech revenue to grow because tech companies have succeeded in passing along costs to their customers.

Kim Parlee: So tell me though, when you look in terms of what's going to be the driver going ahead, because I know that when back in the day when before, I'll say, the macroeconomic forces started, I'll say, messing with technology valuations, it was all about structural growth. There were some really interesting things happening from demographics and the cyclical side and just the nature of technology, really, growing so much. What are you seeing specifically that's going to make the fundamentals compelling enough that people want to pay attention?

Jim Kelleher: It's a great question. And so in past cyclical downturn, so you have to understand technology companies always sold to other technology companies. And they were very leveraged to what we call edge devices, meaning PCs and smartphones. That's a cyclical business. And when the economy turned down, that part of the business turned down very drastically. But what we're seeing now is something different. First of all, on the cyclical side, yes, we do expect lower PC units this year and lower smartphone units this year. But because the consumer has kind of dropped out of the low end of those markets due to inflationary pressures, we're seeing higher average selling prices for phones, higher average selling prices for PCs. And we're also seeing more content per device as we get more business users and fewer consumer users. So the revenue in this area is not going to be that bad, so that's the cyclical part. There's also a demographic element. And that's the fact that it's the rise of the global middle class. Something like 2 billion people have joined the global middle class, defined as having assets worth about $100,000, since 2000. And the first thing they want to do is have connectivity because that's really part of how you do business, and how you get jobs, et cetera. So that's the demographic part. And finally, there's a secular part. Instead of just relying on smartphones and PCs, tech companies sell to the world. So they sell factory automation, which we call IoT. They sell to the automotive industry, which is EVs and now autonomous driving. So there's much more to sell to right now. And then as my teaser, I'll say there's one other big factor going on right now.

Kim Parlee: All right. Well, I got a couple of minutes, and I want to -- if you could, because I think I know what you're going to be talking about in this next piece. But if you could use Nvidia as maybe the poster child for what you're about to talk about as well too, because whether it's near-shoring, and I think national security is a lot of part of this too, is it not?

Jim Kelleher: Well, that's exactly what we call it. We call it national security. When we had not just going back to the supply chain crisis of the past year, but going back to the trade war of 2017 through 2019, 2020, there's a realization that companies need to onshore production to have things closer to them. And so that in particular in the US, which accounts for almost half of global semiconductor revenue but only 12% of physical production, companies are now dedicating a tremendous amount of money to put new chips facilities on the ground in places like Oregon and Texas and Arizona and upstate New York and all over the place. And we estimate that spending will be over $100 billion just for US companies. And if you include Samsung and Taiwan Semi, up to $300 billion over the next two decades. And then the CHIPS Act comes along and helps to further finance this thing that was going to happen kind of anyway. But let's get to Nvidia. So Nvidia has had kind of a one-two punch. And the first punch came from them reducing their guidance for the current quarter due to a very sharp slowdown in consumer demand for gaming cards, those GeForce cards. And that greatly related to overseas weakness, whether that was in Asia, a slowdown as it were. But a lot of that is really reflective of this slowdown in accumulation by distributors. And we think that part of it will normalize. Now, more recently, Nvidia was in the news because the US announced that its A-100 and H-100 AI chips, sale of those chips will be prohibited to China. Now, Nvidia sells a lot of product to China. Those products represent the very absolute peak and crest of Nvidia technology. And even if those chips are excluded, we still see Nvidia selling a lot of technology to China, not just over the long term, but even in the intermediate term. So there are some dislocations at Nvidia related to the slowdown and gaming, which we think is partly related to the distribution channel, and then a trim off the top end related to the AI chips.

Kim Parlee: Fascinating thoughts around Nvidia. And Jim, I'd love to get you back and talk about it again, but we're at time. I'm going to remind everyone to do their own research, important. Good insights here, but you got to make sure it works for your own portfolio. Jim, thanks so much.

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Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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