One of the hottest topics in the financial news these days is whether the global economy is going to enter a recession. And if it is, what should we be looking for to not be caught off guard when it comes to investments in the stock market?
You may have come across a term “bellwether” during the companies’ reporting season. If you haven’t, it is a good word to know. Bellwether is a leading indicator of an economic trend. From a stock market perspective, the term is associated with a company whose earnings underscore a larger economic trend. In other words, a bellwether stock is a stock that is used to measure macro-economic activity. Between 1940’s and 1980’s there was a saying in the US “What’s good for Genral Motors is good for America”. However, as the world changes, so do bellwethers in the stock market. And in the global economy sense, there are now whole new industries that can potentially gauge its performance. One such industry is semiconductors and microchip manufacturing. In fact, this market is closely correlated to the global economic growth. Semiconductors have long been essential components for everything from refrigerators to ballistic missiles. Therefore, if the world economy is slowing down, so will the level of production by key producers in the industry, which will be evident from their quarterly reports.
Currently, the semiconductor industry is going through a crisis that mainly comes from a global slowdown and a significant drop in demand for personal computers. According to IDC data “Cooling demand and uneven supply have contributed to a year-over-year contraction of 15.0%” in the third quarter, following a 15.3% decline in the second quarter of this year. According to Citi Bank study, smartphones and PC’s make around 50% of the total demand for microchips. Therefore, decline in sales in this segment means there will be a lesser demand for those components. And the recent financial reports of the leading companies of the industry are already beginning to manifest it.
Taiwan Semiconductor Manufacturing Company (TSMC) has given concerns to investors despite posting a decent report and beating expectations. In addition to cutting its yearly investment budget by at least 10% for 2022, TSMC expressed more caution than normal regarding future demand, warning of challenges from growing inflationary pressures, projecting a decline in microchip sales in 2023 and raising concerns regarding political struggle between the US and China. It is worth noting, TSMC produces 90% of the most advanced processor microchips, which are used in everything from PCs to smartphones to datacentres.
Applied Materials, the global leader in providing equipment for production of semiconductor microchips, lowered its forecasts for the fourth quarter. However, it has to be noted that the reason for the downgrade is not related to the state of the global economy. It is to do with the regulatory prohibition in the United States to supply China with advanced technology.
And these weren’t the only negative developments to hit the sector last week. Intel, the biggest high-tech employer in Israel, is likely to commence a global restructuring plan that would result in the layoffs of thousands of employees, including those based in Israel. With the release of its financial results at the end of the month, Intel is reportedly planning to announce a wave of global layoffs that would affect thousands of workers. Some corporate divisions, like the marketing and sales department, are anticipated to reduce the workforce by as high as 20%.
In addition, AMD, American multinational semiconductor company, announced that its revenue will be significantly lower than the original forecast, due to the impact of the decline in demand for personal smartphones and computers.
So, if the global economy is slowing down based on the performance of the producers of microchips and semiconductors, what are we to expect from those companies in the interim? The demand for semiconductors is growing and there is a constant need for updating of these goods. According to Deloitte report, global semiconductor revenue could reach $600 billion in 2022, up around 8% from last year. This industry can be compared to oil production 70 years ago, when the globe needed the growth of the oil industry because there weren’t as many vehicles, airplanes, and steamships.
Typically, stocks react ahead of time rather than waiting for the performance. At this stage, the stocks have been falling for six months, and now the negative performance is becoming reflected in the reports. The negative impact on future projections and the downgrading of the outlook is the next phase, with companies’ valuations getting back in line with its fundamental values. However, the stocks likely to begin to rise before the improved performance manifests itself. Statistically speaking, it will still be at least a quarter or two before things start to improve, and this will mostly depend on the global macro-economic factors. Therefore, even though the industry as a whole is experiencing a downturn in the short term, the longer-term outlook has more reasons for optimism.