Semiconductor stocks 'have a way of smelling' future market downturns ahead of time: Analyst

Bank of America Senior Semiconductor Analyst Vivek Arya assesses the outlook of semiconductor stocks amid waning demand and export restrictions on China

Video transcript

RACHELLE AKUFFO: Well, chip stocks are falling today after the Biden administration announced clamping down on China's access to chip technology. Meanwhile, the world's top maker of memory chips, AMD and Samsung, are sparking fears that a slump in semiconductor demand could be much worse than expected.

Let's bring in Vivek Arya, Bank of America senior semiconductor analyst to take a look at all of this. So Vivek, welcome back to the show. What should we take from this? When we look at some of the chipmakers that are down the most year-to-date, led by NVIDIA, what is it that concerns you about the trend you're seeing right now?

VIVEK ARYA: Yeah, thank you very much for having me. I think the semiconductor industry is one that makes us feel very profitable and productive for three years in a row, and then just makes us feel awful in that fourth year. And it seems like we are in that fourth year. The specific things that are causing the headwinds this year are threefold.

First, there is just enormous pressure on the consumer because of all the inflationary issues, because of all the turmoil in Europe, because of the lockdowns in China. Secondly, we have the specter of rising rates, which is never good for valuations in high beta, high multiple sector. And then on top of it, as you mentioned, there are some additional restrictions on semiconductor companies in terms of shipping to China.

And look, China is the largest customer for semiconductors, then it's never good to have friction between the largest designer of semis, which is the US, and the largest customer. So I think where we are today, when I put it all in the context, is the semiconductor stocks have a way of smelling the turn in the economy 6 to 9 to 12 months before it happens.

So last November when semiconductor stocks peaked, there was no talk of recession. The same way, there is no talk of an upturn or the next cycle today. So our assumption is that compare stock to get easier for the sector next year. And if that is the assumption, and if that's the right assumption, we think semiconductor stocks can try and find a bottom sometime in Q4. And meanwhile, the valuations are starting to look very interesting for what is a very profitable industry.

SEANA SMITH: So Vivek, that's interesting just in terms of what you said to export restrictions, and then taking that in coupling that with your predictions here, your expectations for this space going into 2023. So it sounds like you view it as a challenge here in the near term, but you don't think it's going to have a significant impact in terms of sales. Is that right?

VIVEK ARYA: Yeah. So let's talk about those restrictions. So first of all, as I mentioned, friction is never good between the largest designer and the largest buyer of semiconductors. But when you take a step back, the majority of chips that are shipped to China are actually for a lot of consumer applications.

They are for smartphones, they are for PCs, they are for a lot of low end consumers, speakers, and so forth. Like the largest buyers of semis in China are not supercomputing or military companies. They are companies like Oppo, Vivo, Xiaomi, Lenovo, ZTE. So it's not really supercomputing.

In fact, if I take the entire supercomputing and military end use market for semiconductors globally, it is not more than 5% or 10% of in demand. And even if you assume half of it is in China, which is a very big number, it still says that there is not more than a 5% or so headwind.

Second point I would mention is that we have to be careful when we use the term restriction. So what is happening is that there is a set of rules that now forces a lot of semiconductor companies to first go and ask for approvals. So they are not actually banned outright from shipping. They have been given this extra step to go and verify that the end customer is not a military end use customer or a supercomputing customer that might be on an entity list.

Which is why we think that, yes, it's a headwind and it doesn't help when the sector is already facing a lot of the macro pressures. But in terms of specifically this incremental headwind, we don't think it's more than 5% to 7% incremental. And that, it's only apply to very specific set of companies.

RACHELLE AKUFFO: And Vivek, I want to draw your attention to something that we saw from Truist Securities in talking about Tesla perhaps being a dark horse when it comes to AI and perhaps a rival for NVIDIA, saying that they actually see it-- obviously, though, NVIDIA is the leader in this space. They see a path for Tesla to build its own business to compete with it. What's your take on perhaps the role that some of these non-traditional chipmakers like Tesla might play in this space?

VIVEK ARYA: Sure. Absolutely. Look, first, when it comes to the field of artificial intelligence, we are still in the first innings. You know, that means if I take all the servers that were shipped in the world in the last year, less than 15% of them actually had an AI accelerator in them. And the majority of them used an NVIDIA product.

And then if I couple that with the automotive industry, where Tesla participates, the entire automotive industry is only 8% of the semiconductor market. So I think we have to keep a lot of these things in context of what the sizes of these markets are.

So we really like NVIDIA. And the reason is that their specific technology of AI accelerators, it's not just a chip. They're not just designing a chip. They're actually designing a complete end-to-end system and a stack of software and a big number of developers, 3 and 1/2 million developers that have been trained on using this product.

So I would say that Tesla use case is a very, very specific one, maybe less than 1% of the entire semiconductor industry. But it is a rising tide, many companies will participate, but we think NVIDIA is on a different-- not say different planet, but I think in a different solar system when it comes to the application and the benefits of AI.

SEANA SMITH: Vivek Arya, always great to get your perspective of Bank of America. Thanks so much for joining us today.

VIVEK ARYA: Thank you.