Buoyed by successful vaccine rollout programmes and the sense that we are at the beginning of a positive new global economic cycle, stock markets around the world, notably in the US, UK and China, have bounced back strongly.

Now investors must confront a challenge: how to reconfigure their portfolios in the light of this cyclical economic recovery.

The problem is that classical cyclical stocks — industrial, hotel, restaurant, airline, car rental, mining, energy and even cruise line shares — have already spiked sharply, with many reaching record levels. While we are seeing a nascent economic recovery, backed by promises of monetary support, a big question is how sustainable economic growth will be when the fiscal props are removed.

It is challenging, even for disciplined investors, to judge correctly how this concern plays in the financial market and sell cyclical shares in good time. It’s surely far wiser to invest in sustainable longer-term structural growth stocks — shares that are far less influenced by economic cycles.

Some growth stocks are universally recognised, such as Apple and Amazon. Equally, mining stocks and consumer goods are easily categorised as being cyclical. But what about those somewhere in between — shares that have been seen as cyclical in the past but which are suddenly seeing a structural growth surge? Take, for example, the industry of semiconductor manufacturing.

Historically cyclical, the sector changed dramatically in 2019/2020. After a prolonged stretch of disappointing performance attributed to various factors including the US-China trade conflict, a crash in cryptocurrencies and fears of a global demand slowdown, the industry suddenly surged.

In contrast to its declines in all previous recessions, the Philadelphia semiconductor index, an industry indicator, rebounded sharply, eventually rising over three quarters through the virus-induced recession.

This is a direct result of global technological developments and the exponential growth in data consumption. While some developments were already taking shape well before the recession, the economic lockdowns further accelerated demand in hi-tech businesses including cloud computing, data storage, big data management and artificial intelligence. 

Looking ahead, we can see further exponential growth in data management with the rollout of 5G mobile networks, the internet of things and machine learning. While semiconductors historically were mainly used in consumer and auto electronics — and were therefore cyclical — they now play a much larger role in a wider range of business, administrative and personal applications. In short, they have become the technological “staples” of economic activity, with excellent further sustainable growth potential.

Outstanding businesses have developed in three main areas: semiconductor design, the production of the manufacturing equipment and circuit manufacturing. The supply chains are well established in advanced economies. While many of these businesses have to invest vast amounts of capital to update or create new capacity, overall profitability and cash generation is strong with solid returns on invested capital.

Though many tech share prices remain at historically high levels, I believe companies in this sector are fairly valued. I do not look for “cheap” stocks, but instead ones that are priced appropriately for their current and future sustainable growth.

Nasdaq-listed Cadence Design Systems and Synopsys provide leading software design technologies for the manufacture of integrated circuits. Many manufacturers rely on them for cutting-edge technology to develop new semiconductors. Apart from the strong overall industry structural growth they enjoy, they additionally benefit from clients such as Google-parent Alphabet, Amazon and Apple, which develop their own semiconductors and need expert support. Growing demand from China has also become prominent for these designers.

The chip equipment supply chain also features well-established companies. Two US groups, Lam Research (Nasdaq-listed) and Applied Materials, produce fabrication equipment products. Then there is Dutch-listed ASML, formed from a partnership with Philips and today operating independently as the world’s largest and technologically most advanced supplier of photolithography systems for semiconductor manufacturing.

These companies benefit hugely from worldwide industry growth and clients that are expanding their own manufacturing capacity, generating a record, multiyear order book for these sophisticated equipment manufacturers.

There is an array of semiconductor manufacturers. US multinational technology firm Nvidia is any interesting example with a focus on the 3D graphics, and on the data centre and cryptocurrency industries. The Nasdaq-listed company has made a bid for ARM, the UK-based semiconductor design business. Though it has been reported that the offer remains under regulatory scrutiny, this deal may go through in some form, transferring ownership from Japan’s Softbank.

Jensen Huang, Nvidia’s cofounder and CEO, is seen as an industry leader and is expected to focus more on artificial intelligence and autonomous driving. Nvidia can in some way be seen as the Tesla of the semiconductor industry, often ahead of others technologically.

The new Biden administration does not seem to show appetite for reversing its predecessor’s  clampdown on US companies’ hi-tech trade with China, highlighted by the argument over Huawei, the huge Chinese electronics group. The dispute with Beijing highlights how reliant global chip production is on a small number of mainly-Western, Taiwanese and South Korean producers and their technologies, and how entrenched the established order is.

It is clear that it will take a long time to disrupt the strategic positions of companies, despite China’s efforts to increase self-reliance in semiconductors. Taiwan Semiconductor is an interesting company as it is a critical supplier to most nations, including China, with a huge production capacity and a $100bn three-year capital expenditure programme. Intel, long the chipmakers’ bellwether, also recently announced an unexpectedly large $20bn programme in the US.

There are many exciting opportunities in the sector: in our concentrated 29 stock portfolio with a strategic long-term orientation, we have to be as ruthless in our selection as we are diligent. While the semiconductor industry’s excellent operational results and its critical role in most aspects of technological advancement have not gone unnoticed among investors and are well reflected in equity valuations, we still see good investment opportunities.

With global technological developments probably less than halfway through a revolutionary multiyear growth cycle, our view is that there is still plenty for strategic investors to go for.

• Smit is a partner and head of equity management at Stonehage Fleming.


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