- Nvidia and Micron warn of a weakening sales environment
- The Philadelphia Semiconductor Index, the industry benchmark, is up more than 19% during the past month
- Some investors see value in the beaten-down sector after a drastic correction
Once regarded as one of the most resilient sectors of the digital economy, chipmakers appear to be at a crossroads. After two years of astronomical demand, the industry's leading companies have begun to warn that demand for their products may be declining.
NVIDIA (NASDAQ:NVDA), the largest U.S.-based chipmaker by market value, said last week that its second-quarter sales would fall well short of its previous forecast. The Santa Clara, California-based company expects revenue of $6.7 billion for the quarter ended July 31, some 17% below the $8.1 billion it had forecast in May, amid a 33% drop in gaming revenue.
Following that announcement, Micron Technology Inc (NASDAQ:MU), another leading U.S. maker of memory chips, also warned investors that revenue wouldn't meet projections. There will be "significant sequential declines in revenue and margins," the company stated in a regulatory filing on Aug.9.
The warning from NVDA and MU came after disappointing results from Intel (NASDAQ:INTC) and Advanced Micro Devices (NASDAQ:AMD)—a trend that indicates that the slowdown is widespread.
However, despite signs of a broad-based demand deterioration, these producers' share prices have been on the rise since last month. The industry's benchmark, the Philadelphia Semiconductor Index, has increased more than 19% over the past 30 days. 
Nonetheless, the Index is still down 22.8% for the year, underperforming the broader NASDAQ Composite.
Near Trough Valuations
One plausible reason for the recent recovery is related to the general feeling in the market that the economy is likely to avoid a prolonged recession, and a soft landing is now possible after the central bank's aggressive monetary tightening cycle.
Another logic prompting some investors to look semi favorably is that a deceleration in demand may have been already priced into these beaten-down stocks throughout the year's first half.
In a recent note, KeyBank said it remains "constructive" on semiconductor companies, as they are "trading at or near trough valuations." The bank also expects a soft landing for the industry, given the resilience of secular trends such as 5G, electrification, and artificial intelligence.
JPMorgan said some semiconductor firms could still do well, driven by solid spending on cloud infrastructure. Companies will drive expenditure in this area — on the back of the strong adoption of public cloud services and new data center construction. The bank forecasted that cloud spending would accelerate in the second half of this year, jumping 22% from the first half. The investment bank's analysts wrote:
"Overall, this is in line with our sector thesis where we continue to be positively biased on the cloud datacenter market for the mid-to-long term and look for semiconductor companies levered to datacenter spending to outperform across computer, networking, and storage/memory."
Chip shortages, which badly hurt automakers and smartphone producers during the pandemic, continue to linger, offering another positive sign for chipmakers that demand from some sectors of the economy remains solid.
According to a report in Bloomberg, the average wait times for semiconductors soared to 27 weeks in June. Before the pandemic, average lead times were typically less than 15 weeks. Last week, TSMC reported a 50% surge in July revenue, underscoring major industry players were still benefiting from competition for supply.
Analysts at Barclays, however, said in their recent note that the bounce in semiconductor names is likely only a "head fake."
While downgrading Lam Research Corp (NASDAQ:LRCX) to equal weight, Barclays said that the chip equipment maker is among a slew of names due for a "substantial reset" following a double-digit rally in recent weeks. Its note adds:
"Semi cap may look attractive on the first pass, but we see further downside even when assuming normalized earnings and multiples.
We see a semi correction in 2023/24 and don't see how the equipment used to produce those chips avoids an even larger correction as the market moves to oversupply."
Bottom Line
Chip stocks are rebounding after a sharp pullback this year as investors begin to notice the long-term value in some companies, such as Nvidia, Micron Technology, and AMD. They assess that the digital economy, like cloud and artificial intelligence, will likely maintain its strong demand even if the economy slips into a recession.
However, macroeconomic risks remain elevated despite the recent broad market rebound, prompting some analysts to shun the sector.
Disclosure: The writer doesn't own shares of the companies mentioned in this article.