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In a normal period, “just in time” manufacturing was the norm for most companies. They ordered chips as close to production time as possible to avoid excess. But everything changed when the outbreak started in March 2020 and supply chains increased. Hoarding became the new normal. Companies have been stockpiling chips all around the globe a bit like consumers stockpiled toilet paper in Spring 2020 as they feared shortage. This is about to change. Inflation out of control in many developed countries along with Covid restrictions in China and recession fears will dampen demand in the short and medium term. Semiconductors are basically a cyclical industry. Demand is high when GDP growth is strong, and it is low when growth slows. But the downturn might be more significant this time than in previous economic turmoil. We are unable to know how many excess chips are in warehouses around the world. However, we know inventory is at a record high. According to the latest data, South Korea’s semiconductor inventory levels increased by 53 % year-over-year in May – see below chart. This is only the beginning. A few months ago, companies were wondering how to secure supplies. Now they wonder why they have all this inventory and what they will do with that as demand is slowing down. Expect manufacturers to decide to use up chips in warehouses instead of buying new ones and to cancel orders. This is already happening. Several companies have recently announced they will reduce supply due to lower demand (Micron Technology, Nvidia, for instance). Orders from key clients have been reduced, sometimes drastically (Apple, Advanced Micro Devices etc.). This will certainly get worse in September when a lot of companies will review their business plan and cut demand expectations and investments. This is likely to last. Going into 2023, we believe overcapacity will remain a major issue for the semiconductor industry, especially if the economic slowdown accentuates (this is our baseline, actually).
Chipmakers supplying automotive, data centers, low-end smartphones, gaming and mining cryptocurrency will thrive in the coming quarters. However, there is one exception: demand for high-quality smartphone devices (typically for Apple devices) remains high. This will likely help Taiwan Semiconductor Manufacturing Co (TSMC), Apple’s main supplier, to do better than most of its competitors. TSMC accounts for half of all global chipmaking revenue.
The United States’ goal to boost local semiconductor manufacturing is another factor which will increase the supply glut. Democratic lawmakers and the White House are currently working on a legislation which would fund $52bn for chips production subsidies and boost U.S. scientific and technological innovation to compete with China. Hopefully, this legislation will be passed in the coming days or weeks (before many Congress members hit the campaign trail ahead of November’s midterm elections). The impact on the industry will not be overnight. This is a long-term process, of course. But it will certainly push prices lower.
This is a worrying moment for the semiconductor industry. In the long run, we still have a positive view on this industry. The trend of the Internet of things will drive high growth. This is basically the idea that ever more physical objects in the world will get microprocessors and sensor integration and communicate with the Internet. Typically, the 5G rollout globally will add to demand over the coming decade (see our report, Internet of things to drive high growth for semiconductor industry, July 2021).
In the short-term, the U-turn in the semiconductor industry is not all negative. This is a positive signal on the inflation front. The semiconductor glut will push for further stabilization for the price of vehicles and electronics in the coming months. This is what is needed to tame inflation. Other factors are also pushing inflation down at the global level: lower commodity prices, falling freight rates, easing rents (in the United States) and rising retail inventories. All of this is the sign of a cooling global economy (but this is not necessarily the sign of an upcoming recession).