A weak manufacturing survey reading put semiconductor sector investors in a profit-taking mood, but the sell-off may be an opportunity.
Shares of semiconductor sector favorites Micron Technology (MU -7.96%), Arm Holdings (ARM -6.88%), and ASML Holdings (ASML -6.47%) fell hard to start off September, down 8%, 6.9%, and 6.5%, respectively, as of the close of trading Tuesday.
Weaker-than-expected macroeconomic data sent the entire chip sector down hard, and ASML drew attention in a trade war spat regarding China over the weekend. But is this pullback a buying opportunity?
Weaker-than-expected manufacturing sends chips into a tailspin
Coming into Tuesday, each of these three stocks had good-to-great results in the market year to date, which perhaps set them up for more pronounced sell-offs on bad news. As of Friday’s close, Arm Holdings had soared 77% in 2024 as AI enthusiasm took hold for its newer data center and PC solutions. ASML, which is the dominant provider of the EUV lithography machines that are crucial for the production of cutting-edge chips and memory for AI, was up by 20%, despite a July swoon. And Micron was up by just 13% as earlier enthusiasm for its AI prospects had moderated amid soft economic readings for the highly cyclical memory player.
While these three companies have benefited from the optimism around the future of AI, each is also somewhat cyclical, and their results can ebb and flow with the economy.
On that front, there was pessimistic news regarding U.S. and Chinese manufacturing. On Tuesday morning, the Institute for Supply Management released its Manufacturing Purchasing Managers’ Index for August, which came in weaker than analysts expected. The August reading was 47.2. While that was up from 46.8 in July, it was below the Dow Jones analyst consensus expectation of 47.9.
But some details were more worrying. The New Orders Index was worse than the overall reading at 44.6, down from 47.4 in July. But the Prices Index actually rose to 54 from last month’s 52.9 reading. And the Inventories Index rose 5.8 points to 50.3.
The combination of lower orders, rising inventories, and still-rising labor and freight costs points to the worst of all possible worlds: a stagflationary setup. That could hamstring the Fed’s ability to cut rates aggressively, despite Tuesday’s downward lurch in the manufacturing sector.
Of note, there was also trouble with China over the weekend: A report showed that its manufacturing activity fell to a six-month low of 49.1 in July, marking its fourth straight reading below 50. China’s economy has been mired in a slump for some time, and doesn’t appear to be coming out of it anytime soon. Of note, China is a big purchaser of semiconductors, so weak economic activity there could have an effect on all three of these companies.
In addition, China threatened Monday to stop buying ASML’s equipment. Last week, it was reported that the Netherlands may restrict ASML’s sales and service even for certain older deep ultraviolet lithography machines in China. But on Monday, an article in China’s government-backed Global Times said that China could cut off ASML “permanently” from the country if the Dutch government went ahead with those restrictions.
ASML is the outright global leader in lithography, so it’s unclear how China could replace all those machines. Still, losing that country as a market would be a bad scenario for ASML — it got 49% of its revenue from China last quarter. While some of the machines that would have gone there would likely be sold to companies in other geographies if China couldn’t make its own chips, ASML might not recover 100% of those lost sales, and that kind of move would be highly disruptive.
Image source: Getty Images.
But it may not be all bad news
August’s manufacturing reading was certainly not great, which fueled fears that the Federal Reserve has fallen behind the curve on its fiscal policy pivot, which could potentially lead to lower U.S. economic growth or even recession in the coming quarters.
However, there were a couple of things for semiconductor bulls to hold onto. First, while a reading below 50 indicates a contraction for the manufacturing sector, the threshold of 42.5 is the level that indicates a broader economic downturn overall, and the U.S. is still well above that.
Second, delving into the quotes from purchasing managers included in the report, the electronics industry manager’s quote was actually bullish: “Business outlook is good. Recovery from the electronics slowdown is strong for the second half of the year.” Furthermore, the institute reported that out of the six largest manufacturing sectors, only the computer and electronics segment reported growth in new orders and increased production.
The personal electronics industry entered its downturn in late 2022 and appears to be recovering, while industrials and autos are now mired in the middle of their own downturns. So while higher benchmark interest rates appear to have contributed to a slowdown across most manufacturing sectors, the computer and electronics sector appears to be a strong outlier — at least for now.
Since the chip sector is largely selling off on Tuesday’s bad economic headlines, investors may want to take the opportunity to add to their positions in their favorite chip stocks.
