Portfolio manager outlines cyclical changes prompting a headwind, highlights areas of idiosyncratic risk
A cursory read of the business pages might have investors and advisors thinking semiconductors have been the hottest item on the market for years now. While chip designer Nvidia has become the darling of the AI boom and the world’s largest company by market capitalization, the wider semiconductor industry has struggled with an inventory-led cyclical downturn. According to one portfolio manager, that cycle is beginning to turn.
Alexander Smahtin, Portfolio Manager at Global X Canada, outlined what he sees as a cyclical turn in the semiconductor market that extends beyond just the AI theme. He explained why demand for these chips is resuming and why he expects a broad-based move for the sector. At the same time, he highlighted the key sources of risk for the sector, namely idiosyncratic risk related to geopolitics and US policy. He explained how, in that environment, Canadian investors and advisors can navigate.
“Semiconductors underpin essentially all of our technology. When we think semiconductors, our first thought is about AI, but the whole industry span a much broader set of opportunities and companies and participants than just AI,” Smahtin says. “So AI sits as a as a structural tailwind, but cyclicality exists within that.”
In recent years, while Nvidia and AI chips dominated headlines, the broader industry was somewhat held back by a degree of oversupply. Now, however, a broader array of semiconductor companies look set for stronger performance in Smahtin’s view. The earlier downturn, he explains, was driven by overheating demand at the start of the AI boom. As a result, semiconductor companies ramped up supply only to overshoot demand. Now that oversupply has largely been worked through and there is an upsurge in demand across what Smahtin says are the three distinct areas of semiconductor firm specialization.
Firms like Nvidia, Smahtin explains, are primarily chip designers rather than manufacturers. Those manufacturers include key global names like TSMC and Intel. The third category is the resting, packing, and memory firms or firms providing other ancillary services. All three subsets are now benefitting from both this work through of inventories and an increase in demand for services beyond AI. That includes the need for semiconductors in EVs and automated driving, as well as memory chips and consumer products.
While Smahtin sees this cyclical turn as broad-based, he notes that US policy and global geopolitics can function as both a source of risk and possible upside. It’s hard to discount the fact that the world’s largest semiconductor manufacturing hub is Taiwan, with TSMC specifically manufacturing the vast majority of the specialized chips required for AI. The geopolitical tensions surrounding Taiwan, therefore, offer a level of risk for the sector that investors should be aware of.
US policy has also dictated export controls on chips being sent to China, in part due to an AI arms race between the two countries. While the industry is somewhat bifurcated between China and the US, companies are finding ways to operate in both markets. Smahtin sees the dynamic as having the potential to serve as a headwind or a tailwind, depending on the course each country takes.
“Some domestic companies in the US and in China can benefit or be really harmed by the way that the tensions and tariffs and all these policies play out,” Smahtin says. “But who comes out as a winner is anybody's best guess.”
Trump administration spokespeople have also publicly discussed the prospect of purchasing significant or controlling stakes in semiconductor companies out of a concern for national security. Smahtin says that any moves like that would need to be assessed on a case by case basis, noting that if the investment is passive it’s not necessarily a bad thing for investors. However, if a US government stake ends up compromising a semiconductor companies’ ability to operate in foreign markets, other investors may not react so warmly.
Given the tailwinds for semiconductors appear broad-based, but the risks appear idiosyncratic Smahtin notes the value that could come from a wide exposure to the sector through vehicles like ETFs. Without being able to predict the winners and losers, he believes that the fundamental principle of diversification should hold.
In the face of concerns about those idiosyncratic risks and possible geopolitical tensions of policy issues derailing the semiconductor upswing, Smahtin believes that reframing the conversation can be helpful. For advisors talking with clients about the sector, highlighting the role of semiconductors in technology’s inexorable march forward can help ground expectations.
“The conversation should begin with where you think your phone's going in the next five years,” Smahtin says. “The technology in our society is becoming more advanced the demand for semiconductors will rise with that. They underpin essentially all of it. The conversation is less about AI and TSMC and Nvidia. It's more about whether you believe in the overall technological progress of our economy as a whole.”
