A VIEW FROM THE TOP END

Markets:

This past two weeks in the US has been “wait and see” for markets as inflation figures were to be released this week after a positive jobs report in late May that showed the recovery was still on pace. The S&P500 and the Nasdaq were largely flat over the period returning 0.5% and 0.95% respectively for an AUD investor. Here in Australia the RBA continued to hold interest rates near zero in their monthly meeting. Australian building approvals have come off a touch in April (May data will be released early July) and despite subdued auction clearance rates in Melbourne the national rate remains strong, an indicator of continued strength in the housing market. The ASX200 returned 3.38% for the period lead by energy (+9.67%), utilities (+5.53%), and real estate (+5.22%). Detractors on the ASX200 the last two weeks were the health sector (+0.88%), consumer discretionary (+1.57%), and financials (+2.83%).

Semiconductors - The New Oil:

Over the past year we are sure that our readers have heard of either the global shortage of semiconductors, or seen semiconductors referred to as the new oil in reference to the fact that nearly everything we use is connected to the devices. What are semiconductors, why are they so important now, and why are there not enough of them? These questions and more as we explore this key investment theme.

First up there are many different types of semiconductors and subcategories. Key semiconductor categories are optical devices (LEDs, lasers, photodetectors, etc), sensors (thermal, pressure, acceleration, magnetic and illuminance), integrated circuits that can be broken down further into memory, logic, power electronics and of course microprocessors. Globally the market for semiconductors was $440 USD billion in 2020 (up 6.8% on 2019) and is expected to grow to $528 USD billion by the end of 2021 (+20%!!!). Driving that growth are memory, sensors, and analogue (power electronics), all other categories are also expecting double digit growth this year.

For a basic understanding of what a semiconductor is, we must understand what they are turned into, and that is transistors. Those transistors act as a switch with no moving parts. Apply electrical current with a threshold voltage in a certain way and the switch is open, apply the same current in a different direction or under the threshold voltage and the switch closes. Using these smart switching properties of a transistor in different configurations or materials leads to power amplifiers, logic gates, microprocessors and light. The transistor was an incredible invention, having humankind figure out how to print millions of transistors onto a silicon wafer was a massive leap that is the fabric of our digital world.

As investors we break the semiconductor industry up into three groups, chip manufacturers, fabless chip companies and chip-equipment makers.

• Chip Manufacturers: Includes companies such as Taiwan Semiconductor (TSMC), Samsung and Intel. They own large facilities called foundries where silicon wafers are laid with millions of transistors by lithograph machines and handled in clean rooms. The facilities themselves are cutting edge, dust free and cost billions. Landing a state-of-the-art facility in your region provides hundreds of high paying, high tech jobs from manufacturing, quality assurance and design. These are big facilities, but when talking about how important they are it is all about how small they can go. Currently the top facilities in the world can produce transistors that are 5 nanometres, and current technology is expected to go as small as 2 nanometres. Automobile grades are closer to 14 nanometres at the moment. For reference a human hair is 80,000 nanometres wide.


• Fabless Chip Companies: The most famous fabless chip companies are Advanced Micro Devices (AMD), Qualcomm and Nvidia. These companies design and plan chips, but they do not fabricate themselves, they rely on chip manufacturers like TSMC and Samsung to bring their designs to life. Fabless companies either do not have the necessary skills to manufacture at the cutting edge or the economic desire to do so. With stumbles in recent years Intel has even considered moving to a fabless chip model as TSMC and Samsung have surged to the forefront of fabrication. In April a US government push saw Intel surprise the World by reversing course and building a new $20bn fabrication foundry in the US. The political motivation was hardly veiled.


• Chip-equipment Makers: The unsung heroes of the semiconductor industry are the ones that make it possible. Leaders such as Tokyo Electron, ASML, and Applied Materials are hardly household names as chip-equipment manufacturers. Tokyo Electron and ASML are so dominant in their fields that they own 100% of the market share of the 5-nanometre market. Their equipment is essential to the process, and they are the only companies on earth able to make extreme UV lithography work. The lithography machines themselves are enormous, taking up multiple rooms, and are highly complex with decades of research behind them. Despite price tags that tops over $150m per machine, there is over a two year wait list for the equipment.

Driving the cycle for semiconductors is twofold, as the cycle is tied to consumer spending and technological change. Designs for new chips take 18-24months to come to fruition, so R&D spending is steady, but the advent of AI, machine learning, 5G, the Internet of Things (IoT), and data centre expansion are pressing the need for chips to new heights. The amount of data being processed is growing substantially and speed counts, so the infrastructure responsible for these technologies is seeing huge pressure to keep up with ever smaller and smaller processers.

With a current shortage of chips in the world due to the long run times (multiple months) and the recovery surging demand, chipmakers are focused on the most cutting-edge designs as they return the highest margins. Automobile manufacturers have been left out in the cold as the 14 nanometre chips they desire are left off manufacturing runs as fabricators do not see the same profits as 5 nanometre chips for datacentres. Capacity is expanding, but it takes time to catch up. Even looking further ahead to 2022 the industry is expecting 8.8% growth, well ahead of even the best economies.

With so much focus on the semiconductor industry, we cannot neglect the political angle. Many of us have heard of Huawei and their connection to the Chinese government. Huawei is a leader in 5G technology, but they use fabrication technology that is produced in the West by ASML. With fears of China taking the lead in key technologies such as AI and 5G, the US government started a campaign to block sales of key lithography equipment from the Netherlands starting in 2018 (ASML is a Dutch company). The export ban to China has seen Chinese companies shut out of the key 5 nanometre and below market. This has a huge impact as to develop the necessary lithography technology to unlock smaller chip fabrication will take more than 4yrs by best estimates. Technology in the eUV space is now as guarded as nuclear weapons and more tightly controlled. The stakes are big as countries posture for their place on the digital frontier.

Here at TFM we hold several the names mentioned in this piece through a holding in Loftus Peak. The team at Loftus has been on the forefront of disruption in the 5G space and have identified a number of the names mentioned early. With the recent tech sell off a few of the semiconductor names got caught in the down draft but were able to recover quicker than rest of the tech sector. Looking at the technology change in front of us the next decade and the capital spending expected, TSMC has committed $100bn alone over the next three years, the future is bright in semis.

Updating our checklist:

• Valuation: The ASX200 P/Efwd is 19.61x and the S&P P/Efwd is 22.49x. Ratio levels continue to be elevated. We are seeing value in places like the UK, Japan and of course Australia as their forward estimates are closer to historical averages or provide exposure to commodities, financials and value.


• Global PMIs: Chinese PMIs continue to stay elevated, and the inventory stockpiling is at 50% of levels seen during the last commodities boom mid-decade. This bodes well for continued strength for Australia’s resources. We watch the PMI cycle closely, and one economy that is small and export dependent is Sweden. Their PMI survey can act as a canary in the coal mine for the global economy. At the moment Swedish manufacturing remains near all time highs for next month orders when compared to previous month, so the data points to the recovery continuing.


• Downgrades on guidance: The biggest action that we saw the past two weeks is in the mergers and acquisitions space. Altium and Hansen Technologies saw bids lobbed at them, breathing life into a beaten-up Australian technology sector. Altium ultimately rejected the $38.50 (40% premium) offer made by competitor Autodesk, but the opportunistic bid highlights the underlying worth of these homegrown businesses. Autodesk is a leader in CAD (computer aided design) software in mechanical and civil applications, but lags Altium in the circuit board space. The bid for Altium’s business was an admission that Autodesk’s competing product is at best a distant second in the growing market. Tech players such as Appen and Nuix both benefited from the bid for Altium as investors took notice that foreign investors were circling Australian waters.


• Infection rates to slow globally: Melbourne is set to lift its latest lockdown at 11:59 on Jun 11th, 2021. Residents of the city will be able to move freely within a 25km radius of their homes with some restrictions on dining, gyms, etc remaining in place. Melbourne’s latest lockdown is a reminder of how quickly the virus can spread in an unvaccinated population that has yet to achieve herd immunity. The exponential nature of Covid19 outbreaks will remain a danger to any community until immunisation figures reach 70%+. On a state by state (or territory) vaccination rate basis the NT, Tasmania and ACT are leaders, South Australia is next up, followed by Western Australia, Victoria is charging, and NSW and Queensland are bringing up the rear. Internationally the US has committed to providing 500million vaccines to be donated to mid and low-income countries on top of the 80million does pledged to the World by the end of June. America is back making headlines for the right reasons on the world stage.

  You can follow Australia’s vaccination journey with our live vaccine tracker at the link below:

  
  TFM Vaccine Tracker


• Monetary and Fiscal stimulus announcements globally: Central banks are continuing to hold rates at near zero. The market is awaiting next weeks Federal Reserve meeting for guidance on when the US central bank will stop buying US Treasuries (quantitative easing) which will give some inference to when interest rates could rise. Many are pointing to next year for a hike. More interesting is the G7 meeting set for next week. With America back as a teammate instead of going it alone, it is a big year for the climate. The United Nations Climate conference is set for November, but we expect posturing to be done at the G7. In our sights is Europe’s proposed carbon border and details of new energy infrastructure promised in the United States. We also expect the World against China rhetoric to ratchet up. Our investment themes for the decade of de-globalisation and “green” will be front and centre next week.
  

Another two weeks are in the books, and we are seeing real movement in the reopening play. If you are a fan of North American sport, you will notice that crowds are returning in the US. It has been a little under a year since the 2020 State of Origin game 3 at Suncorp that signalled the return of crowds to sporting events for the World. Time has flown by since that night, and as we watched the Blues lay a beating on the Maroons in Townsville this week, we are reminded of how good we have had it here in Australia (despite the result). Looking forward we are enthusiastic about the next few years as our miners will continue to lead the nation to further prosperity. A commodity backed country like Australia is set for a good run the next few years. Our financial house was in good order before the pandemic hit, so the government is well situated to help the recovery if there is a stumble. We look forward to the jobless rate continuing to tick down and our freedom to travel within and abroad to increase. With that said if you do find yourself with some extra capital over the next few months, please make an appointment with on of our advisors to put those funds to work for you and come up with a plan to meet your financial goals. There are always bumps in the road, and getting sound financial advice means you are not navigating on your own. Take care and we will be in touch again in two weeks.

Regards,