Nvidia’s Rebound Hides Tough Reality for Chipmakers

(Bloomberg) — US semiconductor stocks have come roaring back over the past month, and the largest of them — Nvidia Corp. — has led the charge. Even some bulls on the company say the rally may not have much further to run.

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Nvidia’s third-quarter results late Wednesday are likely to show that demand for electronics is still drying up, with analysts predicting an 18% drop in sales. Yet the stock, at 39 times estimated earnings, is still priced for a much better environment, at a time when the global economy appears to be heading for recession.

“It’s the worst of all worlds, because the rate of revenue growth is declining, macro fundamentals are deteriorating, and the valuation is still exceptionally high,” said James Abate, chief investment officer at Center Asset Management. “If we do go into a recession, which I think we will, the next stage will be a deterioration in earnings, and it would not be abnormal to see further weakness in Nvidia.”

Abate owns Nvidia but has been trimming his position in the stock, which has risen nearly 50% from its mid-October low. It’s still down by 43% for the year. The stock rose 2.9% on Tuesday, supported by the latest data on producer prices, as well as signs of improving China-US relations.

Plenty of investors are betting that this year’s bear market in tech stocks has run its course: Regulatory filings this week showed that Warren Buffett’s Berkshire Hathaway Inc. took a stake of about $5 billion in Taiwan Semiconductor Manufacturing Co., which makes chips for Nvidia among others.

The bull case is that the Federal Reserve will slow the pace of interest rate increases as inflation gradually cools off, allowing the economy to dodge a recession. In that scenario, investors can look ahead to an imminent rebound in tech demand.

Nvidia is a bellwether in all this because it’s the largest component of the Philadelphia Stock Exchange Semiconductor Index by market value, and a leader in the key market for data-center chips. It’s long been a favorite of institutional investors because of its record: In the decade leading to their peak a year ago, Nvidia shares returned 58% annually, far outpacing Apple Inc., Microsoft Corp. or Amazon.com Inc.

Yet there’s still no evidence the worst has passed. Delivery times for semiconductors shrank by six days in October, the biggest drop since 2016, while Morgan Stanley wrote that the latest industry data showed weakness across product categories. Texas Instruments Inc., Qualcomm Inc., and Intel Corp. all issued cautious forecasts in their results this earnings season, as Nvidia did last quarter.

Geopolitical concerns have also weighed on the stock, given US restrictions on China’s access to semiconductor technology, although Nvidia is producing a processor that conforms to the regulations.

Analysts have been slashing their estimates on the sector, and Nvidia has not been spared. The average estimate for the company’s 2023 earnings has dropped 16% over the past three months while the consensus for revenue is down 11%. Revenue growth is expected to be barely positive in 2023.

Yet the stock, at 39 times earnings, is a third more expensive than its average for the past decade, and sells for more than double the multiple of the semiconductor index.

Analysts do forecast that Nvidia will return to double-digit growth in 2024. That expected rebound is a reason why they remain largely positive on Nvidia’s long-term prospects. Citigroup Inc. says the stock is “close to a bottom,” with data-center sales likely to trough in the first quarter, while Morgan Stanley also sees the business bottoming.

Some longtime bulls on the stock are, like Abate, hedging their bets. Funds run by Cathie Wood’s ARK Investment Management LLC — which have held the stock since the firm began operating in 2014 — have been paring their stakes in recent weeks.

Tech Chart of the Day

The Nasdaq 100 Index last week posted its biggest weekly gain since November 2020, and the advance has it looking much stronger on a technical level. On Friday almost half the index’s components were above their 200-day moving average price, the highest percentage since March, and up from about 8% in late September. Over the past year, an average of 32% of components have been above this closely watched technical level.

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  • Amazon.com plans to cut about 10,000 jobs, the largest ever headcount reduction at the e-commerce giant as it braces for slower growth and a possible recession.

  • Apple is trying to spur Mac sales with a rare promotional deal for small businesses that buy computers in bulk, an effort to cope with a slowdown during the holiday quarter.

  • Warren Buffett’s Berkshire Hathaway Inc. took a stake of about $5 billion in Taiwan Semiconductor Manufacturing Co., a sign the legendary investor thinks the world’s leading chipmaker has bottomed out after a selloff of more than $250 billion.

  • ASML Holding NV may conduct acquisitions to meet soaring demand for advanced chips worldwide, its chief executive officer said, defying the broader sector downturn.

  • Twitter Inc. owner Elon Musk, who has called himself a “free speech absolutist,” has resorted to firing company engineers who publicly criticize him on the social-media service.

  • Samsung Electronics Co. said the global technology industry is in search of alternative sources for advanced semiconductors given rising political risks.

  • A group of small tech companies, which compete with Alphabet Inc.’s Google, Amazon, Apple and Meta Platforms Inc., this week will launch an advertising campaign urging lawmakers to pass landmark legislation that would diminish the power of the country’s largest internet giants .

  • Sea Ltd. has cut about 7,000 jobs, or roughly 10% of its workforce, in the past six months as it fights to stem ballooning losses and win back investors, according to a person familiar with the matter.

–With assistance from Subrat Patnaik.

(Updates to market open.)

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