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  • Dorian Chin

Why Investing in Semiconductor Stocks is Trending: A Look at the Soaring PHLX Semiconductor Sector Index (SOX) over 15% year-to-date

▌1. Understanding the Fluctuations in the Semiconductor Sector

Monthly data from Semiconductor Equipment and Materials International (SEMI) regarding semiconductor equipment billings offers insights into the expectations of semiconductor manufacturers about future chip supply and demand.

A rise in these billings suggests a growing optimism among manufacturers that there will be increased demand for electronic devices, leading to greater purchases of equipment and higher capital expenditures to expand production capabilities. On the other hand, a decline in billings can indicate a buildup of inventory and a reluctance to invest in new equipment, often heralding a downturn in the semiconductor industry. The chart demonstrates a strong correlation between global semiconductor equipment billings and the SOX Index.

The semiconductor industry, crucial to consumer electronics like PCs and smartphones, experiences significant cyclical fluctuations influenced by broader economic trends. These cycles typically include periods of growth lasting 1.5-2 years and full inventory cycles extending over 3-4 years, as shown in the chart.

▌2. Examining the Inventory Cycle of Chip Manufacturers

In the semiconductor industry, the gap between order placement and product shipment is substantial, leading upstream IC design companies to place orders well in advance. Should downstream demand falter, resulting in excessive inventory levels, semiconductor stocks often undergo corrections.

The accompanying chart illustrates the inventory days for key players across the semiconductor supply chain, including upstream IC designers (e.g., TSMC), midstream wafer foundries (e.g., MediaTek, Broadcom), and downstream companies (e.g., SK Hynix, Micron, NVIDIA, AMD), focused on various sectors (e.g., Texas Instruments, Infineon, STMicroelectronics, NXP).

The formula used to calculate inventory days is as follows:

Inventory Days = 365 × (Average Inventory / Cost of Goods Sold)

By analyzing the year-over-year growth in inventory days for major semiconductor firms, we can determine the current phase of the inventory cycle:

  1. Passive Destocking: Early demand recovery leads to natural inventory reduction as sales pick up, with companies not yet replenishing stocks.

  2. Active Restocking: A surge in demand boosts business confidence, prompting firms to increase their inventory levels.

  3. Passive Restocking: A deceleration in demand causes inventory accumulation.

  4. Active Destocking: Rapid demand decline compels companies to actively reduce their inventory due to a negative outlook.

▌3. Assessing End-Market Demand in Major Consumer Markets

Semiconductor chips find extensive applications in a range of consumer electronics, making new orders in sectors like automotive, home appliances, and personal computing, especially in the U.S. (the largest consumer market globally), vital indicators of chip demand. Increases in new orders for these products typically signal an uptick in the semiconductor cycle, while a decrease can point to a slowdown. The chart reflects how new orders for computers and electronic products in the U.S. help confirm trends in end-market demand.

▌4. Monitoring Key Indicators from Taiwan in the Semiconductor Supply Chain

Taiwan holds a critical position in the global semiconductor supply chain, particularly in midstream processes. The health of Taiwan's economy, heavily reliant on exports, offers valuable insights into semiconductor industry trends:

A significant metric is the ratio of the Leading Index to the Lagging Index, with increases suggesting an economic rebound and decreases indicating potential downturns. This ratio often precedes shifts in global semiconductor equipment shipment growth rates by three to six months, serving as a predictive tool for industry outlook improvements.

Current indicators, including year-over-year growth in global semiconductor equipment billings, inventory days, and other key metrics discussed, suggest the semiconductor industry is in a growth phase. This supports the ongoing rally in tech stocks and record highs in the SOX Index. Investors should continue monitoring these indicators to gauge the duration of this bull market.

Source: MacroMicro

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