Are semiconductors the new indicator of the economic cycle?
5 December 2019
David Jane, multi asset fund manager at Premier Miton Investors, comments:
Investors have been buying cyclicals in recent weeks – or at least so the headlines say. Yet traditional heavy industries have failed to rally. A traditional approach to playing a cyclical rally no longer works.
The world economy is very different today than in the past. 30 years ago, the dominant industries were what was then known as heavy industry, such as steel, chemicals and automobiles. Over the past decades, service industries, such as retail, leisure and business services have become much more important. Within manufacturing, the key industries are now electronics and particularly semiconductors.
This transition has been reflected in the stock market. Traditionally, when considering the economic cycle, we worried about steel makers and chemical companies and these would be weak as the economy slowed, followed by very strong rallies. Monitoring these industries gave a good indicator of the overall strength of the economy. At the same time, when investors wanted to increase their cyclical exposure, they bought those industries and vice versa.
In the modern economy, the semiconductor cycle has become a much stronger indicator of the economic cycle, particularly as some of the more mature cyclical industries appear to be in increasingly rapid structural decline. Semiconductors are now a key part of a huge variety of manufactured goods ranging from the obvious electronic goods, such as phones, right through to kitchen appliances. This trend is set to accelerate with the emergence of the internet of things. Semiconductors are now the key ‘raw material’ that goes into so many products that comprise our data driven economy to such an extent that their cycles are a much better indicator of the health of the world economy than the demand for steel.
This transition may have been masked until recently with the emergence of a huge new source of demand for traditional basic industries from China. China’s rapid industrialisation in the past decade led to it building vast amounts of new capacity in basic industries to build new factories, offices and homes. Now China is maturing and transitioning to a more service driven economy.
Another key driver pushing investors away from traditional cyclical industries is the increasing importance of ESG. These industries are amongst the heaviest polluters and therefore score poorly on ESG grounds. For this reason, many investors are now avoiding them either by choice or because of their mandate.
In the funds we run, when looking to increase our cyclical exposure, we took this change into account. During the recent cyclical rally, we have avoided buying industries in structural decline for a quick return. Rather, we have been increasing our exposure to long term thematic winners, but those with more cyclical businesses. Semiconductors and electronics suppliers to new energy industries meet these criteria.
Despite the recent cyclical rally, traditional materials stocks have failed to outperform, while semiconductors have accelerated. We believe that semiconductors are the new cyclicals while materials are simply in structural decline.”
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