The advent of AI has sent the semiconductor industry into overdrive over the past year. Volatility is part of the price of admission.
Markets ended the week on a somber note, with the economy once again in the spotlight. Investors were digesting a surprisingly strong jobs report that highlighted the Fed’s continued fight against inflation, the possibility of future rate cuts, and what that means for the broader economy. To add insult to injury, the Biden administration’s decisions regarding advanced semiconductors used in artificial intelligence (AI) have sent ripples through the semiconductor industry.
Against this backdrop, database and AI chip maker Oracle (ORCL -5.06%) Chip architect Arm Holdings fell 4.4% (arm -3.24%) Semiconductor specialist Broadcom fell 3.4%. (AVGO -2.18%) The stock was down 2.8% as of 1:10 p.m. ET on Friday.
After checking all the usual suspects, including financial reports, regulatory filings, and changes in analyst price targets, we couldn’t find any company-specific news that would explain this swoon. This suggests that the development of the economy and semiconductor industry received attention.
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tightrope walking
Nonfarm payrolls rose by a seasonally adjusted 256,000 in December, well above the 153,000 expected by economists, according to the monthly employment report provided by the U.S. Bureau of Labor Statistics.
The report highlights not only the remarkable resilience of the job market, but also the difficult tightrope the Fed faces between controlling inflation and cutting interest rates. Under normal circumstances, a strong job market is a good thing, but rapid growth keeps inflation high. Wall Street and Main Street alike want rates cut, but the data suggests it’s unlikely the Fed will be able to cut rates any further until they address inflation.
Fed officials are scheduled to meet later this month to discuss the issue, but the chance of a rate cut is low, currently at just 2.7%, according to the CME FedWatch tool.
Further exacerbating the chip industry’s problems, the Biden administration plans to introduce a new wave of export controls related to high-performance, AI-centric processors, making this cutting-edge technology available to foreign countries including China and Russia. This is a move aimed at distancing the country from hostile countries.
The plan includes a three-tier system that would allow sales of these chips to U.S. allies, while sales to many other countries would be tightly regulated. Last-tier countries are simply not eligible to purchase these advanced processors. This is the third such regulation aimed at preventing third countries from circumventing U.S. export controls by acting as intermediaries.
The news wasn’t all bad, as Broadcom raised its price target several times. Mizuho analysts raised their price target to $260, and Goldman Sachs raised their price target to $255. This represents a potential upside of 13% and 11%, respectively, for investors compared to Wednesday’s closing price. Unfortunately, the bullish sentiment towards Broadcom wasn’t enough to overcome the gloomy mood in the market.
take a step back
This is something of a one-two punch for our AI stocks. Wall Street is keen to see interest rates fall, as this is likely to encourage more corporate borrowing and capital spending, which is likely to include investments in AI. Additionally, any restrictions affecting the semiconductor industry could weigh on the overall adoption of AI and ultimately impact the next major players.
Broadcom provides many semiconductor and ancillary technologies used in data centers and cloud computing, where much of the AI processing takes place. Arm Holdings creates and licenses many of the high-end processor designs that are integrated into larger, more complex semiconductors and AI chips. Oracle is a provider of database and cloud infrastructure services, but it also designs and engineers AI chips.
When it comes to reviews, beauty is in the eye of the beholder. Arm, Broadcom, and Oracle are currently selling at forward price/earnings multiples of 90x, 35x, and 27x, respectively, suggesting Oracle is the best bargain.
However, the most widely used valuation metrics tend to fall short when it comes to measuring high-growth stocks. Applying a more appropriate forward price-to-earnings ratio (PEG) that accounts for accelerating growth rates, Oracle, Arm, and Broadcom sport multiples of 0.38, 0.21, and 0.09, respectively, below the 1 threshold. This is the standard for cheap stocks.
Aside from today’s economic downturn, AI is expected to continue to grow rapidly. The technology is expected to contribute $15.7 trillion to the global economy by 2030, according to Big Four accounting firm PwC. This shows the magnitude of the opportunity in the coming years.
If our three AI companies can control even a portion of that windfall, today’s decline will be just a drop in the bucket, despite daily fluctuations. This helps explain why investors should focus on the long term.
