Semiconductors and Advancements Investors Should Watch Out For

Semiconductor Industry: An Overview

Semiconductors are materials that conduct electricity but only under certain conditions (hence the "semi"), making them an essential component in modern electronics. They are found in products from smartphones and laptops to cars and medical devices. Semiconductors include microprocessors, memory modules, and integrated circuits, among other components.

Their importance lies in their ability to process and transmit information, making it a major industry in the global economy. Semiconductor companies are among the largest in the global stock markets, including NVIDIA Corporation (NVDA), Taiwan Semiconductor Manufacturing Company (TSM), and Broadcom Inc. (AVGO). Semiconductors are critical in most modern electronics and are essential to technologies such as artificial intelligence (AI) and the Internet of Things.

A notoriously cyclical industry that faces vast shifts in demand, the industry is expected to grow tremendously by the early 2030s. For example, worried about the effects on national security and competitiveness of such shortages, the U.S., EU, and other areas have committed billions to expand regional semiconductor manufacturing. The U.S. CHIPS and Science Act of 2022 is the biggest at $39 billion in grants and a 25% investment tax credit (plus $13.2 billion in research and development). In a May 2024 report, the Semiconductor Industry Association predicted these and similar incentive programs in Taiwan, South Korea, Japan, India, and elsewhere should help propel about $2.3 trillion in private sector investment in wafer fabrication from 2024-2032, with the U.S. seeing the largest increase in capacity, about 203%.

Semiconductor Shortages

After the pandemic, the semiconductor industry faced a prolonged chip shortage that disrupted supply chains and delayed manufacturing in autos and other sectors. Even as PC sales have slumped, overall demand for semiconductors of all stripes—from basic microcontrollers and memory chips to the most sophisticated high-performance processors—had outgrown producer capacity. By mid-2024, production and supply chain slowdowns were largely mitigated, though the effect would likely be felt for some time for some types of chips.

Before the pandemic, the industry was already seeing demand outstrip supply because of the increasing demand from companies involved in AI, the Internet of Things (IoT), and advanced cellular networks, which require more powerful and efficient semiconductors. The pandemic also reshaped global demand as people shifted to remote work and online learning, exacerbating trends already underway. International trade in semiconductors increased 43% between 2017 and 2022.

In addition to increased demand, the semiconductor industry has been an issue in geopolitical strife and trade tensions. For example, in recent years, the U.S. government has placed export restrictions on Chinese semiconductor companies, citing concerns about intellectual property theft and national security.

Record Profits

The semiconductor industry itself, however, had record profits and record stock prices from 2020 through 2024 after a brief dip in 2022. The chart below depicts the VanEck Semiconductor Index ETF (SMH) prices from 2020 up to the second quarter of 2024.

Chip stocks slumped in 2022 due to fears of a global recession. In addition, weaker consumer spending meant companies cut back on semiconductor products, even as chipmakers invested billions in new fabrication plants to increase supply. Then, in 2022, the U.S. Department of Commerce announced strict export restrictions on selling semiconductors and equipment to China, which could cost up to billions of dollars in revenue over the next few years for several struggling semiconductor firms.

The semiconductor sector, however, began recovering by mid-2023, reaching record highs in early 2024. This was due in no small part to the rise of NVIDIA, a leader in the growing GPU market for crypto mining and AI applications. NVIDIA is the largest holding for SMH at about 20%, with TSM at about 13% and Broadcom at 8%.

Technological Advances in Semiconductors

The semiconductor industry's future is closely intertwined with the development of several key technologies, including AI, IoT, green energy, autonomous vehicles, and 5G+ networks. The increasing demand for faster, more efficient, and more powerful computing devices is driving the need for semiconductor materials, manufacturing processes, and chip architectures.

A notable recent development is the return of germanium as a semiconductor material. Germanium was used in the first transistors but was largely replaced by silicon since the latter is abundant, costs less, and tests better for certain aspects of conductivity. However, germanium's higher electron and hole mobility could make it more efficient for future high-performance transistors. Researchers are exploring ways to integrate germanium channels into circuits, which could lead to faster and more energy-efficient devices. Advances in germanium-based transistors, such as FinFETs and nanowire designs, could help overcome some of the limitations of silicon as the industry approaches the physical limits of its current materials.

In addition to the potential comeback of germanium, researchers have recently made a breakthrough in manufacturing highly purified silicon, which could be a boon for quantum computing. Using a focused beam of pure silicon-28 to replace the undesirable silicon-29 atoms in a chip, they have created a material that can sustain the delicate quantum coherence needed for reliable quantum calculations, bringing the realization of robust, scalable quantum computers one step closer.

Scaling Up Capacity

Scaling up production is critical for the semiconductor industry while maintaining quality and reliability. This could involve investing in new manufacturing technologies, such as extreme ultraviolet lithography, which enables the creation of smaller and more precise chip features. In addition, the development of sophisticated packaging techniques, such as 3D chip stacking and wafer-level packaging, can help improve chip density and performance.

The $52 billion in funding from the CHIPS Act is expected to vastly increase the size of the U.S. semiconductor industry, tripling domestic semiconductor manufacturing capacity by 2032. The EU will also see the fruits of its European Chips Act, and China initiated the third phase of its semiconductor funding. Incentive programs emerged or expanded in the first half of the 2020s in Taiwan, South Korea, Japan, and India. In parallel, companies have made significant investments in both established and new semiconductor manufacturing regions. These will also increase production across the world.

Wafer fabrication is projected to become more durable by geographically diversifying, with leading-edge capacity expanding beyond Taiwan and South Korea to include the U.S., Europe, and Japan. In assembly, testing and packaging (ATP), China and Taiwan should continue to hold the largest share in global capacity. However, countries in Southeast Asia, Latin America, and Eastern Europe are expected to expand ATP activity, helped along by government and investor support. The development of sophisticated packaging and new chiplet designs is also driving some ATP production growth in the U.S. and Europe near their new wafer fabs.

However, the semiconductor industry also faces potential challenges. A major concern is the increasing cost and complexity of chip manufacturing, particularly as sizes continue to shrink. Developing new manufacturing processes and materials, such as germanium, requires billions in research and development. Additionally, geopolitical tensions and trade disputes, such as those between the U.S. and China, can cause bottlenecks in trading.

Top Semiconductor Stocks and ETFs

In mid-2024, the largest semiconductor stocks by revenue (trailing 12 months) are as follows:

1. Samsung (005930.KS)—$197 billion
2. TSM—$74 billion
3. NVIDIA—$61 billion
4. Intel—$54 billion
5. Broadcom—$39 billion
6. Qualcomm Inc. (QCOM)—$36 billion
   
7. ASML Holding N.V. (ASML)—$30 billion
8. Applied Materials (AMAT)—$26 billion
9. Advanced Micro Devices Inc. (AMD)—$23 billion
10. SK Hynix (000660.KS)—$22 billion

Based in South Korea, Samsung has semiconductor revenues but is a diversified business. The others above have a very high percentage of their companies involved in semiconductors.

Here are important exchange-traded funds (ETFs) that track the semiconductor sector:

• VanEck Semiconductor ETF (SMH)
• iShares Semiconductor ETF (SOXX)
• SPDR S&P Semiconductor ETF (XSD)
• Invesco Semiconductors ETF (PSI)
• First Trust Nasdaq Semiconductor ETF (FTXL)
  

The Bottom Line

The semiconductor sector is a major part of the stock market. It's not just a major player by market capitalization, but is critical to many industries, such as automotive, healthcare, and telecommunications. Disruptions in the industry, such as after the pandemic, showed its importance across the economy.

The performance of semiconductor stocks can impact the broader market, as seen in 2024, when the sector hit record highs, following a sluggish 2022 to 2023, when the sector experienced losses, contributing to a measurable drag on the overall market. As the chip market is expected to continue growing, investors should closely monitor the performance of the companies that make them.