Chip stocks tumbled in 2022. How to play the sector in the new year

Published Sun, Jan 8 20237:28 AM EST

Semiconductor stocks suffered a series of blows in 2022 as demand for consumer discretionary items fell off a cliff and supply chain disruptions continued. As the new year kicks off, those problems linger, but opportunities also abound for investors who choose wisely. Both the iShares Semiconductor ETF and VanEck Semiconductor ETF tracking the chip sector plummeted more than 34% last year as investors veered away from growth stocks, demand slowed for consumer products like personal computers and the broader market retreated 20%. Once high-flying names like Nvidia and Advanced Micro Devices suffered some of the steepest declines, cratering more than 50%, stunted by dwindling demand for discretionary items even as some of their own pandemic supply chain problems eased. They two were the worst-performers in the tech-heavy Nasdaq-100 index . Against this backdrop, questions have grown over where to find opportunity in the industry in 2023. With recession fears mounting and many analysts expecting an inventory correction to persist in 2023, questions also linger over where investors should park their money. "We'd rather stick with quality and take our cyclical bets elsewhere, in other parts of tech or industrials," said Michael Bailey, director of research at FBB Capital Partners, who is slightly underweight semiconductors relative to their weighting in the S & P 500. "It's a good sector to own but we are a bit cautious here at this point." Despite a cloudy near-term outlook, semiconductor analysts expect the sector's outperformance to eventually resurface again. JPMorgan agreed with that view in a note to clients last month, highlighting names with solid market leadership, scale and opportunities for margin expansion as safer bets. "Despite a cyclical downturn in 2H22 and into 2023, multi-year outperformance for the group remains intact, and we expect that trend to continue in 2023," wrote analyst Harlan Sur. While the outlook may look a little more hazy in 2023, come companies are better positioned to ride out the volatility than others. CNBC spoke with investors and analysts who shared their perspective on the market ahead. Betting on semiconductor favorites Despite ongoing volatility, some analysts and investors are still betting on once high-flying names in 2023, even though the challenges of 2022 continue. One of those is Advanced Micro Devices, a chip stock commonly connected with PC and server chips that fell hard in 2022. Despite these near-term challenges, firms including UBS and Bernstein named the stock among their top picks for the new year. AMD 1Y mountain Advanced Micro Devices fell 55% in 2022 "In the current environment we would hence be looking for names that have cut [their own guidance], and where there is a strong secular story that can play off that bottom," said Bernstein's Stacy Rasgon of the stock, along with Nvidia and Qualcomm . While Nvidia sank more than 50% in 2022, Credit Suisse analyst Chris Caso said in a note this month that the company's gaming segment has likely gotten less risky, expecting inventory to normalize or come close to doing so when it reports earnings next month. Despite lingering short-term risk, Caso expects Nvidia's datacenter business to benefit from cloud demand. Caso's bullish take on Qualcomm also hinges on the expectation that estimates have come down, given that it's handset business was among the first market segments to enter a correction. The consensus price target on implies about 26% upside for the stock from Friday's close. "Our checks suggest that Chinese OEMs are consuming components at very low levels in 4Q as they burn inventory, at such low levels that we don't believe quarterly shipments from QCOM can get much worse," he wrote. Looking for defensive names Bailey's strategy in the current macroeconomic environment is to take less risk and search for defensive names. That's led him to Texas Instruments, a company he describes as a "crossover industrial slash tech company." Texas Instruments held up better than the rest of the semiconductor market in 2022, shedding a little more than 12%. The company's long product cycle with slow turnover means it should benefit even as fear of a recession grows. "If you get a little bit tougher recession, you get some unexpected problems, it's probably a good defensive semiconductor name in a portfolio," Bailey said. For investors with a slightly higher risk tolerance, he recommends Taiwan Semiconductor Manufacturing , given its high —and growing — market share. Warren Buffett's Berkshire Hathaway made a bet on the semi stock last year, revealing a more than $4 billion stake in November . After falling 27% last year, TSM's valuation sits at a decade low and it looks positioned for a rally should sentiment pivot, he said. The consensus price target on shares suggests they can rally more than 86% from Friday's close. Bailey is mostly shying away from former, rapid growth names, with small bets on ASML and Marvell for clients looking for possible higher growth. He described Marvell as a "slightly lower risk" way to own Nvidia, given its similar focus on cloud computing but minimal exposure to gaming. MRVL 1Y mountain Marvell shares tanked about 58% in 2022 Morgan Stanley is also maintaining a bullish stance on Marvell, viewing its cloud business as durable. Despite concerns that the semiconductor market could fall between 8% and 10% year over year, JPMorgan's Sur expects Marvell's "strategic infrastructure end markets" and company-specific programs to support growth. ASML, meanwhile, holds a monopoly over part of the machinery market for its extreme ultraviolet lithography machines (EUV) required in creating advanced chips. Bailey highlighted its dominance in that market and improving fundamentals, while Bank of America also named ASML among its preferred equipment names. Robert Pavlik, a portfolio manager at Dakota Wealth Management, agrees with Bailey's take on ASML, noting that while shares are a little expensive, currently at 19 times forward earnings, the company expects decent revenue growth when compared to 2022. "It's not for widows and orphans," he said. "You have to rely on not only what the company does, but on what the whole industry does, so you have to be somewhat confident in the semiconductor space." Another play that Wall Street is coalescing around this year is Analog Devices , one of the market share leading analog companies that outperformed last year, when it fell just 6.7%. Bank of America recently named ADI a top pick, as did JPMorgan's Sur, who highlighted its push into growth areas like automotive and digital healthcare. Sixty percent of analysts hold a buy rating on ADI, with the consensus price target implying more than 17% upside from Friday's close. "We believe the team has multiple cost levers to shield its earnings power and free cash flow generation ...," Sur said. "In addition, the team is prudently holding more inventory on its balance sheet vs shipping products into the channel" and that should soften revenue declines if demand drops. — CNBC's Michael Bloom contributed reporting