Wall Street sees a semiconductor industry bottom coming. Here's how we're playing the stocks

Published Wed, Apr 12 202310:34 AM EDTUpdated Wed, Apr 12 202310:41 AM EDT

Semiconductor stocks are on a roll this year, with Club holding Nvidia (NVDA) leading the way. Two popular exchange-traded funds — the iShares Semiconductor ETF (SOXX) and VanEck Semiconductor ETF (SMH) — are both up roughly 25% in 2023, more than three times the year-to-date return of the S & P 500 . Though to be fair, the chipmakers did have a lot more room to bounce back after performing horribly in last year's terrible market. Case in point, Nvidia and fellow Club stock Advanced Micro Devices (AMD), among our worst performers last year, are some of our best in 2023 — soaring year-to-date by more than 85% and 45%, respectively. NVDA AMD YTD mountain Nvidia vs. AMD year to date So, the question now is: Can the rally in semis continue? To help us read the tea leaves, here's a look at what Wall Street analysts are saying about the underlying fundamentals of the industry. Additionally, we offer our view of the potential of our semiconductor holdings as demand for artificial intelligence explodes after the release of ChatGPT from OpenAI, which is backed by Club-name Microsoft (MSFT) and leverages Nvidia's powerful chips. Evercore ISI Starting with Evercore ISI, where the analysts have designated Nvidia as a Top Pick, along with a few other non-Club names, raising NVDA's price target to $320 per share from $300. Evercore said a "fundamental bottom" for the semiconductor industry currently playing out in March and April "has only strengthened" recently. Analysts there believe the inventory correction that's plagued the industry in recent quarters will be largely complete by the second quarter. As a result, they're looking past the near term to an acceleration in the back half of 2023 into 2024. Regarding the various end markets, the analysts pointed out improving visibility in PCs and smartphones, thanks to "inventory digestion." They noted that automotive and industrial demand remains resilient and to expect a bottom in the data centers and networking in Q2. Evercore also sees the "soft landing" scenario playing out for the sector and it's modeling a 5% revenue decline in 2023 followed by 7% growth rebound next year. Speaking to our holdings, the analysts believe the makers of central processing units (CPUs) and graphics processing units (GPUs) will lead the recovery due to the "bottoming PC market and strong AI-related demand." Of course, they cite Nvidia as the best play given its dominance in GPUs, which enable artificial intelligence. We would call out AMD as another key beneficiary. Bank of America BofA analysts share a similar view on the timing for an industry bottom, expecting continued near-term volatility in the first half before entering a second-half-of-the-year rebound. In line with Evercore, BofA cited "still elevated inventory levels" primarily in consumer segments such as PCs and smartphones, along with some parts of the enterprise and data center end markets. They believe the PC inventory correction could last into the third quarter — so a bit longer than Evercore appears to be modeling — noting it could pressure AMD. Our view is that any weakness in AMD shares could be a buying opportunity for investors who can look past the next one or two quarters. There's been no change in AMD's longer-term secular growth prospect. If anything, it's improved in recent months with the renewed push for AI adoption. As for data center demand, BofA analysts are positive on a second-half rebound as "hyperscalers invest in hardware to support AI projects," favoring (surprise surprise) Nvidia for its exposure to everything AI. On the auto and industrial fronts, the analysts see resilience and maybe a demand surprise to the upside on the back of strong pricing power and bigger backlogs. Looking ahead, BofA cited the tailwind resulting from the push toward electric vehicles, noting it's leading to more pricing power and may prove current estimates conservative, particularly in the second half. KeyBanc Analysts at KeyBanc also see a semiconductor industry bottom this year — and like their counterparts at BofA and Evercore, they don't expect it until the second half of the year. Near-term, KeyBanc is more pessimistic, citing "weakening demand trends in cloud/enterprise data center, ICE (internal combustion engine) auto, PCs, smartphones (Android and Apple), and consumer." That said, the analysts still believe the current environment provides a "favorable risk/reward" scenario predicated on the belief that a "soft landing" for the sector is very much in play. Matching up with the modeling at Evercore, analysts at KeyBanc see cloud and enterprise demand bottoming in the first quarter before a real recovery begins to play out in the second half of 2023. As a result, they raised third- and fourth-quarter estimates on Nvidia and their price target to $320 per share from $280. The analysts called out "strengthening demand for AI" and the ramp-up of the company's newest gaming chips where "demand continues to exceed supply." However, KeyBanc was a bit more mixed on AMD, where it took down second-quarter estimates due to weak cloud demand, a delay in the Genoa processors ramp, and a "more muted recovery in PCs." Despite that, they still raised their AMD price target to $110 per share from $95. Similar to their view on Nvidia, the analysts also see the "increasing mix of AI server projects" benefitting AMD longer-term. Bottom line While there's some variation on timing, Wall Street clearly believes a bottom is in the process of playing out in the semiconductor industry. Some investors may think themselves good enough to get out of the stocks at these higher levels and buy back in at possibly lower levels, all in hopes of catching that end-market bottom. We caution against that, encouraging them to think about how that worked out for those thinking about timing the exact bottom in Nvidia's stock price. We don't fool ourselves into thinking we're that good/lucky. Remember, stocks are forward-looking — and by the time an actual bottom happens, you've likely already missed the move. That's why we kept Nvidia during the bad times of last year (and times were really, really bad), so we were invested when shares turned higher (and did it ever soar). Jim Cramer has dubbed Nvidia as our second "own it, don't trade it," a designation first bestowed on Apple (AAPL). So, whether the chip bottom is playing out now, or in the next three to six months, is far less important than the fact that AI adoption is happening. It's driving demand for semiconductors and stands to provide a multiyear secular growth opportunity to the benefit of our chip holdings. Investors, even shorter-term ones, tend to look out at least one to two quarters, which is why it's so crucial to focus on where the puck is going, rather than where it is or where it's been. With that mindset, it's hard not to like the setup for Nvidia and AMD here, despite their year-to-date outperformance — both versus the semiconductor industry at large and the broader stock market. We would also note that both stocks are still down versus where they were trading at the end of 2021 even though their fundamental outlooks appear stronger than ever as AI adoption goes mainstream following the release of ChatGPT. Lastly, it's worth mentioning that while rival AI services exist, such as Club holding Alphabet 's (GOOGL) Bard, ChatGPT was the first one to capture the interest of the masses and provide the world a glimpse of how artificial intelligence may be leveraged in the future. It represents a key event in history that's sparked demand for the technology. We are now in a world where users across every industry are thinking about how they can customize and leverage generative AI to enhance productivity and efficiency. (Jim Cramer's Charitable Trust is long NVDA, AAPL, GOOGL, MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Nvidia's A100 GPU, used to train ChatGPT and other generative AI, is shown at the demo center of Nvidia's headquarters in Santa Clara, California, Feb. 9, 2023.

Katie Tarasov

Semiconductor stocks are on a roll this year, with Club holding Nvidia (NVDA) leading the way.