Semiconductor stocks surged in 2023. Why investors may want to brace for volatility in the new year

Published Tue, Jan 16 20249:53 AM EST

Prepare for volatility in the semiconductor industry after an exuberant 2023 that saw prices surge and left many companies with lofty valuations. "Higher valuations in my experience lead to higher investor expectations and those higher investor expectations typically lead to higher volatility," said Michael Brenner of FBB Capital Partners . Computer chip stocks surged in 2023, largely due to enthusiasm surrounding the use of artificial intelligence and the need for advanced semiconductors. The iShares Semiconductor ETF soared 66% last year for its best performance since 2009. Many on Wall Street expect the uptrend in semiconductors to continue in the new year. But the gains are unlikely to surpass last year's, nor are they likely to take as smooth a path as in 2023. "Volatility in those names will be a whole lot more than last year," said Heritage Capital's Paul Schatz. "That's why I would advocate some restraints." Bracing for volatility Semiconductor companies have a lot to prove in 2024 after wowing investors last year. "The investment thesis remains that AI is going to be a driver of growth in technology and various sectors," said Sylvia Jablonski, CEO of Defiance ETFs. "Monetization of AI is just starting to play out and just starting to show up in earnings." The first test could come as fourth-quarter earnings season gets underway and may contribute to dramatic, short term price movements, according to Dakota Wealth Management's Robert Pavlik. One reason for concern is the sector's premium to the broader market. Brenner of FBB notes that while the industry has always offered growth and traded at a discount to the market due to its cyclicality, that shifted over the past year. The price-to-earnings ratio on a next twelve month basis sits at nearly 25 for the S & P semiconductor and semiconductor equipment industry after starting 2022 under 18. The forward PE for the broader S & P is below 20. Nvidia is even higher with a forward multiple at 27 as growth expectations balloon, but that's down significantly from a high of more than 62 within the last year. The elevated multiple assumes more growth in the industry, but also means companies have more to prove to investors to justify their prices, Brenner said. How to play the AI story Nvidia took center stage in artificial intelligence-centered, semiconductor investing in 2023 as Wall Street amped up bets that the Jensen Huang-led company's graphics processing units will power many large language models and chatbots. Even after a record-breaking year that saw Nvidia shares surge a record 239%, Wall Street remains bullish, projecting 21% upside from Friday's close. Many investors believe the tailwinds for Nvidia aren't played out but that any potential gains are likely to trail those of 2023. After the record-breaking year, Schatz is maintaining a position in Nvidia, but intends to eventually trim that stake given the performance, expecting some volatility in the sector. Jablonski also highlighted Nvidia as an AI play to own in 2024, but said it's far from the only stock poised to benefit this year. She pointed to Broadcom , Micron Technology and Advanced Micro Devices as other chip names with potential. Intel's also begun paving a better path after its value was cut in half in 2022, she added. Jablonski highlighted Intel's recent progress, including a 90% gain in the stock in 2023 amid a $3 billion cost-cutting plan. Tailwinds from heightened government spending on semiconductors under the CHIPS act are also starting to help. In its industry outlook last month, Deutsche Bank's Ross Seymore named Broadcom and Marvell Technology his top AI-focused picks. "Within AI, we expect demand tailwinds to persist, but likely to be somewhat offset by questions of sustainability, so we recommend names where revenue is accelerating and diversifying," Seymore said. Brenner points to Taiwan Semiconductor as another name to watch in 2024. The stock benefited last year, climbing 40%, as a supplier of graphics processing units to Nvidia and Advanced Micro Devices. That outlook should only brighten as GPU manufacturing gains steam. Looking outside AI Beyond artificial intelligence, other semiconductor themes could emerge in 2024. Brenner points to Infineon as a potential winner from the transition to electric vehicles and EV chargers and away from fossil fuels. Infineon's green industrial power business arguably offers a stronger longer-term growth profile than other parts of its business, he argues. To be sure, Brenner fears some volatility in the short-term as inventories rise in the automotive sector and some original equipment manufacturers cut back electric vehicle production. So far, however, auto semiconductor shipments have hung on. Brenner isn't alone in his call. KeyBanc Capital Markets' John Vinh said in a recent note to clients that auto industry semiconductor demand in the new year will benefit Analog Devices , NXP Semiconductors and On Semiconductor . However, at the end of the day, Wall Street expects much of the upside for the semiconductor industry as a whole to emerge as a result of AI advancements. An AI reset in the handset industry, for example, could bode well for shares of Qualcomm , Vinh said. As AI server adoption gains steam, and memory chip and wafer fab equipment demand grows, beneficiaries will include Lam Research and Micron Technology, Mizuho's Vijay Rakesh wrote in a January note. — CNBC's Michael Bloom contributed reporting