“Semiconductor industry, increased volatility and the prospect of soft landing”

Marco

Today, we will be discussing both the short and long-term outlook for the semiconductor sector, with a particular focus on the fabless semiconductor model.

A fabless semiconductor company specialises in designing chips while outsourcing the manufacturing process to foundries. This approach allows these companies to prioritize innovation without the heavy capital expenditure tied to owning and operating fabrication plants. While short-term challenges like supply chain disruptions or geopolitical tensions remain, the long-term outlook for fabless semiconductors is strong.

The demand for advanced chips continues to rise, driven by AI, 5G, IoT, and autonomous vehicles. These technological advancements position fabless companies to benefit immensely over the coming years. Moreover, supportive government policies such as the U.S. CHIPS Act and the European Chips Act provide a robust foundation for the sector’s resilience, offering financial backing for R&D and bolstering local manufacturing capabilities to reduce reliance on foreign suppliers.

The BlueStar Top 10 U.S. Listed Fabless Semiconductor Index has outperformed both the NASDAQ Global Semiconductor and NASDAQ 100 indices in cumulative returns over the past three years. This reflects the growing investor confidence in the fabless business model.

Nvidia, the largest player in the fabless space, continues to report strong earnings. Its revenue exceeds that of the next three largest fabless companies combined. Despite this, the pace of its revenue growth has shown signs of slowing, particularly over the last two quarters. Valuations for Nvidia remain a key concern as the company faces increasing pressure to consistently surpass earnings expectations.

However, Nvidia’s long-term outlook remains positive. The company’s dominance in the GPU market and its CUDA platform creates significant switching costs for users, forming a wide economic moat. Nvidia’s strategic positioning within AI and other emerging technologies will likely sustain its leadership and market influence over the coming years.

Although not traditionally classified as a fabless company, Apple’s success with the M1 and M2 chip designs underscores the benefits of this model. By maintaining control over chip design while outsourcing production to TSMC, Apple has demonstrated the fabless approach’s flexibility and effectiveness. As AI continues to advance, demand for Apple’s consumer hardware is likely to increase, creating a positive feedback loop that will further strengthen the broader semiconductor industry.As more tech companies adopt the fabless model, the sector’s growth prospects remain promising.

In summary, despite short-term hurdles such as supply chain risks and high valuations, the semiconductor sector—particularly fabless companies—presents a compelling long-term investment opportunity.

Bonds

Consistent with a baseline soft landing and gradual policy normalisation scenario, current pricing of US yields implies around 35 bp of cuts for September and 110 bp by year-end. Downward revisions in US employment data leaves asymmetry still towards larger moves. The Fed’s stronger emphasis on avoiding further weakening in payrolls increases the risk that the market judges the Fed to be falling behind the curve. The current narrow gap in national polling averages between Vice President Harris and former President Trump reduces upside risks to yields from the legislative agenda of a prospective Republican sweep of the Presidency, Congress and Senate. Taken together, this suggests that a climb back towards higher yields should be capped. We are inclined to increase duration of bond portfolios.

S&P Ratings commented that its ratings outlooks for banks in the Asia-Pacific region are largely stable. The ratings agency sees risks to asset quality from commercial property, especially in China, Hong Kong, and Vietnam. Household debt may be strained by high interest rates, but this is so far not translating into asset quality pressure. Meanwhile, the sector’s credit strengths will continue to underpin ratings, including strong profitability and capitalization. In terms of ratings outlooks, Southeast Asia has the most favourable starting point, with roughly one fifth of ratings across the region on positive outlook, while the rest are stable. Among Southeast Asian banks, Philippine bank spreads are relatively attractive in combination with solid fundamentals.

Macau gross gaming revenue (GGR) grew 15% year-on-year, +6% month-on-month to MOP 19.8 billion in August. This marked the second-highest level in 55 months and was above the seasonal pattern; +6% month-on-month is above the historical seasonality of +2-3%. The August data suggests that GGR is holding up better than expectations due to slower China consumption and that the Macau gaming recovery has not been derailed. Most operators have turned positive free cash flow in recent quarters given capex remains rather muted. It is expected that most issuers continue to pare down their debt levels. From a valuation perspective, the long end of some operators offers 7+% yields which is relatively more attractive vs other Asia HY (excluding China real estate) or US gaming peers at 6+% currently. We are inclined to increase positions in longer tenor Macau gaming bonds.

Macau Visitor Arrivals Climbed Month-on-Month in August

Source: Bloomberg Finance L.P.

Equities

The U.S. economy has exhibited increased volatility following weaker-than-expected ISM data and a disappointing jobs report. These factors have triggered market pullbacks and raised concerns about a potential recession. However, despite these fears, the prospect of a soft landing remains strong.

Inflation is on a clear downward trend, with both headline CPI and core PCE steadily decreasing. This disinflationary movement, which began in May, has provided much-needed relief to market participants, indicating that price pressures are easing and economic stability is improving.

The labor market has shown some signs of softening. Job openings are down, and the unemployment rate has risen to 4.3%. Additionally, nonfarm payrolls and ISM manufacturing data were weaker than anticipated, which has fueled concerns about the economy’s trajectory. However, this cooling in the labor market is seen as part of the natural economic adjustment, not necessarily a precursor to a recession.

Positive signs are also present in the GDP data. Q2 real GDP growth was revised upwards to 3%, and initial jobless claims remain within expectations, decreasing by 2,000 to 231,000. While the labor market continues to cool, it remains resilient, and the economy is still on track for a potential soft landing.

In Japan, the economy grew at an annualized rate of 2.9% in Q2, a slight downward revision from the initial 3.1% estimate. The adjustment reflects weaker corporate and household spending, which signals increased caution among both businesses and consumers.

Corporate and household expenditures have been revised down, and capital expenditure, a critical indicator of private sector strength, has also been adjusted lower. Private consumption rose by 0.9%, slightly below the original 1% estimate, underscoring subdued domestic demand. These revisions, driven largely by global uncertainties, are exerting a drag on Japan’s growth momentum.

From a monetary policy standpoint, the Bank of Japan faces challenges balancing the need to support economic growth with the rising inflationary pressures. The weakening domestic demand puts policymakers in a delicate position as they attempt to navigate these conflicting priorities.

Japan also faces risks from weaker external demand, particularly from the U.S. and China, two of its largest export markets. Any slowdown in these regions could hamper Japan’s economic momentum in the coming quarters.

In summary, while both the U.S. and Japan are facing challenges—softening labor markets in the U.S. and reduced corporate and household spending in Japan—there are still reasons for cautious optimism. The U.S. remains on track for a soft landing, supported by easing inflation and a resilient GDP outlook. In Japan, although the GDP has been revised downward, the economy continues to grow at a healthy pace, though external risks and subdued domestic demand warrant close monitoring. Both economies will require careful navigation of their respective challenges moving forward.