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NVIDIA’s warning may point to bigger problems in the semiconductor space
Thursday 22 Nov 2018 Author: Russ Mould

Alongside electric car maker Tesla, global graphics processing unit leader NVIDIA has acquired quasi-FAANG status, helped by the phenomenal capital gains which it has provided to investors.

This makes the company – and its sudden travails, in the form of a profit warning (15 November) and steep share price slide – interesting to this column for two reasons.

First, it puts further pressure on the tech sector, which has been a rare source of juicy capital gains for investors in 2018.

Second, it brings silicon chip stocks back into the spotlight. They are interesting because their main benchmark, the Philadelphia Semiconductor index, or SOX, has a good record as an indicator for global economic and financial market health that dates back to its inception in 1994.


After the disappearance of ARM, ARC, Imagination, Wolfson, CSR and PureWafer, the UK stock market is not blessed with exposure to the global semiconductor industry, which has annual global sales of more than $400bn. IQE (IQE:AIM) is one of the UK’s remaining quoted players.

But this does not mean investors can ignore NVIDIA’s big profit warning, which cited indigestion in the video consoles market and also a slowdown in demand from makers of Bitcoin mining equipment.

The alert means that a stunning run of increases in quarterly sales and profit is about to come to a crashing end, with founder and chief executive Jensen Huang forecasting a 7% year-on-year drop in sales and a 28% year-on-year plunge in operating profit for the fourth quarter.


This is not to say that NVIDIA cannot bounce back but investors must now mull over three issues.

1. Is it time to keep buying on the dips? A stock market bull run that is nearly 10 years old has conditioned many market participants to use any share price weakness as a chance to pile back in.
Like all investment strategies this one works well, until it doesn’t.

It may not be obvious from the long-term share price chart but NVIDIA’s shares fell by more than 80% in both of the 2001-03 and 2007-09 bear markets. A repeat this time would take NVIDIA back to barely $60 – still miles below the $164 price at the time of writing.

2. Is this a stock-specific situation or indicative of wider problems for end-demand for silicon chips? It is tempting to say this is a situation that lies solely with NVIDIA, given the damage done by relative niche markets such as bitcoin mining equipment. But NVIDIA has not been alone in warning of softer end markets.

A string of Apple suppliers have coughed up disappointing results, including Japan Display, Lumentum and AMS; while Texas Instruments, Infineon and STMicroelectronics have all issued cautionary outlooks.

This feels like it could be broader-based and investors must now keep an eye on NVIDIA’s quarterly balance sheets. A second-quarter jump in inventories and trade receivables warned of a possible slowdown and now it has come to pass, with inventories and receivables rising must faster than sales yet again.

Tech-stock bulls will want to see this bulge of finished parts start to diminish to suggest this is just a blip and not an end-of-cycle downturn.

3. What, if anything, does this mean for stock markets more generally? NVIDIA is a leading member of the SOX index, which peaked before the wider US stock market in both 2000 and 2007 and bottomed before headline indices such as the S&P 500 began to find their footing in 2002 and 2009.

This is because silicon chips – semiconductors – are everywhere. They can be found in cars and computers, smartphones and tablets, video games and robotics, and even display screens and data centres, so they are good proxy for economic growth and broader end-market demand.

In addition, chip stocks are traded as momentum and growth stocks, doing well when earnings estimates are going up and badly when they are going down. As a result, the SOX can be a good guide to financial market sentiment more generally.

The SOX had rallied going into the NVIDIA report so it will be interesting to see if the index can shrug off the disappointment as we head into the key festive gadget selling season.

Buyers on the dips will certainly be hoping so, although they may note with some trepidation that the SOX index has yet to recapture the highs reached in March of this year.

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