Shortages of semi-conductors have been a hot topic recently. The surge in their prices during the post-Covid recovery is unprecedented: a jump of almost 230% in the cost of a chip between the lows of Q4 2020 and the high in Q1 2021! Although prices have started to level off, they are still very high. In August they were 11.5% above their peak of 2014, during the preceding period of serious pressure. It certainly raises questions over the nature of this market.
The issue has clearly moved beyond corporate boardrooms and the economy and into international politics. Given that this technology will remain a key factor in maintaining or aspiring to world leadership, all of the major economic powers are seeking to safeguard their own supply chains and thereby guarantee their independence. A number of recent announcements bear witness to this concern. In the USA, Joe Biden’s ],200 billion infrastructure investment plan – still subject to congressional approval – includes billion in semi-conductor R&D. In the EU, Ursula von der Leyen explained in her state of the Union address on 15 September that she wanted to confirm the bloc’s technological sovereignty via a target of producing 20% of the world’s semi-conductors by 2030, up from around 10% today. While the EU’s ambitions are laudable, we should not lose sight of the fact that the European market is much smaller than that of its Chinese and American competitors and appears to lack dynamism.
Although technology gaps can always be closed, it would be a fair bet to assume that the market’s main players – Taiwan and South Korea – will dominate the semi-conductor industry for some time yet. Not only is research in this area very onerous; the industrial process is itself extremely complex, involving high robotic content and several hundred stages of production. These characteristics tend to reinforce quasi-monopoly on the part of the market’s current leaders and it will not be easy to dislodge them.
The past two US results seasons featured sharp upward revisions to earnings projections and a high positive surprise rate. The combination of the two has helped drive equity prices to new highs on Wall Street. Will the Q3 season be any different? So far, it seems not. American firms are demonstrating remarkable resilience to everything being thrown at them. The season just starting (23% of S&P 500 firms have already published) is going swimmingly: analysts currently expect EPS to be up 32.7% in Q3, compared with their end-September estimate of 27.5%. If it materialises, the gain would be the third-largest since 2010, trailing only Q2 2021 (up 92.4%) and Q1 2021 (up 52.7%). A powerful base effect from last year is still at work. As in previous quarters, the number of companies beating consensus estimates is at a record high, with 84% of positive surprises since this results season began. In aggregate terms, firms have so far announced earnings 13.4% higher than analysts predicted.
Our valuation model continues to suggest that European equities are more attractive than their American counterparts. At current interest rates, US markets could be facing a modest 5-6% correction, but they would be more or less fair value overall were 30-year yields to tick down to 1.75%. Corporate newsflow is clearly a support factor in Europe, where 2021 results are set to be better than previously expected. Our model indicates that European equities offer around 10% upside, especially given recent upward revisions to earnings estimates. Importantly, that is true of each scenario, as in the case of a slow recovery we would expect interest rates to fall back to around zero. We therefore continue to overweight European equities against US equities.