AI Semis: Run-up into year-end likely as macro factors lose potency
The 10-year yield jumped ~15bps yesterday, the 30-year jumped 10bps. The SOX index, down ~1%, hardly took notice. Have rising bond yields lost their potency to depress semi stocks? If so, the recent run-up in SOX could have legs as investors look past rising rates and focus on the fundamentals of high-growth AI stocks.
Macro factors added an additional layer of complexity to AI semi stock response to fundamentals in recent months. Key inflection points in our SOX vs. SPX outperformance metric coincided with turning points in crude oil price and the long bond (Exhibit 1).
Earlier in Q3, even as fundamentals-based investors ascribed falling AI stocks to bearish calls in the media, we think the real culprit may well have been rising bond yields and oil prices. In this context the FOMC decision last week took on extraordinary importance. A rate hike and the prospect of more hikes to come may have mollified bond investors.
The above-normal volatility in semi stocks seen in May-July timeframe has subsided as investors de-risked holdings due to rising crude prices, rising long bond and a steady din of bearish media headlines. All three factors may have lost their potency as volatility got squeezed out. For the past two months, semis have traded in a relatively narrow range.
Case in point – MU’s daily volatility in August has come down to nearly half of what it was in June/July. As we wrote in our MU preview 3 months ago, the stock becomes investible after daily volatility subsides (link). And now it has subsided. In recent days, high beta semis such as SNDK and MU made a break for the upside as daily volatility begins to mean-revert.
We expect a run-up in AI semis into year-end as company management stick to their multi-year optimism and as distractions from extraneous factors give way to investors refocusing on fundamentals. We note that fundamentals remain strong and may have incrementally strengthened in recent months.
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Are animal spirits returning? In a span of five trading days since the FOMC rate hike, the SOX index outperformed SPX by ~10 percentage points. Have semis has finally escaped the thrall of bearish headlines, rising oil prices and bond yields? They may well have. After months of tossing around the ‘AI is a bubble’ theme, the bears seem to be on the verge of throwing in the towel. A sense of FOMO could descend on the sector as seen in the frenetic action in SNDK, up 20% in 5 days.
SOX – Key inflexion points coincide with pivots in oil and bond yield: Exhibit 1 is a trend chart of SOX outperformance vs. the SPX indexed to Jan 2020.
Falling bond yield – Semis uptrend: Our SOX/SPX metric inflected sharply upwards on April 8th coinciding with a sharp drop in crude oil price. The next inflection of metric the happens on May 19th coinciding with the 10-year yield making a local peak (see Exhibit 1). May 19th thru June 30th the SOX/SPX metric rises further. The SOX gains 26% as the 10-year yield drops 29bps
Rising bond yield – Semis downtrend: The SOX/SPX index peaks on June 22nd, heading into MU earnings. The 10-year yield bottoms on June 30th and starts rising. For the next one month thru July 31st, the 10-year yield rises 33bps and the SOX drops 12%. Investor favorite SNDK drops a gut-wrenching 47%.
Rising bond yield – Semis go sideways: After the drop in the July, the daily volatility shrinks and stock settle into a relatively narrow band through August. Semis became less sensitive to movements in oil prices and bond yields. Between August 27th (Jackson Hole event) through September 16th (FOCM event) the 10-year yield rose another 33bps, but the SOX/SPX metric stayed with a narrow range (see Exhibit 1, blue dashed lines). The SOX stay flattish and so do high beta names such as SNDK.
Bond yields stay flattish – Semis uptrend: September 15th through September 22nd, the 10-yr goes sideways as the Fed rate hike on September 16th appeared to stabilize the long bond. With the uncertainty around FOMC now behind, semis investors come off the sidelines. The SOX jumps 12.8% vs. SPX up 2.8%, a 10pp outperformance of the SOX over SPX in a just 4 trading days. Investors appeared anxious to load up on high beta names – SNDK jumped 23% in 4 days. ARM jumped 17% in just one trading day. The catalyst for ARM may well have been the success of the agentic super app Muse from Meta. However, the double digit gain was enabled by a constructive macro environment, in our view.
Semis volatility has come in: The above-normal volatility in semi stocks seen in May-July timeframe has subsided as investors de-risked holdings due to rising crude prices, rising long bond and a steady din of bearish media headlines.
Take Micron for instance. The 7%-8% daily volatility in June/July, delivered a 19% gain in June and a 20% drop in July. In our MU preview 3 months ago, we wrote that the stock would become investable only after the daily volatility settled down. And now it has. Volatility has indeed settled down. The month of August witnessed daily volatility dropping to 3.5%, half of what is was in the preceding three months. During a low volatility month, the MU stealthily climbed 16%. MU now trades only ~10% below its June peak vs. down 30% at the July low.
On the verge of a breakout: In a brief note on September 4th, we pointed out that high beta names such as MU and SNDK were on the verge of a breakout. Since our brief note, MU is u 12% and SNDK 17%
SOX volatility has come in: Exhibit 2 shows the SOX/SPX outperformance metric shown in Exhibit 1 but on a longer time scale. The April thru June rally is indicated by the two red lines. The SOX igained 83%, it outperformed the SPX by 70 percentage points. July thru the present, the volatility in the SOX/SPX metric declined as show by the two dashed lines in Exhibit 2. The two dashed lines converge on the black solid line which falls almost exactly halfway between the two red lines.
Our take: The SOX/SPX metric has worked out the volatility in an orderly manner and is now ready to climb higher (Exhibit 2, black arrow) as volatility mean reverts to the upside.
Net/net: Even as fundamentals-based investors ascribed falling AI stocks to bearish calls in the media, we think the real culprit during the July sell-off may well have been rising bond yields and oil prices. Key inflection points in our SOX vs. SPX outperformance metric coincided with turning points in crude oil price and the long bond (Exhibit 1). The above-normal volatility in semi stocks seen in May-July timeframe has subsided as investors de-risked holdings due to rising crude prices, rising long bond and a steady din of bearish media headlines. All three factors may have lost their potency as volatility got squeezed out. For the past two months, semis have traded in a relatively narrow range. The SOX/SPX metric has worked out the volatility in an orderly manner (Exhibit 2) and is now ready to climb higher as volatility mean reverts to the upside.
The 10-year yield jumped ~15bps yesterday, the 30-year jumped 10bps. The SOX hardly took notice. Have rising bond yields lost their potency to depress semi stocks? If so, the recent run-up in SOX could have legs as investors take another look at high-growth, low-multiple AI stocks. A sense of FOMO could descend on the sector as seen in the frenetic action in SNDK, up 20% in 5 trading days.
KC Rajkumar
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