Jahanara Nissar

Into the run-away enthusiasm for semicaps in recent weeks, we would be cautious heading into earnings season. Its not just that the new export restrictions may have more bite than imagined even a week ago, we think the Street may have become overly optimistic with regards to fundamentals. If investors are looking for the multi-year AI demand outlook from the likes of OpenAI, ORCL and a slew of neocloud companies to get reflected in material improvement in WFE commentary from semicap management, we think investors may be disappointed. Earnings calls may not be quite as boisterous as investors seem to expect. We are looking at 2026 WFE moving from ~$105bn three months ago to $110bn-$115bn range vs. Street consensus moving to ~$125bn.

The new bout of US-China trade wrangling is likely to puncture the AI momentum. The haircut AMAT provided for its current quarter due to the so-called Affiliates Rule from the US Commerce department may not be Applied’s last word. AMATs peers too are likely going to have to trim China outlook. The impact of the far more onerous Rare Earth Element (REE) rules released by China’s MOFCOM late last week, we think is likely have an even more material impact on the semicap sector.

Net/net: We expect the trade wrangling to last through the earnings season. We expect ASML to sound the alarm at their upcoming earnings call, China’s REE rules likely to hit ASML’s laser shipment especially hard. We think a degree of froth has crept into semicap names thanks to the multi-year expectations in the AI space. We think it prudent to step to the sidelines. We are leaving our $120PT for LRCX unchanged until we get further clarity on the call.

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Thots on LRCX: We have been positive on LRCX all year. We reiterated the call at the start of the phenomenal ramp in SNDK stock starting late August, early September (link) and rode the stock as Street analysts rushed to upgrade views. After a month of relentless melting up, we began to get queasy with the outsized, multi-year outlook from Samsung/Hynix in response to purported demand from OpenAI. Every new AI headline bumped up semicap stocks more. Street enthusiasm coming out of Semicon West found its way into another round of PT increases for semicap names.

Some improvement in outlook but not enough: Despite a month-long jamboree of head-spinning AI headlines, we think the tangible business outlook at semicap companies has barely budged. Their view may improve in the future, but we will not look for semicap captains to thump the table in the days and weeks to come. We think there has been modest improvement in 2026 WFE over the past three months. The outlook for 4Q may see modest improvement due to pull-in from 1H26, but not enough to justify the super strong gains of the past month. Having said that, the overall tendency has been towards pull-ins. Pull-ins are typically leading indicators of an eventual raise in annual outlook.

Key ideas: Change in 2026 WFE over the past three months

• There has been some improvement in DRAM prospects in 2026, but modest.
• Despite understandable bullishness in the storage market, NAND WFE into 2026 has not budged
• TSM capex into 2026 remains in the low 40s billions, unchanged from 3 months ago, a little bit of pull-in into 1H.
• Samsung/Taylor WFE has remained largely unchanged, but with the more pronounced pull-in into 1H

The return of geo-political uncertainty: China’s rare earth element (REE) rules released last week could have a substantial impact on the shipment of semicap companies worldwide, far worse than the impact from the US’s Affiliates rule. The REE retaliatory package specifically calls out the semicap industry. Rule 61 in the package requires license review for semicap companies for shipping equipment containing even tiny amounts of REE from China. Litho tools need lasers, which contain REE. Etch and dep tools need pumps, which contain REE. The retaliatory package has the potential to shut down large chunks of the semicap shipment and essentially grind semiconductor manufacturing worldwide to a complete halt. The only hope for the industry is for the US to convince China to lift the REE package. And in order to do that, the US may have to rescind its Affiliates rule.

Net/net: Our 2026 WFE goes from $105bn three months ago to $110bn-$115bn range vs. the Street bulls converging to ~$125bn. The upper end of our range depends on US-driven uncertainty around China exports. If China’s REE rules are not rescinded, there could be downside to the lower end.

The tendency on the Street is to buy the tariff dip. However, we note that the negotiations could drag on into November, thus jeopardizing the earnings season. On the AI front, we think the Street may be disappointed with little of the AI bullishness from downstream players percolating upstream to semicaps and foundries. We think the upstream players could take a conservative wait-and-watch approach. We would be taking profits in the semicap space ahead of earnings.

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