Views From the Floor

Why we believe the semiconductor sector could see a recovery; and is emerging-market volatility underpricing macro risks?

A Light at the End of the Semis Tunnel: Japan, Korea and the Cycle

The dispute between Japan and South Korea has spilled into the economic arena. Earlier this month, Japan restricted exports of etching gas, photoresist and fluorinated polyimides - materials critical to South Korea's high-tech industries of semi-conductors and panels.

Japan produces about 90% of fluorinated polyimide and photoresists. 1 South Korea imported $144 million of the three materials from Japan in the first five months of this year, Korean industry data showed.

Not only has the dispute resulted in an uptick in the prices of DRAM and NANO (Figure 1), but it could, in our view, speed up the semis inventory clear out (Figure 2). This is essential for a durable recovery in the sector, where earnings per share have been under considerable pressure (Figure 3). Indeed, it's hard to see how we could see a turn in the cycle without a recovery in semis (Figures 4, 5).

Figure 1: Uptick in Prices for DRAM, NAND

Uptick in Prices for DRAM, NAND

As of 20 July 2019. DRAM spot price represented by the ISPPDR35 Index (inSpectrum Tech Inc DRAM Spot Price DDR4 4Gb 512Mx8 2133/2400 MHz); NANO spot price represented by the ISPPND17 Index (inSpectrum Tech Inc NANO FLASH Spot Price TLC Flash 64Gb 9182Mbx8).

Figure 2: Inventory Clear-Out to Come?

Inventory Clear-Out to Come?

As of 2019 Q1.

Figure 3: Semis' EPS Has Been Under Pressure

Semis' EPS Has Been Under Pressure

As of 16 July 2019. Ratios for the MXWD0SE (MSCI AC World/Semiconductors & Semiconductor Equipment) Index.

Figure 4: Semis Sales Versus 12-Month Forward ACWI EPS

Semis Sales Versus 12-Month Forward ACWI EPS

As of 2019 Q2.

Figure 5: Semis Sales Versus JPM PMI

Semis Sales Versus JPM PMI

As of 2019 Q1.

EM Volatility: Underpricing Macro Risks?

As we highlighted earlier in the year, EURUSD implied volatility continues to remain at very low levels; however, potential rate cuts and other expected central bank actions have also recently resulted in significant declines in emerging market (‘EM’) currency volatility (Figure 6).

Similarly, implied volatilities for out of the money puts on EM bonds have fallen close to all-time lows. Markets are pricing in central bank actions with some certainty in the short term. However, the longer-term picture – not just for central bank actions, but also the global economy and the ongoing US-China trade war – is less clear. Although the rate environment appears more favourable for EM assets, volatility markets may be underpricing other macro risks on the horizon.

Figure 6: Emerging Market Currency Index Implied Volatility

Emerging Market Currency Index Implied Volatility

As of 17 July 2019.

Figure 7: Emerging Market Bond Index Implied Volatility

Emerging Market Bond Index Implied Volatility

As of 16 July 2019.

With contribution from: Ed Cole (Man GLG, Managing Director) and Peter van Dooijeweert (Man Solutions, Head of Institutional Hedging).

1. Source: Reuters

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