To provide forward-looking perspective on inflation, Director of Equity Research Matt Peron and analysts from our Equity and Fixed Income Research Teams assessed comments made by listed corporations addressing the topic. In a series of articles – also available as a whitepaper – they discuss how select sectors are being impacted by rising prices and what it means for both company profitability and the health of the economy.
- Semiconductor (semi) manufacturers were not prepared for the surge in demand during the pandemic. But with end users scrambling for the chips essential to their products, they have had little problem passing along costs.
- Semi companies’ contribution to inflation is not solely due to them passing along higher input costs. Many have capitalized on strong demand by pivoting toward the highest-margin products, resulting in record profitability.
- Looking ahead, with many chips sold out for the rest of this year and little incremental supply slated to come online, we expect the inflationary environment for semis to last.
Typically, the technology sector has been a disinflationary force for the economy as it provides the digital tools that make companies more productive and, thus, cost competitive. Yet during this cycle, tech has played a central role in perhaps the highest-profile supply-chain disruption: The semiconductor (semi) shortage. Given the ubiquity of semi chips across an ever-growing array of industrial and consumer products, a shortfall in controllers and microprocessors can shut down entire production lines, with the result being unfulfilled orders and inflated prices on the goods that ultimately reach the market. Two years after the nadir of the pandemic, used vehicles continue to be a material contributor to core inflation as new car lots remain understocked.
As with other industries, semis were caught flat-footed by the surge in demand during the pandemic – first by companies seeking to rapidly increase their digital capabilities for the stay-at-home economy, and then by the quick economic reopening. After reducing capacity in the wake of canceled orders, chipmakers were unable to ramp up production to meet renewed demand.
Cancellations filtered through the supply chain and these have contributed to the supply/demand imbalances that continue today. Chipmakers face higher costs from inputs such as wafers, other raw materials, freight and – like elsewhere – labor. But with end users scrambling for the chips essential to their products, semi manufacturers have had little problem passing along costs. One exception is the semi-capital equipment industry that makes the machinery to produce chips. This segment typically operates on fixed volume-price agreements governing a particular period, meaning they are unable to pass long their increasing costs to chip fabrication facilities for the duration of the contracts.
Semi companies’ contribution to inflation, however, is not solely due to them passing along higher input costs. Many have capitalized on strong demand by pivoting production toward the highest-margin products. This has resulted in record profitability. Thus far, business customers including cloud, enterprise, automotive and industrial companies have absorbed higher prices as semi content comprise only a small portion of overall input costs.
Yet, knock-on effects are being felt in certain end markets. The absence of lower-margin chips means that some end users must turn to third-party markets to source essential chips, often paying up to 50 times the wholesale price. That does eat into margins. In many cases, the lack of a single type of chip can halt production on an entire product line, resulting in supply imbalances and higher prices for goods that at first glance have little connection to the chip industry. A noteworthy example is the plight of low-priced appliances. With the chips upon which they are dependent a low priority for semi makers, appliance manufacturers must curtail production. On the opposite end of the spectrum, higher costs and lower supply of inputs– including chips – are enabling automakers to capitalize on pent-up demand by prioritizing the highest-margin, highest-end vehicles. The resulting upward skew in sticker prices is a driving force behind the 17% year-over-year price for new cars in the U.S.
Looking forward, with many chips effectively sold out for the remainder of this year and little incremental supply slated to come online, we expect the inflationary environment for semis to last well into 2023. And while strong demand has meant both businesses and consumers have been willing to accept high prices for chips and chip-enabled products, a weakening economy could dampen that trend. We see the European market especially vulnerable as a weakening economy – combined with supply-driven inflation – could result softer demand for consumer products like personal computers, smartphones, tablets and TVs.
Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.