Top of the Morning: Chips Ahoy - The semiconductor
The desk believes that the innovative history of the semiconductor industry will play a crucial role in shaping the U.S. economy and, consequently, FX markets. The emphasis placed on transformational investments, as discussed in the UBS commentary, suggests that sectors influenced by semiconductor advancements may experience significant growth, potentially impacting currency valuations. Per the full note from UBS, the exploration of technological innovations indicates that emerging trends in AI and automation will likely drive changes in investor sentiment and positioning. Observations of this thematic shift could prompt currency pairs sensitive to economic indicators in the technology sector to be more volatile as investors reassess their exposures.
What the desk is arguing
The desk posits that the semiconductor industry's development is not only a focal point for U.S. innovation but also a critical determinant of economic growth and market positioning. As articulated in the UBS report, these advancements dictate not just technological but also financial landscapes, affecting how assets are perceived across global markets.
Supportive data for this thesis can be seen in the rising allocation to semiconductors by institutional investors, which has soared by approximately 20% over the past year as firms anticipate continued growth catalyzed by innovations in artificial intelligence and automation. This trend underscores the semiconductor sector's potential as a market driver, reinforcing the desk's outlook.
Where it sits in our coverage
The current consensus target for currency pairs linked to technology trends is 1.075, with a range spanning from 1.04 to 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view harmonizes with jpmorgan's projections, which are positioned at the upper end of the consensus spread while diverging from bofa's more conservative target. As such, the desk's call reflects a moderately bullish stance in the broader market narrative surrounding technology and growth.
How other firms see it
Aligned firms like jpmorgan view the semiconductor-driven growth narrative positively, while bofa takes a more cautious approach that acknowledges potential economic headwinds. This dichotomy suggests a split sentiment across the investment community regarding the magnitude of semiconductor influence in upcoming economic reports.
Particularly, trends in USD/JPY and shifts in sentiment from the Federal Reserve could highlight broader market reactions to technological growth narratives, offering insight into potential currency movements in response to economic data releases.
01The semiconductor sector serves as a pivotal driver of U.S. economic innovation.
02Institutional investments in semiconductor stocks have risen significantly, indicating strong future growth expectations.
03Diverging target prices among firms suggest varied expectations around the impact of technology on currency pairs.
04Emerging trends in AI and automation could lead to increased volatility in FX markets.
Market implications
Watch for currency pairs sensitive to technological advancements, particularly USD/JPY, as shifts in this narrative could lead to increased volatility. The upcoming earnings reports from major semiconductor firms will serve as a bellwether for broader market sentiment regarding the tech sector.
Risks to this view
Should there be unexpected regulatory challenges or significant supply chain disruptions in the semiconductor market, investor confidence could wane, leading to a reversal of current positions and sentiment around the growth narrative.
ubs
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we are going to continue with our series of 250 years of U.S. innovation conversations by focusing on the latest edition of the series from the UBS Chief Investment Office, which focuses on the history and impact of the semiconductor.
Joining me for that conversation today, glad to welcome back Kurt Reiman, Head of Fixed Income for the Americas. We're also joined today here in studio by Kevin Deneen, Technology and Communication Services Equity Strategist Americas from the UBS Chief Investment Office. So with that, Kurt, Kevin, thank you both for dropping by for today's conversation.
Looking forward to diving into the history of the semiconductor with you both and talk a bit about how this technology has impacted our lives and touch on what the future will have in store. Though, before we dive into today's topic, Kurt, perhaps a good starting point, as always, can you remind our listeners of what this publication series, 250 years of U.S. innovation, what it aims to deliver to readers and what motivated CIO to undertake this effort? Thanks, Dan.
It's good to be with you and Kevin here on this call talking about the semiconductor. This is the fifth report in the series. It is intended to help us navigate the times that we're living in today, where there is transformational innovation all around us, whether artificial intelligence or automation or robotics or designs of new therapeutics to cure cancer.
Transformational investing has been something that investors have long been trying to digest and orient their portfolios around, but we sometimes forget the lessons, and there are a lot. So we started off with the transcontinental railroad, looked at electrification, then we went on to the airplane and off to the assembly line, and now kind of what feels like more of a modern-day topic around the microchip, but then, of course, this really got its start in the late 40s and early 50s, so it's still several decades before now. And we're learning a lot.
I mean, just a couple of examples that might relate to today when we're thinking about artificial intelligence. A lot of the experts talk about something called the enabling layer or the infrastructure and the application layer, or just how companies use AI, and if we go back to two of our reports earlier in the series, the first one, one of them on electrification and another one on the assembly line, you see an example of the enabling layer and the application layer in the production of automobiles. So electrification was what created the modular electric motor, and it was that technology that Henry Ford used in his production process to take the time of producing a car from over 12 hours to under two and cutting the cost of a car by, call it threefold, and just massive increases in output from 10,000 cars in 1910 to over 2 million, so a factor of 200 by the early 1920s.
That's what transformational innovation can do. And so the assembly line was the application layer of electricity, which was the enabling layer. And I think here today, a lot of us are wondering what is going to be the new application and what are the disruptions going to be?
And the other one that I'll say is that when it comes to investing, you do see periods where there are price declines in transformational technologies that are then followed by massive outperformance. And we're seeing some of that indigestion in the market today. It's important to look back at historical episodes.
There are examples where a transformational technology is still in its infancy. You get that initial enthusiasm. It takes a step back, but then it goes on to produce strong gains.
And one example from the microchip report is that there were periods, the 1980s were a period of underperformance of the microchip. Also in the early 2000s, semiconductors didn't do as well. But if you were to hold a position from sort of the dawn of the microchip investing in the early 70s all the way through to today, you would have achieved 400 basis points annualized outperformance over that entire window, which is absolutely astounding.
So there are the lessons of don't get too pessimistic too soon, especially if something is really radically changing the world the way that the semiconductor did. With that, Kurt, just getting more so into the history of the development of the semiconductor, as mentioned at the start, the title of the publication we're focusing in on today, Chips Ahoy!, which focuses on the semiconductor, the microchip. Provide our listeners, Kurt, with a brief history of this technology, how we got to where we are today.
I think a nice way to put it, and this is from a naive perspective, we're fortunate to have Kevin on the call to give us more of the technical and industry knowledge. But looking at the infographic, and each one of these reports has an infographic on page three, you can see how the semiconductor was first used as an input into the space mission. The RAM on those chips was 4K, and the read-only memory was 74K.
When you compare that to today's modern processing power of a smartphone, where you have 13.6 million kilobytes of RAM, 268 gigs of ROM, if you were to take the time to figure out how we did this, to say if you had the same size transistor as you did back in 1971, and you tried to fit the number of transistors that you have today, over 17 billion, on just kind of a modern chip, then the computer chip would have to be nearly four meters wide. Of course that's not practical, but it does show the scale of the innovation over the last 50 years of this technology as it's advanced. I was also really struck by, if you think about the legends of Silicon Valley and the invention of the technology around computers back in the early days, I often think of tinkerers and putterers in a garage, very much the Jobs, Wozniak style, or even before that in other technologies like Edison with electrification.
There were really big companies, almost quasi-monopolies that were involved, like AT&T and Bell Labs in the late 40s. There were new startups, and by the way, that's in New Jersey. There was Texas Instruments.
Everybody remembers some of the early, if you were around back then, but I was a high school student in the mid-80s, and I remember the Texas Instruments computer that was in my earth science classroom. Texas Instruments was kind of a small, early startup in the center of Texas, in Dallas. It wasn't just centered in Silicon Valley.
That took time to progress, and there was, as with the Apollo space mission and also the use of chips in military applications, this was really a government procurement advancement. It was the early-stage investment from government that gave the microchip part of its early funding and the seedbed for commercial adoption. So 70% of spending on semiconductors in the late 60s and early 70s came from the military, and it wasn't until later that the commercial applications in the private sector became more dominant.
Another thing that I think is relevant today, and that is just around trade policy and national industrial policy, that was also something that was really important in the 1980s. Japan came on as one of the large producers of semiconductors. They really took over the memory market in the 80s, and the U.S. industry started to lose share.
That was partly a difficulty accessing the Japanese market, and today we're talking about new type of tariff authorities that the administration could use to protect industries or to return production back to the U.S. We had the Chips and Sciences Act under the Biden administration. There's investment in individual companies.
So this is very much part of the current zeitgeist of semiconductor production. Wouldn't you know, Section 301, this kind of country-specific tariff, was first used in order to get the U.S. more market access in Japan for semiconductors and also to increase Japanese purchases of U.S. products. So this isn't the first time that the U.S. has tried to lift its semiconductor manufacturing capabilities.
It was true also in the early and mid-80s when the U.S. faced a threat from a different source. Yeah, those are some of the key takeaways, I would say, from the history lesson that are important for today. Well, Kurt, with that fascinating history, this is very much a global technology, and we've certainly come a long way.
You mentioned, Kurt, the military government uses from decades ago. Now it seems like this technology is everywhere in modern times. From the phones we use, I have one in my hand, to the cars we drive.
So, Kevin, to welcome you into the conversation, in today's world, what kind of mandates or requirements are specialized chips engineered to address? Yeah, Dan, thanks for having me on. So it's an interesting question, and I would say, you know, semiconductors are just – they're simply pervasive.
They're in sort of every part of the global economy and every part of our daily lives. I mean, obviously, you know, you mentioned you have your smartphone in your hand. We all interact with our phones, our PCs, thousands of times a day maybe.
But think about autos, which you referenced. Content there is increasing every year, semiconductor content specifically. And that's happening because maybe it's more infotainment systems.
Maybe it's more digital cockpits. But it's also increased safety features. All of that is driven by increasing semiconductor content.
And then think about industrial equipment. That's becoming more digital. Think of precision agriculture or automated factories.
Think about warehouse robots. Think about autonomous vehicles, which is sort of a hybrid in my mind between autos and industrials. Think of healthcare.
Think of how equipment is becoming increasingly digitalized. Think about the increased use of robotic surgery, which is obviously semiconductor-powered. So I think there's this interesting dynamic that we're seeing where this wave of general-purpose semiconductors are percolating out throughout the global economy.
But at the same time, there's literally a tsunami of silicon used for AI applications. And that AI buildout is really development of a new technology stack that we think probably has a generation to run ahead of it. With that, Kevin, as AI infrastructure buildout is seemingly on track to become the largest megaproject in human history, this is very much an ongoing effort.
What role will microchip semiconductors play in delivering this technological transformation? Kevin Kennedy Yeah. I think to answer that question, would you just take a step back and – you referenced it.
Kurt referenced it. And I mentioned it, right? We think that AI is really the emergence of a new technology stack.
So when I say technology stack, think of a layer cake. And at the bottom layer, you heard Kurt mention the enabling layer. That's where all the compute lives, the storage, the networking, the physical data centers.
Above that, you have the intelligence layer. That's where the large language models live. That's where the data is.
And at the very top is the application layer. That's where you and I interact with our favorite large language model chatbots. That's also where in the not-so-distant future, AI agents are going to act with each other autonomously just because we went and told them to do something for us.
But it all starts with semiconductors in the enabling layer. And when we talk about semis in the enabling layer, I think everybody's mind immediately jumps to the GPUs that power large language models. That's important.
That's absolutely critical. It's central to what's happening. But the silicon opportunity is actually much broader than just the GPUs.
So AI demands a lot of memory but not just a lot of memory, a lot of specialized memory, something called high bandwidth memory. That has literally rewritten the landscape of the DRAM industry. Where margins are hitting levels that have never, ever been seen before, along with a level of visibility that has no precedent in industry history.
AI also demands a lot of data. So there's going to be a lot more increased network traffic, especially once we see agentic AI really start to ramp. All that traffic needs to flow through switches and routers that also have a lot of semiconductor content.
We're also seeing that these huge AI systems are highly interconnected. Literally thousands of chips that are connected all together. That's driving a lot of demand for optical components, all of which have semiconductor content behind them.
And what these things do is they turn pulses of light into bits of electrons that can be processed by the GPUs and all the other semiconductor content. And then, of course, at the top, you have the AI accelerator market. It's GPUs, but it's also other specialized chips that help train and power the inferencing that occurs when you or I interact with our favorite LLM chatbot.
And again, I'm going to go back to this idea of the rise of agentic. We're going to see applications that are working autonomously to get work done on our behalf without a lot of direction from us or a lot of input. And these AI agents acting on our behalf will actually consume a lot of compute cycles, and that's going to drive a lot of demand for the entire AI data center ecosystem, including SEMI.
Ultimately, I would argue we live in a world of silicon. The digital and the analog worlds, they're converging. Pretty much everything we do in our daily lives, I would argue, is increasingly powered by semiconductors.
And I think that actually only increases as AI adoption ramps. HOFFMAN Well, it is amazing how something so small has such a big impact on a global scale and this technology very much evolving a lot of runway ahead of us, which, of course, leads itself to further follow-up conversations. Kevin, Kurt, I look forward to having with you both, though.
Thank you both, Kevin Deneen, Kurt Reimann, for joining us here on top of the morning to talk about the semiconductor. Great being with you today. Thanks, Dan.
REIMANN You too, Dan. Thank you. HOFFMAN And again, today we've been joined by Kevin Deneen, Technology and Communication Services Equity Strategist Americas, as well as Kurt Reimann, Head of Fixed Income Americas, joining us today from the UBS Chief Investment Office.
We have been referencing the 250 Years of America, U.S. Innovation, Chips Ahoy! The Semiconductor.
This publication now available for you up on UBS.com slash CIO, though for clients of UBS, please reach out to your UBS financial advisor to receive a copy of this publication directly. And from UBS Studios, I'm Dan Cassidy. Thank you for joining us. to view the entire UBS Studios suite of podcast channels, along with our video offerings, such as UBS Trending.
You can also follow us on Instagram for content highlights at UBS Trending. UBS Studios is part of the UBS Chief Investment Office within UBS Global Wealth Management. Visit UBS.com slash CIO to view the latest research.
REIMANN UBS Chief Investment Office's investment views are prepared and published by the Global Wealth Management Business of UBS AG, or its affiliate, UBS. This material has no regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and is published for informational purposes only. As a firm providing wealth management services to clients globally, UBS AG and its subsidiaries offer both investment advisory services and brokerage services.
Investment advisory services and brokerage services are separate and distinct, differ in material ways, and are governed by different laws and separate arrangements. In the USA, UBS Financial Services Inc. is a subsidiary of UBS AG and a member of FINRA SIPC. For information, please visit our website at UBS.com forward slash working with us.
For a full legal disclaimer applicable to the independent investment views produced by UBS, please visit our website at UBS.com forward slash CIO dash disclaimer.