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Commentary

The chip crisis

March 18, 2021

COMMENTARY

Dear Clients and Colleagues:

COVID-19 has led to a turbulent economy characterized by faster adoption of technology, increased environmental urgency and inflation from unprecedented stimulus. The widespread government support is resulting in inflation across many goods as economy rebounds quickly. Fortunately, the debt service ratio of consumers in the United States (US) is at a 40-year low, meaning they can probably handle rising prices for some time.

While certainly not linear, inflation is exacerbated by the unprecedented stop-and-start occurring across economic sectors, especially when comparing goods versus services. Demand is high for some products such as those related to home improvement, yet low for others like restaurant equipment. Demand for goods are presently outweighing demand for services in a major way. The imbalance is inflating prices notably through a supply chain shock that has significantly increased transport prices. The US Consumer Price Index is higher by 11% y/y at the goods level, while its service counterpart is down 5% y/y.

The rush for certain goods, such as personal electronics has created a global semiconductor chip shortage. As a result of increased demand, the personal computer sector grew by 10% in 2020, and surging demand in the fourth quarter reached 25.4%. The impact of this high demand was felt across the entire technology supply chain.

Why are automakers shutting down production?

Automakers spent $43 billion on microchips in 2019, representing 10% of global semiconductor sales. Chips are more critical to automakers than automakers are to chip manufacturers. In 2020, car manufacturers planned for a 35% drop in sales, but ended up with a drop of 8%, thus they quickly needed more chips to fill inventories. These emergency chip orders went to the back of the line behind larger electronics clients, which had better estimated their future needs during the crisis. The impact on 2021 production could mean 1.5% of new cars not being available, a material number that will certainly affect availability and pricing.

The average electric car features roughly 3,000 chips. Cars have become a laboratory for human machine interface, where manufacturers continue to innovate at a frantic pace. This will certainly continue to provide us with interesting investment opportunities. There are a number of emerging human interface trends that will change the way we use our cars, including:

  • Screens: A full-screen interior, with infotainment screens up to 48 inches wide on the dashboard.
  • Voice commands: As voice recognition technology evolves, so does its complexity, with functions from adjusting following distance in adaptive cruise control, to fully self-driving cars that don’t require physical steering, braking, or acceleration input.
  • Touch to movement: BMW is already using gesture control technology, where cameras “see” hand movements to perform in-vehicle functions. Taking it further, under development is technology to give the sensation of virtual touch response in the air using ultrasound.
  • Driver assistance: Rather than the constant go, stop, and steer motions a driver must perform, driver assistance commands are alleviating the need for attentiveness and active participation.
  • Virtual assistants: Based on emotional and physical demeanor, machine learning can predetermine the best outcomes for driving routes, temperature control, communication and musical preferences.

Global Alpha is exposed to the noted trends and futuristic electronics in the automotive sector. Gentherm (THRM:US) is the uncontested leader in thermal management with heated and cooling seat systems. Among new smart products, Gentherm is launching its ClimateSense system, featuring sensors that detect heat from each passenger and optimize the climate with exterior conditions throughout the car. The company expects to save up to 50 miles driven in electrical capacity.

Cerence (CRNC:US), a leader in speech integration and digital content delivery for the automotive industry, is launching Cerence Look, a new product enabling drivers and passengers to interact with points of interests outside the car, like a machine co-pilot. Mercedes-Benz is the first carmaker to launch this technology in its Travel Knowledge feature.

These trends confirm that carmakers will continue to increase their dependence on technology and semiconductor chips.

The chip shortage will subside but could signal an onshoring trend in semiconductor production. Taiwan-centric TSMC, the world’s largest semiconductor manufacturer, controls over 70% of the world’s chip production.

Industry players sensed the importance of strategic semiconductor assets, and 2020 was one of the highest years on record in terms of M&A activity. Global Alpha is participating in this phenomenon, as three different companies have publically disclosed their offer to acquire one of Global Alpha’s holdings, Coherent (COHR:US), a leading provider of laser-based technologies to the semiconductor industry.

The chip shortage crisis provided additional insights, including a supply quasi-monopoly by TSMC with its mega factory, heightened international trade tensions, and the erratic effects of an intense stimulus or expansive monetary policy. Historically, the situation is very similar to the 1970s oil crisis, without the geopolitical catastrophe. Interestingly, the semiconductor has become the new oil; the most critical component to every machine we use. Now, we just need to hope that lessons learned from the 1970s can help us handle higher levels of inflation.

Have a good day.
The Global Alpha team

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