Asian semiconductor strongholds poised for 2024 upside

As the post-holiday news flow ramps up again, we believe it’s worth keeping a close eye on two Asian economies that have long been punching above their weights—South Korea and Taiwan. Both struggled in 2023 with weak gross domestic product (GDP) growth in the range of 1%–1.5%. For 2024, however, we believe we could expect a brighter picture. Growth projections are 2.2% for South Korea and a very solid 3.3% for Taiwan, which are substantially higher than the projections for 2023. Global growth, meanwhile, is expected to add only 10 to 20 basis points versus the 2023 figure.¹

Taiwan’s presidential elections in mid-January have the potential to inject further volatility into the cross-Straits relationship. But the island’s technological prowess should remain an indispensable factor for Western economies, with 60% of the world’s semiconductors, and 90% of the most advanced ones produced there. South Korea, meanwhile, dominates the global DRAM (dynamic random-access memory) chip market, with almost a two-thirds share of global output.²

We are optimistic that both economies are set to benefit from a semiconductor rebound that we expect to unfold in 2024. Early signs for a turnaround emerged when South Korea’s export growth, led by chips, turned positive in November 2023 for the first time since September 2022.³ Taiwan Semiconductor Manufacturing Company, an industry leader, also announced strong third quarter results last October, beating analysts’ projections and forecasting falling inventory levels and healthy growth.⁴

Analyzing historical global semiconductor cycles, our optimism is further supported. We see that, by and large, the historical billing cycles since 2000 follow a relatively predictable time pattern. The last five cycles had an average duration from peak to trough of 6.4 quarters and ended between -30% and zero billings growth year-on year. The sixth, most recent cycle peaked in the second quarter of 2021 and appears to have troughed in the first quarter of 2023 at a negative growth of -20%. This is seven quarters post peak.⁵ That interpretation is very consistent with the figures above. While this is no exact science, we believe the bigger picture of predictable cyclicality is well grounded in economic realities. The semiconductor industry has notoriously high barriers of entry, thanks to massive outlays for new production facilities with extensive planning and building periods; a limited supply of workers with the required know-how; and long-standing relationships with buyers that often require custom-designed, rather than off-the-shelf products. Lastly, the leading companies in the sector have the capability to invest vast sums in research and development that helps them retain their technological edge and often act as price makers, rather than price takers.

In the shorter term, an anticipated rebound should bode well for the South Korean and Taiwanese equity markets. Both are distinctively tech-heavy and led by renowned chip giants. If we take a look at three quarters post-cycle trough as a starting point, and seven quarters post-trough as the end point, we find that out of 10 one-year-returns (i.e., five cycles and two equity indexes), no market posted a single negative number. In fact, the average post-trough one-year-returns for South Korea and Taiwan exceeded 30%, while their long-term annualized returns are far more moderate, albeit still attractive at 8.4% and 7.7% per annum, respectively. We note further that both markets’ post-trough returns clearly outstrip those of broader emerging markets indexes but are roughly in-line over the long run.⁶

All the above should be taken with a grain of salt, firstly because the sample size of five cycles cannot be representative, and secondly because the post-trough period of the fifth cycle coincided with the pandemic-induced technology rally, exacerbated by unprecedented fiscal and monetary stimuli. This resulted in outlier returns of high double digits likely distorting the average.

With that in mind, we believe nonetheless that it may be time for investors to keep South Korea and Taiwan on their overweight watchlists as:

• We believe there is a decent chance that the current semiconductor cycle has passed, or is currently going through, its trough.
• Past average post-cycle equity returns for South Korea and Taiwan, from three quarters post-trough to seven quarters post-trough, have exceeded 30% vs. 23% for broad emerging markets.
• Those returns also far outstrip the long-term annualized returns for both markets.

A fourth point is more significant for strategic, rather than tactical considerations. With the rise of artificial intelligence (AI), the proliferation of the Internet of Things, and the mainstreaming of the metaverse, global demand for high-tech semiconductors will only continue to shift higher. The market will remain cyclical, for reasons we discussed above, but it may well be that future peaks and troughs are less pronounced than in the past. Should this lead to less volatility, it would likely also justify higher valuations. In our opinion, Asian industry strongholds have competitive advantages that place them in pole position to benefit from such long-term developments.