Capital Investment Boom Raises Semiconductor Demand

Do not overlook the impact of the ongoing capital goods boom on semiconductor sales while focused on the current stall in the growth of sales for semiconductor devices and the equipment to manufacture them.

Source: National Statistical Agencies, Reed Research Group

Semiconductor parts consumption in end products has continued to expand, mostly for capital investment products, while the early 2004 surplus of parts and capacity is still being absorbed. So the stall in the semiconductor and the equipment market will be followed by renewed growth in 2005, rather than a slide into a sustained market decline. The renewed growth will be at a 10-15% annual pace, not the 40%+ pace of last spring. If semiconductor and equipment sales resume growing at a stronger pace, a two- to three-quarter inventory adjustment cycle will begin this summer.

The 2004 inventory cycle appeared in most industries, but was much milder than it was for semiconductors. Most of the industries that buy semiconductors had their inventories back in balance by early last fall, although consumer electronics assemblers appear to be taking several months longer to trim inventories to normal.

Let us turn the focus to trends in underlying economic demand. 2005 is the best capital investment environment in at least a decade in countries that account for more than half of the world economy and more than half of world economic growth. Corporate profit margins are unusually high; cash reserves are enormous; and the surplus of industrial capacity that plagued manufacturers from 2001-04 is nearly gone. The result is a capital spending boom — and surge in semiconductor demand — in North America and Asia, excluding Japan, Korea and most of the developing world. The capital spending boom is not happening in Japan, Korea and the euro currency countries that have long-term domestic economic growth problems and short-term currency overvaluation problems that restrict economic growth. But the demand for capital equipment is so strong elsewhere in the world that equipment exports are keeping Japan, Korea and Europe out of recession.

Equipment investment, including imports, is rising at a 13% annual pace in the United States, with little weakening expected by the end of 2005. This is 3× faster than growth in consumer durable goods, where a spending boom initiated the economic expansion last year. In China, investment is growing at a 25-30% pace. By contrast, domestic investment is generally flat in Japan, Korea and Europe, with total machinery orders up from a year earlier by 3-4% in Europe, 6% in Japan and 16% in Korea to satisfy soaring demand in the United States, China and the developing world that cannot be met domestically.