Strong World Economic Cushions Market Inventory and Capacity Adjustments

Semiconductor sales in 2005 began at steady to slightly lower, based on reduced production at the large Asian foundries as well as lower DRAM prices. Semiconductor shipments will be below end-market consumption this year, offsetting shipments above end-market consumption last year.

The sales trend for semiconductors, like any other product, stems basically from the underlying economic growth trend. To this are added or subtracted changes in market share vs. competitive products resulting from relative price changes between semiconductors and competitive products. This sum is then temporarily adjusted for the impact of returning producers' margins and inventories anywhere in the distribution chain to "normal," often because of errors in supply capacity planning. Temporary can be six months or more if suppliers are unwilling to shut production lines quickly and frequently, as the automotive companies do. The adjustment to normal has been getting all of the attention lately, because the semiconductor market has been afflicted for more than six months with both surplus inventory throughout the distribution chain and surplus capacity from overly aggressive investment.

It is easy to lose sight of the other two terms in the equation while struggling with inventory and capacity problems. The underlying economic growth trend has strengthened in recent months, and weak chip prices have widened the competitive price advantage against competitive mechanical, electrical, hydraulic and manually operated products. This enables new electronic end markets.

Economic growth has revived from a summer lull in the two largest economies, and has returned to a 4% pace in the United States and an 8-9% pace in China. All of the latest demand volume reports in the United States were unexpectedly strong. Demand growth accelerated across the economy, including retail sales, business shipments, exports, employment and housing.

In China, February economic data showed a return to the high 16% growth rate in production that set off the commodity price surge a year ago. Both retail and wholesale inflation have picked up to near the peak levels reached last year. This confirms stronger spending growth throughout the Chinese economy. Japan is pulling out early in 2005 from a nine-month recession. Germany and Italy are expanding again after brief recessions at the end of last year. The Table underestimates the acceleration in semiconductor end market growth, because capital equipment spending has picked up faster than the rest of the economy. And very significantly, the materials-exporting developing countries enjoyed a once-in-a-lifetime boom in profits last year and are holding or expanding those sales this year.

Electronic system prices have fallen 5.5% over the last year relative to non-electronic capital equipment. The price gap has widened faster in recent months with sharp price increases for metals. This is data related only to the United States, but the changes are similar in other countries.