The Electronic Components Outlook: Indicators to Watch in 2H 2022, TTI MarketEye Update

SOURCE: TTI MarketEYE

 

With the current level of uncertainty in the electronics industry today, we would do well to remember that the stock market is not a proxy for the economy. Paul Samuelson humorously illustrated this truth by noting that “the stock market has predicted nine of the last five recessions.”

Even as the Federal Reserve begins to reverse course on quantitative easing, the consumer side of the U.S. economy remains strong thanks to low unemployment, rising wages and the halo effect of extensive COVID-related government subsidies. The decline in U.S. gross domestic product we saw in Q1 of this year was driven by chip shortages, the spread of the omicron variant of COVID-19, a reduction in government spending and a ballooning trade deficit (which subtracts from GDP). The other elements that make up GDP were quite strong and there is reason to believe that Q2 GDP will reflect growth, thereby sidestepping the possibility of a recession in the economy in the short term.

Indeed, despite some recent declines in leading economic indicators, the absolute values for each of those indicators are still healthy and, in some cases, well above their pre-COVID levels. Examples include private sector employment, industrial production rates and capacity utilization, wholesale trade of durable and non-durable goods, and non-defense capital goods new orders.

Another positive is that the Institute for Supply Management’s Purchasing Managers Index (ISM PMI) remains in growth territory above 55 even though it has declined from its post-coronavirus-recovery high in Q4 2021. And, while the JP Morgan Global PMI also declined recently for the first time in 22 months (due to lockdowns in China) it remains positive as well.

The Outlook for Electronic Components

Another factor in the current, post-2020 industry results is the growing gap between cost and price which has contributed to both revenue and gross profit growth. After a long-term buyers’ market, we find ourselves in an extended sellers’ market that is being driven by supply chain constraints, inflating cost inputs and environmental factors.

For example, in the pre-2020 market, there was a ready supply of labor and wage rates were steady; today, labor is scarce and wage rates are rising. Before 2020, production capacity was underutilized and underinvested; today, production capacity is tapped out and lead times are long and growing. And costs for things like raw materials and transportation are up significantly relative to the years of stability that were the norm prior to 2020.

What is remarkable about the current industry growth cycle is that it actually kicked off prior to COVID and has pushed through some very strong headwinds in the form of a multi-year trade war with China and a multiyear global pandemic. Through it all, global electronic component unit shipments continue to grow; semiconductors in particular are growing logarithmically, which is worth noting.

According to the Semiconductor Industry Association (SIA), in 2021 semiconductor sales grew 26 percent to $556 billion. In a recent CNBC report, SIA President and CEO John Neuffer said: “Demand for semiconductor production is projected to rise significantly in the years ahead, as chips become even more heavily embedded in the essential technologies of now and the future.”

What is true for semiconductors holds true for the entire electronic components industry. The demand we’re seeing encompasses all industry verticals and is being driven by a significant surge in demand that is above and beyond the COVID recovery. This surge is driven by the fact that almost every product being produced today, in almost every industry, is becoming more digital and new technologies are prolific and combining in ways that are creating entirely new applications and markets.

Supply Chain Disruption and Digitalization

This sustained surge in demand, coupled with growing weather-related shocks, has put tremendous pressure on electronics supply chain. Today’s supply chains were developed over the course of the last fifty years using analog thinking to optimize for cost rather resiliency. They are keyed to labor rates, not disruption rates; and built for linear, not exponential, rates of growth.

Despite what you might have learned from Aesop’s fable of the tortoise and the hare, in today’s market “slow and steady” not only fails to win you the race – going forward, it will get you disqualified at the starting line. Too often in recent years, manufacturers have attempted a hybrid analog-digital approach before committing to a complete digital transformation. As the present market has shown, incremental change will not future-proof the supply chain. The old playbook is obsolete and a new one must be written before the supply chain can be mended and rebalanced.

The Outlook for the Electronics Industry

As has been demonstrated time and again, the U.S. economy can take a punch and keep on coming. While headwinds and uncertainty will curtail U.S. GDP growth this year to something like 3 percent, my prediction is that we will not see a recession in the industry until the middle of this decade and, when we do, it will be a minor correction.

In the meantime, demand for electronic components is unlikely to abate, though as the supply chain normalizes, price and margin inflation will abate. Even as prices moderate and incremental production capacity comes online, pent-up demand for components will consume those parts. Additionally, the imbalance between semiconductor supply and demand will continue through 2023.

I expect that when we look back on the 2020s, we will see that component demand growth outpaced price declines resulting in an industry more than twice as big in the 2020s as it was in the 2010s. Challenges will persist, but so will record-setting sales and profit milestones as the electronics industry becomes an ever-bigger factor in global economies and global trade.

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