Semiconductors, also known as microchips or integrated circuits, are a critical for the electronic devices that have revolutionized our lives. However, the semiconductor sector has a history of dramatic volatility. Recently, the industry endured semiconductor supply-chain disruptions and a pandemic-era boom. The expansion of artificial intelligence (AI) applications could offer new avenues for growth for the sector, though it faces a potential decline in demand from data centers for web services and cloud computing providers. Geopolitical tension, trade wars, and regulatory changes are additional factors that could impact the industry. For investors, the sector offers options from well-established giants to emerging startups.

What Are Semiconductors?

Because of their role in electronic devices, semiconductors are omnipresent. Without microchips, no smartphones, radios, TVs, computers, video games, or advanced medical diagnostic equipment would exist. Semiconductors are made from materials with an intermediate level of electrical conductivity—the measure of electricity's ease flowing through something—that can be controlled, making them ideal for electronic circuits. Semiconductors are made of elements such as silicon, germanium, or gallium arsenide. They are crystalline in structure, which means their atoms are arranged in a highly ordered, repeating pattern known as a crystal lattice.

This structure provides highly predictable electric, thermal, and optical properties, making semiconductors ideal for electronic devices such as transistors, diodes, and integrated circuits. These, in turn, have a wide range of applications beyond computers and smartphones, including solar cells, graphics processing units, and LED lights.

The Importance of Semiconductors

Semiconductors are essential elements of modern life, allowing some of the following:

• Creating electronic devices: Semiconductors serve as the backbone of modern electronics. Without these materials, essential elements like transistors, diodes, and integrated circuits—necessary for computers, smartphones, and many other devices we now take for granted—would not exist.
• Miniaturization: A key advantage of semiconductors is their small size, enabling the integration of increasingly greater numbers of transistors and other elements onto single chips. This allows manufacturers to produce ever-more compact yet powerful devices.
• Reliability: Compared with mechanical devices, which can wear out over time, semiconductors are highly reliable. Their durability makes them indispensable for critical applications, from medical equipment to aircraft control systems, where failing is not an option.
• Energy efficiency: Semiconductors consume considerably less power than other electronic elements, making them ideal for portable electronics and other battery-powered devices.
• The breadth of applications: Semiconductors are used in vastly different sectors, such as communications, transportation, manufacturing, and energy production. They are also essential for emerging technologies such as artificial intelligence (AI), the Internet of Things, and renewable energy.

Historical Overview of the US Semiconductor Industry

The U.S. semiconductor industry dates to the mid-20th century. Below is an overview of some of the main events and developments in the sector:

• 1940s: Researchers at Bell Labs, including William Shockley, John Bardeen, and Walter Brattain, invented the first transistor in 1947. This invention helped found modern electronics and the creation of the semiconductor industry.
• 1950s: Companies such as Texas Instruments and Fairchild Semiconductor International were founded and began mass-producing transistors and other semiconductor devices.
• 1960s: The first integrated circuits combined several transistors and other elements onto a single microchip. This enabled the creation of more complex electronic devices and fueled significant industry growth.
• 1970s-1980s: Pivotal industry players like Intel, Advanced Micro Devices, and Motorola emerged to develop microprocessors and other advanced elements that powered the personal computer revolution.
  
• 1990s-2000s: The industry continues to expand, especially with the rise of the internet. Companies like Qualcomm, Broadcom, and Nvidia became leaders in mobile device and graphics processor production.
• 2010s-present: Despite challenges such as increasing competition, particularly in China; rising device complexity; and component shortages, the semiconductor industry remains critical for the U.S. economy, supporting a broad array of industries and technologies.

The Pandemic's Effect on the Semiconductor Industry

The pandemic significantly impacted the semiconductor industry, resulting in challenges and shifts in the global supply chain. The U.S. and Europe have focused on boosting domestic industrial capacity to reduce their reliance on other regions, lower trade complexities, and mitigate risks from global crises to ensure the uninterrupted supply of semiconductors. However, achieving regional self-sufficiency is generally considered unlikely.

The U.S. and Europe are diversifying not only fabrication facilities (“fabs”) but also aspects of the semiconductor supply chain, including assembly and testing. As a result, the traditional strongholds of the semiconductor industry in the Asia-Pacific region are shifting to North America and Europe.

However, replicating the capacities of Asian manufacturers is no easy task. The effort requires identifying new sourcing and trade routes, establishing new air and sea routes, and observing export control regulations. Trade restrictions and geopolitical tensions, such as the U.S.-China trade conflict and the Russia-Ukraine war, have produced additional complications and risks.

AI Fuels New Semiconductor Industry Investment

The emergence and growth of AI applications are generating more investment in the semiconductor industry. The pace of AI-related semiconductor growth is estimated by global consulting firm McKinsey & Company to be five times faster than the rest of the semiconductor industry.

Semiconductor companies stand to capture a significant part of the AI technology stack, particularly in computing, electronic memory, and elements for networking. By developing specialized hardware solutions and adopting value-creation strategies, these companies can capitalize on the burgeoning growth of AI. Increased profitability and share-price gains for semiconductor makers have already been linked to advances in AI.

Regulatory Risks in the Semiconductor Industry

As in other industries caught up in trade and geopolitical tensions, semiconductor firms confront challenges and uncertainty arising from government regulations and policy changes that can affect their operations, market access, and profitability.

Here are the key regulatory risks in the semiconductor industry:

• Export controls and trade restrictions: Governments often impose export controls and trade restrictions on specific semiconductor technologies, equipment, or materials for national security or economic policy reasons. These restrictions can limit the ability of semiconductor companies to access international markets, collaborate with foreign partners, or sell their products to specific countries.
• Intellectual property (IP) protection and enforcement: Protecting and enforcing IP rights is crucial in the semiconductor industry. Companies risk IP infringement by competitors and the counterfeiting of their products. Inadequate or lax IP enforcement in certain jurisdictions compromises the competitiveness and profitability of semiconductor companies.
• Data privacy and security regulations: The semiconductor industry has a significant role in data processing and storage. Compliance with data privacy regulations, such as the General Data Protection Regulation in Europe, is essential. Semiconductor companies must put in place robust data protection measures, secure storage facilities, and proper data-handling practices to mitigate the risk of regulatory penalties and reputational harm.

The Price Returns of Semiconductor ETFs

ETFs offer investors a way to own a collection of shares in an industry through a single security. The table below lists the last decade's average annual price returns for the semiconductor industry through sample ETFs as of June 15, 2023.

The performance of these ETFs shows how semiconductor company stocks have delivered solid returns in the last decade, revealing one part of the sector's impact on the overall stock market.

Sample Semiconductor ETF Returns
Ticker	Name	Assets Under Mgmt (US$ B)	1-Year (%)	3-Year (%)	5-Year (%)	10-Year (%)
SOXX	iShares Semiconductor ETF	9.26	38.17	26.26	22.96	24.76
SMH	VanEck Semiconductor ETF	9.42	44.13	28.88	24.29	24.92
XSD	SPDR S&P Semiconductor ETF	1.72	35.83	26.09	23.67	24.22
FTXL	First Trust Nasdaq Semiconductor ETF	1.14	27.77	19.20	16.28	-
PSI	Invesco Dynamic Semiconductors ETF	0.64	29.71	24.13	19.36	24.47

The chart below displays the cumulative returns of SOXX, SMH, XSD, FTXL, and PSI over the last 10 years, illustrating the sector's volatility.

Price Return and Volatility of Several Semiconductor Stocks

The table below provides price and volatility data for several larger semiconductor companies.

Semiconductor Stocks Returns and Volatility
Ticker	Name	3-Mth (%)	6-Mth (%)	YTD (%)	1-Year (%)	5-Year (%)	Since Inception (%)	1-Year Beta	Volatility	ATR (14)
AMD	Advanced Micro Devices	25.39	82.95	83.65	39.91	649.11	26,344.65	1.82	4.33	5.41
AVGO	Broadcom Inc.	38.09	57.67	55.56	71.68	226.74	5,226.85	1.10	2.03	31.80
INTC	Intel Corp.	20.59	33.63	33.41	4.28	33.55	89,361.94	1.14	2.49	1.28
MU	Micron Technology Inc.	19.66	31.38	34.43	19.24	18.00	4,711.99	1.07	6.72	2.11
NVDA	Nvidia Corp.	67.44	157.97	192.94	174.31	560.47	99,339.55	1.74	2.49	14.92
QCOM	Qualcomm Inc.	2.29	6.44	10.96	2.15	108.31	23,530.65	1.35	2.31	3.18
TXN	Texas Instruments Inc.	0.16	5.42	6.54	17.58	55.46	16,325.95	1.05	1.50	3.33

The chart below shows the 10-year returns on AMD, AVGO, INTC, MU, NVDA, QCOM, and TXN.

The Bottom Line

Semiconductors are essential for many electronic devices, from smartphones to servers, controlling the flow of electricity while performing a wide range of functions in electronic circuits. The semiconductor industry has grown steadily over the past few decades in response to increasing demand for electronics, the growth of the Internet of Things, and the rise of AI and machine learning.

Investing in semiconductor stocks can be attractive for investors looking for exposure to this growing market, as well as the potential for solid earnings growth and diversification benefits.

But, as with any investment, there are risks to consider with the semiconductor industry and its impact on the overall stock market, including competition, a history of market volatility as demonstrated by semiconductor ETF performance, and regulatory risks.