William Warren, co-managed Artemis’ US long/short strategy
Vital components used in consumer electronics and internet infrastructure could soon be in short supply, but demand could be about to rise. Will Warren, US equity manager, reveals how the team are playing this imbalance in their portfolios.
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. CAPITAL AT RISK. All financial investments involve taking risk and the value of your investment may go down as well as up. This means your investment is not guaranteed and you may not get back as much as you put in. Any income from the investment is also likely to vary and cannot be guaranteed.
The distortions in supply and demand produced by the pandemic years are still being played out across different industries. In many cases there has been a dynamic of rapid inventory growth leading to oversupply, followed by destocking and depressed pricing.
This has resulted in a ‘rolling earnings recession’ across the market. We have found some interesting opportunities where suppliers have addressed an oversupply situation with aggressive production capacity cuts and now demand is recovering.
Covid's impact on Inventory: Core-large capitalisation stocks: year-over-year inventory growth
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Source: Empirical Research Partners as at 10 January 2024. Excludes financials, REITs, utilities and energy.
For example, retailers such as Amazon experienced a boom in demand during Covid. The company responded by building large amounts of distribution capacity that in hindsight proved to be more than the market required in a post-Covid world. Amazon quickly recognised the problem and got to work shedding a significant chunk of this over-investment. Ecommerce demand has now rebounded and Amazon is structurally more profitable.
Hard disk drives and NAND flash storage
When most of the world was stuck at home during the pandemic, elevated demand for consumer electronics and internet infrastructure created a corresponding boom in demand for hard disk drives and NAND flash storage. Once the pandemic ended, demand growth slowed, inventory ballooned and prices fell.
The industry reacted by aggressively cutting capacity. Seagate, a leader in hard disk drives, for example, has reduced capital expenditure significantly.
Seagate capex
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Source: Company disclosures and Bloomberg estimates as at 31 December 2023.
And Lam Research, which makes the equipment to manufacture DRAM and NAND flash, has also seen its sales into this industry fall to near-decade lows.
Lam Research memory equipment sales ($m)
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Source: Company disclosures and Bloomberg estimates as at 31 December 2023.
Inventory has now normalised and demand for these products is returning, but into a dramatically reduced production capacity. A setup like this usually leads to a strong pricing upcycle. This cycle could be further amplified by generative AI, a new demand driver that has emerged over the past year.
The hard disk drive industry could be particularly well positioned. As shown in the chart below, for increased demand for hard drives from cloud computing the past five years has been largely offset by decreasing demand from legacy applications such as PCs. Going forward, hard drive demand from cloud computing and AI should continue to grow strongly while declining legacy markets are no longer large enough to create a headwind.
New demand growth vs legacy shrinkage
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Source: Gartner Group as at 31 December 2023.
Across our US equity fund range, we have gained exposure to this dynamic with a position in Western Digital, a leader in both hard disk drives and NAND flash storage. The stock underperformed significantly during the NAND and hard drive down-cycle and is now poised for a strong recovery.
The company is also in the middle of a process to spin off its NAND business into a new company, a transaction that we believe could unlock additional shareholder value. Investing in commodity technology stocks such as Western Digital requires a degree of nimbleness and the cycle must be closely monitored, but we believe this is currently one of the better risk/reward setups in the technology sector.
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS.
Capital at risk. All financial investments involve taking risk and the value of your investment may go down as well as up. This means your investment is not guaranteed and you may not get back as much as you put in. Any income from the investment is also likely to vary and cannot be guaranteed.
This is a marketing communication. Before making any final investment decisions, and to understand the investment risks involved, refer to the fund prospectus (or in the case of investment trusts, Investor Disclosure Document and Articles of Association), available in English, and KIID/KID, available in English and in your local language depending on local country registration, available in the literature library.
Risks specific to Artemis Funds (Lux) – US Extended Alpha
- Market volatility risk: The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.
- Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund's value.
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- Cash risk: The fund may hold a large amount of cash. If it does so when markets are rising, the fund's returns could be less that if the cash was fully invested in other types of assets
- Leverage risk: The fund may operate with a significant amount of leverage. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested. A leveraged portfolio may result in large fluctuations in its value and therefore entails a high degree of risk including the risk that losses may be substantial.
- ESG risk: The fund may select, sell or exclude investments based on ESG criteria; this may lead to the fund underperforming the broader market or other funds that do not apply ESG criteria. If sold based on ESG criteria rather than solely on financial considerations, the price obtained might be lower than that which could have been obtained had the sale not been required.
Risks specific to Artemis Funds (Lux) – US Select
- Market volatility risk: The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.
- Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund's value.
- Concentration risk: The fund may have investments concentrated in a limited number of holdings. This can be more risky than holding a wider range of investments.
- ESG risk: The fund may select, sell or exclude investments based on ESG criteria; this may lead to the fund underperforming the broader market or other funds that do not apply ESG criteria. If sold based on ESG criteria rather than solely on financial considerations, the price obtained might be lower than that which could have been obtained had the sale not been required.
Risks specific to the Artemis US Extended Alpha Fund
- Market volatility risk: The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.
- Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund's value.
- Derivatives risk: The fund may invest in derivatives with the aim of profiting from falling (‘shorting’) as well as rising prices. Should the asset’s value vary in an unexpected way, the fund value will reduce.
- Cash risk: The fund may hold a large amount of cash. If it does so when markets are rising, the fund's returns could be less that if the cash was fully invested in other types of assets.
- Leverage risk: The fund may operate with a significant amount of leverage. Leverage occurs when the economic exposure created by the use of derivatives is greater than the amount invested. A leveraged portfolio may result in large fluctuations in its value and therefore entails a high degree of risk including the risk that losses may be substantial.
Risks specific to the Artemis US Select Fund
- Market volatility risk: The value of the fund and any income from it can fall or rise because of movements in stockmarkets, currencies and interest rates, each of which can move irrationally and be affected unpredictably by diverse factors, including political and economic events.
- Currency risk: The fund’s assets may be priced in currencies other than the fund base currency. Changes in currency exchange rates can therefore affect the fund's value.
- Concentration risk: The fund may have investments concentrated in a limited number of holdings. This can be more risky than holding a wider range of investments.
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