Welcome to Thoughts on the Market. I'm Shawn Kim, Head of Asia Technology Research for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends and themes impacting technology stocks in the region. It's Tuesday, February 2nd, at 8:00 p.m. in Hong Kong.
Technology stocks in Asia had a bit of a mixed year in the first half of 2020, as both COVID-19 and trade tensions disrupted supply and demand dynamics. But improved fundamentals and strong demand in all end markets suggests an optimistic outlook for 2021.
One particular area of strong demand is semiconductors, where we're seeing shortages build in many parts of the supply chain. Demand has exceeded capacity for logic wafer foundry since late last year, alongside DRAM and NOR flash memory, ABF substrates, wire bonding, integrated circuits for display drivers and power management, and soon passive components could be next.
What's interesting across semis is that current company valuations are very high, something that is not typical of early cycle, especially coming out of a recession. Normally in an early part of an economic cycle, customer inventories are very lean. But on this one, companies were not able to draw down on inventory because of covid supply chain issues. Another factor was that China was blocked from purchasing components due to trade tensions. So bottom line, we think, there may be less room for multiple expansion. Instead, the focus will be on earnings revisions, and we think the highest revisions will come from areas with cyclical tailwinds, such as memory and passive components.
We favor upstream parts of tech, such as DRAM and integrated circuit design companies, where content growth and pricing power drive higher growth in relative earnings. Least favored are downstream tech hardware, like modular assembly and set manufacturers, where we see room for margin pressure.
So what trends should investors be watching in the year ahead? We're looking at five key themes.
First, we're more optimistic on cyclical parts of tech, such as memory and exposures to autos, as there's a clear path to pricing power, earnings, and multiple expansion.
Second, China's self-sufficiency in semiconductors will continue to be a key secular theme, as it seeks to localize its own chip making capabilities in areas such as computer processors and various integrated circuits.
Third, in communications, we like 5G systems-on-chip. We're forecasting 40% 5G-smartphone penetration, with about 600 million units projected for the year. 5G is nearing 80% of total smartphone shipments in China, and this bodes well for system-on-chip and high-performance chip makers.
Fourth, the pace of adoption of Wi-Fi 6 could surprise this year, as users accelerate to supplement 5G for seamless connectivity. There are many ways to play this theme, such as integrated circuit design companies, wireless RF equipment makers, and gallium arsenide wafer manufacturers.
And finally, as the pace of electric vehicle adoption increases, we like companies making large pivots into EV supply chains, in both charging technology and manufacturing.
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