Despite decades of evidence, markets aren’t good at trusting in the inevitability of the economic cycle.
Some companies are especially affected by the wider economy. When economic uncertainty rises, businesses and consumers spend less and save more, and this means cutting out non-essential goods and services.
In the case of businesses, it is often the advertising budget that is the first to be cut. There are signs this dynamic has started to play out once again, with Martin Sorrell’s S4 Capital (SFOR) seeing its like-for-like revenue drop 4.5 per cent last year.
In the case of consumers, it is the electronics budget that gets slashed. Having a new phone or laptop is nice, but it is not as important as buying food or paying the bills. Apple (US:AAPL) might be one of the most profitable companies of all time, but it has not been able to create a product people value ahead of heating or sustenance. Last year, Apple’s product sales dropped 6 per cent to $298bn (£239bn), with a 2.3 per cent fall in iPhone revenue.
These signs of cyclicality are even more apparent elsewhere in the supply chain. This is because consumer electronics companies will often over-order chips when demand is high. When the down-cycle arrives, their inventories are overstocked. They might still be selling a few phones or laptops, but they are barely buying any semiconductors. This is often referred to as the “bullwhip effect”.
British semiconductor company IQE (IQE) was badly struck by the “bullwhip”. As a wafer manufacturer, it is one step even further down the supply chain than chip manufacturers such as TSMC (TW:2330). Correspondingly, in the six months to June last year, revenue dropped 40 per cent to £52mn, for which it pointed to “weaker demand leading to inventory build-up throughout the supply chain”. In 2023, the share price more than halved.
Its wafers are used in chips for 3D sensing, 5G and electric vehicle charging. These are all long-term growth industries but have struggled since the pandemic. At the time, chief executive Americo Lemos was confident demand would return, but the market didn’t agree.
Last week, the company published its full-year results, and it seems that Lemos might have been right. IQE’s revenue increased 22 per cent in the second half of 2023 compared with the first, and it said this momentum has continued into the first months of the new year. The order book is also strengthening, and IQE expects to see further improvements through 2024. Broker Numis was impressed by the fact that net debt had fallen from £15.2mn last year to £2.2m; this was also meaningfully better than the £3mn IQE had pre-announced in January.
The share price jumped 30 per cent on the day of the news. And it is now up 40 per cent since we featured its turnaround prospects in our Companies section.
Of course, there are no guarantees a company won’t fall into structural decline. Intel (US:INTC) was the world-leading semiconductor company before it failed to invest in the most cutting-edge lithography machines and fell behind TSMC. However, on average the market consistently overrates the significance of economic downturns.
Most investors know in theory that patience is essential for success. It is only a few that are capable of putting it into practice.
