What happened
Shares of Micron Technology (MU 0.76%), Nvidia (NVDA 3.38%) and Advanced Micro Devices (AMD 1.19%) were all down big along with the tech sector on Monday. As of 2 p.m. ET, these stocks were down 4.7%, 5.8%, and 6.1%, respectively.
Each of these stocks has been delivering terrific earnings beats and great guidance, so why is this happening?
Last week's inflation reading was higher than expected, which is leading to fears the Federal Reserve will have to hike interest rates more aggressively to get prices under control, which could lead to a recession. Even though the chip sector is arguably at its healthiest position relative to its history, its cyclical reputation is causing investors to sell en masse amid recession fears.
Also, a downgrade for Micron today isn't helping matters.
So what
On Monday, analyst KinNgai Chan from Summit Insights downgraded Micron from buy to hold. Micron is one of the more cyclical stocks in the semiconductor sector, since its memory chip prices fluctuate with supply and demand in the economy, leading to volatility. Recently, it has been delivering very strong results and guidance, as its management has out-executed rivals. However, Chan thinks the good times might soon end.
He says his recent channel checks revealed persistently weak demand for memory chips for smartphones and PCs. This is not surprising. As the pandemic-era boom in personal computing devices comes to an end with the economy reopening, consumers are now spending on experiences -- not to mention high food and gas prices biting into household budgets. The same thesis led analysts at Piper Sandler (PIPR -2.29%) to downgrade Micron to sell last week.
The same fears are likely plaguing Nvidia and AMD today; both of those companies are exposed to PCs and gaming, two discretionary sectors that could see a decline this year amid a consumer spending slowdown.
Yet while fears about consumer electronics sales have been affecting each of these stocks, these names are also exposed to the data center sector, which has been very strong and remains so. Even Chan, in his note, pointed out the continued strength in the data center, as the cloud transition and artificial-intelligence (AI) applications continue to grow.
Last quarter, Nvidia saw its data center segment rise a whopping 83%, with AMD's embedded, enterprise, and semi-custom segment, which includes its EPYC data center chips, up 88%. These figures for the data center segment were the strongest for all of these companies last quarter.
However, if there is a broader economic slowdown, Chan's fear is that data center customers could also begin to pull back at some point. While there isn't a sign of that now, that would affect these companies' current pillars of strength.
Now what
Therefore, whether these stocks are now bargains or not is largely dependent on the all-important data center market. But before everyone panics, some analysts are still optimistic on that front. UBS (UBS) also came out with a note today, reiterating a buy rating on Micron, although the firm lowered its price target to $115, down from $120. Even so, that's still significantly higher than today's $59 share price.
UBS points to the secular strength in the data center market, as new server formats ramp up this year requiring much more memory content. The analysts also pointed to controlled supply growth from the big memory names, as capital equipment is in short supply.
Nvidia CEO Jensen Huang also noted strong visibility into data center growth on Nvidia's recent earnings call, as recent strides in AI have led to huge demand. For its part, Micron pointed out at its recent analyst day that the data center segment was now its largest, surpassing the mobile segment in size and growing faster. By 2025, Micron sees data center chips making up 42% of its revenue, up from 30% today, while it sees PC and mobile combined (the concerning segments today) falling from 55% of revenue to 38% by that time.
Therefore, the big theme to watch is data center investment. If it keeps up, these three stocks look awfully cheap after this sell-off. But if a broader recession takes down even the strongest of secular trends in cloud AI, then there could be another leg down.
Still, while the short-term is unclear, over the long term -- say, five to 10 years -- I'd expect each of these stocks to do very well, due to the growth of cloud-based AI applications as a necessary tool for all enterprises large and small.
