What happened

Shares of semiconductors were outpacing the broader markets, which were quite volatile today. Industry leaders Taiwan Semiconductor Manufacturing (TSM -0.23%), Micron Technology (MU -1.24%), and Aehr Test Systems (AEHR -3.51%) were up 2.1%, 5.5%. and 8.8% on the day, respectively.

There wasn't any company-specific news today, but the broader semiconductor sector was up strongly, even as many other cyclical industries outside of tech were struggling.

One likely reason for the surge in chip stocks today was strength in technology more broadly, as long-term interest rates fell hard today. In addition, investors may be getting excited about the prospects for semiconductors on the heels of Nvidia's (NVDA 1.75%) GTC conference on Tuesday.

So what

From the day's actions, it appears that the bond market is pricing in lower growth on the heels of yesterday's raising of the federal funds rate by the Federal Reserve. Today, the 10-year Treasury bond yield fell in response, declining 2.7% to a yield of 3.4%, which is around the lows for 2023. That seems to indicate the bond market foresees lower growth this year and potentially a recession, but with a welcome decrease in inflation, as well.

Most technology stocks are considered growth stocks, with the bulk of their earnings occurring well beyond the next year. Therefore, as technology stocks were among the hardest hit last year -- semiconductors included -- they actually rose off these lower levels, despite recession fears. This is because a lower long-term interest rate increases the value of earnings that are far out in the future. 

While lower-growth cyclical stocks in, say, energy, financials, and industrials struggled, technology stocks rose, as lower long-term bond rates appeared to outweigh concerns about the next quarter's or even this-year's earnings growth picture.

This may be one reason Aehr did so well today. It's a high-growth semiconductor-equipment stock that helps produce Silicon Carbide (SiC) wafers. SiC is viewed as a key enabler of electric vehicles and is currently on more of a secular growth path than the more mature corners of the chip industry.

But aren't most semiconductors cyclical stocks? Well, semis are an interesting hybrid, as their earnings can fluctuate wildly year to year but typically make higher highs and lows as semiconductor content increases over time -- usually at a faster pace than the economy at large.

In addition, chip stocks have been on fire since the fall, with the unveiling of OpenAI's ChatGPT last November. Investors now may be coming around to the notion that artificial intelligence has hit an inflection point and will be an important growth area for all business. Of note, artificial intelligence systems are extremely compute-intensive, requiring greater numbers of more powerful semiconductors.

New AI systems will require the latest logic chips, and Taiwan Semiconductor Manufacturing is currently the clear leader in leading-edge manufacturing. AI systems will also require newer and powerful high-bandwidth memory, of which Micron is one of just three leading global producers.

This AI enthusiasm may have gotten a new jolt this week, as Nvidia held its GTC conference on Tuesday, where it unveiled a deluge of new AI innovation. Nvidia's newest H100 chips and integrated networking systems are the current leaders in AI enablement, including ChatGPT-4.

At the conference, Nvidia described exciting new use cases for AI, from drug discovery, to industrial and auto design. This also included the acceleration of chip production itself, through a new software library called cuLitho.

Given the sheer amount of new AI applications touted at the GTC conference this week, investors may be getting more enthusiastic about a recovery in chip stocks, which were severely beaten down in 2022.

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Now what

The semiconductor sector is fascinating, as leading-edge chips are powering some of the most exciting technology innovations in the market. Of course, that also makes them politically contentious, as we have seen with the new restrictions on chip sales to China, along with the passage of the CHIPS Act last year. Moreover, since semiconductors are primarily a hardware-focused industry, sales can be uneven from year to year.

Yet if one can stomach the volatility, the iShares Semiconductor ETF has more than tripled the return of the S&P 500 and more than doubled the return of the Nasdaq 100 over the past 10 years. While the sector was down 35% last year in one of its more brutal annual performances, that volatility is the price one pays for this type of long-term outperformance. Days like today help explain why.