(Bloomberg) -- It’s time to step back from market-darling chip stocks, according to Morgan Stanley.
The U.S. semiconductor sector now has the poorest risk-reward ratio in three years as cyclical risks are piling up, according to the broker, which last month said investors should sell the crowded technology sector.
“Cyclical indicators are flashing red,” analysts including Joseph Moore wrote in a report, cutting their view on the group to cautious from in-line. “Elevated inventory and stretched lead times leave no margin for error as any lead time adjustment or demand slowdown could drive a meaningful correction.”
Gains for chipmakers in recent years have stood out even against the index-beating performance of tech stocks in general. The Philadelphia Semiconductor Index has more than doubled in three years, compared with a 36 percent gain in the S&P 500 Index and an 81 percent advance in the benchmark’s best-performing sector, information technology, which includes heavyweights Apple Inc. and Google parent Alphabet Inc. The top chip stocks from this timeframe are graphics-card makers Nvidia Corp. and Advanced Micro Devices Inc., boosted by demand for cryptocurrency mining.
Deteriorating trade relations between the U.S. and China are also likely to prevent any large-scale M&A, removing a previous boon for the group, the analysts said. Semiconductor capital equipment stocks are set to be “range-bound” for the next 6 to 12 months, Morgan Stanley said, downgrading its recommendation on the sub-group to in-line from attractive.
Still, amid the gloomy outlook, the broker sees exposure to cloud and IT spending as well as breakthroughs in machine learning providing some protection against a cyclical downturn, with favored stocks including Nvidia, Xilinx Inc., Ambarella Inc. and Intel Corp.