3 Reasons to Buy Semiconductor Stocks in October

The best-performing sector in the market over the past 10 years has been the semiconductor sector. But many investors shy away from chip stocks due to their volatility.

For investors with a time horizon beyond five years, you could be costing yourself outsized gains by shying away from chips. After all, every device people use contains more and more chips every year, and that only seems to be increasing with the AI revolution.

Moreover, now may be an especially opportune time to invest in the sector.

Images source: Getty Images.

Reason #1: Chips were down in the third quarter on fears that may not materialize.

While the overall market is looking at a modest gain for the third quarter, chip stocks aren't. The VanEck Semiconductor ETF (NASDAQ: SMH), which tracks the top 26 names in the sector, fell 5.4% in Q3 and a more dire 11.5% from all-time highs set in mid-July.

There were various reasons for the pullback, which, taken together, resulted in these poor returns. Still, none seem so dire as to affect the long-term picture.

After all, the semiconductor stocks already had a big run to start the year. That came on the back of Nvidia (NASDAQ: NVDA), SMH's largest holding, having a monster first half. So, a pullback or correction was not unexpected at some point, with investors perhaps looking for excuses to take profits.

That excuse came in July when a soft jobs report led to concerns over a potential recession. Meanwhile, skeptics on the artificial intelligence (AI) boom sold the chip stocks when big cloud-infrastructure companies reported earnings, complaining that these companies needed to show even better revenue and profit growth than they did to justify their heavy capital spending on chips.

Meanwhile, non-AI chip spending remained muted, including for PCs, smartphones, and electric vehicles. All of these end markets have been crowded out by corporate AI spending or because of consumers limited by higher interest rates.

Yet by the end of the quarter, the U.S. received better economic data. Jobs growth returned to higher levels after the July scare, and inflation continues to come down toward the Fed's 2% target. On Sept. 18, the Federal Reserve cut the federal funds rate by 50 basis points, which was more than some had expected. That has the potential to revive consumer spending on big-ticket items like autos and also relieve corporate spending, too.

Moreover, virtually all technology executives remain quite bullish on the AI buildout continuing for some time. All Magnificent Seven companies forecast increased AI investment and maintain they are seeing early returns that should grow in the future. In early September, Oracle Chairman Larry Ellison dismissed the pessimism on AI spending, calling the AI races an "ongoing battle for technological supremacy" among giant, well-funded companies, and "a race that goes on forever."

Reason #2: Micron's earnings defy skeptics

Late in September, Micron Technology (NASDAQ: MU) reported its fiscal Q4 earnings, smashing expectations and also delivering better-than-expected guidance. As with other chip stocks, Micron had sold off by nearly 50% from its June highs, but its stock rallied big-time after the earnings release, which seemed to allay fears outlined by some Wall Street analysts over the summer.

Micron is one of only three major producers of dynamic random access memory (DRAM) memory in the world, and DRAM goes into just about every electronic device there is. So, Micron's outlook provides a good barometer for the health of the chip market.

By all indications, Micron's high-bandwidth memory (HBM) product for AI applications continues to be in very high demand for AI data centers, with Micron indicating its entire HBM capacity was already sold out for 2025. Furthermore, management cited growth of AI-enabled PCs and smartphones as a catalyst to grow demand for non-server DRAM applications next year.

The prolonged downturn in PCs and smartphones could therefore lead to a very strong recovery in 2025. Devices bought during the pandemic in 2020 and 2021 are aging, while AI-enabled capabilities are coming to new models. That means increased purchases of higher-content devices, boding well for chip stocks.

Micron management therefore remains very optimistic about 2025, projecting a "substantial revenue record" in 2025, with significantly improved profitability.

Reason #3: China's big stimulus

Finally, last week China unleashed a large stimulus for its economy, with policymakers also signaling even more fiscal help is on the way.

China's economy is important for the semiconductor market, as its massive population consumes more than half of the world's chips. Let me repeat that: China consumes over half of the world's chips.

Even though some of the most advanced semiconductors are banned from sale or use in China, China's 1.4 billion people still consume a lot of chips in terms of smartphones, PCs, and non-AI servers. Additionally, China has a thriving clean-energy market, with 80% of the world's solar production. New energy vehicles, classified as either battery-powered or hybrid electric vehicles (EVs), just reached 50.7% of all new vehicle sales in China in July, overtaking traditional internal combustion engine (ICE) vehicles for the first time. EVs and hybrids all require more semiconductors than traditional vehicles.

China's economy has really struggled following the pandemic, as the government's clampdown on tech companies, prolonged "zero-Covid" lockdowns, and the bursting of the country's property bubble have caused a big downturn in consumer spending. Yet it looks as though after three years, China is finally getting serious about reviving growth.

That's good news for chip stocks, which have had a tough couple of years in large part due to the depressed Chinese economy and associated overhang. If that reverses, it's yet another catalyst for semiconductor growth in the year ahead.

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Billy Duberstein and/or his clients have positions in Micron Technology. The Motley Fool has positions in and recommends Nvidia and Oracle. The Motley Fool has a disclosure policy.