AI Stocks Suffer Declines Amid Economic Uncertainty and Trade Fears

Investors are reminded that stock prices can decline, with a notable correction occurring as recent as October 2023. The last major index to fall over 10% from its peak marked a significant shift in market sentiment. Recent market trends have shown that corrections can happen gradually, as seen in 2023, or swiftly, as observed from February 19 to March 10, when the Nasdaq Composite plummeted nearly 13%.

The sell-off was significantly influenced by President Donald Trump’s trade policies and rising concerns regarding potential additional tariffs on Taiwan, a crucial supplier of chips used in artificial intelligence (AI) data centers. This uncertainty primarily affected AI stocks that had previously driven the Nasdaq to record highs in February.

During this decline, key players like Nvidia (NASDAQ: NVDA), Broadcom (NASDAQ: AVGO), and Taiwan Semiconductor Manufacturing Company (NYSE: TSM) witnessed a significant drop, resulting in a combined market capitalization loss of $1.16 trillion.

Investors may feel tempted to acquire shares of these companies at reduced prices; however, one company stands out due to its sustainable competitive advantage.

Image source: Getty Images.

Understanding the Fear Behind Falling AI Stocks

Several factors have contributed to the recent decline in AI stock prices. Economic uncertainties have weakened consumer confidence, while rising U.S. trade tensions exacerbate market fears. Investors are apprehensive about geopolitical developments, particularly the potential of the Trump administration implementing new tariffs on Taiwan, home of TSMC.

Most major chip manufacturers, including Nvidia and Broadcom, rely heavily on TSMC for chip production and packaging. As TSMC commands approximately two-thirds of all chip fabrication spending, a tariff on Taiwan could significantly increase production costs for these companies. Higher operating costs could force them to raise prices or sacrifice profit margins.

In turn, elevated prices might trigger decreased demand for their chips. While major tech clients possess substantial budgets, they are not limitless. Companies like Nvidia and Broadcom face pressure to deliver significant returns on their investments, reducing available funds for increased chip purchases.

This drop in demand would ultimately impact TSMC. The semiconductor manufacturer has considerable fixed costs, and lower utilization of its production facilities could lead to significant profitability challenges if tariffs are enforced or demand weakens for other reasons.

In an effort to appease the Trump administration, TSMC has pledged to invest an additional $100 billion in U.S. operations, expanding its facilities in Arizona over the next two years. This move signals TSMC’s commitment to increasing domestic chip manufacturing.

Investing with a Long-Term Perspective

Given the current market downturn, it’s crucial for investors to consider long-term potential in their portfolios.

Nvidia’s long-term outlook appears troubling. Escalating chip costs may drive its largest customers toward more cost-effective alternatives.

Meta Platforms is actively developing a custom AI accelerator chip for its Llama foundational models, with plans to implement these chips by 2026. This aligns with its current use of proprietary chips for machine learning and AI inference expansions. Other large tech firms are pursuing similar paths, attaining favorable outcomes with their custom-designed silicon.

It’s also noteworthy that Meta and Alphabet both utilize Broadcom’s technology for custom chip production. Increased costs could inadvertently bolster Broadcom’s custom AI accelerator division. Management anticipates this market segment, combined with its networking solutions, could reach an addressable market size of $60 billion to $90 billion by 2027. However, the reliance on networking chips could temper these expectations.

TSMC, on the other hand, may not be as adversely affected in the long-term as some analysts predict. The company maintains a significant technological advantage, with Nvidia CEO Jensen Huang stating that TSMC is “the world’s best by an incredible margin.”

Transitioning away from TSMC poses a challenge for Nvidia, Broadcom, and other key customers. Few alternatives possess the required manufacturing scale, and ramping up production at other foundries is a time-intensive process. Additionally, chips are specifically designed around TSMC’s manufacturing processes. Switching to a competitor could lead to extensive redesign phases and decreased product quality, given that other foundries may lack TSMC’s capabilities.

Investing in AI Stocks with Long-Term Value

TSMC appears to have the most enduring long-term competitive advantage, creating a self-reinforcing cycle. As TSMC secures more revenue from high-end chip designs, the company can reinvest in research and development, innovative equipment, and expand capacity, strengthening its position to secure future contracts.

While the foundry may experience a temporary decrease in demand, it lacks significant competitive threats. Demand should remain stable as hyperscaler clients transition to more affordable alternatives for GPUs or opt for custom silicon. TSMC holds contracts with major players, including Meta for its new AI chip initiative.

Critically, TSMC also trades at favorable valuations in the wake of the recent market correction.