High Yield in View: An Update on Autos and Semiconductors

The intricacies and knock-on effects of the COVID-19 pandemic on the semiconductor and automotive industries continue to present interesting dynamics for investors to navigate. Franklin Templeton Fixed Income Research Analyst Aleck Beach offers his view of the space from a credit lens.

By now we’re all well aware of the widespread supply chain challenges that have emerged as the world has come back from the COVID-19 economic lockdowns of 2020. Shortages in labor, materials, shipping and logistics have been a headwind to economic growth and have led to inflationary pricing pressures across the economy. Nowhere has this been more evident than in the auto industry, as shortages in semiconductors limited the rebound in global vehicle production over 2021 relative to the depressed production environment of 2020.

Following factory closures mandated by government shelter-in-place orders early in 2020 to address the emerging COVID-19 pandemic, consumer demand for personal transportation was strong as lockdowns were lifted. Vehicle sales rebounded and what was initially feared as a potentially long and deep downturn for the auto industry saw a relatively strong rebound as buyers returned to showrooms. The recovery in vehicle sales over the second half of 2020 soon hit a wall though as a shortage in semiconductors emerged in early 2021, thereby weighing on new vehicle production and limiting vehicle supply.

The auto industry was initially optimistic that semiconductor supply could catch up with demand, thus allowing lost vehicle sales during the first half of 2021 to be largely recouped over the second half of the year. However, the realities of long lead times to add semiconductor capacity as well as long production cycle times for chips meant improved supply would take time to benefit vehicle production. The disruption to industry output proved much more significant than initially hoped for.

Production Disruptions Meet Strong Demand

Over the course of 2021, semiconductor production was disrupted by unexpected events and further COVID-related challenges. Unusually strong winter weather conditions in Texas led to power outages at several semiconductor factories, which was followed in March by a fire at another chip plant in Japan. Over the summer of 2021, the spread of COVID-19 through Southeast Asia constrained operations at subcontractors involved in late-stage semiconductor assembly and final testing. This string of one-off impacts to semiconductor industry production in an already tight supply environment were added headwinds to the recovery in vehicle production. During this time period, demand for many technology-related end products that consume semiconductors remained strong, further adding to the supply demand imbalance. Strains from shipping and logistics challenges from port delays around the world have been an additional burden to supply chain continuity.