Cramer says chip cycle is defying old boom-bust pattern

CNBC’s Jim Cramer told Investing Club members that memory and semiconductor component stocks are testing the market’s long-held assumption that sharp rallies in the group must be followed by severe busts. He cited Western Digital’s more than 180% gain this year and said investors remain divided between fears of a classic cycle reversal and signs that chip supply is still constrained.

Cramer framed his view during the club’s July Monthly Meeting by recalling a loss from 37 years ago, when his former hedge fund, Cramer & Co., held 4.9% of Western Digital. He said Western Digital’s preliminary fourth-quarter results came in far below estimates at the time, damaging the fund’s year and leaving him wary of semiconductor cycles for decades.

According to Cramer, that experience reflects the traditional risk in memory and component stocks: capacity expands during strong demand, supply later catches up or overshoots, and earnings can fall faster than investors expect. He said that pattern had shaped expectations around companies including Western Digital, Seagate, Sandisk, Micron and SK Hynix.

Cramer said the current cycle is behaving differently from earlier ones because chips are being rationed and some companies are securing longer-term contracts. He identified Micron as a major data-center supplier and Applied Materials as a company that provides equipment used by chipmakers such as Micron.

Longer-term supply agreements can change the mechanics of a cyclical market by giving producers more visibility into demand and giving customers greater assurance of access to components. Cramer said experienced fund managers remain skeptical that these arrangements can alter the pattern, even as he argued that the evidence is visible in current supply conditions.

He also pointed to valuation as a sign of persistent doubt. SK Hynix, which competes with Micron, trades at six times next year’s earnings estimates, according to Cramer. He said that multiple reflects investor concern that those profit estimates may prove too high if memory supply rises or demand weakens.

Cramer said short sellers are part of the force behind the sector’s gains. Short selling involves borrowing shares and selling them in anticipation of buying them back later at a lower price. If prices rise instead, short sellers may need to buy shares to close positions, adding demand to the market.

He attributed recent declines in some chip-related shares more to market behavior than company fundamentals. Cramer said retail traders had pushed some stocks into sharp, fast advances, and he argued that such moves often correct before stabilizing. He said professional investors with memories of earlier semiconductor downturns had joined retail sellers, making a bottom harder to identify.

Cramer distinguished between stock-price swings and the operating performance of component companies, saying the consistency of earnings in the current period is unusual by historical standards. He said the Investing Club is seeking to build a larger position in Intel because it expects central processing units to become the next area of tight supply after memory chips.

Cramer said Intel is his favorite stock. CNBC disclosed that Jim Cramer’s Charitable Trust holds Intel shares. CNBC also said Investing Club members receive trade alerts before Cramer buys or sells securities in the trust, subject to specified waiting periods and the club’s terms, conditions and disclaimers.

This story draws on original reporting from CNBC.