Thanks for the report.

This seems to be very similar to the final element of this thread for the Uno R4 Minima, where the path to the arduino-portable folder is too long for the compiler to use.

Testing with the ESP32S3 in the v2.0.17 board package as you have, the maximum path to the arduino-portable folder is 38 chars.

i.e. Current Path (44 Chars): d:\My Documents\Projects\Arduino\ESP32S3Test\arduino-portable

Will work if it is shortened to:
d:\My Documents\Projects\Arduino\ESP32\arduino-portable

You should be safe to close the solution, and rename the folder as above (as the VCXPROJ is still within a subfolder of the correct sketch name).

We will investigate if we can detect the root cause of this happening, so we can output a useful hint in this scenario.

FYI, just a few more observations...I am now using this folder:

c:\Arduino\ESP32S3_4848S040_Clock3\arduino-portable

so 35 characters before arduino-portable and when I use esp32 3.0.0 I get the same error while it's building a different file:

allocator.h: 46:10: fatal error: bits\c++ No such file or directory

If I switch to 3.0.7 it builds fine.
And If I shorten the path to 

c:\Arduino\ESP32S3_4848S040\arduino-portable

it does build on esp32 3.0.0 fine too.

Also one small thing I noticed, when you uninstall esp32 it still keeps these folders:
(added a space in the path to get it rendered correctly in the forum)

c:\Arduino\ESP32S3_4848S040_Clock3\arduino-portable\packages\esp32 
c:\Arduino\ESP32S3_4848S040_Clock3\arduino-portable\packages\esp32\hardware
c:\Arduino\ESP32S3_4848S040_Clock3\arduino-portable\packages\esp32\hardware\ esp32
c:\Arduino\ESP32S3_4848S040_Clock3\arduino-portable\packages\esp32\tools

they are empty so not a biggie.

And unrelated to the above I wanted to ask...I am trying to test my project with different core and library versions. For that I create copies of the project folder so I have like

c:\Arduino\ESP32S3_4848S040_Clock1
c:\Arduino\ESP32S3_4848S040_Clock2
c:\Arduino\ESP32S3_4848S040_Clock3

and using the board manager I install a different esp32 version in each. Underneath those folders there's arduino-portable folder and the folder for the ino:

c:\Arduino\ESP32S3_4848S040_Clock1\ESP32S3_4848S040_Clock\ESP32S3_4848S040 _Clock.ino
c:\Arduino\ESP32S3_4848S040_Clock2\ESP32S3_4848S040_Clock\ESP32S3_4848S040 _Clock.ino
c:\Arduino\ESP32S3_4848S040_Clock3\ESP32S3_4848S040_Clock\ESP32S3_4848S040 _Clock.ino

the problem with that is they all build to the same temp VMBuilds

\AppData\Local\Temp\VMBuilds\ESP32S3_4848S040_Clock\esp32_esp32s3

If I understand correctly that's based on the project name and selected board which in my case is the same for all 3 copies. So if I want to test something simultaneously in Clock1, Clock2 and Clock3 projects it has to rebuild the cores as I try to sequentially build Clock1, Clock2 and then Clock3 (and ideally I'd like to do the builds simultaneously).

To get around it, I am now renaming the projects as well, so I have 

c:\Arduino\ESP32S3_4848S040_Clock1\ESP32S3_4848S040_Clock1\ESP32S3_4848S040 _Clock1.ino
c:\Arduino\ESP32S3_4848S040_Clock2\ESP32S3_4848S040_Clock2\ESP32S3_4848S040 _Clock2.ino
c:\Arduino\ESP32S3_4848S040_Clock3\ESP32S3_4848S040_Clock3\ESP32S3_4848S040 _Clock3.ino

which then creates different folders in VMBuilds. Is that the way I need to do it or is there something else I can do to keep ino files the same in all 3? 
I like the concept of arduino-portable and I am thinking that if VMBuilds folder could be made configurable per project (or have VMBuilds next to the arduino-portable folder) it would make the project and it's build fully isolated. I also understand that my use case is probably quite niche so I am fine doing the rename.

One more thing I noticed when renaming the project...If I rename let's say ESP32S3_4848S040_Clock3.ino to ESP32S3_4848S040_Clock4.ino in visual studio, it asks me to if I want to rename the folders to which I say OK and it renames it but the .filters file remains the same: ESP32S3_4848S040_Clock3.vcxproj.filters so when the project automatically reloads, all files are at the root level in solution explorer. I have to manually rename the filters file and restart VS.

Thanks for your time to read this