The PHLX Semiconductor Index (SOX) bounced strongly off December's 16-month low in January and February but has now reversed at a key retracement level that's notorious for printing lower highs within long-term topping patterns. This bearish action waves a red flag for the broad swath of chip stocks, warning shareholders to tighten stops and/or take profits because a deeper slide is possible in the coming weeks.

The index fell to a three-week low on Wednesday, cutting through the 20-day simple moving average (SMA) for the first time since Jan. 4. The downdraft has dumped the weekly stochastics oscillator into the first sell cycle in more than two months, predicting at least six to eight weeks of relative weakness. Taken together with the reversal, it looks like the sector's oversold technicals have now eased out of the system, eliminating the tailwind that underpinned first quarter gains.

Micron Technology, Inc. (MU) and NVIDIA Corporation (NVDA) declines fueled Wednesday's rout, but bigger names are at risk as well in coming weeks. Intel Corporation (INTC) has reversed within 25 cents of harmonic resistance, but weekly stochastics needs further weakness to generate a sell cycle, telling market players to watch the reaction to Broadcom Inc. (AVGO) earnings next week. That stock reversed within one point of the November 2017 high about two weeks ago.

SOX Long-Term Chart (1994 – 2019)

Long-term technical chart showing the performance of the PHLX Semiconductor Index (SOX) 

The index joined U.S. exchanges above 200 in 1994, entering an immediate uptrend that reversed near 570 in 1995. The subsequent downturn posted an all-time low at 139 in 1996 and tested that level in 1998, carving a double bottom reversal ahead of a parabolic buying impulse that continued into March 2000's historic peak at 1,362. It completed a broad topping pattern in October and broke down, spiraling lower for the next two years.

Selling pressure eased less than 60 points above 1998 support after relinquishing more than 1,000 upside points, while the subsequent bounce stalled near 550 in January 2004. Breakout attempts in 2006 and 2007 failed, giving way to a decline that accelerated during the 2008 economic collapse, dropping the index to a 12-year low at 177. That vertical impulse finally ended the eight-year downtrend, ahead of a powerful recovery that completed a round trip into the 2004 resistance level in 2014.

A breakout into 2015 failed to develop momentum, yielding repeated testing that completed a triple bottom reversal in 2016. The subsequent uptick posted a new high in July and took off in a healthy uptrend that continued into January 2018, when the advance reached long-term resistance at the 2000 high. Volatility surged into March while price posted an all-time high at 1,465 and eased into a trading range that broke to the downside in October.

SOX Short-Term Chart (2015 – 2019)

Short-term technical chart showing the performance of the PHLX Semiconductor Index (SOX)

The sell-off into year end violated 50-week exponential moving average (EMA) support for the first time since 2016, hitting a 16-month low at the .382 Fibonacci retracement level of the uptrend that started in 2015. The index turned higher into the first quarter of 2019 and reversed at the .786 Fibonacci sell-off retracement level in February, warning that a test of the 2018 low will complete the next leg of a potential long-term topping pattern.

The 1,270 level has set up as an important price zone, marked by the breakout above fourth quarter resistance as well as the narrowly aligned 50- and 200-day EMAs. Three-month price action has carved unfilled gaps near 1,300 and 1,200, exposing a decline in excess of 10% below the most recent close. Market tone may then dictate the outcome of this progressive pattern, with a bounce yielding a more complex trading range, while a decline through 1,100 would set the stage for a major downtrend.

The Bottom Line

The PHLX Semiconductor Index has reversed at the .786 retracement of the 2018 decline, which started after a reversal at 19-year resistance. This bearish combination could be potent, presaging a topping pattern and the start of a multi-year downtrend.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.