Chip stocks are losing altitude after a sturdy two-month bounce and could test much lower price levels in coming weeks. In turn, that could add downside pressure to the market-leading Nasdaq 100 index, bringing its short-term performance in line with the lagging S&P 500 index. A sell-off would also undermine the semiconductor sector's improving technical outlook, keeping the door open to an unwelcome test at the March low.

The 90-day enforcement provision of the fragile phase one trade deal expires at midnight on Friday, raising the threat of renewed tensions between the United States and China at the same time that tens of millions are out of work. According to Reuters, President Trump will block chip sales to Huawei, the smartphone manufacturer under investigation for alleged political schemes. China has said that it will retaliate with an "unreliable entity list" if that happens, limiting sales of U.S. high-tech products that include semiconductors.

The president has pulled back from the most extreme retaliatory measures since firing the first shot of the trade war in January 2020, but his hands may be tied by the enforcement provision. In addition, he's now looking for a way to make China "pay" for the coronavirus, keeping it on top of the 2020 political agenda into the November election. This brinkmanship could put a nail in the coffin of the two-month bounce, right at major Fibonacci and moving average resistance levels.

Chart showing the performance of the PHLX Semiconductor Index (SOX)
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The PHLX Semiconductor Index (SOX) topped out at 1,362 in 2000 after a blistering uptrend, underpinned by the expanding internet bubble. It crashed off that peak into 2002, losing nearly 85% of its value, ahead of a recovery wave that added less than 400 points into 2004. A sell-off starting at that level in 2007 broke support at the deep low during the 2008 economic collapse, coming to rest at a 12-year low in 2009.

A recovery wave into the new decade completed a round trip into the 2004 high in 2014, yielding a breakout that stalled at the 50% retracement of the nine-year downtrend. The SOX cleared that barrier in 2016, completing a 100% retracement into the 2000 high in 2018. It ground sideways at that level into October 2019 and broke out, posting an all-time high at 1,983 in February 2020, just ahead of a 39% decline into the March low.

The bounce through April reversed at the .786 Fibonacci sell-off retracement level at month's end, yielding a downturn that’s now testing 50- and 200-day exponential moving average (EMA) support between 1,650 and 1,675. A breakdown would reestablish resistance at those key levels, raising the odds that the index will retrace most of the first quarter decline. That level also generated a successful test at October breakout support in March, raising the stakes during a return visit.

NVDA
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NVIDIA Corporation (NVDA) stock entered a historic advance in the second half of 2015 when cryptocurrencies triggered a mining frenzy, spiking interest in the company's high-tech graphics cards. The rally stalled at $293 in October 2018, giving way to a fourth quarter decline that relinquished more than 57% of the stock's value into December's two-year low. The 2019 bounce completed a 100% retracement into the prior high in February 2020, but the breakout failed in a 40% downdraft into the March low at $181.

The recovery wave into May completed a 100% retracement into the February high earlier this week, yielding a minor breakout followed by a minor reversal. More importantly, the on-balance volume (OBV) accumulation-distribution indicator has retraced less than half the distance back to the February high, indicating that short covering rather than committed buying interest has driven most of the bounce's upside. This deficit and increased selling pressure in the past few sessions is likely to presage a sizable pullback. 

The Bottom Line

Chip stocks are running low on gas after a two-month bounce and could retrace the majority of short-term gains.

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