Assessing the Trend in Chip Stocks

The Nasdaq Composite closed at another all-time high yesterday, but some are questioning this rally's sustainability due to the underperformance of the Semiconductor Index. Given we're open minded about our bullish technology thesis, we want to use this post to explore the sector's recent performance and its possible implications.

Let's start with a basic weekly line chart of the PHLX Semiconductor Index (SOX). For the past nine months, prices have been trading around their 2000 closing highs of 1,330 while momentum remains in a bullish range and is working off its bearish divergence through time rather than price. After prices rallied 150% over two years into a key resistance level, these developments should be expected, and as of now, there's little to suggest that this is anything more than a pause within a structural uptrend.

Chart showing the performance of the PHLX Semiconductor Index (SOX)

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Below is a chart of the 30 PHLX Semiconductor Index components with some performance metrics we find relevant. What I want to focus on here is that, since the Semiconductor Index made a new high on July 26, 2016, its median component is up 71%, and only one of the 30 have a negative price return over this period (-2.16%). The index itself is up 81.3% in two years and is still up 8% year to date despite the sideways action, compared with gains of 55% and 15%, respectively, for the Nasdaq Composite.

Table showing important metrics for 30 PHLX Semiconductor Index components

The point of these stats is to highlight that these stocks have all had massive runs over the past two years. Prices don't go up in a straight line, and they don't go down in a straight line, so shifts from an uptrend to a sideways trend are not inherently bearish. In fact, periods of price consolidation are normal and tend to resolve themselves in the direction of the underlying trend, which in this case is most certainly higher.

The next thing we want to look at is semiconductor performance on a relative basis. One chart we've seen floating around is the Semiconductor Index relative to the Nasdaq Composite on a year-to-date basis.

Chart showing the performance of the PHLX Semiconductor Index (SOX) vs. the Nasdaq Composite Index

If you look at this ratio over the short term, you see it moving from the upper left to the lower right, but if you zoom out for a structural perspective of the chart, you'll see that prices broke out of a nine-year base in early 2017 and are now coming back to retest that breakout area. Momentum remains in a bullish range, and the 200-week moving average remains higher, so unless we see prices fail this retest and fall back into that nine-year range, this looks like a correction within a structural uptrend. Again, pretty standard stuff. (See also: 7 Chip Stocks Poised for a Big Short-Term Bounce.)

Semiconductors also broke out of a nine-year base relative to the S&P 500 two years ago and are now consolidating around the 38.2% retracement of the 2000 to 2008 decline as momentum works off its bearish divergence and the 200-week moving average catches up.

Chart showing the performance of the PHLX Semiconductor Index (SOX) vs. the S&P 500 Index

The takeaway is that semiconductors have been underperforming the broader market indexes year to date and that one is correcting through time while the other is correcting through price. Additionally, these long-term charts tell us that, until a lower low is made, the long-term trend in both of these ratios remains higher despite the short-term noise.

The Bottom Line

The bullish thesis for technology stocks as a group includes the Semiconductor Index participating in the upside. History has shown a strong correlation between the absolute price performance of the Semiconductor Index and the Nasdaq Composite; however, evidence for the thesis that outperformance from this sector is needed for the broader market to go higher is mixed at best. Sometimes the semiconductor sector leads; other times it lags. Sector rotation is the lifeblood of a bull market, and this time is no different.

We'll keep an eye on the 2000 closing highs and the index's performance relative to the Nasdaq and S&P 500 for new lows, but for now, the weight of the evidence continues to suggest that this consolidation in the index and its components is a healthy development and a much needed pause after its gains of roughly 150% from the 2016 lows. (For more, see: The Industry Handbook: The Semiconductor Industry.)

Until this consolidation resolves itself, we continue to want to focus on other areas of the market showing relative strength, but Premium Members of All Star Charts can click here for a deep dive into the sector's components where we outline the stocks that may lead if and when this consolidation resolves higher.

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Thanks for reading, and let us know if you have any questions!

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