The PHLX Semiconductor Index (SOX) rallied nearly 40% in 2017, but technical and political forces have aligned against this high-flying cyclical group, raising the odds that chips may have already hit their 2018 highs and will head into steep corrections as the year progresses. The potential impact of those headwinds should be obvious to market watchers, with the index up just 1% in the past four months.
Many U.S. chip manufacturers have grown dependent on China sales in recent years, raising the stakes in the ongoing trade dispute. Qualcomm Incorporated (QCOM) and Micron Technology, Inc. (MU) sit at the top of this vulnerability list, with more than 50% of sales coming from the Asian nation. China has also stated that it will grow a local chip industry if tensions escalate into a trade war, with the potential of massive supply coming to market in the next three to five years. (See also: Stocks That Could Be Hit by a Trade War With China.)
The chip index completed a 17-year round trip into resistance at the 2000 internet bubble high above 1,350 in January 2018 and lifted to an all-time high in March, triggering a reversal and failed breakout that set off major sell signals. The retracements into these multi-year obstacles often mark major cyclical turns, including the possibility of a bull market top that won't be exceeded until the next decade.
Choppy price action since October 2017 has carved a bearish Three Drives pattern that can end long-term uptrends. However, the index is still holding the trendline of horizontal lows, with a decline through 1,200 triggering the next set of sell signals. More ominously, the monthly stochastics oscillator crossed into a sell cycle in January and is accelerating to the downside. This vertical downturn predicts relative weakness into the second half of 2018. (For more, see: The Industry Handbook: The Semiconductor Industry.)
Micron Technology, Inc. (MU) hit an all-time high near $100 in 2000 and entered a long-term downtrend that finally ended at $1.59 in 2009. The subsequent recovery unfolded in three broad waves that reached the 50% sell-off retracement level in March 2018. The rally promptly reversed, dumping the stock 15 points into early April. It has bounced at support generated by the February breakout above the November high at $49.89 but failed to attract buying interest, rolling over at the 50-day exponential moving average (EMA) just above $50.
On-balance volume (OBV) hit a multi-year high in March and turned lower with price, indicating that distribution that could eventually signal a long-term top. The stock also crossed into a monthly stochastics sell cycle in January, suggesting that bears will control the tape until the summer months, at the earliest. Even so, it will take a decline through the April low at $47.26 to set off the next round of sell signals.
[Learn to identify technical buy and sell signals in Chapter 4 of the Technical Analysis course on the Investopedia Academy]
Qualcomm Incorporated (QCOM) has taken a bigger beating than its rivals in recent months, undermined by the U.S. government's rejection of the Broadcom Inc. (AVGO) $117 takeover bid. Qualcomm's merger with Europe's NXP Semiconductors N.V. (NXPI) is now at risk, with China regulators forcing a withdrawal of its official application in apparent retaliation against U.S. threats to shut down intellectual property cooperation.
The stock topped out at a 14-year high in the low $80s in 2014, following a four-year uptrend, and entered a decline that bottomed out in the low $40s in February 2016. The subsequent bounce stalled near $70 in the fourth quarter of that year, carving a broad topping pattern with support near $50. It is now testing that trading floor for the fifth time since February 2017, with a breakdown opening the door to the 2016 low. (See also: Qualcomm Is a 'Value Play' in Tech Turmoil.)
The Bottom Line
Chip stocks could top out and head lower following a blistering 2017 uptrend, with growing technical and political headwinds guiding bearish price action. (For additional reading, check out: Top 5 Semiconductor ETFs as of April 2018.)
<Disclosure: The author held no positions in aforementioned securities at the time of publication.>