The PHLX Semiconductor Index (SOX) shook off weak guidance from NVIDIA Corporation (NVDA) and Applied Materials, Inc. (AMAT) on Friday, Nov. 16, closing lower but holding above the most recent downtrend lows. This minor resilience could be instructive, indicating that the beaten-down index is oversold and ready to squeeze short sellers. If so, the tape into mid-December will reflect more bullish price action, with a rally back to resistance above 1,300 on the semiconductor index.
The index finally reached the 2000 bubble high in January 2018 and eased into a topping pattern that violated support in October. This breakdown signals the first semiconductor bear market since 2008, when the group was engaged in a two-year 70% decline. The current malaise may not last that long or exhibit similar intensity, but major caution is advised, including exits on the majority of long-term sector holdings.
Even so, major breakdowns tend to overshoot downside targets, attracting weak-handed sellers who fuel short squeezes up to key resistance levels. Underlying technical readings suggest that this is about to happen with chip stocks, opening the door to more than 100 upside points on the index and even stronger percentage gains on more resilient components that include Intel Corporation (INTC), Xilinx, Inc. (XLNX) and Broadcom Inc. (AVGO).
SOX Monthly Chart (1998 – 2018)
The index hit a two-year low at 182 in the fourth quarter of 1998 and took off in a parabolic buying impulse that topped out at 1,362 in the first quarter of 2000. It broke down from a nine-month topping pattern in October, entering a downtrend that gave up nearly 98% of the vertical uptrend into 2002's bear market low at 209. A sturdy bounce into 2004 stalled well below the .382 Fibonacci selloff retracement level, marking resistance that repulsed 2006 and 2007 breakout attempts
The 12-year low at 167 posted in 2008 ended the multi-year downtrend, giving way to a recovery wave that mounted 2004 resistance at 560 in 2014. The index stalled with the broad market in 2015, carving a relatively narrow sideways pattern ahead of an August 2016 breakout and uptrend that generated the most prolific gains so far this century. The rally reached 2000 resistance at the start of 2018, two months after the stock entered a topping pattern that broke support in October.
Price action from 2008 into 2016 has carved a perfectly formed Elliot five-wave advance, with a dynamic fifth wave climax. Theoretically, this price structure now exposes a 100% retracement into the bottom of the last rally wave, translating into a steep decline down to 550. This sounds extraordinary and unrealistic, but the first down leg after the 2000 top reached 576, and we can't rule out fractal behavior.
SOX Weekly Chart (2015 – 2018)
The monthly stochastics oscillator is engaged in a multi-wave sell cycle that hasn't reached the oversold zone yet. However, the weekly indicator entered an intermediate buy cycle two weeks ago, predicting a countertrend rally that could lift price into the intersection between the 18-year-old high (blue line) and apex of the broken triangular top (black line), translating into 100 to 150 upside points.
A Fibonacci grid stretched across the 2015 into 2018 uptrend placed that most recent low near the .382 retracement level. The 50-month and 200-week exponential moving averages (EMAs) have risen to 1,000, which marks the 50% retracement, offering a logical downside target if selling pressure picks up in coming months. Unfortunately for bulls, steady 2017 upside carved few obvious support levels, raising the odds that deeper downside targets will eventually come into play.
The Bottom Line
Chip stocks have entered their first bear markets since 2008 but could shake out short sellers before heading for deeper downside targets in 2019.
<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>