The PHLX Semiconductor Index (SOX) has finally reached 17-year resistance at the 2000 internet bubble high, setting off a long-term sell signal that tells risk-conscious investors and market timers to take profits or set protection stops. The strongest performers have the most to lose in this sector-wide scenario, so it is recommended that NVIDIA Corporation (NVDA) and Micron Technology, Inc. (MU) shareholders pay close attention to price action in the coming weeks.

Chip stocks lagged broad benchmarks after the market bottomed out following last decade's economic collapse, with the SOX index forced to retrace steep losses incurred during an eight-year bear market that ended at a 12-year low in 2009. Overcoming that deep trough has required intense buying pressure, delaying a round trip to the bubble high while the Nasdaq-100 and other tech indices completed long-term testing at similar levels and are now trading near all-time highs.

That testing process is just now getting under way for the semiconductor index, predicting a long period of underperformance that may include significant downside exposure. To illustrate, the Nasdaq-100 reached resistance at the 2000 high in the first half of 2015 and required 18 months of volatile sideways action to complete a major breakout. Those volatile whipsaws suggest that holding on at this juncture will require an exceptionally strong stomach. (For a primer on the chip sector, check out: The Industry Handbook: The Semiconductor Industry.)

SOX long-term chart (1995 – 2017)

 

The PHLX Semiconductor Index (SOX) opened for business near 240 in 1994, entered an uptrend that topped out at 571 in 1995 and sold off to an all-time low near 140 one year later. A 1998 test at the low found aggressive buying interest, generating a historic uptrend powered by the internet bubble. That vertical impulse peaked at 1,362 in the first half of 2000, setting the stage for an equally historic collapse.

A bounce into mid-decade stalled above 550, while the 2008 economic collapse completed the long-term downtrend with a vertical breakdown that ended less than 30 points above the 1996 low in November. It took more than five years to complete a round trip into the 2003 to 2007 resistance zone, generating a 2014 breakout that ran out of steam at the 50% sell-off retracement​ in 2015.

The index cleared resistance at 750 in August 2016 and took off in a powerful trend advance that booked the most prolific gains since the last decade of the 20th century. The rally has quickly recouped the last 50% of the round trip into the 2000 bubble high, reaching within 20 points of that level last week while predicting a major reversal in the coming months. However, no short- or intermediate-term sell signals have sounded yet, telling market players that there is plenty of time to take defensive measures. (See also: Top 5 Semiconductor ETFs as of November 2017.)

A December decline or breakdown is unlikely because leadership groups usually end the year at or near rally highs because they are widely held by funds and institutions trying to make their annual performance numbers. That should delay selling pressure into January, when capital gains tax selling often targets the prior year's biggest winners. That is also the time the index could roll over and enter a multi-month decline that could easily test the 1,000 level.

The long-term outlook is exciting for sector bulls willing to wade through a long period of profit taking to grab a lower-risk entry into the top players or index funds. However, many folks forget that chips have acted like commodities for several decades – highly vulnerable to boom and bust profit cycles. In turn, that raises the odds that industry profitability will turn lower along with price, perhaps signaling a cyclical peak that takes many years to overcome. (For more, see: Are Red-Hot Semiconductor Stocks Top Heavy?)

The Bottom Line

The SOX index has rallied within 20 points of the 2000 bubble high and could reverse at this resistance level in the coming months, entering a correction or downtrend that could relinquish more than 25% of its value, dropping the index toward 1,000. (For additional reading, check out: In the Chips: 10 Experts Share Semiconductor Buys.)

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

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