Why Chip Stocks May Rebound to Record Highs

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

Chipmakers have been one of most volatile groups in the stock market in 2018, with shares of the iShares PHLX Semiconductor ETF (SOXX) trading in a 19% range. Now, after two sharp pullbacks this year, technical charts suggest the ETF could surge by roughly 5% to its previous highs. And strong customer demand for chips could push these stocks into record territory.

According to Semi.org, the North American Semiconductor Equipment billings continued to climb during February, up 22.2% from the same period a year ago, and up 1.7% over January. The overall trend for the group continues to rise, with the three-month billings coming in at $2.411 billion, up from $1.974 billion in February 2017, and up from $2,370.1 billion in January. The strong billings suggest that the chip sector should continue to remain strong, and that could mean that the industry is poised to remain one of the hottest in the stock market. 

A Sharp Rebound

The Semiconductor ETF retested support at $181 in the recent sell-off on March 23 and has been able to rebound sharply. Should the ETF rise above $189, it would indicate a further rebound to its previous highs near $200 seems likely. 

The Sector Has a Strong Correlation to Billings

Since Feb. 12, 2016, the PHLX Semiconductor Sector Index has increased an incredible 142.5%, versus an S&P 500 that is up by only 43%. Meanwhile, the average billings for North America have surged by just over 100%, rising from $1.204 billion to $2.411 billion currently. Since May 1994, the billings average and the Semiconductor Index correlate at 0.71. That relationship is even stronger in recent years, at 0.93 since January 2012, where a perfect correlation would be 1. 

Smoother Cycle

The strong correlation, and the positive trends in the average billing, suggest that the recent stock market weakness, is not fundamentally driven, and that the group should continue to rise as billings continue to advance. What seems to be even more favorable about the current cycle is the steady growth trends that started taking place in 2012, replacing the old boom and bust cycles.

For now, the current setup in the technical chart, and the fundamentals of the industry continue to remain strong, and that would suggest the current stock run-up in the chip sector is far from over.

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.