Investor enthusiasm for chip stocks is wearing thin after 18 months of growing hostility between China and the United States, setting up a perfect storm for a secular breakdown that ends the decade-long semiconductor bull market. Components with the greatest exposure to the Asian nation could be hit the hardest, giving up 50% of more of their current market value, while an economic slowdown impacts companies with more local interests.
President Trump’s Friday tweet-storm, "ordering" U.S. businesses with Chinese exposure to leave the country, is especially dangerous for the semiconductor sector due to its wide-ranging manufacturing and sales exposure. In addition, China has embarked on an ambitious schedule to ramp up local chip production, eventually shutting out American companies from their largest growth venue on the planet.
The president’s flip-flops and soothing words from China have put a floor under major benchmarks on Monday, but we’ve been down this road a hundred times before, with optimism replaced by continued failure to cut a trade deal that lower odds for an economic slowdown. Sadly, it’s likely that both countries already know how this crisis will turn out and are manipulating local press to keep a short-term floor under the financial markets.
The list of semiconductor companies with heavy exposure to China reads like a who’s who of American business giants, with 40% to 65% of total revenues at Dow component Intel Corp (INTC), Texas Instruments Inc (TXN), NVIDIA Corp (NVDA), and Micron Technology Inc (MU). It will takes years and trillions of dollars to rearrange supply chains if the trade war escalates, compounded by massive loss of market share and the cyclical nature of chip sales.
SOX Long-Term Chart (1995 - 2019)
The Philadelphia Semiconductor Index (SOX) embarked on an historic trend advance in 1998, lifting from 183 to 1362 in just 18 months. The parabolic impulse ended in March 2000, giving way to a burst bubble that found support less than 30 points above the 1998 low in October 2002. The index performed poorly during the mid-decade bull market, stalling above 500 in 2004 and failing two breakout attempts into 2007.
A selloff during the 2008 economic collapse completed a round trip into the 1998 low, undercutting that level by 15 points before turning higher into the new decade. The index finally mounted the 2004 high in 2014 and took off in the strongest uptrend in years, reaching 2000 resistance in January 2018. Price action has been testing that formidable barrier for the last 18 months, carving a rising wedge pattern that will issue a major sell signal with a decline through 1350.
SOX Short-Term Chart (2017 - 2019)
SOX posted three major peaks into July 2019, drawing a wedge resistance line while the December 2018 and May 2019 lows are defining wedge support. The index closed less than 50 points above support at Friday’s close but a breakdown through 1400 will issue an early warning rather than full-blown sell signal because the 2000 high (blue line) marks a more urgent trading floor for bulls to hold at all costs.
It’s instructive to note that wedge support and resistance will merge in March 2020, just 8 months before the presidential election. However, it’s traditional for this pattern to generate a breakout (low odds) or a breakdown (high odds) at around the two-thirds level between pattern inception and the vertex. Ominously, the rising wedge passed that point on July 19th, less than a week before July 24th all-time high at 1573.
The Bottom Line
All technical elements are now in place for a semiconductor decline that ends the decade-long bull market.
Disclosure: the author held no positions in aforementioned securities or their derivatives at the time of publication.