Chip stocks have shot ahead of the rest of the market since equities bottomed out in late December, with the Philadelphia Semiconductor Index (SOXX) rising 19.1% so far this year, almost double the S&P 500’s 11.5% rise. The sector's market value has risen by more than $210 billion during that period.

But the sector has a big problem, according to a detailed story in Bloomberg.

Its lofty ascent lacks fundamental support. A third of chip-related companies in the S&P 500 missed revenue estimates in the fourth quarter, marking the sector’s worst performance in a decade. First-quarter forecasts aren’t providing much hope either. “The biggest fear that I have is that we have rebounded too quickly and that it’s not potentially justified by fundamentals,” said Bloomberg Intelligence analyst Anand Srinivasan. “First-quarter forecasts were still bad. I want to see evidence that it’s not as bad ad companies have predicted,” he continued.

Chip Stocks Flying High

·           Chip Stocks: 19.1%

·           S&P 500: 11.5%

·           Nasdaq Composite: 13.9%

Source: CNN Money, YTD performance as of 4pm EST 02/25.

What it Means for Investors

Missing revenue estimates and weak forecasts aren’t the only factors creating skepticism among analysts and investors. Chip makers also are plagued by excess inventory and slowing end demand. Another factor is the unresolved trade dispute between the U.S. and China, the world’s two largest economies. “A big impediment to this entire equation is China,” Srinivasan said, per Bloomberg.

The semiconductor industry, with almost $500 billion in annual revenue, is one of the most heavily exposed U.S. stock sectors to China, which is the world’s largest consumer of semiconductors. U.S. President Donald Trump indicated that progress had been made in recent talks with Chinese President Xi Jinping, but a final agreement has yet to be reached.

Trade deal or not, investors separately are concerned about China's slowing economy and whether it will decelerate even further. “Even if the trade war [with China] is resolved it doesn’t solve the biggest underlying issue: is growth weaker than we fear?,” Srinivasan questioned, as per Bloomberg.

Prospects for chip stocks also look weak from a technical analysis perspective. The charts show the Philadelphia Semiconductor Index closing in on a technical resistance level after its big rally over the past two months. The index hasn’t been able to break above that resistance since falling from record highs reached last March. “The index has failed at the downtrend line multiple times, hitting its head ‘to the penny.’ Our thinking here is that the SOX will fail yet again at the line. Sell.” wrote Carter Worth, head of technical analysis at Cornerstone Macro, in a recent note to clients, per Bloomberg.

Looking Ahead

The recent rally has been a big surprise for hedge funds, many of which have missed the semiconductor rally. While they missed the boom that they are now calling overdone, there are some, like Cowen analysts Matt Ramsay, who believe right now is a buying opportunity for discriminating investors to select stocks highly exposed to the artificial intelligence (AI) industry.