Semiconductor Stocks Enter Mid-Term Correction Phase
The PHLX Semiconductor Index has shifted into a prolonged sell cycle, signaling potential declines in chip stocks throughout the third quarter.
The PHLX Semiconductor Index (SOX) rebounded off a robust support level last Friday and extended its gains into Monday, closing above the 200-day exponential moving average (EMA). Despite this short-term strength, the index has officially entered a long-term sell cycle, indicating potential weakness through the third quarter and suggesting that the recent peak may only be the start of a broader pullback. Investors in the sector might consider reducing their holdings during this rally and explore cost-effective options hedging strategies available this week compared to last.
Since confirming a historic breakout above multi-decade resistance in late 2019, chip stocks have driven significant gains. From December 2018, the sector has experienced remarkable growth, with the SOX climbing 86% to reach an all-time high of 1,983 on February 14. However, such rapid appreciation appears unsustainable amid current market conditions, as the sector heavily relies on Asian markets to meet profitability goals.
Domestic demand remains uncertain, with U.S. consumers historically resilient against tariffs, natural disasters, and other shocks over the past decade. Nonetheless, the current environment is different, marked by heightened panic disproportionate to actual infection rates. Moreover, the lack of a clear trajectory for the ongoing outbreak raises concerns about prolonged impacts on consumer spending and business operations well into the third quarter.
The SOX completed a full cycle touching the 2000 internet bubble peak of 1,362 in early 2018, then hovered within a trading range testing long-term resistance for nearly two years before breaking out decisively in October 2019. Following a 300-point surge to a January peak of 1,975, the index failed to sustain a breakout in February, forming a minor double top pattern.
Last week’s drop pushed the index below the 200-day EMA for the first time since mid-2019, though this support level has since prompted a strong rebound. However, the recovery is nearing resistance at the previous double top breakdown, increasing the likelihood of a reversal and further decline that could retest last week’s lows. There is limited evidence to suggest this support will hold, potentially exposing the index to further losses into the 1300 range.
Traders should monitor the ascending trendline established since December 2018. The February pullback found support at this trendline last week, but another test could threaten its integrity and raise the risk of a breakdown. While this scenario may not unfold immediately, the upcoming March triple witching options expiration is known for heightened volatility, which could accelerate price movements.
NVIDIA Corporation (NVDA) has delivered substantial returns since mid-2019 but recently failed to break above its October 2018 high, suggesting potential for significant declines in the near term. The stock’s historic uptrend began in 2015, fueled by demand from bitcoin miners for high-end graphics cards, progressing through two major rally phases with a notable correction in early 2017.
The stock fell over 40% to a December 2018 low, and its 2019 recovery stalled around $190 in April. A bullish breakout in October propelled shares 122 points higher to a record $315 in February. However, last week’s heavy-volume sell-off reversed this breakout, triggering strong sell signals.
Selling pressure is expected to intensify as the stock approaches the $300 level and the unfilled gap, which present attractive entry points for aggressive short sellers. The technical outlook would significantly improve if prices break above the $305 gap resistance, reinstating the breakout. Nonetheless, such a positive development would likely require favorable news regarding the outbreak, which currently appears improbable.
Conclusion
Semiconductor stocks are undergoing intermediate corrections that may lead to further price declines through the third quarter of 2020.
Disclosure: The author did not hold positions in any securities or derivatives mentioned at the time of writing.
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