We have been quite positive on the chip stocks for a while now...and we turned particularly bullish on the group three months ago, in early September. Back then we said that although it was a good idea to pare-back on some of the mega-cap tech names like the FAANG stocks...we ALSO said that other areas of the tech sector continued to look quite good. Therefore, we said, even though people should indeed rotate out of some of those big tech names, they should also be rotating WITHIN the tech sector...especially towards the chip names. This is something we continued to say over the next 2+ months.
Since we made that call in early September, the SOX semiconductor index has spent the past three months rallying strongly...and it has rallied a whopping 35%! This compares to a 9% rally in the S&P 500...and rallies of only 4%-7% in stocks like FB, AAPL & MSFT, 6% in AAPL...and a 2% decline in AMZN. Yes, GOOGL is one mega-cap name that has seen a nice rally (of 16%) over the past three months, but that still pales in comparison to the jump in many of the chip stocks. (BTW, we’re using the SOX index instead of the SMH ETF in this note because we’re going to look at a very long-term chart in this comment...and the SMH only goes back to late 2011. However, they do trade in tandem.)
In other words, our bullish stance on the chip stocks has worked out very well. HOWEVER, this group is getting very overbought, so we’re going to rein-in our enthusiasm on the semis up at this level. We’re not saying that the group should be shorted at these levels. We remain bullish on the broad stock market over the near-term, so if the S&P 500 continues to see its Santa Claus rally, the chip stocks could/should keep moving higher. However, we no longer believe it can keep up the pace of outperformance it has seen over the past three months. Therefore, we believe that investors should avoid chasing the semis at the present time...and traders should start taking some chips off the table (now...and into any further strength over the next few weeks).
Let’s be more specific about what we’re seeing. There are two developments that are causing us to become a bit more cautious right now. First, the weekly RSI chart shows that the SOX index has become quite overbought...as it has reached the 76 level. That is the same level it reached at the beginning of this year...just before it fell out of bed (with the rest of the market). We readily admit that the SOX became more overbought in early 2018...when its weekly RSI chart move into the mid 80s. It has also moved up to 78 a couple of times since the over the past decade before it rolled-over. Thus, it could definitely rally further from current levels. (This is another reason why we do not think investors should short the group...at least not yet.) However, it is still getting very close to levels that should be considered frothy on a short-term basis....so we now want to take a bit more cautious view.
Another reason that our concerns are growing is that the SOX index has reached a premium of whopping 89% to its 200 week moving average. That’s much higher than the premium it reached just before the Q1 decline of this year (when it reached 60%)...and it was also a bigger premium than it reached in 2018 (just before it saw a 14% correction). The 73% premium to its 200 week MA that the SOX reached in 2018 was the most extreme reading of this century, so the fact that it has reached an 89% premium today show just how overbought the group has become.
Of course, we always have the tech bubble, so we do admit that the SOX got a premium of 272% before it topped out (that’s not a typo), so there is no question that we just might be turning a bit cautious too early in this cycle. (This is yet another reason why we’re not suggesting people should start shorting this group.) However, the SOX is just getting to a level that will make it very tough for it to outperform in any meaningful way...at least until it can work-off some of these extremes.
Finally, we also want to say that this call has nothing to do with concerns about the fundamental outlook for the group. It’s just that there are times when a group (or a stock) can get too far ahead of itself on a short-term basis...and therefore it is important acknowledge these kinds of situation when they develop...and adjust one’s investment strategy accordingly.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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