Given the recent concern about the uncertainty in predicting the yield curve and, with it, the likely direction of the market, investors would be better informed by looking at one measure that, since 2016, has had a high probability of predicting the direction of the overall market.
Trade tensions with China have caused shares in the semiconductor industry to drop precipitously over the past two months. There is a strong correlation between the direction of semiconductor stocks and the direction of the broader market. Chip shares often precede the S&P 500’s fall and rise. According to Dow Jones Market Data, The PHLX Semiconductor Index and the overall stock market have moved in tandem 78% of the time this year. The semiconductor group comprises 3.2% of the index. Since 2016, when semiconductor stocks started their rapid ascent, the correlation was 76%.
Some individual stocks in the sector have fared better than others. Despite a steep drop of 3% since October, Advanced Micro Device’s (AMD, Financial) stock still retains its status as the best-performing stock in the S&P 500 this year, with a phenomenal gain of 108%. AMD shares have swung wildly this year, with a 52-week high of $34 and a low of $9.
Shares of other microchip makers didn’t fare as well. Micron Technology’s (MU, Financial) stock tumbled 16% since the beginning of October, giving the shares a 7.8% decline for the year. Shares of Nvidia (NVDA, Financial), which was swept up in the tech rout, has fallen 44% since early October.
Misery loves company, and other tech stocks have joined the semiconductor group suffering steep losses recently, based on indications of slowing revenue growth. Investors have fled the sector, pulling $2.2 billion from global tech funds for the month, according to EPFRE, a fund-flow data company. This exodus comes after investors added $52.3 billion to the sector during the August 2016 through August 2018 period.
Investors are anxiously awaiting the outcome of the G20 summit for an update on the state of trade negotiations with China. Microchips are used in a variety of sectors that recently have been posting rapid growth, such as the fast-growing rise of data centers to facilitate the increasing move to cloud computing as well as gaming and artificial intelligence.
Lessening global demand and the imposition of retaliatory measures by China will have a severe impact on the group. The drop in semiconductor shares could prove to be foreboding for the market. As chipmakers face uncertain demand, many investors have shifted out of the sector into software stocks that are involved in the increasingly lucrative business of cloud database services.
Two companies, VMware (VMW, Financial) and Palo Alto Networks (PANW, Financial), have ridden the explosive growth in the cloud or cybersecurity businesses and have poster strong earnings. Another company that is attracting investors' attention is surging cloud computing giant Microsoft (MSFT, Financial).
Some fund managers have viewed the steep declines as presenting a propitious buying opportunity. For some investors, one of the attractive buys was Nvidia. Nvidia currently has a forward price-earnings ratio of 22.8, a drop form 42.1 at the beginning of the year. By comparison, according to FactSet, the price-earnings ratio for the S&P 500 is currently 15.3, down from 18.1. Nvidia shares are currently $163, up from its 52-week low of $137 and down from its 52-week high of $292.
Disclosure: I have no positions in any of the securities referenced in this article.
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