Semis Action Signals Potential Q4 Cyclical Advance
The S&P 500 index’s rally caught a lot of investors by surprise as it rallied through 2940, the upper end of the August trading range. For traders, don’t be surprised to see the S&P 500 churn near current levels given there is considerable resistance ahead of 3027. Nevertheless, I continue to view the market’s chart as bullish, with the recent trading range looking more like a consolidation within a long-term uptrend than any top. I expect an upside acceleration by late Q3/early Q4 through year-end.
“It’s not a party without the semis,” they say, and I view the semiconductor industry as one of the market’s most important industry groups as a leading barometer typically for the overall economy. I’ve focused on this group regularly in this space and are revisiting it again this week given the bullish technical action the past week.
Think about the contrast between the barrage of negative macro headlines versus the resilient trading for most semis. How can that be? From my perspective, they are reinforcing the bullish behavior of the S&P 500 and are likely signaling a potential improvement for cyclicals in Q4.
Let’s review the chart below of a semiconductor ETF (SMH). First off, price (second panel) pulled back and bounced strongly off a broad support band, illustrated in blue. That coincided with the upper-end of the 2018 trading range, near the 40-week (200day) moving average. In a bullish environment, that is where the SMH should have held and it did!
Next, look at how it is performing on a relative basis because if it’s not showing signs of leadership then we really should be looking to put new capital elsewhere. Relative to the S&P (third panel) the SMH is on the cusp of breaking above its an 18-month trading range at its 2018-2019 highs. I’d wager there are plenty of machine/algorithm traders zeroing in on groups/ETFs breaking out to new all-time relative highs as potential momentum trades. The semis are perfectly in that crosshair.
What’s particularly interesting is the relative performance of the SMH vs the software ETF (IGV) in the bottom panel. Why? Software stocks tend to offer more secular growers and are less cyclical, so when the semis begin to reverse their downtrend to software, as they are doing now, it’s signaling an important shift taking hold in investor risk appetite. The key upside level in this relationship is at the summer highs indicated by the blue arrow.
What to watch for? A price and relative performance move above the summer highs will be a major bullish signal for semis specifically and more importantly for cyclicals in general.
Noteworthy
Secular growth leadership in technology re-accelerated toward the July highs with consumer discretionary rebuilding its uptrend. Secondly, defensive leadership, such as utilities and consumer staples, had rallied back to the upper end of their 2019 trading ranges and began to peak while cyclical sectors began to rebound from oversold levels.
While my expectation is for cyclicals to rebuild leadership into year-end, a clear uptrend won’t develop until Q4. A move above declining 200-week relative performance moving averages will be needed to technically confirm an upside trend reversal. Until then expect a defensive-cyclical tug-of-war to continue into late Q3/early Q4.
