The Semiconductor Singularity
Semiconductors (SMH) have become wildly popular, up 60% YTD. Ultimately, I’d just call that reflexivity in motion. AI is the growth sector, and semiconductors are the picks and shovels of that AI movement. Since we’re still heavily building out AI, SMH is growing sharply. Semiconductors have been the safe purchase if you want to buy growth.
Of course, after going up so much and so fast, it’s reasonable for people to ask when the upside ends and the crash begins. I’d say you need to segregate that into two different ideas-- when’s the pullback and when is the top?
I think betting on a pullback is relatively easier. If you look at something like Relative Strength (RSI,) we’ve really been deviating from recent pricing. The idea of SMH taking a break seems quite possible. One broad thought is that once RSI looks to have peaked out or maybe is no longer overbought, you can sell or short. Or when momentum slows.
However, I’d view that as a temporary short unless news changes. Demand for semiconductors still seem insatiable. Yes, the expectations implicit in semiconductor stock prices reflect at least some of that but in theory this demand can last for years. I’d feel better about selling or shorting semiconductors once they stop responding so positively to news.
So, while the upside in semiconductors has been remarkable, that’s because the fundamentals have also been remarkable. While I could see a pullback, I’d be reluctant to call a top. For our part, we did slightly trim our semiconductor holding last week, in part because some of the individual names had become such a big portion of the portfolio and we weren’t comfortable with the potential loss.
We’re also not adding to semiconductor holdings up here, though. I don’t really think they’ve topped but I do think there are better places to be. I keep banging the drum on software (IGV,) for example, as earnings still seem strong and they’ve been pretty de-risked by the decline. I also think as wars seem to be winding down, that should help the dollar to fade, which should help international stocks gain a bid, again.
In terms of catalysts, I think there’s been a lot of fear of late, which in my mind is part of why the rally has been so narrow. To the extent investors have been willing to take risk, they’ve focused (perhaps overmuch,) on semiconductors. I’d say the fear stems from the concern inflation will cause trouble, which in turn is due to soaring oil prices. Fix oil concerns and investors may find it easier to relax.
Thus, I think an end to the Iran war can help broaden the market rally. In theory, this could take the shape of semiconductors and megacap tech taking a break while the rest of the market catches up. The line above is equal-weighted SPY versus SPY, and I wonder if it’s getting close to a time for that to head up again.
Bottom-line, semiconductors have certainly moved quite a bit in a short period of time. They may be due for a rest but there’s nothing obvious saying they’re peaking. It does seem reasonable to think we may be ready for different leadership at least for a time, though. Perhaps a more relaxed investor will be more willing to invest in a broader array of stocks when and if war concerns abate. As always, we’ll see what happens.