Friday's Ugly Semiconductor Reversal Likely Marked a Medium-Term Top in the Sector
Follow me @TheBon_Scott on Twitter, and please share this newsletter if you find my work valuable.
In my November 21st, 2023, newsletter, I wrote, The Semiconductor Breakout is Strongly Suggesting That the Semis and the Market have Much More Upside. I followed that up, on December 11th, with another Semiconductor focused newsletter where I wrote, The Semiconductor Sector Breaks Out to a New All-Time High, Suggesting Much Higher Prices.
The Semiconductor Sector ETF (SMH), went on to rally 45% from November 21st through this past Thursday, March 7th, and then fell 3.9% on Friday. Of course, a number of individual semiconductor stocks had far greater percentage moves during that stretch, such as Nvidia (NVDA) rallying 85% and Advanced Micro Devices (AMD) rallying 77%.
Friday saw an ugly, high-volume, intraday reversal in the SMH and in most individual semiconductor stocks. After Friday’s action, I think it’s likely that we’ve reached a medium-term top of the semiconductor sector, with Thursday’s closing high of 234.17 unlikely to be exceeded (on a closing basis) anytime soon.
The semi sector got off to another strong start on Friday, with Nvidia (NVDA) jumping out to a 5.5% gain and the SMH rallying 2%. But at an hour into trading, heavy selling hit the sector and lasted most of the rest of the day, with NVDA finishing down 5.5% and the SMH down 3.9%. The 11% intraday swing in NVDA, one of the largest companies in the world and with a $2 trillion market-cap, is the kind of frenzied trading you see when markets & stocks are highly stretched — be it to the upside or the downside.
On Friday, NVDA printed a bearish engulfing candle, often a reversal indicator after a stock or index has had a strong bullish move. It did this on heavy volume. I don’t think that NVDA completely falls out of bed, here, but that I supect the stock pulls back and consolidates until it 2nd quarter earnings report in latter May. We’ll go from there.
The company has had incredible revenue and earnings growth over the past year, and that growth will continue (but the year-over-year comparisons will get more difficult next year), it’s just that it has probably got ahead of itself for the time being. I’ll elaborate more on NVDA’s financials and growing competition in another newsletter; at this time I want to focus on the sector and market dynamics that I see shaping the sector’s behavior over the medium-term.
The SMH ETF also printed a bearish engulfing candle on Friday, and the ETF saw its heaviest volume day since April 2022 while doing so.
What caused the semiconductor sector’s big downside reversal on Friday? As is usually the case, there are a variety of reasons why sectors have big short-term swings. But firstly, whenever a stock or sector has had a very large move, it becomes more susceptible to profit-taking (and short-selling) after disappointing or less-than stellar news.
And the action in the semi sector had been getting pretty frothy. During trading on Thursday, with the SMH up 3.6%, I posted on my public Twitter page that the action in the semi sector felt like a “buying panic,” and a short-squeeze. That’s when FOMO (fear of missing out) seems to be palpable, and even the dogs in the sector are rallying strongly as investors “just want to get in” at whatever the price. There’s no magic formula for measuring a frenzy, but it’s easier to try to do so when you see it happening across an entire sector rather rather than just an individual stock.
And, at a little less than 2 hours into trading on Friday, I posted on Twitter (X) that Nvidia (NVDA), the semi sector and tech space looked to be forming a big downside reversal.
NVDA went on to finish down 5.5% on the day, the SMH down 3.9%, and the tech-heavy Nasdaq 100 down 1.4%. Bitcoin held up, though.
Getting back to catalysts for Friday’s big reversal, with the semi sector being quite extended, and call it frothy, the market wasn’t impressed by a couple of semiconductor company’s 4th quarter’s earnings reports.
Broadcom (AVGO), the 4th largest component of the SMH ETF at 5.7%, reported earnings Thursday after-the-close; as did Marvell Technology (MRVL), a smaller chip maker but with a heavier AI-focused growth strategy than AVGO’s. AVGO beat revenue and EPS expectations, but the market was not impressed with AVGO’s revenue projections for next quarter, and the stock responded with a 7% decline on Friday on heavy volume.
Marvell’s (MRVL) next-quarter revenue guidance disappointed even moreso than AVGO’s, and MRVL got beat up for 11% on Friday on heavy volume.
The fact that the market wasn’t able to brush off AVGO’s and MRVL’s less-than-stellar earnings reports suggests that a sentiment shift is starting to occur where semi investors and analysts are going to start wanting to see even bigger and better news to justify continuing to keep the foot on the gas, and for those with big profits to take.. to keep holding.
Another possible catalyst for Friday’s big reversal in the semi sector, I believe, is the risk that the AI semiconductor export restrictions to China may get notched up further, again, and that China is aggressively throwing even more cash at trying to develop its own high-end semiconductor technology & manufacturing to make it less reliant on the West. None of this is a secret, and I’ve discussed it in detail in the past. But I think some recent developments that aren’t getting much media play, are starting to concern some big players who are close to the situation.
Last Tuesday, Advanced Micro Devices (AMD), opened down 2.5% on news that the U.S. had blocked the sale of a chip it had designed to pass the AI chip export restrictions to China. U.S. regulators deemed that the chip was still too high-powered for sale to the Chinese market. AMD will now have to reduce the chip’s performance and go through the regulatory process of getting it approved and licensed for sale into China.
Despite opening down on Tuesday on this news, AMD rallied back to finish unchanged for the day. And it resumed rallying with the semi sector through Friday morning. This is what happens during big bull runs when momentum buyers are lined up to buy.. and they buy first and ask questions later. Eventually, some concerning news starts to accumulate, and more buyers start asking questions.
This brings us to a news story that Bloomberg released late on Thursday evening, that China was in the process of raising another $27 billion for its largest domestic chip investment fund in its effort to develop its high-end chip making expertise and manufacturing to counter U.S. led efforts to thwart its rise.
This news story isn’t getting any play in the major financial media regarding the semi sector’s bearish reversal on Friday, but I don’t think this Thursday evening news story and Friday’s semi sector bearish reversal wasn’t just a coincidence; particularly after Tuesday’s news on the U.S. denial of AMD’s chip designed for China.
Don’t be surprised if we see a further escalation of U.S. technology curbs directed at China, and more attention being focused on the long-term effect of permanently closing off China’s very large market for AI-focused chips and high-end chip making equipment.
In short, I think Thursday marked a medium-term top for the semi sector and it will go into consolidation mode as it awaits next quarter’s earnings. It may very well take another stab at making a new high, and it may briefly do so, but look for more selling to start coming into rallies as momentum wanes and less-than-stellar news stops getting dismissed so readily.
As for the broader market, if you take a step back and look at a lot of weekly charts, you'll see that we've come a long way in many areas, and it obviously reduces the risk versus reward of taking on more risk at this point. Furthermore, the S&P 500 printed a doji candlestick on its weekly chart, suggesting an elevated risk of a reversal.
That doesn't necessarily mean the market is going to completely fall out of bed, here, but making money on the long side will probably start getting harder and we're most likely going to start seeing more red bars on the weekly charts. A 5%, plus or minus, pullback after this big rally would be normal and healthy, but you always have to be on the lookout for short-term moves morphing into larger ones.
A pullback to support at 4800 would be an approximate 6% pullback. We would likely need some sizeable macro news deterioration for that support level to break, such as growing recessionary risks or inflation remaining stubbornly high.
Keep an eye on the Dollar. Its pullback over the past 3 weeks has been supportive of equities and bitcoin (risk assets). The Dollar printed a hammer candlestick on Friday, indicating a pretty good chance of marking at least a short-term bottom. A bounce would likely put downward pressure on gold, which is short-term extended and due for a rest. And it would also probably put some pressure on risk assets in general.
Speaking of Bitcoin, as typically a pure risk-on/off gauge, I think that how it acts from here will shed a lot of light on what we can expect from equities over the near and medium-term. Bitcoin is currently testing its all-time high after getting a huge boost from the SEC approval of bitcoin spot ETFs.
If bitcoin continues to rally, or even if it just manages to hold up pretty well while testing major resistance after a huge run, it will suggest that a general risk-on sentiment remains in risk-assets and any pullback in equities will probably be fairly limited. If bitcoin rolls over in sizeable-way, I suspect that equities are highly likely to do so as well. Disclosure: WMI went short bitcoin on Friday, and we’ll cut any potential losses quickly if it decisively rallies above Friday’s intraday high.
That’s it for now, and as always, I’ll be posting frequent market commentary on WMI’s private Twitter page.
On to a new/updated long & short focus watchlist.
Focus Watchlist
I try to recommend trades that are timely and that a breakout/breakdown is likely to occur soon. If I take a stock or ETF off the focus watchlist, it may be because the trade needs more time to ripen, it ran away from us, or I’m no longer considering it at all.
Longs:
Keep reading with a 7-day free trial
Subscribe to Wade's Market Insights to keep reading this post and get 7 days of free access to the full post archives.