The Semiconductor Breakout is Strongly Suggesting That the Semis and the Market Have Much More Upside

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Nvidia (NVDA) reports earnings after the close on Tuesday. And it’s occurring right as the semiconductor conductor sector ETF (SMH) is breaking out to a new all-time high out of a long-term base.

Looking at a weekly chart of the SMH as of last Friday’s close so that it gives you a true weekly chart, the SMH is breaking out of a major cup & handle formation. The beginning of the base dates back to approximately the market’s (S&P 500) peak on January 3^rd on 2022. The SMH peaked just days before the S&P 500 did.

The S&P 500 is still 5.5% below its January 3rd, 2022 close. With its breakout to a new high, the SMH is outperforming the S&P 500 and the broader market — it has broken out to a new high well before the S&P 500 has. You want to see the semiconductor sector outperforming the S&P 500 in a risk-on, bullish market environment.

The high-beta semiconductor sector is always a good barometer of the market’s risk-on or risk-off environment. I’ve been frequently writing about that since latter 2021 on my public twitter account and on this newsletter.

Looking at a daily chart of the SMH, you’ll see that it rallied another 1.4% on Monday, and it has decisively broken out above the late-July pivot (breakout) price of the long-term cup & handle formation.

On the lower section of the chart, you’ll see that the SMH has resumed its relative strength outperformance against the S&P 500. Again, this is what you want to see in a risk-on, bullish market environment. The SMH’s major breakout strongly suggests a continued stock market rally, and the semiconductor sector will continue to outperform the market. There’s other factors currently working in the market’s favor, i.e. lower Treasury yields, positive seasonality, etc., but the outperformance of the semiconductor sector is an important confirming factor.

Looking at the chart of Nvidia (NVDA), it rallied another 1.43% on Monday and made a new all-time intraday and closing high. Interestingly enough, the stock has now just poked above Nvidia’s intraday high price the day after it reported 2nd quarter earnings in August. If you want to read more about the stock’s volatile reaction to its 2nd quarter earnings report, I wrote an August 24 newsletter on it, Nvidia's Blowout Earnings Provide a Good Sell On the News Opportunity.

I suspect that we will get a less-swingy (sharply up and down) stock reaction to tomorrow’s 3rd quarter earnings report and forward guidance from Nvidia. When Nvidia reported its 2nd quarter earnings/guidance in August, expectations were sky-high and the company delivered. But the stock had just had a huge 400% run since October 2022, and it’s not surprising that there was some significant profit-taking on the good news.

At this time, the stock has had time to consolidate and let its earnings “grow into” its valuation, somewhat. Furthermore, in August, long-term yields were rallying, and now they’ve been materially declining — a much better environment for long-dated tech stocks and stocks in general.

Expectations are again sky-high going into Tuesday’s report, and the company is likely to deliver. And like the 2nd quarter, investors and analysts will be focusing on the company’s top-line revenue growth and its revenue forecast for the 4th quarter. Consensus expectations are that Nvidia will report a 173% gain in revenue for the 3rd quarter, and forecast a 195% revenue gain for the 4th quarter. Big-time growth.

While there will be questions and concerns around the impact that the new and heightened semiconductor export restrictions to China may have on Nvidia, the company has recently announced 3 new chip models to bypass/get around the new restrictions. I don’t think that investors and analysts are going to hear anything from the company that will be a significant surprise regarding the export restrictions issue.

Getting back to the semiconductor sector and the SMH ETF, while Nvidia has the largest market-capitalization weighting in the SMH — by far — at 20.1%, it’s important to evaluate the other important stocks in the SMH to gauge its outlook from here. For time and space reasons, I won’t delve too much into the fundamentals of these companies in this newsletter, even though it’s something I spend a significant amount of time on.

Taiwan Semiconductor (TSM), has the 2nd largest market-cap weighting in the SMH at 12.8%. As the largest semiconductor manufacturer (foundry) in the world, TSM’s stock provides an important “tell” about the condition of the broader semiconductor market beyond AI-focused chips. TSM has recently broken out of an inverse head & shoulders formation, and has followed-through on it nicely.

After trending down and significantly lagging the SMH since June, TSM’s breakout back into an uptrend, and back above its 200 dma, is good news for the SMH. It’s no longer a drag on the SMH’s performance.

Broadcom (AVGO), has the 3rd largest weighting in the SMH at 6.8%. It has broken out of a nice 5-month base and is giving the SMH a good boost.

ASML Holding (ASML), has the 4th largest weighting in the SMH at 5.9%. Like TSM, it had been trending down and significantly lagging the SMH. And like TSM, it has also broken back into an uptrend and has moved back above its 200 dma, providing more good news for the SMH. It’s no longer a drag on the SMH’s performance.

Advanced Micro Devices (AMD), has the 5th highest weighting in the SMH at 5.2%. AMD is NVDA’s top competitor in the AI chip market, but is a far-distant second. AMD rallied strongly on it November 1st earnings report and optimistic forecast for $2 billion in AI-chip sales in 2024. The market has given credence to that optimism, and this is more good news for the SMH.

Intel (INTC), has the 6th highest weighting in the SMH at 5%. Once the undisputed leader of the semiconductor sector, it has long-underperformed the SMH as it was late in identifying and capitalizing on some major shifts in the semiconductor business. INTC has recently gotten some of its mojo back, and has rallied strongly on expectations of new data center AI chips and other product roll-outs in 2024. This is more good news for the SMH.

In my view, Intel’s strong recent performance is a reminder, and another confirmation, that the AI chip market is very large and growing very quickly. And there’s a lot of business to go around — both in terms of end-market chips and the manufacturing thereof. Simply put, this is very bullish for the SMH.

Again, the very bullish action in the semiconductor sector isn’t the only reason I’m bullish on the market, but it’s hard not to be bullish when the semiconductor sector is breaking out of a major base and making new highs. And, there is a fundamental/business justification for the rally; it’s not just declining long-term yields pushing up valuations of long-dated growth stocks.

Both the SMH and the major indexes are short-term extended and overbought, and are vulnerable to a profit-taking pullback. But I think that a pullback is a buying opportunity as long as long-term Treasury yields don’t resume a strong upward trend, or decline too sharply, which would indicate growing recession fears.

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.