Logically, there is not, nor can there ever be, a 100% reliable market indicator. If there were, we would all know where stocks were headed, and markets would cease to exist. But, if something has shown itself to be right more often than not and there is a logical reason why it may give clues as to market direction, it is worth paying attention. For that reason, the fact that the market is being dragged lower this morning by a broad selloff in semiconductor stocks is a worry.
Over the last couple of years, the Semiconductor ETF SOX has shown a tendency to move, albeit in an exaggerated fashion, with the broader S&P 500 ETF SPY, at times hitting highs and lows a day or two before the index. In that context, this morning’s move is concerning because it is based on an assessment of future business, not historical data.
Earnings from Broadcom (AVGO) sparked the selloff in chip stocks, or more accurately by comments that accompanied the release. The backward-looking part of the report was pretty good. Broadcom increased sales by around ten percent from a year ago and beat expectations for EPS of $5.16, reporting an adjusted $5.21. As is so often the case with earnings though, the devil was in the detail.
The company cut its full-year guidance by a sizeable $2 billion, with all the projected shortfall coming from its Semiconductor Solutions segment. They quoted problems arising from the trade war and the Huawei affair as potential catalysts for a downturn in demand, and the implications of that are not good for other sectors.
The Huawei part of it is not exclusive to Broadcom, but problems there will have an outsized effect as they accounted for around $900 million of 2018 revenue, but obviously, there is more to it than that. Even if that business were to be cut in half, that still leaves a $1.5 billion shortfall that would be down to more general market conditions.
Given that, it is not surprising that other stocks in the industry are also trading lower after yesterday afternoon’s news. All 22 of SOX’s components are indicating a lower opening this morning, which suggests that traders believe this is not an isolated issue.
When you extend the time period of the chart comparing SOX and SPY as above, you get a clue as to why that can be taken as a warning sign. Semiconductors have outperformed the S&P massively since 2016, and for a good reason. The growth of cloud computing and the ubiquity of mobile devices have resulted in exploding demand for processors and memory and, in the process, that demand has become a decent indicator of overall economic sentiment. Tech is where most companies that are anticipating good times invest first, and if they are not looking to do so in the second half of this year, it will affect everything.
Right now, the drop in SOX on one piece of news is not enough to prompt a response from investors. As I have said in the past, low interest rates are the main driver of stock gains at the moment, and with the Fed meeting next week offering a decent chance of a rate cut, it would be foolish to even trim positions before then. Once that is out of the way, however, keep an eye on chip stocks. Broadcom’s prediction of a weak second half could easily spark a sustained selloff, and if it does, history indicates that that should be taken as a warning sign.