Semiconductor Bear Market Could Trap Complacent Shareholders

Chip stocks could punish complacent shareholders in the coming months, entering a bear market cycle that lasts several years and gives up the majority of gains posted since 2015. That decline could proceed despite continuing uptrends in other high-tech groups, confusing market players who don't understand the semiconductor group's perennial boom-bust cycles or its capacity to trade against broad benchmarks for months or years at a time.

Semiconductor analysts at Morgan Stanley, Deutsche Bank, SunTrust Bank and other investment houses have been sounding the alarm for weeks now. Morgan Stanley's Craig Hettenbach recently summed up the growing consensus, noting that "there has been greater excess built up in the supply chain in the current cycle relative to 2015" and that "any trading bounces will probably offer better opportunities to further reduce exposure."

Recent price action in the biggest names should send chills down the backs of the most optimistic chip bulls. Intel Corporation (INTC) shares spent years struggling in the $20s and $30s, finally breaking out in the fourth quarter of 2017 and entering an uptrend that posted a 17-year high in the upper $50s in June. It has been all downhill since that time, with the industry leader retreating nearly 25% while breaking support at the 200-day exponential moving average (EMA). Intel stock is now posting negative 2018 returns.

Micron Technology, Inc. (MU), the seventh highest capitalized chip stock, has suffered through its fair share of booms and busts in the past 30 years. It broke out above the 2014 high at $36.59 in September 2017 and surged into the mid-$60s, topping out in March 2018 and carving a double top pattern that broke to the downside in September. That decline also broke the 200-day EMA while triggering the first stage of a test at 2017 breakout support.

What about over-loved market leader NVIDIA Corporation (NVDA)? The graphic giant's long-term uptrend entered a rising channel in June 2017 and broke the channel to the downside in April 2018, entering a shallower channel. The latest downswing has broken that channel and dumped the stock into the 200-day EMA for the first time since February 2016. More importantly, NVIDIA stock is now trading below the January peak after giving up the past nine months of upside.

The PHLX Semiconductor Index (SOX) has flashed multiple warning signs about the bull market's demise since the first quarter of 2018. It finally completed a 100% retracement into the March 2000 internet bubble high at 1,362 in January and reversed after piercing that level by 31 points. A March breakout attempt failed at 1,464, dropping the index below the 2000 peak a few weeks later. A June attempt also failed, carving a potential triple top, while price action since that time has broken the 200-day EMA and settled at the December 2017 low near 1,200 for the third time.

The index has now completed a complex head and shoulders top that predicts a decline to 950 or so after a breakdown. More ominously, 100% retracements into major highs posted years or decades ago often mark the end of secular uptrends. Given the broad retreat in recent months, there's little reason to believe that funds and retail investors will have a sudden change in heart and pump sidelined capital back into this market group any time soon.

The semiconductor sector may have ended a multi-year boom cycle and could be heading into a bust cycle, which would be characterized by much lower prices.

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>