Semiconductors are hot right now. Whether you're talking about NVIDIA Corporation (NVDA), Advanced Micro Devices Inc. (AMD), or another company, those pesky little chips are all over the place.
They've got a history. Everybody who thinks they first appeared in 1990 is wrong.
You gotta go back to the 1800s.
Start figuring out why they're called semiconductors and you'll see it has to do with the metal that they use and the way they conduct electrons. The history behind them started back more than a hundred years ago.
But I'm not interested in the beginning portion of the history of semiconductors. I want to find patterns throughout the entire timeline.
We often talk about the market repeating itself - or at least rhyming.
I've noticed a lot of rhyming right now in the semis that you want to take advantage of...
The Fundamentals
Taking a walk down main street, as we like to do from time to time, the worldwide demand for semiconductors is starting to dip.
And given that semiconductors are in just about everything but your coffee mug (unless you have one of those fancy ember mugs that heats your coffee), a slowdown in this sector warns of bumpy roads ahead for the rest of the market.
I've mentioned this before - the idea of the "new-age dow theory" - and it's worth covering again.
At its most basic level, the original Dow theory says that transportation is what leads the market.
If planes, trains, and 18-wheelers started to fail, everything else would follow.
After all, the products had to make it to the shelf somehow, and if you think your hometown is well equipped enough to grow bananas and mine for the metals to make your car, we need to have a talk...
Now, this age-old theory still holds water. The more goods purchased, the better the people moving them will do.
Well, over the last two decades, we have created a technological boom that is reliant on semiconductors.
So now, with a world full of them, if the semiconductor sector starts to drop, the transportation sector never even has a chance to hit the tape - as there is just less being purchased, which leads to less being shipped.
It's a cyclical economy where everything will flow down from the origin point. It's always been this way, just now, the origin is more precise.
What we are seeing right now is a 20% decline in semiconductor revenue and a 4% decrease in demand for semiconductors...
And when we pull in the notion of the new-age dow theory, you are going to see it start to take a toll on the rest of the economy.
This is the fourth time we've seen both actual semiconductor demand and forecasts for demand go negative on a year-over-year basis since 2000, but things are different now...
The last drop in demand was just before the pandemic hit. The market was already stretched and falling into a potential recession...
Now, short-term demand may be waning, and that's a likely sign of a coming recession.
But let's make sure we're keeping the long-term perspective in consideration...
After all, there is going to be more than just a silver lining in terms of a buying opportunity in this sector at the end of all this.
You can see that when the economy starts to face some trouble, the semis get hit hard. That's because demand for many of the luxury items riddled with semiconductors falls off and people start to save money for the necessities.
It happened in the Dot-com bubble, the 2008 recession, and it's happening again today...
What's important is the long-term trend in growth for the sector - after all, the trend is your friend, and this trend is showing STRONG growth over the last two decades, with a 313% increase in sales.
And according to a 2020 study by SIA and the Boston Consulting Group, global demand for semiconductor manufacturing capacity is projected to increase by 56% by 2030
From a fundamental perspective, you can't go wrong in the semiconductor sector over the long term, you just have to get past the recessionary dip before you start trading it in that way.
Technical Tales of the Tape
There are a few places where you're likely going to see some strong performance in the VanEck Semiconductor ETF (SMH). Now, the top of the list, as everybody knows, is NVDA.
They have been hitting home runs left and right, strictly because of the A.I. power struggle.
But take a look at some of the names that make up SMH:
Even the laggard of the group, KLA Corp (KLAC), is up over 1% this year.
At the end of the day, this has been the sector that's outperformed the market and followed its trend.
But let's dig into the chart on SMH for a true technical read:
We shorted this sector a lot last year, but looking at the trend in the 50-day moving average (MA50) as it starts to roll over and the growth has slowed, it might be time to start hitting a few of those shorts again.
And for what it's worth, the semis were the bottom-feeder group throughout all of last year.
BUT, what's going to drive this ETF lower now that the MA50 has rolled over is the enormous amounts of selling pressure as the recession continues to pull closer.
The Sentiment
There is one aspect of trading that drives everything in the market no matter what sector you're looking at, and that's the analysts...
They come out and upgrade the stock, and boom, the juice from Wall Street drives a stock higher.
So, it's important to take a look at where the analysts' recommendations are within the components of the SMH ETF:
Looking at the data this way, it is the perfect setup to identify a crowded trade.
And in this case, the crowd has really piled into Marvell Technology (MRVL). You can see that there are currently 22 analysts with this company on their radar.
What makes this one really interesting is that 91% of those analysts are recommending to buy the stock.
I'm sure you've heard me say it before, but this is a very bearish signal for the company.
They are tipping the boat too far to one side, and at the first sign of trouble, they are going to start running the other direction.
This means you'll have nearly all of that 91% and their hundreds of thousands of followers trying to get out of the trade, causing the stock to tank. It's not a matter of if it happens, rather when it happens...
Then you have the second-most-covered stock on the list, Intel Corp. (INTC) which is also highlighted...
This is for a better reason - it only has 14% of the analysts recommended buying during a time when Intel is actually innovating.
This is a company that has unrecognized bullish potential that I want to get a piece of.
So, how do you use all of this information to make a trade?
Well, there are a few ways to trade it. NVDA is likely going to keep its relative strength crown, and you could just go long, but it's already made its way higher.
Looking at all of the data, if I wanted to go long on a company in the semiconductor space, I would pin my eyes to INTC.
With the stock trading above target prices and at the bottom of the pile for analyst holdings, Intel is the long-term trade to the upside as the semis hit a stride later this year.
It's the "pre-sold special," I guess you could say.
If you want to know how I'm trading it, this is what you would do:
Buy to open the INTC January 17 2025 $40 call
Yes, you read that right - 2025. Remember, we are looking for the long-term trend, and we need to get past the recession risk before it can really take off.
And if you want to stay a bear and short the market into the ground, keep an eye on MRVL.
Given the current buy recommendations and price targets the market is putting out, it's got a lot to prove to Wall Street before it can rip higher.
Here's the trade that caught my eye:
Buy to open the MRVL June 16 2023 $40 put
We are going to keep an eye on this sector, as it's not only extremely tradable, but it is going to give a solid indication of where the market is going to move next.
The post How to Trade the new Dow Theory appeared first on Penny Hawk.
About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.