Henrik Sorensen A decade ago, the average investor was likely unsure where the semiconductor industry was heading, let alone understanding the role that “computer chips” play in our daily lives. Those who came to understand the transformative nature of this industry, and find ways to invest in its leading businesses, have seen one of the most significant periods of price appreciation for any slice of the stock market, ever. And, while we could chock it all up to great companies with great earnings, the truth is that a lot of the price appreciation was due to multiple expansion and investor speculation. That has been more present recently, as speculation about the ultimate impact of Artificial Intelligence has been front-loaded in terms of stock price leaps in some prominent stocks like Nvidia (NVDA) and Broadcom (AVGO). One of my own “conventional wisdom” I find myself using a lot recently is this: just because an investment within the stock market flies higher in price, even for an extended period of time, that doesn’t mean there wasn’t risk attached. In fact, in my own proprietary rating system for ETFs, developed over more than 30 years of scouting these innovative vehicles, the rating I assign to many ETF like iShares Semiconductor ETF (NASDAQ:SOXX) today is “red.” That’s in a color scale that runs green-blue-grey-yellow-red. Red is not the “lowest” per se. Because this is my estimation of reward potential versus potential risk of major loss. So, red really can either describe an ETF that, I believe, is in big trouble, with a low likelihood of climbing out of its ever-deepening hole, or a situation where the ETF offers high continued upside, but with high risk alongside. SOXX is the latter. Here is the technical chart of weekly prices for SOXX. Frankly, it looks just like the daily price chart. Like an athlete in their prime, this ETF and industry could be lifting off in a 2000-like parabolic move. But the steeper that upward move becomes, the more likely there is as equally steep move to the downside. As for the timing? Don’t ask me, I’m not a timer, I’m a risk manager! Barchart.com NVDA and AVGO now account for 19% of SOXX. Add in the next 6 stocks and 8 names in total get us to half of SOXX’s total portfolio. 27 stocks complete the ETF, which is not surprising, since this is not a sector, but an industry within the technology sector. Seeking Alpha What’s next for SOXX? Here we are now nearing the end of Q2 2024, in the midst of another market rally, led again by an industry continuously gaining momentum, those semiconductors. But perhaps the biggest risk to SOXX is that unless the rest of the market eventually tags along, there are lurking macro risks that could create a selling wave in the broader equity market. In other words, with so much money tied to S&P 500 Index funds, and SOXX’s largest holdings also occupying a lot of space at the upper end of S&P 500 weightings, a range of non-fundamental reversals of trend could ultimately be the downfall of this industry’s market success. I do not aim to be a gloom-doomer here, just a realist. Semiconductors are an essential component to electronic devices such as mobile phones, computers, medical devices and automobiles. But no matter how much they speed up our lives and make modern life unique, the stock market, even these stocks, ultimately answer to more than just earnings and revenue reports. The US Presidential election looms, the Federal Reserve is in a quandary regarding rate policy, and that’s just in the United States. Increasing political stress in Europe, as well as ongoing wars and the tenuous China-Taiwan takeover threat, are all “last straw” types of events that represent macro market risk. And, while semiconductors were an emerging industry 30 years ago, today they are so correlated with, and an influence on, the broad stock market, I can’t look at past results and put a high probability on them continuing long-term. That said, a 2000-style melt up could be underway. That leads to a situation where position sizing and in my own case, converting ETF and stock exposure in this industry to out of the money call options to define my downside and not limit my upside, is what I’ve done personally, for the most part. SOXX versus its chief rival ETFRC.com ETFRC.com Shown above, SOXX and the VanEck Semiconductor ETF (SMH) overlap significantly, with 22 common holdings and more than 70% of each ETF’s exposure also part of the other. SMH is more focused, with just 2 stocks accounting for more than 37% of assets. The continued bull case (besides the aforementioned “melt up” scenario) SOXX is led by some of the biggest players in the market today, and there is a case to be made for those giants to continue to be the favored sons of the investing public. We’ve seen it before, just maybe not to this extent. Below is an analysis of the largest contributors and detractors from SOXX’s performance over the past 12 months. The changing of the guard in this industry is clear by the presence of Intel (INTC) in the lower portion, down over this period. Once the clear leader in this group, it reminds us that any company can dominate for a decade or two, but there’s no guarantee of eternal superiority. Just ask holders of General Electric (GE) and IBM Corp. (IBM) from the 1970s. Ycharts.com Ycharts.com Above is a very detailed but potentially helpful outline of 25 of the 35 stocks in SOXX. The 50x trailing P/E ratio can be dismissed by fans of this industry as something these stocks can grow into. But 10x trailing sales is a whopper of a valuation. I don’t think valuation can be used as a rationale for being highly bullish here. The madness of crowds, swept up in euphoria that will last until it ends? That’s a more plausible case to me. Similar to the early 2000s and the race to find a better internet and technology, the market is seeing this among companies seeking to discover the next breakthrough in semiconductors, microchips or AI. SOXX holds many of these robust companies that are all competing either with or against each other within this industry. Business is ultimately a competition, and that is exactly what drives our economy to be continually improving. The sense of urgency to find the next competitive edge will drive this industry higher in years to come. Within the semiconductor industry, there are so many more knowns now than there was a decade ago. The growing realization of our societies everyday dependence on semiconductors may effectively act as a “hedge” for this industry’s stock prices, given how emotion and sentiment are such a bigger part of what influences modern markets. Conclusions There is no equivalent to my “red” grade on SOXX in the Seeking Alpha system. So I’ll rate it a hold and leave my analysis above, and explanation of my internal grading system for ETFs and my statements about my personal positioning in it, for investors to determine how this enticing, but potential dangerous ETF fits for them, if at all.
sekar nallalu AVGO,Cryptocurrency,NVDA,SOXX,Sungarden Investment Publishing SOXX: See ‘Red’ on Semiconductor Stocks, High Risk/High Reward