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Semiconductors Confirming Economic Strength

Technology shares have remained a thorn in investors' sides since the unwinding of the 1995-2000 tech boom and the group, broadly speaking, has left many investors still far under water. Most would rather not hear and even think about purchasing any stock in these sectors. But as a trend and sector watchers, some very interesting devolvement are rumbling in tech land.

I began noticing this around the time of my early June publishing, just as many investors were likely getting their May statements telling them how ugly things had been for their accounts. As I reviewed where the strength was in the 2nd quarter, the Biotech and Real Estate sectors were the top two performers. But looking further to see what groups were improving the most and might emerge as leaders, I saw strong relative strength in many of the still-hated groups like Software, Telecom, Internet and yes, Semiconductors. This may be at odds with the theory that growth sectors do lousy in the summer, but the signs from our database are unmistakable.

Semiconductors

I usually look to this group for clues on where the market is headed in managing our client portfolios. What are the tea leaves telling us now about the chip stocks?

I wrote in my June 2nd essay "Commodity Investments - Stress at the Trend lines" to watch the SOX, the "manufacturing commodity." The chips were gaining sponsorship as evident in the improving relative strength readings, which told us the uptrend that started late 2003 was still intact. Recent action shows even more improvement.

The Semiconductor Bullish Percent had fallen to a low of 22% (22% of semiconductor stocks on Point and Figure buy signals) in April and then reversed up to X's in May as 6% of the stocks in the sector moved from a Point & Figure sell signal to a buy signal and gave us the first signs of life for the group. Over the past six weeks or so, the group has continued to improve on an absolute as well as a relative basis.

Before going further, let's review the concept of the Semiconductor Bullish Percent. Using the same concept as the broad NYSE Bullish Percent, this indicator plots the percent of stocks on buy signals in each sector and is plotted on a grid from 0% to 100%. As with the NYSE Bullish Percent, the best buy signals historically come when a sector goes below 30% and then reverses up, signaling first that supply has become exhausted, then that demand has taken control. Conversely, the best sell signals come when a sector goes above 70% and then reverses below that level. How has this played out for the chip stocks over the last few years?

In retrospect, October 2002 and March 2003 can be widely seen as significant market bottoms. These lows coincided with the final post-9/11 sell-off and the pre-Iraq War nervousness. In both cases the market rallied after those positive reversals. Both of these were fabulous buy signals from below the 30% level on the Semiconductor Bullish Percent. It would stand to reason that these should be important markers on the SOX chart as well as the Semiconductor Bullish Percentage and most individual chip stock charts.

The Philadelphia Semiconductor Index

The SOX index is aligned very closely with these lows, making a low on October 10, 2002 and then a late February of '03 reversal from a higher low just before the war nervousness lifted and the market headed higher.

The trend turned positive in October 2003 and rallied up to 560 by January of 2004. After the brutal summer sell off, it made higher bottoms at 360 and 380 then gave its second consective buy signal recently at 460. We believe the SOX index still has a way to go as the price objective points toward its all time highs, but there is one caveat: summertime blues are not usually kind to the chips, so don't be surprised by some backing and filling in this key growth sector in the short-term.

The Semiconductor Bullish Percent

Interestingly, the semiconductor Bullish Percent accurately called the important bottoms not just for the sector, but for the overall market, as well. While this chart tends to have wild swings and round trips, reversals from below the 30% tend to be low risk entry points, not to mention leading signals for the market itself. The recent bottom of 22% and subsequent breakouts bode well for a possible run toward the 80% range, where tops have been seen over the last few years. In short, this indicator suggests there's room for many more semiconductor stocks to join the party and rally before seeing this group make a top.

Now lets take a look at how a couple of chip stocks, Intel (INTC) and KLA-Tencor (KLAC), have performed since the time of the late-2002/early-2003 market lows.

Intel Corp. (symbol: INTC):

Intel represents 5.25% of the SOX index. The important markets turns are very similar on each chart. The October '02 low is quite obvious and in the post 9/11 environment seemed like a reckless buy signal to act on. Could the August '04 bottom look the same two years from now?

KLA-Tencor (symbol: KLAC):

KLA Tencor represents 9.81% of the SOX weighting. One of the reasons we pay more attention to the Semiconductor Bullish Percentage (unique to Point & Figure analysis) than the SOX index itself is because it is equal weight, one semiconductor point and figure buy signal, one notch in the positive column. This "one stock, one vote" methodology tends to filter out the distortion a heavy like KLA can create. Be that as it may, KLA chart is right where you would expect, showing market turns in lock step with its peers, the SOX and the bullish percentage.

Something really interesting appears to be developing that's worth keeping your eye on. Semiconductors have a track record in illuminating important market shifts and trends. As well, they tend to be a useful proxy for all the technology-related sectors. The relative strength of the semi's tells us these have come back in fashion. Take this as a sign that growth in the economy will continue into next year with sufficient vigor to support higher prices in these areas. We see investment opportunities in the still-unloved technology areas amid overly-skeptical markets observers. However, a late summer pause from the April lows is a very good possibility. Investors should look to use any such pullbacks as buying opportunities.

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