Industryweek 11742 Chip 1

Semiconductor Manufacturing Rally at 20%

Aug. 22, 2016
Gains in the Philadelphia Stock Exchange Semiconductor Index are up 20% this year after capping an eighth-straight weekly gain, the longest in two years.

A rally in chip stocks is one of the only things to get excited about in a market that is indifferent to just about everything.

Gains in the Philadelphia Stock Exchange Semiconductor Index are starting to take on historic dimensions. The gauge is up 20% this year after capping an eighth-straight weekly gain, the longest in two years; a ninth would be the longest since 1995.

A 4% jump in August has occurred even as the broader market was flat. The S&P 500 Index continued to drift on August 22, rising less than 0.1% to 2,183.93 at 12:40 p.m. in New York.

Amid the calmest August since 1994, Strategas Research Partners LLC sees reason for optimism, going so far as to frame the rally in semiconductors as part of a “Dow Theory” for the electronic age. According to the New York-based firm, an argument can be made that the pervasiveness of microchips makes them the same kind of bellwether for growth that railroad stocks were when Dow Theory was formulated a century ago.

One of the philosophy’s tenets was that gains in the Dow Jones Industrial Average were unlikely to last unless matched by strength in the Dow Jones Transportation Average.

“We know this may vex traditionalists and we are not advocating a complete replacement of the traditional heuristic,” Jason Trennert, the firm’s chief investment strategist, wrote in a note to clients August 22. “But we wonder whether a better measure of market health in an economy increasingly based on the storage and transport of information technology might not be better based on the Nasdaq and the Philly Semiconductor Index.”

Strength in chip stocks has boded well for future performance in the stock market. Based on a study by Sundial Capital Research on data going back to 1928 through June this year, there have been 11 times semiconductor shares broke higher when the S&P 500 was within 1 percent of its one-year high. All but one saw the market going up in the following three months, with the broad benchmark measure rising 2.5% on average.

Semiconductors aren’t the only tech companies whose potency is on display. Fueled by three-year rallies in which Microsoft Corp. and Alphabet Inc. doubled, Inc. tripled and Facebook Inc. surged fivefold, computer and software stocks have increased to almost 21% of the S&P 500 Index’s value, near a 15-year high.

The rally comes amid warnings from bears such as billionaire investor George Soros that stocks are at risk for a repeat of the 2008 crisis and turbulence have plunged. At an average of 12.05, the CBOE Volatility Index is trading lower than any August except for 1993 and 1994.

In a year where widening valuations and demand for safety trades such as utilities and low-volatility shares have stirred anxiety, the resurgence in tech shows one cornerstone of the seven-year bull market is behaving as it normally does. The industry just delivered the biggest earnings beat among 10 S&P 500 groups and while third-quarter growth estimates just turned negative for the broad measure, tech companies are expected to expand profit by 2.8%.

“If tech gets to the point where they’re not growing at all, then it would be really a red flag -- that would signal one of the strongest and fastest growing area of the economy is stalled out,” said Curtis Holden, a senior investment officer in Houston at Tanglewood Wealth Management, which oversees $870 million. “There is probably some realization in the market that ultimately for stock values to go up, there’s got to be some growth and tech has a little bit of edge.”

Tech shares in the S&P 500 edged lower on August 22, weighed by Apple Inc.’s 0.8% slide. The Dow Jones Industrial Average rose 3.28 points to 18,555.85, while the NASDAQ Composite Index added 0.% after swinging between gains and losses.

A rally that has brought equities to a series of all-time highs since early July lost some momentum last week as investors mulled extended valuations, skepticism over a recovery in corporate profits and mixed signals from policy makers over the timing for higher rates. The S&P 500’s price relative to future earnings has climbed to 18.6, the highest since 2002.

Speaking in Colorado on August 21, Federal Reserve Vice Chair Stanley Fischer signaled that a 2016 rate hike is still under consideration, and forecast economic growth to pick up in coming quarters as investment recovers. New York Fed President William Dudley warned last week that investors are underestimating the likelihood of an imminent rate increase.

Attention will now turn to Fed Chair Janet Yellen’s Aug. 26 address in Jackson Hole, Wyoming. Focus is shifting back to the Fed as the second-quarter earnings season ends. About 96 percent of S&P 500 companies have now reported, and while most beat profit and sales forecasts, analysts project earnings for the September-ending quarter will fall 0.9%. That would be a sixth consecutive drop, the longest since the financial crisis.

“Clearly there is a battle going on between what seems to be a perfectly reasonable macro environment on the one hand, against the lack of positive earnings growth,” said Daniel Murray, head of research at EFG Asset Management in London. “Although earnings growth is beating expectations, in absolute terms, earnings growth has been quiet muted.”

By Lu Wang

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