Lately, all eyes are on the semiconductor chip sector.

From geopolitical tensions between China and leading chip supplier Taiwan – to massive U.S investments bringing chip production on home soil – this sector is dominating the headlines.

There’s a global power struggle to control chip production. That’s because we’ve all come to depend on semiconductors to power not just the most cutting-edge technology, but also our washing machines and light bulbs.

But I’ve got my eye on the sector for a different reason.

With its ascent as an economic bellwether… chip stocks could tip the next big move in the stock market.

Chips and the State of the Stock Market

The chip sector has grown into a $600 billion behemoth that’s found its way into all aspects of our daily lives.

They’re the building blocks for the electronic things we interact with every day… from making our morning coffee to commuting in our vehicles.

Because of that, the global ebb and flow of the chip industry can deliver timely insights into the state of the economy. And those fortunes (or lack thereof) are reflected in the stock prices of semiconductor companies.

So just as chip companies can tell you about the state of the economy, chip stocks can tell you about the state of the stock market.

That’s why I compare the performance of chip stocks to the broader stock market to confirm a trend, spot a developing opportunity, or an early warning signal.

For example, chip stocks delivered a warning just before the peak in the stock market at the end of 2021, right before this bear market started.

You can see that on the chart below…

As the S&P 500 made a new high at the end of 2021 (dashed line), the VanEck Semiconductor ETF (SMH) failed to confirm that new high (boxed area).

Chip stocks were delivering a warning about the stock market…

Now, with the S&P 500 recently testing an important resistance level, chip stocks could be confirming the next move yet again.

Here’s what I’m watching now…

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Follow the Breakout

First, let’s take a look at this chart of the S&P 500…

After finding a low in mid-October, the S&P 500 rallied right up to its 200-day moving average (MA – green line) marked by the circle.

The index saw a similar test of the 200-day MA back in August (arrow) when the S&P 500 was rejected, and a big decline gave way.

Now look at the chart of SMH below with the 200-day MA as well – over the same time frame. There are a couple things I want you to notice…

First, look at the rally with the arrow. SMH never came close to its 200-day MA as the S&P 500 tested its own level. The relative weakness in chip stocks warned of the last big breakdown in the S&P 500.

But look at the recent price action. With the S&P 500 attempting to trade above the 200-day MA again, SMH is confirming the move this time – while also breaking out of a tight trading range as shown with the trendlines.

That means chip stocks are confirming the S&P’s move higher this time.

(Note that I’m writing this in the immediate aftermath of the latest consumer price index [CPI]. We still have a Fed meeting to contend with later today.)

But a sustained breakout can set up a tactical rally into the end of the year for the stock market.

Alternatively, if the S&P 500 and chip stocks can’t hold over the 200-day MA in the coming days, then that’s a warning sign to prepare for another decline.

This week is packed with catalysts, so be sure to confirm the stock market’s next move with the price action in chip stocks.

Best regards,

Clint Brewer
Analyst, Market Minute

Reader Mailbag

What other sectors do you watch closely to predict the stock market’s next moves?

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