Nvidia epitomizes the heart of the AI theme, and its strength over the last six to 12 months has been astounding to witness. But are we seeing signs of a potential top in semiconductors, and what could that mean for the equity markets? Before exploring the charts, there's an essential technical analysis tool I'd like to introduce.
The head and shoulders pattern is based on classic trend reversal dynamics, and represents a shift from a bullish phase to a bearish phase. Lately, there's been a buzz about whether the chart of the VanEck Vectors Semiconductor ETF (SMH) exemplifies a head and shoulders top. My quick take? Not yet. Price patterns like the head and shoulders top, triangle pattern, and others have three phases: setup, trigger, and confirmation.
The setup phase is where a pattern starts to take shape. Currently, the SMH chart shows a potential head and shoulders setup, with a clear head formed by a double top in June and July, a left shoulder in March, and a probable right shoulder in August. Every peak (head and shoulders) has been marked by a bearish engulfing pattern—a strong indicator of short-term sentiment change. But for a head and shoulders top to be confirmed, two phases need to follow: the trigger and the confirmation.
The trigger occurs when a pattern breaks a crucial level, called the neckline. For the SMH chart, using intraday lows as discussed in Edwards and Magee's classic book on technical analysis, the neckline runs around $200. A break below this would complete the pattern. The confirmation phase requires a follow-through to avoid the dreaded whipsaw—when the market fakes out traders by reversing direction shortly after a signal.
So, while we might be in the setup phase, a clean break below the $200 neckline would be the trigger. For those preferring a more conservative approach, using closing prices, the neckline moves up to $215, aligning with the 200-day moving average. Thus, holding above the 200-day moving average signifies the market's resilience.
What does this imply for semiconductors and the broader market? Let's compare the year-to-date returns of semiconductors against major equity ETFs. From end-2023 to now, SMH is up 38.1%, whereas the S&P 500 is up a modest 18.7%, and the Nasdaq 100 by 16%. Meanwhile, the equal-weighted S&P 500 is up just under 12%. Interestingly, since the market peaked in July, semiconductors have underperformed. While the S&P 500 nearly rebounded to its peak, the equal-weighted S&P surpassed it. Conversely, semiconductors trailed, underscoring a sectoral shift away from AI-driven stocks.
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So, what does all this mean? If the SMH forms a head and shoulders top, it suggests semiconductors are in a vulnerable position. This vulnerability could drag the Nasdaq 100 and S&P 500. However, the equal-weighted S&P remains robust, indicating that other market areas continue to break out and show strength. Diversification into other sectors such as industrials, materials, real estate, utilities, and consumer staples might be a prudent strategy, given the current market dynamics.
As we move into September, it's crucial to reassess portfolios and consider areas with emerging strength outside the semiconductor space. For Market Misbehavior, I'm Dave Keller, and we'll connect again soon.
RR#6,
Dave
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.