Semis Bend, but the Uptrend Is Not Broken

Semiconductors stole the spotlight this week as NVIDIA (NVDA) reported its highly anticipated third-quarter earnings after yesterday’s close. The company topped earnings and revenue estimates, with adjusted gross margins coming in at 75%, as expected. Revenue guidance for the current quarter came in at $37.5 billion, compared to expectations of $37.1 billion. And while guiding $400 million above estimates may sound exciting, it wasn’t enough to excite NVDA investors who have become acclimated to billion-dollar or more guidance beats (shares are down over 1% in today’s session). Despite the high expectations vs. reality gap, there was little uncertainty about the future of artificial intelligence (AI) from CEO Jensen Huang, who stated, “It is the case that demand exceeds our supply, and that's expected as we're in the beginnings of this generative AI revolution as we all know.”  

Outside of NVDA, the broader semiconductor space failed to clear a relatively high bar this earnings season. While most companies delivered solid earnings per share (EPS) and revenue growth in the third quarter, there has been little reward from investors. For example, the Philadelphia Semiconductor Index (SOX) components beat EPS estimates by an average of 3.3%, but the average post-earnings day price reaction was -1.7%. This compares to the S&P 500’s average EPS upside surprise of 6.9% and post-earnings day price reaction of 0.1%, according to Bloomberg.  

Elevated valuations likely contributed to investors remaining on the sidelines this quarter. Even after a 17% drawdown from the July highs, the SOX Index is trading at 23.7 times 12-month forward earnings estimates, well above its 10-year average multiple of 17.6. On a relative basis, the index trades at nearly one standard deviation above its long-term average valuation spread to the S&P 500.  

Semiconductor Valuations Cheapen Up but Still Expensive

Source:  LPL Research, Bloomberg 11/21/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. 

Turning to the technicals, the SOX Index is retesting an uptrend off the bear market lows after recently violating its 200-day moving average (dma). Momentum indicators have turned bearish, while breadth continues to deteriorate (only 23% of SOX components remain above their 200-dma). A break below the uptrend would leave the September and August lows (4,508 and 4,290, respectively) as the next major levels of downside support.  

Relative strength also continues to deteriorate. As highlighted in the lower panel, the SOX vs. S&P 500 ratio chart has recently broken to the downside of a multi-month consolidation range, pointing to a likely continuation of semiconductor underperformance. Given the consistent leadership expressed by semiconductors over the last two years, we view the breakdown as a character change in this bull market. And while semis are widely considered a leading indicator and represent a heavy weight within the broader market, weakness in the space is being offset by rotations into other cyclical sectors like financials and industrials — a good sign for the sustainability of this bull market.   

Semis Slide Into Support

Source:  LPL Research, Bloomberg 11/21/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. 

Despite some of the uncertainties in the space, especially those related to tariffs, semiconductor sales remain strong. According to the Semiconductor Industry Association (SIA), global chip sales jumped to $166 billion in the third quarter, marking a 23.2% year-over-year increase and a 10.7% jump above second-quarter sales. The chart below highlights the building sales cycle in chips, which turned positive late last year, an event we highlighted in our Semiconductors Lead Stocks Higher blog back in January.  

The Chip Cycle Remains Strong

Source: LPL Research, Semiconductor Industry Association 11/21/24 
Disclosures: Past performance is no guarantee of future results

Summary  

Semiconductors have struggled to keep up with the broader market over the last several months. Elevated valuations, profit-taking pressures from an impressive first half, tariff concerns, and a weaker outlook for non-AI chip demand have all weighed on the space. Longer term, global chip sales remain strong, and most companies are pointing to robust AI-fueled demand over the coming year. Technically, the SOX Index has pulled back to an uptrend stemming from the 2022 lows, creating a major test for bulls. The breakdown in relative strength has been more pronounced, and ratio chart trends point to continued semiconductor underperformance ahead. While we believe the long-term bull case for semis is not broken, the software space appears to be a better place to invest within the tech sector right now. 

LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its tactical neutral stance on the technology sector and broader equity market, with a preference for the U.S., a slight tilt toward growth, and benchmark-like exposure across the market capitalization spectrum. However, we do not rule out the possibility of short-term weakness, especially as geopolitical threats in the Middle East escalate. Equities may also readjust to what we expect will be a slower and shallower Fed rate-cutting cycle than markets are currently pricing in, although both post-election and fourth-quarter seasonality are favorable for stocks.