geoffreyip523

Double whammy of demand contraction and political leverage

Short
NASDAQ:SOXX   iShares Semiconductor ETF
Summary
The semiconductor sector is expected to enter a difficult period with demand contraction due to recession and crypto winter. As the US government is increasing the effort to use semiconductors as a leverage to put pressure on China, companies in the sector might be forced to prioritize the national political agenda against profit and growth, which further amplifies the negative impact from slowing demand.

Demand contraction
The US economy officially entered a technical recession as the GDP figure announced this week unexpectedly shrank again by 0.9%, making a 2 quarters consecutive decline. Large employers such as Amazon are also announcing their layoff plan to better weather the worsening economic outlook. Companies downsizing will reduce the demand for office electronics such as laptops and work phones.

Although the commonly reported U3 unemployment rate remains stable at 3.6%, the U6 unemployment rate has actually increased for 2 consecutive months from 6.6% to 7%. With states continuing to pair back the covid unemployment benefit, more people are forced to re-enter the job market which in some cases the pay are not even as good as the unemployment benefit they have been receiving. The reducing disposable income of the US consumers is likely to negatively impact the demand for goods, especially for the non-essential durable consumer product such as electronics. High food and energy prices also contribute to such change in spending allocation.

Political leverage
Semiconductor chips are one of the most critical building blocks for most electronic products. The new product trend such as electric vehicles further push up the demand for chips. To put it into perspective, a Ford Focus uses roughly 300 semiconductor chips, whereas the electric Mach-e utilizes almost 3,000 semiconductor chips. The US government has been using national security reasons to block companies from selling gears for fabricating advanced chips (<10nm) to China since the Trump era. This week, the Biden administration has notified equipment suppliers such as NASDAQ:KLAC and NASDAQ:LRCX that the restriction is further tightened to <14nm, and it will also cover fabrication plants run by non-Chinese companies such as NYSE:TSM in China. Semiconductors will continue serve as a tool to slow Chinese growth at the cost of industry profitability.

Earlier this week the US Congress had passed the chips act and approved $52 billion in funding for domestic semiconductor manufacturing. While there is definitely a strategic necessity to rebuild the US fabrication ability given the political tension between China and Taiwan, the difficulty to establish a fabrication facility should not be underestimated, if you look at how hard even for Samsung to catch up TSM on defect rate especially for the <7nm advanced chips. For most semiconductor companies it is not just about the funding but also if there is a profitable way out for domestic production, or it is going to be a capital blackhole that keeps sucking investment without meaningful outcome.

Technical discussion
The US equity market is currently rebounding as rate expectation cooled off due to increasing risk of recession. S&P500 and Nasdaq100 have already broken through the 50 days moving average and are now challenging the Jun rebound peak. The 20 days moving average is also catching up and is about to sit on top of the 50 days moving average. In fact, the sustainability of this rebound will depend on how long can the 20 days stay above the 50 days moving average, as (1) upward pointing 20 days and 50 days moving average, with (2) 20 days higher than the 50 days moving average are the basic forms of a bull market.

S&P500

NASDAQ100

In this regard, by comparing SOXX and QQQ , one can visualize the sector discount due to the double whammy discussed above. Although SOXX has also broken through the 50 days moving average, the 20 days moving average is still further away from the 50 days moving average, which makes it a better short candidate compared to QQQ for those who believe the recent uptrend is a bear rebound but not the beginning of a bull.

Here are the levels SOXX trader should pay attention to:

Downside Resistance
  • 370 - 385: 20 days and 50 days moving average levels
  • 326.7: Jul-05 52 weeks low
  • 270-280: Post-covid bull breakout level in 2020-Jun

Upside Resistance
  • 433.99: Jun-02 rebound peak
  • 455-465: 250 days moving average level
  • 501.09: Mar-29 rebound peak

While our view toward the semiconductor sector remains bearish , shorting too early in a rebound can be very costly to traders. It is recommended to scale in the position either when SOXX itself, or at least until the border markets show sign of momentum decline (e.g. reverse hammer candlestick pattern)

Note: For traders who wish to trade leveraged ETF such as AMEX:SOXL (3x bullish ) or AMEX:SOXS (3x bearish ), it is still recommended to use the non leverage version SOXX for technical analysis purposes. As the daily 3x process sometimes will shift the resistance level and make the reading less accurate.


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