2023-10-05 18:15:06 ET
Summary
- S&P 500 historically bottoms in October and ends the year strong, setting the stage for a potential rebound in equity markets.
- Sentiment is extremely negative, with investors in "Extreme Fear" territory. Market breadth is the weakest it has been the whole year, and is almost at September 2022 and Covid lows.
- Semiconductors are the leading sector, and have been outperforming the broad market. They are likely to continue doing so, whether the broad market falls or rebounds from here.
- SMH ETF provides good diversified exposure to the semiconductor space. The leading semiconductor stocks I am focused on are NVDA, SMCI and VRT.
After two months of market weakness, there are two factors which are now favourable for bulls:
- The S&P 500 ( SPY ) has historically put in a near-term bottom in mid-late October, and ended the year on a strong note
- Sentiment is currently extremely negative, with the majority bearish on the markets. This is a huge flip in sentiment from two months ago
With this, I believe we could see an imminent rebound in the equity markets. My focus sector will be semiconductors, which have been outperforming the broad market, even through this two-month pullback.
Seasonality Favours Bulls
First, let us take a look at the seasonality chart for the S&P 500 index, derived from data from 1950-2022. As we may observe, the index tends to put in a near-term bottom around mid to late October. On average, October tends to be a green month.
This sets the stage for a powerful rally in November, December, and January, which are the 1st, 3rd, and 6th best months of the year for equities respectively.
Sentiment Extremely Bearish
Next, let us look at how pessimistic investors are on the market.
We are apparently in "Extreme Fear" territory. This is the most pessimistic reading so far for the whole year. Look how quickly the market flipped from "Extreme Greed" in late July to the current state.
Next, market breadth is horrible, with the percentage of stocks within the S&P 500 that are below their 50 day moving average standing at 11% currently. This is very close to the bear market low in September 2022 (3%) and Covid lows (1%). Such extreme readings have typically led to bounces in the S&P 500.
Percentage of stocks within S&P 500 below 50 day moving average (in purple) vs S&P 500 (in orange)
Semiconductors The Leading Sector
In every market pullback, it pays to determine the sector that is leading or outperforming the broad market. The leading sector is likely to hold up better than other sectors if the pullback worsens, and is likely to outperform the other sectors if the broad market rebounds.
Semiconductors ( SMH ) are the leading sector. Looking at the ratio of the semiconductor sector ETF against the S&P 500, we may observe that SMH/SPY broke out from a two year base in May. Since then, the ratio has been consolidating above the breakout zone, also during the last two months.
Weekly Chart: Ratio of SMH/SPY
The next step is to look for the leading stocks within this sector. I have identified a few, largely based on the strength of their uptrends and whether they have been able to stay above their key moving averages.
NVIDIA ( NVDA ) looks constructive, finding support around the key moving averages on the daily chart. It is on a strong uptrend, which has been powered by strong earnings results.
Daily Chart: NVDA
Super Micro Computer ( SMCI ) - reaction after post-earnings drop in August has been pretty good, building a base and not trending lower. Watching if it can break out of this base.
Daily Chart: SMCI
Vertiv Holdings ( VRT ) - Related to the semicon industry. Bounced off 10 and 20 day moving average convergence. Broke above downtrend resistance and holding up well.
Daily Chart: VRT
For those who want broad sector exposure instead of choosing individual stocks, they may consider the VanEck Semiconductor ETF. SMH looks like it is building a bearish distribution pattern, but the follow through lower has not been smooth. This could trap many shorts, who would be forced to cover if prices rise higher. I would not be surprised if we see a rebound higher at this $144 key pivot.
Daily Chart: SMH
SMH holds a diversified portfolio of semiconductor stocks, with NVDA not surprisingly the top holding in the portfolio. Other stocks include Taiwan Semiconductor Manufacturing ( TSM ), Broadcom ( AVGO ) and ASML Holding ( ASML ).
All in all, I believe we could see an imminent rebound in risk sentiment. I wrote recently here that pullbacks in energy plays - uranium ( URA ) and oil & gas ( XOP ) ( OIH ) ( XLE ) would be welcome for the markets, as that would likely mean a softer USD and lower yields going forward.
If risk sentiment does rebound, I believe semiconductors will continue to outperform the market as a sector. Within the sector, my top picks are NVDA, SMCI and VRT based on the technical charts. For those who prefer broad-based diversified exposure, then SMH ETF would be a good vehicle.
For further details see:
Rebound In Equities Imminent, Semiconductors The Leading Sector (Technical Analysis)