A $210 Billion Rally in Chip Stocks Leaving Hedge Funds in Dust

(Bloomberg) -- As fast as the rebound in the broad market has been since Christmas, it's been faster in chip stocks. That's made for hard feelings among traders who have watched in dismay as companies rallied while reporting their worst sales quarter in a decade.

The Philadelphia semiconductor index has surged 28 percent since U.S. stocks bottomed on Dec. 24, outpacing all other S&P 500 sectors. More than $210 billion has been added to the market value of its 30 members, making it the most lucrative rally during any two-month period since 2017.

As has been the case everywhere in equities this year, almost nobody saw it coming. Relative to benchmarks, hedge funds have never been less invested in the sector, according to data from RBC Capital Markets. Stunned by the turnaround, Wall Street stock pickers say the seven-week streak of gains is unlikely to last amid a slowing economy and trade strife with China.

“Semiconductor stocks have been rising on bad news,” Raymond James analyst Chris Caso said in an interview. “The stocks tend to discount bad news earlier. But what we've seen in prior cycles is they didn't recover as quickly as they did this cycle.”

More than a third of semiconductor-related companies in the S&P 500, including Intel Corp. and Texas Instruments Inc., missed revenue estimates in the quarter ended Dec. 31, according to data compiled by Bloomberg Intelligence. That was the worst performance for the group since at least 2009, when the data began. This month, several executives have said they expect the current quarter to mark the bottom of the semiconductor cycle. But analysts want to see signs of more robust buying.

“The biggest fear that I have is that we have rebounded too quickly and that it's not potentially justified by fundamentals,” said Anand Srinivasan, a Bloomberg Intelligence analyst. “First-quarter forecasts were still bad. I want to see evidence that it's not as bad as companies have predicted.”

Not everyone's bearish. Cowen analyst Matt Ramsay says right now is a buying opportunity for discriminating investors focused on chipmakers with higher exposure to industries using artificial intelligence such as data centers, automotive and video games.

“We believe current levels favor stock selectivity in light of the uncertain macro, but broadly present an attractive entry point for many stocks trading below recent historical valuations,” Ramsay wrote in a research note on Feb. 21 recommending companies such as ON Semiconductor, STMicroelectronics and Infineon Technologies.

Chipmakers were among the hottest trades until slowing demand from a broad range of customers derailed the rally in the second half of 2018. After gains of about 30 percent or more in four out of the previous five years, the Philadelphia gauge fell 8 percent in 2018, its biggest loss since 2011.

The nearly $500 billion semiconductor industry is notorious for its boom-and-bust cycles. It's one of the most heavily exposed industries to China, and there have been few developments in trade relations with the U.S. in recent months. China is the biggest consumer of semiconductors and home to a key portion of the electronics supply chain.

“A big impediment to this entire equation is China,” said Srinivasan. “Even if the trade war is resolved it doesn't solve the biggest underlying issue: is growth weaker than we fear?”

Concerns about excess inventory and slowing end demand are clouding the outlook for the industry. Then there are the technical charts that don't look good. After a 28 percent advance since late December, the index is bumping up against a technical resistance level that's been keeping stocks from breaking out at several attempts since March, when chips hit a record.

Absent any fundamental catalysts, the same scenario could play out this time again, Cornerstone Macro LLC's Carter Worth and Bay Crest Partners' Jonathan Krinsky said.

“The SOX is back to an inherently difficult level, where overhead supply comes into play,” Worth, head of technical analysis at Cornerstone Macro, said in a note to clients. “The index has failed at the downtrend line multiple times, hitting its head ‘to the penny.' Our thinking here is that the SOX will fail yet again at the line. Sell.”

--With assistance from Wendy Soong.

To contact the reporters on this story: Jeran Wittenstein in San Francisco at jwittenstei1@bloomberg.net;Elena Popina in New York at epopina@bloomberg.net

To contact the editors responsible for this story: Catherine Larkin at clarkin4@bloomberg.net, Chris Nagi, Richard Richtmyer

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