Breaking down the bull vs. bear case for chip stocks

U.S. stocks experienced high volatility yesterday, but selling pressure gave way to a strong rally, with the S&P 500 posting its largest one-day gain since late 2022, closing up 2.30%. According to the financial newsletter Sevens Report, the upsurge was driven by easing recession fears and stabilizing currency and derivatives markets.

For the third consecutive session, stocks opened higher, largely due to a sense of relative calm in both the yen and the VIX, two key factors that had previously contributed to last week's spike in volatility. While economic data was sparse overseas, the U.S. saw an important release with weekly jobless claims, which have recently been rising and fueling recession concerns.

However, yesterday's jobless claims figure declined from the previous week and came in well below expectations, which “prompted a “good news is good news” reaction as evidence of a tight labor market contradicts the idea that the economy is already in a recession,” Sevens Report noted.

Semiconductor stocks, one of the key drivers of the current bull market, also came under pressure amidst the recent pullback.

The Philadelphia Semiconductor Index (SOX) retreated 27% from its July highs through Monday’s lows before attempting to stabilize earlier this week.

According to Sevens, the Philadelphia Semiconductor Index index is closely scrutinized because semiconductors often lead the market. Given the current high level of market uncertainty, with an inverted yield curve, recession warnings, and the broader stock market near record highs, investors and analysts are debating what’s next for semis.

As highlighted by Sevens Report in its note, SOX is still in a near-term pullback within a long-term uptrend.

This week, it has been testing three crucial technical levels around 4,275, including the year-to-date intraday lows, the 200-day moving average, and the uptrend line dating back to the October 2022 lows, which notably intersects with the October 2023 pullback lows.

“Diving deeper into the technicals, the uptrend line in relative strength to the S&P 500 dating back to October 2022 was violated last Friday,” Sevens Report notes.

"This suggests semis may be forfeiting the leadership role here, but that doesn’t necessarily mean long-term bull market is over,” it added.

The daily Relative Strength Index (RSI) is negative but not yet oversold, indicating there could still be room for further declines, while the weekly RSI turning negative suggests sellers are gaining control of the market.

“Considering all of these technical developments the outlook for the SOX depends on time horizon and what the semis do in the weeks ahead,” the report adds.

For SOX bulls, the key signal to gain confidence in adding or initiating speculative long positions will be a break above the steep downtrend line from the current record highs, Sevens points out. However, those buying the dip should “be ready to “jump ship” if the SOX fails to make new all-time highs in the weeks ahead.”

As for the bear camp, the 4,275 level has become critical medium- to long-term support. A break below this level would indicate multi-month lows, a more significant decline below the 200-day moving average, and a breach of the uptrend established in late 2023. Such a break could trigger a downside target of 2,645, effectively erasing the gains made in 2023 and 2024.