The SOX Don’t Lie

Semiconductor stocks usually don’t lie. 

Many stocks and sectors give off false technical signals (fake breakdowns and breakouts) because there’s not enough information flow about the business between earnings conference calls to make informed trading decisions.  However, the semiconductor industry is so broad and deep, and many companies in the sector actually still carry inventories, that it’s relatively easy for the "smart money" to get a good flow of information about the state of the industry. 

That makes technical analysis on semiconductor stocks more helpful than on most sectors.  And that’s why I’ve been concerned that the SOX has been leading the market to the downside in the past two months.  The SOX often leads the other major indexes because semiconductors are now very intertwined with the entire world economy so they provide a good perspective on general business conditions.   

Semiconductor stocks have been acting terribly for the majority of the year.  But there’s a ray of hope.  Technically, the semiconductor stocks are very oversold and close to important support.  That could indicate that if the semiconductor stocks can hold here they could lead the market higher once again. 

Ironically, the good news is that the "bad news" is finally out in the open.  Intel (INTC) and AMD (AMD) have been battling it out in a race to the bottom.  Intel has been seeing the slowdown since the beginning of the year.  AMD started seeing it last quarter. 

Yesterday, we got hints that the rest of the industry is feeling the slowdown as well.  Taiwan Semiconductor (TSM) said the following on their conference call yesterday (conf call info courtesy SeekingAlpha.com):

"…the inventory level either through the total value or DOI, it’s not coming down from the industry, overall the two large CPU manufactures represent very large chunk of the inventory buildup. If you take the large CPU manufactures you will find the inventory level in terms of the value already has come up by a couple of points….However we believe this correction will probably go smoothly full year of year 2006.

And as a result, the way we look at semiconductor industry growth rate for the whole year 2006 has some change. Three months ago we forecast 8% to 12% growth rate for the semiconductor industry as a whole for 2006, now we are revising that growth rate to the low end of the range that is 3%, maybe to 9%. Now to year 2007, right now we do not have a specific number for the whole industry, however we feel hold a positive view of year 2007. I like to remind you that 8% to 9% growth rate now for the industry in our view represents a very good healthy growth rate, which is also a growth rate that we expect industry to perform over a long period of time going forward."

In addition, Kullicke and Soffa (KLIC) which is about as close to the front lines of semiconductor manufacturing as you can get, had the following to say about the next quarter…

"While our Equipment and Packaging Materials businesses were very solid during the third fiscal quarter, our view is that equipment and materials unit volumes for the September quarter will be lower. While new advanced packaging activities are exciting and represent long-term sales opportunities for all our products, that potential is offset by industry forecasts of short-term moderate IC growth."

Kullicke and Soffa is a very well run company with a very honest and straightforward management team.  Therefore, I always listen to what they have to say about the industry.  And from what Taiwan and Kullicke said, the semiconductor industry will have a difficult time for the rest of the year as the inventory correction gets underway in earnest. 

But pay attention to the stocks to know what’s really going on.  If the smart money starts getting hints that this inventory correction will indeed be over by the end of the year, and that INTC’s chipset introduction will start a new up cycle, the SOX will hold at support and could begin leading the market higher.  If the opposite occurs and the SOX remains oversold, then look for new lows for the other major indexes.   

Remember, the semiconductor stocks usually don’t lie.