The S&P 500 is just 3.5% away from again hitting the record high reached in September 2018 after having bounced from the low reached on Christmas Eve.
But there’s one group of stocks to look at if you want to know where the market is headed next. That’s according to Paul Hickey, co-founder of Bespoke Investment Group, who says that semiconductors are the sector to watch.
“Just looking back at the last six years, semis have been probably the best—if not the best—leading indicator for the market,” Hickey told CNBC on Tuesday. “Semis are the transports of the 21st century. … It involves every aspect of the economy, especially the digital economy.”
Chip stocks ended just a hair under their year-old record on Thursday after comments from Micron (NASDAQ: MU) boosted investor confidence that the worst of the downturn in demand for semiconductors is over.
According to Hickey, semiconductors are typically the first step in the supply chain for the tech world and as such, now act as a leading indicator reminiscent of the Dow Transports. According to the 19th-century Dow Theory, a swing lower in the Dow Transportation index reflects slowing demand for freight and logistics services thus signaling an economic slowdown. In Hickey’s eyes, the slowdown in chipmaker demand has implications for the broader economy.
“If you look at all the large declines that we’ve seen during [the last six years], mainly from the peak in 2015, from the peak last September, and even that short correction in January of last year, they were all preceded by pullbacks in the semiconductor group on a relative basis,” Hickey said.
Last year, the SMH Semiconductor ETF underperformed the market from June and then bottomed in October. During that time, the ETF dropped 20% and preceded a similar drop in the S&P 500 from its peak in September through its bottom on Christmas Eve last year.
Hickey pointed out that semiconductors’ “relative strength started weakening months before the broader market did, and then subsequently the relative strength for the semis versus the S&P 500 bottomed well ahead of the market as well, so it’s been a great leading indicator of the forward returns for the broader market lately.”
And the group’s outperformance recently bodes well for the S&P 500 in the near term, he added.
“Right now, it’s in good shape. We’ve seen it hit new highs on a relative basis for the year,” he said. “As long as you continue to see that trend of outperformance continue, it bodes well for the broader market. And then when you start to see it falter, that’s the time to maybe become a little bit more cautious. But at this point, the peaks aren’t coincident with each other. Semis have been a clear leader.”
The SMH ETF is up nearly 26% year-to-date, double the S&P 500’s 13% increase so far this year. The Philadelphia semiconductor index ended Thursday’s session at 1,442, just 5 points shy of its record closing high from March 2018. The 30-member industry benchmark has rebounded 35% since its December low.
Semiconductor stocks have been climbing as industry executives predict that the slump in demand that spurred last year’s sell-off is changing course. Micron, the largest U.S. maker of memory chips, closed Thursday up 9.6% as the company promised a second-half memory market recovery in its earnings call late Wednesday. While AMD (NASDAQ: AMD) shares are up 22% for the week after Google (NASDAQ: GOOGL, GOOG) announced its new video game streaming service, Stadia, powered by AMD chips.