Head - Equity Strategy
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Semiconductor equities have reversed a previously negative signal for equities more broadly.
Is the ten-year old bull market in US equities about to suffer a short circuit? Many investors are clearly worried that it might be. Market sentiment surveys are subdued, funds have been flowing out of equities globally, and cash balances are high. The recent inversion of US yield curve has added to concerns. Past inversions have often foretold major peaks in US equities. Given its record, we are not dismissing the yield curve’s signal out of hand. However, we do believe investors’ fears are premature. And, the message coming from equities in semiconductor firms support this view.
The Philadelphia Semiconductors Sector Index – or ‘Philly SOX’ – has just hit a new all-time high. This is not what we would expect to see if US equities were just about to enter a major downtrend. Prior to the last two major market peaks in 2000 and 2007 – figure 1 – the Philly SOX began to decline some four to six months ahead of the S&P 500. At one stage in 2018, it did appear that semiconductor equities might be warning of a coming peak. The Philly SOX sold off from March, six months before the S&P 500 began its 19.8% sell-off. However, the recent recovery to new highs in the former index have cancelled its previous bearish signal.
We see various reasons why the Philly SOX’s latest positive message may be correct. In response to last year’s market shakeout, the Federal Reserve has halted its monetary tightening efforts. The US and China have made progress towards a trade truce. Both of these factors could help sustain the economic expansion and equity bull market. We also point out that the subdued investor sentiment, outflows from equities, and high cash balances mentioned earlier are the opposite of what we would typically expect around a major market high.
So, what next? If policymakers and politicians remain protective of the economic expansion, and if corporate earnings can meet or beat low consensus expectations this year, we see scope for further upside for both semiconductor stocks and equities as a whole. We do acknowledge the amber warning lights coming from the US yield curve and tightening bank-lending standards. We are therefore watching the situation closely. For now, though, we believe that fears that US equities will imminently suffer a short circuit do not compute. We remain overweight equities globally.
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