Are Semiconductors Warning of Future Tech Sector Weakness?

Back in 2014 I wrote a post (which Bloomberg picked as their Chart of the Day) outlining how semiconductors had replaced copper as the new barometer for the market. For quite a while copper was thought to have had a PhD in economics, as its price movement acted as a good indicator of economic activity. As the U.S. (and the global) economy shift to be more technology-focused, semiconductors took over at head of the class.

With the prominent use of semi’s in the tech space, they become an obvious tool to be used in evaluating the technology sector. Below is a chart showing the relative performance ratio between semiconductors ($SMH) and the S&P 500 ($SPY), with its respective Relative Strength Index (RSI) in the top panel.

Over the last several years when momentum, as measured by the RSI, diverges (making a lower high as the ratio between $SMH and $SPY makes a higher high), a trend reversal often follows as semiconductors begin to under-perform the overall U.S. equity market. This has also led to lackluster performance by the tech sector ($XLK) as well. In the bottom panel of the chart we have the ratio of $XLK and $SPY, and when $XLK is outpacing $SPY (by either going up more or going down less) the line rises.

The opposite is also true, when momentum for the $SMH and $SPY ratio creates a positive divergence, as it did in February of this year and August of last year, the tech sector’s trend in under-performance has reversed.

Since early November, semiconductors have seen a strong performance. and recently the ratio between semi’s and the S&P 500 made an attempt to break to a new high, surpassing its prior October peak. However, the breakout was accompanied by a bearish divergence in momentum and as of this writing, has failed to hold. This false breakout and bearish divergence creates a poor environment for $XLK, as its relative performance often mirrors that of semiconductors. I think it’s also important to note that while the $SMH-$SPY ratio got back to its prior October high, the $XLK-$SPY ratio did not, an additional sign of technology weakness.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.