Chips Buck the Trend

Keep an eye on tech.

Many observers attributed Tuesday's marketwide selloff to bad news from Home Depot (HD Quote), Sears Holdings (SHLD Quote), D.R. Horton (DHI Quote) and Alcoa (AA Quote). Others cited Ben Bernanke's comments about inflation. Technicians are talking about possible "double tops" in the Dow Jones Industrial Average and S&P 500, which failed to eclipse prior highs after touching them intraday Monday.

But a less obvious, and perhaps more important, indicator is the recent strength in technology stocks -- particularly the semiconductors.

A largely uncommented-upon pattern has been relative strength in the chips this year just prior to near-term setbacks for the broader markets. Tech stocks, especially semis, outperformed on Feb. 22 and March 10 and again in early June -- i.e., just before significant downdrafts for the major averages.

The Philadelphia Stock Exchange Semiconductor Index hit a 52-week high last week, and it seems like everyone on Wall Street loves the semis again. On Monday, UBS had positive comments on Intel(INTC Quote), even after its huge second-quarter advance, while Jefferies upgraded Micron Technology (MU Quote) today. Even AMD (AMD Quote) has been percolating lately, a sign traders are focused more on the sector's momentum vs. the fundamentals of individual companies.

A recent chip rally could therefore point to more short-term pain in the market -- though several observers say the longer-term trends remain bullish.

"Every time over the past year that the S&P has reached an extreme level of underperformance relative to the SOX, the S&P has moved higher to correct that differential," says RealMoney.com contributor Dan Fitzpatrick, who provided the accompanying chart.

Indeed, it appears the SOX is moving roughly in tandem with the S&P 500 year-to-date -- which could be part and parcel of a larger and long-term rotation in the market away from financials and other leaders of the most recent bull move.

"It's pretty clear speculative juices are building coming into earnings season [and] by definition, those things are unsustainable," says John Bollinger, president of Bollinger Capital, who notes recent strength in chips has been accompanied by strength in other speculative areas like biotech and alternative energy.

While Bollinger foresees more weakness as we get deeper into earnings season -- a classic "sell the news"-type setback -- he is not discouraged by the recent speculation in chip stocks and other momentum favorites such as Dendreon (DNDN Quote), Taser (TASR Quote) and First Solar (FSLR Quote).

"In the past several weeks, growth has been prevailing across the board and value has taken a backseat," he says. "Large-cap value dominated for so long you could have quite a nice run for large-cap growth."

Want more? Check out TheStreet.com TV video. Aaron Task discusses how a peak in semis affects the broader market, with Farnoosh Torabi from the floor of the New York Stock Exchange.

Stephen Porpora, head floor trader at William O'Neill & Co., made a related observation in an interview for TheStreet.com TV Friday, noting that while big-caps like Apple (AAPL Quote) "grab all the attention, quietly if you start looking at the small-cap list, a lot more tech stocks are starting to act well."