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Short Circuit the Semis

Editor's note: This piece originally ran earlier today on our newest Premium service, ETF Profits . Click here for a 14-day trial to this exciting product!

Earnings season is just beginning and it has taken a tumble already with Alcoa's (AA) revenue stream coming up a bit light. The higher cost of materials was cited as the reason for the shortfall. With commodity prices skyrocketing lately, AA won't be the only company that will have to contend with higher input costs.

Last week, the European Central Bank (ECB) hiked interest rates for the euro zone, joining the central banks from Australia, Brazil, China and India, which aggressively raised rates over the last year. The ECB's main concern has been that inflation may be starting to spiral out of control, which would raise concerns that the anemic global recovery could be derailed by higher costs.

We experienced similar conditions in the 1970s, when slow growth was accompanied by ever-rising costs. This period was known as the era of stagflation and it was defined by high unemployment, rising costs and a decreasing standard of living for many people.

In addition to the increasing costs for raw materials, the situation caused by the Japanese earthquake and subsequent tsunami has resulted in a supply disruption for many manufacturing companies. This problem has been well documented for the Japanese auto companies, Honda Motor (HMC) and Toyota Motor (TM).

Less understood, however, is the adverse effect for the semiconductor industry. Japan produces approximately 40% of the world's memory chips and accounts for at least 20% of the total global production of semiconductors. Texas Instruments (TXN) had a factory in Miho, Japan, that will most likely remain closed until June. This plant had generated 10% of the company's revenue in 2010.

Tech sector earnings will be watched over the next couple of weeks in light of the recent problems and tougher year-over-year comparisons to beat. The first quarter earnings bar is set pretty high for all companies.

The ProShares UltraShort Semiconductor Fund (SSG) corresponds to twice the daily inverse of the Dow Jones U.S. SemiconductorSM Index. While there are a total of 52 companies that make up the semiconductor index, Intel I (INTC), with a 30.7% weighting in the fund, and TXN, a 10.2% holding, are the dominant weightings for the fund's performance.

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