Chip stocks have held up well in recent months, despite the growing paranoia about overstuffed channels and cyclical peaks. Though this resiliency may continue into 2011, the divide between the sector's winners and losers should widen considerably and contribute to uneven performance that favors individual stocks over broad-based funds.
Just two companies,
, currently make up more than 43% of the capitalization-weighted
Semiconductor HOLDRs Trust
. These two market giants have acted exceptionally well since the August lows, skewing SMH's performance sharply to the upside. This can be seen when comparing SMH to the price-weighted PHLX Semiconductor Index (SOX).
iShares PHLX SOX Semiconductor Sector Index Fund
is the current incarnation of the former
iShares S&P Semiconductors Index Fund
. The instrument changed its name and tracking index on Oct. 15 and now provides a more direct play on the group through the most popular sector index.
While SMH has pushed above its April high, thanks to two strong companies, this SOXX is still trading a point or so under that resistance level. The chart shows a decent volume footprint, with good sponsorship off the summer lows. In addition, the handle-shaped pattern carved out this month suggests it wants to break out and head higher.
However, a breakout will run into a strong resistance band between $55 and $70 that was in place back in 2004, 2006 and 2007. I believe this barrier will permit a basket of sector components to rally strongly while the rest struggle with outdated or over-competitive products and commodity-type chips that carry little or no pricing power.
Overabundant memory chips and electronic components for flat-screen TVs offer are perfect examples of these low-margin businesses. The companies that manufacture these chips have floundered in 2010, thanks to weak computer sales and retail flat-screen competition that's triggered an epidemic of falling component prices.
Lets survey the top-performing chip stocks at different capitalization levels and pick out three of the best plays for now (and heading into the first quarter of 2011).
and Texas Instruments appear to be the best stocks to own at the top of the sector capitalization list. Broadcom, in particular, is firing on all cylinders these days, thanks to its close partnership with
. This market leader is trading at a three-year high and is poised for even more gains as we head into 2011.
The weekly chart shows a five-year high at $50 (blue line), posted in March 2006, followed by a long decline-and basing pattern. Price turned higher at the end of the bear market and has just lifted above the October 2007 swing high at $43 (green line). This breakout sets the stage for a final rally burst up to stronger resistance at the 2006 high.
That uptrend could unfold at any time, but a final pullback to support in the upper $30s (red line) would offer a more favorable reward-to-risk profile for position traders and timing-conscious investors. Just keep in mind that profits need to be taken on a rally into multiyear resistance near $50 because that level will impose a strong barrier that could take months to overcome.
Moving down the capitalization list,
is enjoying its strongest run in years and is currently trading at a two-year high. About two weeks ago, the stock hit resistance at the May 2008 swing high (blue line) at $36.35. It has been grinding sideways since that time. A downturn could yield a selloff into the 50-day moving average, which is currently $32.87.
A well-timed entry at that support level could benefit from a year-end breakout over the May 2008 resistance level and a climactic rally up to multiyear resistance in the lower $40s. As with Broadcom, that barrier could persist for a long time, so I recommend aggressive profit taking if and when that level comes into play.
Let's wrap things up with
, a top-performing chip manufacturer that builds components for set-top boxes, streaming movies and other Internet-driven multimedia. The company made its public debut in late 2007 near $7, hit a high near $8.46 (blue line) and entered into a steep decline that bottomed out in late 2008.
The stock returned to the post-IPO high in July and sold off to the 50-day moving average. It finally broke out on Sept. 13, rallying up to $10.35 before pulling back in a diagonal pattern (red lines) that has yielded aggressive profit taking. It's held up well (despite the selling pressure), and could embark on the next leg of its uptrend prior to year's end.
At the time of publication, Farley was held no positions in the stocks mentioned.
Alan Farley is a private trader and publisher of
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
, a premium product from TheStreet.com that outlines his charts and analysis. Farley has also been featured in
. He has written two books:
, due out in April. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
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