Short Circuit the Semis

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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.

INTC is down more than 10% from its highs set in late February and it has troubling chart formation. INTC is trading below its 50-day and 200-day moving averages and has put in a series of lower highs and lower lows. It may be breaking down again, which could signal that an even lower price is yet to come.

TXN is set to report its earnings after the close next Monday, April 18, and INTC will report before trading begins on Tuesday, April 19. Given the heavy weighting of these two stocks, Tuesday will be the day of reckoning for the semiconductor index.

SSG gapped up this morning and was trading at $53.55, It appears to have broken out of a pennant base today on very high volume. While there may be some near-term resistance at $56.62, SSG could trade up to $65 per share and its 200-day moving average. Place a stop at $47.50 for protection.

There are many concerns about the tech sector's earnings and, in particular, the earning and forecasts for the semiconductor stocks. Technical analysis is a study of the price of the security itself. While there are never any guarantees, the probabilities are favorable for a continued move up for SSG. Results for this recommendation should be very clear by the start of trading next Tuesday.

At the time of publication, Slusiewicz and Pacific Financial held a position in SSG.

At the time of publication, Slusiewicz and Pacific Financial held a position in SSG.

Jerry Slusiewicz has over two decades of professional investment experience. He has worked with individuals and institutions to manage monies for both short and long-term investment horizons. This extensive experience through various stock and bond market cycles enables him to offer a unique blend of professional investment counsel and personal service.

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