Skip to main content

This column was originally published on RealMoney on Sept. 5 at 11:57 a.m. EDT. It's being republished as a bonus for readers. To learn more about a RealMoney subscription, please click here.

Let's look at chip stocks to see if the August rally has improved the sector's outlook for the rest of 2006.

Are these perennial laggards finally engaged in an epic comeback, or will this oversold bounce fizzle out like all the other ones since the start of May? The answer could decide the fate of the broad market in the fourth quarter.

First, here's an anecdote that exposes my bias in this debate. A self-described "value investor" wrote in last week to crow about his recent tech profits. Rather than pat him on the back, I said his narrative showed good trading instincts but said nothing about his investing skills. After all, it could take months before his summer knife-catching proves to be wise or foolish.

All tech bulls face the same predicament as we start the historically unfavorable month of September. The late-summer bounce has lifted spirits considerably and shrunk the red ink in tech-heavy portfolios worldwide. But the good vibes don't necessarily translate into good investments for the fourth quarter or 2007.

For this examination, we need to look separately at the

Semiconductor HOLDRs

(SMH) - Get VanEck Semiconductor ETF Report

exchange-traded fund and the Philadelphia Stock Exchange Semiconductor Index, or SOX. These instruments can show markedly different charts -- chip giant


(INTC) - Get Intel Corporation Report

is given a much greater weighting in the ETF than in the index.

A Bearish View

The weekly chart of the Semiconductor HOLDRs looks downright bearish, despite the run off the July low. Price broke a 20-month rising channel in May and dropped to support in the upper $20s before starting its recent bounce. The August rally has retraced just half of the January-July decline and is now approaching strong resistance at the broken channel.

Unfortunately, this pattern looks like a high odds short-sale setup, rather than a fresh buying opportunity. The daily chart supports this bearish outlook because price just hit the 200-day moving average from below, yet another signal that upside progress is grinding to a halt. In any case, extreme caution is advised on new long positions.

A Look at the SOX

The SOX also shows a broken trend line and rally to resistance. The pattern warns that progress above 460 will be limited because short sellers will be taking aggressive positions as we head into the fourth quarter. Alternatively, a sharp burst above this contested level will improve the sector's year-end outlook greatly.

Elliott Wave Theory also predicts trouble for chip stocks as we head toward autumn. Look at both weekly charts and mark the sequence of two primary selloffs, interrupted by two countertrend rallies. These downward waves predict the current rallies will fail and yield a final selloff that ultimately breaks the lows of the last decline.

Scroll to Continue

TheStreet Recommends

In Elliott terms, this would mark the third primary wave of the chip decline beginning last January. It might also represent the broad capitulation event that everyone thought was happening in June and July. In other words, this market may have not seen the lows of the correction yet, despite the August bounce.

Unfortunately, there's no way to sugarcoat this analysis for summer tech bulls. The pattern structure indicates the entire August move was a countertrend bounce within a larger downtrend. It also points toward a true recovery in the semiconductor sector when we get much closer to year end.

Close-Up on Chip Stocks

Intel is the wild card in this discussion, as usual.

You might think I'm a diehard chip bear, but consider I live within two miles of a major company hub in Chandler, Ariz. Many of my neighbors are employees frightened to death by the prospect of 10,000 to 20,000 layoffs in coming months.

Well, so am I. Just a small workforce reduction at this plant could adversely affect my home's value for many years. I'd much rather be a company cheerleader than a bearer of ill tidings.

So it's sobering to conclude that there's little upside on the Intel chart from here.

Admittedly, price bounced off a three-year low in June and has made steady progress since then. But it's now reached a zone of significant overhead supply, marked by the 200-day moving average and broken 2004 low at $20.

Things aren't much better at

Advanced Micro Devices

(AMD) - Get Advanced Micro Devices Inc. Report

, the junkyard dog nipping continuously at Intel's heels this year.

The stock has retraced only half of its last downleg and suffers the same look of unfinished business seen in all the other instruments reviewed today. The only logical conclusion is that price will be testing, and possibly breaking, the 2006 lows in the weeks ahead.

At the time of publication, Alan Farley had no positions in stocks mentioned. Farley is a professional trader and author of

The Master Swing Trader

. Farley also runs a Web site called, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;

click here

to send him an email.


click here to sign up for Farley's premium subscription product The Daily Swing Trade brought to you exclusively by has a revenue-sharing relationship with Trader's Library under which it receives a portion of the revenue from purchases by customers directed there from