According to Citi analysts, semiconductor stocks have ample room to grow from a margin, revenue, and inventory perspective, driven by demand related to AI.
The broader tech sector trades near record levels, with the upside driven by the optimism concerning artificial intelligence technology. The semiconductor industry, which manufactures chips that power AI applications and processes, has outperformed the tech industry as a whole, with most of these stocks trading at overbought levels.
The iShares Semiconductor ETF (SOXX), a BlackRock-sponsored exchange-traded fund (ETF) that tracks semiconductor stocks, has gained nearly 31% this year, outperforming the Invesco QQQ Trust (QQQ) (+18.5%) and the Technology Select Sector SPDR Fund (XLK) (+23%). The VanEck Semiconductor ETF (SMH), another semiconductor-focused ETF that is heavily weighted toward bigger chip stocks, has advanced a steeper 39% this year.
The gains have rendered these two chip-focused ETFs at overbought levels. The 14-day relative strength indices (RSI) for the SOXX and SMH ETFs are at 78 and 80, respectively. The RSI is a momentum indicator that measures the speed and change of price movements and is used to spot potential buying or selling opportunities. A reading above 70 suggests that a stock has risen too far and too fast, and is ripe for a pullback.
According to a CNBC report, a reading above 80 is unusual for an ETF like SMH, and it has only breached this level three times in the past. On all three occasions, the six and 12-month forward returns have been negative. The performance was the worst in 2021, with the SMH ETF losing half of its value over the following year, as the ETF breached the ‘80’ threshold for the RSI. In June 2024, when this happened, the losses were a more modest 12% after six months and 5% after a year.
Within the industry, Dutch chip-equipment maker ASML (ASML), its U.S. peer Lam Research (LRCX), chip testing company Teradyne (TER) and memory chipmaker Micron (MU) are the most overbought, each having an RSI above 79.
AI has driven the valuation of semiconductor stocks, according to analysts at Citi, as reported by Proactive Investors. The firm believes these stocks have plenty of room to grow from a margin, revenue, inventory, and demand perspective. It sees accelerating growth for chip companies, thanks to higher pricing for the first time in 25 years. According to analysts, AI chip sales now account for a quarter of overall semiconductor sales.
The industry, however, faces headwinds from the Trump administration’s crackdown on China. A Wall Street Journal report, published in late September, stated that the government is considering a plan to penalize companies that do not maintain a 1:1 ratio for domestic manufacturing versus imports. The White House has also restricted the export of advanced AI chips to China, one of the country’s most significant consumers. In retaliation, China has intensified its efforts to support domestic chipmakers, aiming to achieve self-sufficiency.
On Stocktwits, retail sentiment toward the SMH ETF turned to ‘neutral’ (52/100) by late Sunday from ‘bullish’ the day before. The message volume, however, remained ‘high.’ The SOXX ETF has attracted ‘extremely bullish’ sentiment, with the buoyant mood accompanied by ‘high’ message volume. The divergence in sentiment points to potential broadening of buying interest to smaller semiconductor stocks.
In overnight trading, the SMH ETF rose 0.73% and the SOXX was up 0.57%, according to Yahoo Finance.
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