Semis: "Bottom Fishing" Buys

10/29/2004 12:00 am EST

Focus:

John Murphy

Head Market Analyst, Stockcharts.com

"The chip group has been the year's worst performer," says John Murphy, technical expert and editor of StockCharts.com . "I continue to believe that this is a low-risk group in which investors can do some bottom-fishing." Here, he looks at some ways to play a rebound.

"Money has been coming out of former market leaders like basic materials. When money comes out of former leaders, it has to rotate somewhere else. Semiconductors are one of the likely candidates. For one thing, they've been the year's worst performers. Money coming out of the best performers often finds its way into the worst. Secondly, the Semiconductor Index (SOX) appears to have bottomed in early September, and has been outperforming the S&P 500 since then.

"One way to tell if a group is undergoing accumulation is to study its volume pattern. And the volume flow in chips is encouraging. An even better way to track the direction of the volume flow is with On Balance Volume (OBV), a running cumulative total of upside and downside volume. Volume is added on updays and subtracted on downdays. The direction of that line is all that matters. And the OBV line for chips is most definitely rising. That greatly increases the odds for an eventual upside breakout in the chip sector and its related stocks. Right now, I happen to believe that semiconductors are one of the groups that money can be committed to.

"Within the sector, certain stocks are starting to show upside leadership. Whenever an industry group starts to show signs of bottoming, there are some stocks that take over leadership within the group. For a stock picker, I believe that's the way it should be done. First, find a group that appears to be turning up (like the chips). And then look for individual leaders in that group that are leading it higher. Advanced Micro Devices (AMD NYSE) certainly qualifies. The chip leader has broken through its 200-day moving average to reach a new four-month high. Volume has also been rising. The relative strength line also shows that AMD is leading the group higher.

"Another semiconductor stock that recently caught my eye was Teradyne (TER NYSE), which reflects some heavy accumulation. Its relative strength line has also jumped. Texas Instruments (TXN NYSE) is another chip leader. The stock recently gapped higher on strong volume. It's still trading well below its 200-day moving average. But its relative strength compared to the semiconductor index is rising. That's a sign of group leadership. Altera (ALTR NASDAQ) also appears to be a leader in the emerging chip uptrend. That stock has blasted through its 2004 down trend line on very heavy volume. Its ratio versus the SOX has hit a new yearly high. That's leadership. If the SOX group does start to rise (as I expect it will), Altera should be one of the strongest stocks in the group.

"As an alternative to buying individual stocks to participate in a rally in a sector, you could also buy the entire group. If you haven't got time to do the stock research or aren't a stock picker, one of the simplest ways to participate in a potential upturn in the chips is to buy an exchange-traded fund like the Merrill Lynch Semiconductor Holders (SMH ASE), which is moving up very close to a new three-month high. The upside volume is especially impressive. The ratio of the Semiconductor Holders to the NASDAQ is also turning up, suggesting that the chip rally is just beginning."

"There is also a strong global link between the direction of semiconductor stocks and Asia. That's because Asia is a huge producer of semiconductors. One way to play the chip rally in Asia is with two exchange-traded funds - iShares Taiwan ETF (EWT ASE) or the iShares South Korea (EWY ASE). Among Asian countries, Taiwan has the closest link to the semiconductor index. Indeed, 29% of its holdings are in semiconductor and semiconductor equipment stocks. That's the heaviest chip weighting in Asia. Both Taiwan and the semiconductor index peaked together in early 2002, bottomed together in October 2002, peaked again at the start of 2004, and are now turning up together. South Korea has a 25% weighting in the chip group. Another way to participate in the Asian chip rally is by buying Taiwan Semiconductor (TSM NYSE), which is the biggest holding in EWT, at 15% of assets. Its three-year chart also appears to be bottoming, as the stock is starting to move up on strong volume. It's already broken its 50-day average and is nearing a test of its September high."

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