How the SOX index can help investors work out whether stock markets are going to rock or roll

A slide in the share prices of Facebook, Apple, Amazon, Netflix and Google’s parent Alphabet, the so-called FAANGs, and Tesla is grabbing all of the headlines. Whether this is down to a collection of company-specific reasons – such as questions over Facebook’s involvement in the Cambridge Analytica data use scandal, attacks on Amazon by President Trump (which could just be payback for Amazon boss Jeff Bezos’ ownership of the Washington Post newspaper) or Tesla’s inability to meet its production targets or get even close to making a profit – or a wider move away from highly-valued, momentum-driven, risky securities remains to be seen.

Weakness in the FAANG stocks and Tesla may be heralding a wider shift in market sentiment

Source: Thomson Reuters Datastream

Such stock-specific niceties are unlikely to trouble advisers and clients too much. But if they really want to get a grip on technology stocks and stock markets more generally, then they should be keeping an eye on the Philadelphia Semiconductor Index, more commonly known as the SOX index.

The 30 constituents of the SOX index

Source: NASDAQ OMX, iShares

The benchmark contains 30 companies who are involved in the design, manufacture and sale of silicon chips, and it is therefore a very useful guide for advisers and clients on two counts.

  • These integrated circuits are everywhere, from smart phones to computers to cars to robots, so they offer a great insight into end demand across a huge range of industries and therefore the global economy.
  • Chip-makers’ and chip-equipment makers’ shares are generally seen as momentum plays, where earnings growth is highly prized and valuation less of a consideration. As such they can be a good guide to broader market appetite for risk.

Since its launch in summer 1994 the SOX has been a good guide to America’s S&P 500 index but also the FTSE All-World benchmark. Peaks in the chip index in both 2000 and 2007 warned of trouble ahead on a much broader scale.

The Philadelphia Semiconductor Index – the SOX – could provide further useful insight into markets more broadly

Source: Thomson Reuters Datastream

Pull up the SOX

The SOX could be every bit as useful a guide during this equity bull market, which began in 2009.

The good news, for the moment, is that the semiconductor industry grew like a rocket in 2017, as global sales surged by 21% to a new all-time high of $409 billion. Better still, revenues are expected to rise by at least 7% in 2018.

Global semiconductor sales are booming

Source: Statista

This may help to explain why technology overall has been a huge driver of equity market returns for advisers and clients.

The net result is that 10 of the world’s 25 biggest companies by market capitalisation now hail from the tech sector.

This list includes three silicon chip makers – Intel (the world leader in microprocessors), Samsung Electronics (the world leader in memory chips) and Taiwan Semiconductor Manufacturing Company (the world’s biggest foundry, or chip maker on an outsourced basis).

The world’s 25 biggest companies by market capitalisation

Source: Bloomberg

Imminent news flow

The good news is that Samsung Electronics has got the first-quarter reporting season off to a good start by estimating that profit for the January-to-March period will rise by 58% year-on-year.

However, that did not prevent a dip in the shares, which are still trading a fraction below March’s all-time high of Won 2.88 million.

Advisers and clients can therefore look toward the first-quarter reporting season from Intel, TSMC and other leading SOX index members such as Broadcom, Texas Instruments, NVIDIA and Qualcomm for comments on end-demand and also subsequent share price momentum, especially as the silicon chip benchmark is no higher than it was in November.

The SOX index is looking to recapture its recent all-time highs

Source: Thomson Reuters Datastream

After all, some cracks have already appeared in the technology edifice.

Despite the apparent success of the Dropbox and Spotify initial public offerings (IPOs), at least if they are measured by immediate share price performance in the wake of their listings, investors have begun to ask more questions of technology stocks and richly-valued but ultimately loss-making companies.

  • We have already seen the sharp drop in the FAANG stocks and the recently-created index that tracks them, as well as the retreat in wider, technology-laden NASDAQ index.

The NASDAQ Composite index is also looking to return to a recent record peak

Source: Thomson Reuters Datastream

  • Softbank may have shown faith in transport technology platform (or taxi service, depending on your viewpoint) Uber, despite its governance and regulatory problems, but the Japanese technology investment behemoth injected capital at a price which implied a one-third cut in Uber’s valuation to $48 billion. This is known as a ‘down round’ in the world of venture capital and is not normally seen as good news.
  • Twitter and Snap have both struggled to hold on to the share price gains they made in the wake of their respective stock market flotations in 2013 and 2017 respectively.

None of these have to signal that the tech sector is about to fall out of favour and take risk assets more generally with it. But tracking the SOX index and silicon chip stocks in particular may help advisers and clients in forming their view on this sector and, as a result, their asset allocations more broadly.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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