The SOX chip-stock index has a big, bearish pattern building in its chart

MW The SOX chip-stock index has a big, bearish pattern building in its chart

By Tomi Kilgore

If the bearish pattern is completed, the SOX could be engulfed in a long-term downtrend that lasts into 2025

Semiconductor stocks have had a pretty rough week. And the way the charts are set up, the sector that was at the center of the AI-led boom in top technology stocks could very well end up having a pretty bad year.

There's one developing "multiquarter" bearish pattern in particular, that J.P. Morgan's technical strategy team believes, if completed, would foreshadow a lasting weakness.

The PHLX Semiconductor SOX was sinking 4.7% in afternoon trading Friday, with all 30 components trading lower. It has tumbled 12.4% this week, with all 30 components losing ground over that time, and to put it on track for the worst weekly performance since it plunged 15.9% during the week ended March 20, 2020 at the height of the COVID-pandemic panic.

To make matters technically worse, all 30 SOX stocks were trading below their respective 50-day moving averages, which are widely viewed among technical analysts as short-term trend trackers.

The SOX is now up just 8.3% year to date. At its July 10 record close of 5,904.54, it was up 41.4% in 2024, after soaring 64.9% in 2023.

That's the bad news for now.

Looking ahead, the SOX is getting pretty close to where the charts suggest the selloff could continue into 2025, and may even raise the risk of a full retracement of the bull market that started in late 2022.

"Given the overall setup, we suggest carrying bearish short-term trade structures for now, and shifting to a much more structurally defensive bias if the SOX Index...start[s] to break down through the noted 2024 pattern necklines," J.P. Morgan's technical strategy team wrote in a note to clients. (See below for details and meaning of the noted "necklines.")

So here's the current technical setup.

After the selloff from the highs, which accelerated in early August amid growing worries that a looming recession would fuel a continued rotation out of large-cap technology leaders, the SOX staged a rebound into mid-August. But the charts showed how inadequate that bounce was.

First, the rally off the Aug. 7 closing low of 4,426.27 to the bounce's closing peak of 5,267.93 on Aug. 21 retraced just 56.9% of the selloff from the July 10 record close through Aug. 7. That compares with the rebounds for the S&P 500 index, which retraced 96.1% of its selloff, and for the tech-heavy Nasdaq-100 Index, which retraced 69.7% of the decline.

Then, while the S&P 500 and Nasdaq-100 were able get back above their 50-DMAs, albeit not for very long, the SOX's bounce petered out below that trend tracker.

As J.P. Morgan analysts said, the SOX's 50-DMA, which has fallen to about 5,177 on Friday, is where a "key resistance" area for the index starts. And as long as the SOX remains below that level, "the short-term bias stays negative."

And on Friday, the SOX has fallen below initial support at the 200-DMA (currently at 4,747), which many view as a longer-term trend tracker. Add to that the seasonal pressure that sector is facing, as J.P. Morgan noted that September has historically been the weakest month of the year for the chip stocks and the broader stock market.

Now for the longer-term set up.

On a logarithmic chart, there is an uptrend line starting at the October 2022 low that connects low in October 2023 and the low from last month. That trendline currently extends to roughly 4,450, or only about 1.6% below current levels.

(Logarithmic charts are often used to technicians to better relate changes in price over longer periods and after significant moves. For example, in a linear price chart, Friday's 220-point selloff would look twice as large as it did in October 2022.)

Falling below that trendline would be the first clear warning sign that the uptrend may be over.

Just below that is the 4,288 to 4,290 area, which were the lows seen in April 2024 and in August.

That level, as J.P. Morgan says, "defines the neckline of a potential multi-quarter distribution pattern that has formed on the heels of the 2022-2024 rally leg."

That distribution pattern refers to what chart watchers like to call a "head and shoulders" pattern.

For the SOX, the March highs are the left shoulder, and July highs are the head and the August highs mark the right shoulder. The line connecting the lows between the shoulders and head marks the neckline.

Falling below the neckline, which is about 5.2% below current levels, would complete the bearish pattern.

The technical idea behind a head-and-shoulders is that it marks the shift from a pattern higher highs and higher lows, to one of lower highs and lower lows, which many define as a downtrend.

Behaviorally speaking, the pattern depicts bulls' acceptance of failure. After successfully defending support at the previous low, bulls were unable to make a new high. Falling below support at the neckline gives those bulls reason to give up.

"The near-term price action and bearish seasonality that runs through mid-October favors at least a test of that key area," J.P. Morgan said. "A breakdown would shift the longer-term trend bias and point to a full retracement of the 2023-2024 rally leg into next year."

A full retracement, to the October 2022 lows? That would imply a further drop of more than 50% from current levels.

-Tomi Kilgore

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September 06, 2024 14:58 ET (18:58 GMT)

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