After bouncing off its December low, the S&P 500 is less than 4 percent from records.
And there’s one group of stocks to look at if you want to know what’s next for this market, according to Paul Hickey, co-founder of Bespoke Investment Group.
“Just looking back at the last six years, semis have been probably the best — if not the best — leading indicator for the market,” Hickey told CNBC’s “Trading Nation” on Tuesday. “Semis are the transports of the 21st century. … It involves every aspect of the economy, especially the digital economy.”
Semiconductors, often the first step in the supply chain for the tech world, now act as a similar leading indicator to the Dow Transports, says Hickey. A swing lower in the Dow Transportation index typically reflects slowing demand for freight and logistics services and signals an economic slowdown, so goes the 19th century Dow Theory. In Hickey’s argument, a slowdown in chipmaker demand has implications for the modern-day economy.
His theory is borne out by the charts, with the two groups showing high correlation in recent years.
“If you look at all the large declines that we’ve seen during [in six years], mainly from the peak in 2015, from the peak last September, and even that short correction in January of last year, they were all preceded by pullbacks in the semiconductor group on a relative basis,” said Hickey.
Most recently, the SMH semiconductor ETF underperformed the market from June and bottomed in October. Over that stretch, it tumbled 20 percent and preceded a similar drop from the S&P 500’s September peak to its late December bottom.
The semis’ “relative strength started weakening months before the broader market did, and then subsequently the relative strength for the semis versus the S&P 500 bottomed well ahead of the market as well, so it’s been a great leading indicator of the forward returns for the broader market lately,” said Hickey.
Semis’ recent outperformance points to moves higher for the S&P 500, as well, he adds.
“Right now it’s in good shape. We’ve seen it hit new highs on a relative basis for the year,” said Hickey. “As long as you continue to see that trend of outperformance continue, it bodes well for the broader market. And then when you start to see it falter, that’s the time to maybe become a little bit more cautious. But at this point, the peaks aren’t coincident with each other. Semis have been a clear leader.”
The SMH ETF is up 23 percent this year, far better than the 13 percent increase on the S&P 500. It has risen 4 percent this month.