Market Insights

Software versus semiconductors. It’s a major split running down the middle of the technology sector.

The chart below compares the performance between the iShares North American Software ETF (IGV) and the Market Vectors Semiconductor ETC (SMH) since the start of 2016. It clearly shows how chips initially led the charge, but have lagged in recent months.

Weekly chart tracking performances of IGV, SMH and FXI since January 2016.

We’ve covered this trend on Market Insights and our Market Action webinars. On the surface, the divergence is tied to stronger earnings in the software space the last few quarters.

But deeper trends seem to be at work. One is the difference between secular trends and cyclical trends. A secular is a broad, long-term shift like the way computers replaced typewriters 25 years ago.

Cyclical trends are tied to simple economics: A strong business cycle tends to boost spending and investment.

Semiconductor stocks had their secular trend a few years ago as chips spread to new end-markets like industrial goods and autos. However, that trend seems to have run its course and now the cyclical forces are turning more bearish.

This first appeared in the spring in poor guidance from equipment companies like Applied Materials (AMAT) and Lam Research (LRCX). Those two canaries in the coal mine closed yesterday flat on their backs at new 52-week lows.

Several analysts have also warned about flagging demand, and recent industry data from the Semiconductor Industry Association was the slowest in over a year.

There’s another elephant in the living room: China. The giant Asian country, a huge market for integrated circuits, has flashed bearish economic signals as President Trump strangles their factory sector with tariffs.

Do you know IGV made a new high just two weeks ago, but SMH hasn’t done that since March. Click here for lessons on how to find events like this with TradeStation’s award-winning platform.

By the way, Beijing’s set to report industrial production, fixed-capital investment and retail sales tomorrow night. That trio of numbers has worsened sharply since May, precipitating a sharp decline in the iShares China ETF (FXI). See the chart above.

Software’s been the polar opposite. Companies in this group mostly beat estimates last earnings season and also seem to be in the sweet spot of both secular and cyclical turns.

The secular trend is the mass exodus of applications to cloud computing. Perhaps even more interesting was a powerful cyclical boom tucked away in the Commerce Department’s last revision to second-quarter GDP: a sharp boost of software’s contribution to economic growth.

In conclusion, software companies appear to have the double benefit of strong execution and economic tailwinds. Meanwhile, chips may have run their course and may remain at risk of further weakness — especially if China keeps struggling.

Disclosure: This post is intended for education purposes only and isn’t a trade recommendation.