In the second installment of Omaha teaches intermarket analysis, let’s turn our attention to another commonly watched ratio. This one in particular is highly useful in gauging the overall strength of the stock market, and can help us understand where we may be in the overall market cycle. This is the (SMH/SPY) ratio: Semiconductors relative to the SPY.
Before we take a look at the chart, a couple words on why this particular ratio is of importance to us…
Semiconductors are at the heart of all electronic devices like personal computers (PC), laptops and mobile phones and are central to information technology. The industry is massive and highly cyclical as we purchase electronic devices which we understand will become obsolete fairly quickly. Regions Asset Management noted that semiconductors are highly correlated to GDP. In short, GDP and economic growth leads to demand for semiconductors which is an industry group that helps to fuel bull markets in equites.
We have a couple of choices when it comes to tracking the semiconductor market. We can use the SMH ETF or the SOXX ETF fairly interchangeably. We want to gauge their strength relative to “the market” so we will use the SPY ETF to do so. Here is a weekly chart taking into account nearly 20 years of data:
I don’t think expertise in reading technical charts is necessary to get an overall idea of what is happening here. We can see that the semis were weak relative to the SPY beginning around 2004. The ratio was at its weakest near the financial crisis of 2008-2009. Since then, the group has maintained its relative strength through flashcrashes, presidential elections, inverted yield curves, and most recently coronaviruses. In fact, I would argue the pair just made an important new high in breaking above prior resistance put in back in the early 2000s. Provided this general area holds and this particular ratio continues its overall general trend from the lower left to the upper right corner of the screen, this bull remains in tact.
In sum, the SMH/SPY ratio is just another one of the many tools we have at our disposal to put the pieces of the global market puzzle together. These ratios will guide you in times of high market noise. They will serve you well when your neighbor tells you he is going to all cash because a “crash is coming.”
Tell him you know better because you read Omahacharts. Or you can keep it our little secret.
Trent J. Smalley, CMT