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Semiconductor ETFs in Focus After Friday's Rout

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Semiconductors have been the darlings of investors over the past few months and stocks skyrocketed on investors’ continued acclaim for the value-centric traditional stocks of semiconductors and encouraging industry fundamentals. The sentiment seems to have reversed following the heavy sell-off in the broad semiconductor space in Friday’s session.

The worst decline came after the diversified chipmaker Microchip Technology (MCHP - Free Report) lowered its revenue outlook for the recently concluded quarter and warned of the health of the broad-based semiconductor industry. This suggests more pain for the company as well as others in the space as Q3 earnings unfold.

This is especially true, as U.S. semiconductor makers have seen soft sales from Asia to Europe in recent weeks. The major culprits are China, which is suffering from weak semiconductor demand, and Euro zone, which faces danger of falling into another recession and thus weighs on the demand for semiconductors.

Further, the earnings from the broad technology sector look disappointing as earnings are expected to grow only 2.8% in Q3, down from 12% reported in Q2, as per Zacks Earnings Trends. Revenue growth will also likely recede to 4.7% from 6.1% on negative net margins (see: all the Technology ETFs here).

As a result, the Philadelphia Semiconductor Index fell as much as 7.7%, representing the worst one-day decline since 2009 with Microchip Technology plunging 12.3% at the close on the day. Other stocks also scored double-digit losses with Ambarella Inc. (AMBA) dropping 13%, NXP Semiconductors (NXPI) down 12.4%, Avago Technologies (AVGO) down 11.5% and Freescale Semiconductor (FSL) down 10.8%.

Industry primes such as Intel (INTC - Free Report) , Micron Technology (MU - Free Report) , Broadcom and Texas Instruments (TXN - Free Report) dropped 5.1%, 9.3%, 5.5% and 7.1%, respectively.

ETF Impact

The terrible trading in the stock world also sent the semiconductor ETFs space into deep red on the day. In particular, PowerShares Dynamic Semiconductors Fund ((PSI - Free Report) ) and SPDR S&P Semiconductor ETF ((XSD - Free Report) ) stole the show, tumbling nearly 8% at the close on a single trading day. Below we profile the two ETFs and discuss some of the specifics behind their recent slump (read: A Comprehensive Guide to Semiconductor Industry ETFs).

PSI

This fund tracks the Dynamic Semiconductor Intellidex Index, holding 30 securities in the basket with a diversified exposure to various market caps and a number of securities. About 45% goes to small caps, 32% to large caps and the rest to mid caps. Additionally, none of the firms account for more than 5.5% of assets.

The product has so far amassed $28.2 million in its asset base while charges a bit higher fee of 63 bps per year from investors. PSI saw trading volume of more than 2.5 times than the normal average daily volume on the day.

XSD

This fund provides exposure to 49 firms by tracking the S&P Semiconductor Select Industry Index. Here, the product is tilted toward small cap stocks at 61%, followed by 26% in mid caps and 12% in large caps. However, the ETF is well spread out across various securities with none holding more than 2.6% share in the basket (read: 3 Overlooked Funds Beating the SPDR Tech ETF (XLK) This Year).

The fund has accumulated $139.4 million in AUM and charges 35 bps in fees per year. Volume on the day came at nearly two times the average daily volume.

Long Term Outlook

Despite this slide, the outlook for the sector is quite promising. This is because the semiconductor sector is still clearly outpacing the broad market index from the year-to-date look by wide margins. This trend is likely to continue thanks to encouraging industry trends, which point to a solid global semiconductor industry sales of 6.5% for this year, as per the World Semiconductor Trade Statistics (WSTS). Sales will likely slowdown over the next two years with growth of 3.3% and 4.3%.

Additionally, capacity utilization, advanced technologies and new gadgets will continue to fuel demand for the chips and other semiconductor products. The PC market is also showing signs of stabilization and will likely see accelerated growth in the remaining part of the year due to replacement of older devices and upgrades from Windows XP.

Further, the two products detailed above have a top Zacks Rank of 1 or ‘Strong Buy’ with a High risk outlook, suggesting that these will likely outperform the broad market index over a one-year period (read: Make Huge Profits with This Top Ranked Semiconductor ETF).

Given the solid long-term outlook but some concerns on Q3 earnings growth, investors may want to consider staying on the sidelines for the time being. However, risk-tolerant, long-term investors may want to consider this recent slump a buying opportunity, provided they have the patience for extreme volatility.

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