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Will Semiconductor ETFs' Best Start to a Year Last Long?

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Chipmakers are off to the best-ever start to a year in 2019. The industry suffered a lot in 2018 on U.S.-China trade tensions but has rebounded this year on cues of improvement in the duo’s trade relations. A cheaper valuation after last year’s lull may have also helped shares hold up well.

VanEck Vectors Semiconductor ETF SMH has lost 3.4% in the past year even after taking consideration of 21.4% year-to-date gains (as of Mar 18, 2019). This year’s gain is the best in the first quarter since its inception in 2000, per CNBC. The surge has come against the S&P 500’s 12% increase.

Inside the Rally

U.S. Chip stocks are extremely vulnerable to China.Per Morgan Stanley equity strategists, “semiconductor and semiconductor equipment companies have the highest revenue exposure to China at 52%” and are thus exposed to maximum risks on rising trade tensions (read: Apple's iPhone Order Cut Report May Hurt These ETFs).

Chipmaker Qualcomm QCOM has 65% revenue exposure to China and Nvidia’s (NVDA) sales exposure to China is 56%, per Goldman Sachs. Apart from these, some other tech and semiconductor companies, which have sales exposure to China in the range of 22% to 55%, include the likes of Intel INTCMicron Technology MU and Applied Materials (AMAT - Free Report) (read: 5 Sector ETFs Most Exposed to Trade Tensions).

In the recent trade developments, China has offered to buy $30 billion of U.S. chips over six years, per industry officials, basically doubling U.S. semiconductor exports, per the Wall Street Journal. The United States also postponed the hike in tariff rate on $200 billion of Chinese goods that was supposed to take place from this month (read: US-China Close to a Trade Deal? High-Beta & Risky ETFs to Tap).

Will the Rally Last?

However, nothing concrete has come out yet on U.S.-China trade talks. If Washington and Beijing fail to reach mutuality, semiconductor stocks may again be on a downhill ride. This is especially true given that the fundamentals are a bit shaky.

An article published on CNBC pointed out that, in late January, Nvidia (NVDA) reported its first quarterly year-over-year revenue decline in five years, while Intel (INTC) cut its outlook for the year, pointing out trade concerns. Qorvo Inc. (QRVO)issued guidance that came in below Wall Street expectations in early February.

The Semiconductor-General segment has projected earnings growth of negative 19.63% versus 6.45% growth projected for the S&P 500 companies. The segment is not an even a dividend destination as the historical dividend growth of the space was 2.5% versus 5.56% offered by the S&P 500 candidates. Against this backdrop, semiconductor stocks are trading at a forward P/E of 18.20x versus 17.19x of iShares Core S&P 500 ETF IVV.

Any Hopes Ahead?

Nvidia’s recently announced acquisition deal for Israeli chipmaker Mellanox, beating out other big-name bellwethers make sure that the long-term growth momentum in the industry has not subsided by any means. The rapid emergence of artificial intelligence will also keep the sector at a sweet spot (read: Bet on NVIDIA's Largest-Ever Deal With These ETFs).

So, investors can play funds like iShares PHLX Semiconductor ETF SOXX, SMH, SPDR S&P Semiconductor ETF XSD, Invesco Dynamic Semiconductors ETF PSI and First Trust Nasdaq Semiconductor ETF FTXL with a long-term view.

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