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After Upbeat July, Will Semiconductor ETFs Slump in August?

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Semiconductor stocks performed well in July on a fresh start to U.S.-China trade talks. Meanwhile, the world’s largest chipmaker — Intel (INTC - Free Report) — reported stronger-than-expected Q2 results. If this was not enough, an analyst from Sanford C. Bernstein noted that the present trade dispute between Japan and South Korea may potentially raise memory chip prices. SPDR S&P Semiconductor ETF (XSD - Free Report) gained more than 10% in the month (read: Chip ETFs to Surge on Intel's Robust Q2 Results).

Rough Start to August

The start to August looks rough as the month opened on a host of bad news for the space. The first and foremost setback was President Trump’s announcement of slapping a 10% tariff on $300 billion in Chinese imports that aren’t yet subject to U.S. duties. The new tariff will be levied starting Sep 1. Another $250 billion in Chinese goods are already subject to a 25% U.S. tariff.After market close on Aug 1, the president said the new round of tariffs could be increased beyond 25%.

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.

Recent earnings releases also went against the space. Advanced Micro Devices (AMD - Free Report) , reported second-quarter 2019 results on Jul 31, wherein the company matched earnings estimates. Though revenues beat the Zacks Consensus Estimate of $1.524 billion, it fell 13% year over year. But its sales guidance came in short of expectations. For the full year, AMD expects revenue to increase "a mid-single digit percent over 2018." Wall Street was betting on sales to increase 6.4% to $6.89 billion in 2019, per In the past two days (as of Aug 1, 2019), the stock was off 11.8%.

Lam Research Corp.'s (LRCX - Free Report) earnings were nearly reduced in half year over year, but still surpassed downgraded expectations amid a chip glut, per an article published on MarketWatch. For first-quarter fiscal 2020, Lam Research projects revenues to be $2.15 billion (+/- $150 million). The Zacks Consensus Estimate for the same was pegged at $2.28 billion. Non-GAAP earnings are projected at $3.00 (+/- 20 cents). The Zacks Consensus Estimate for non-GAAP earnings per share was $3.23.

Meanwhile, the Fed has come up with a hawkish rate outlook. Though the central bank cut rates in July, the bank noted that the cut was simply a “midcycle adjustment” and that the committee does not see clear economic weakness that would require any longer rate-cutting cycle. Also, the Fed announced plans to end the normalization of balance sheet two months earlier than previously expected. Such hawkish comments made Wall Street slump at July-end.

What Lies Ahead?

As long as the broader market is busy with trade tensions, semiconductor stocks are unlikely to shoot higher. However, on the basis of forward 12-month price-to-earnings (P/E) ratio, we see that the industry is currently trading at 16.52X, below the S&P 500's 18.27X.

So, from the above chart, we can conclude that the sector is well-placed valuation-wise. Some upbeat earnings releases and positive developments in the U.S.-China trade tensions could lead the sector to spring higher (read: Apple May Buy Intel's 5G Modem Business, ETFs to Rally).

SPDR S&P Semiconductor ETF (XSD - Free Report) , iShares PHLX Semiconductor ETF (SOXX - Free Report) and VanEck Vectors Semiconductor ETF (SMH - Free Report) have a Zacks Rank #1 (Strong Buy) and 2 (Buy). First Trust NASDAQ Semiconductor ETF (FTXL - Free Report) has a Zacks Rank #3 (Hold).

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