This sector is on the verge of a big move… and it could take the broad market with it

From Jeff Clark, Editor, Stansberry Short Report:

Pay close attention to semiconductor stocks this week.

The sector is on the verge of a big move.

While the broad stock market has been chopping back and forth in a tight trading range for the past six weeks, the semiconductor sector has been grinding higher.

In fact, the Philadelphia Semiconductor Index (“SOX”) has gained about 10% since late July. The S&P 500 is about even over the same period.

But that outperformance may come to an end as early as this week…

Take a look at the following chart:

Gswchart981

This chart shows the performance of the SOX against the S&P 500. When the ratio is rising, semiconductor stocks are outpacing the overall market. When the ratio is falling, the semiconductor sector is lagging the market.

As you can see, the action over the past six weeks has pushed the semiconductor sector to its highest level of outperformance in more than 10 years. In other words, the SOX is now more overbought versus the S&P 500 than at any time in the past decade.

So one of two things has to happen. Either the broad stock market needs to rally to catch up to the SOX, or the SOX needs to decline in order to come back in line with the S&P 500.

For now, I’ll put my money on the SOX declining. Here’s why…

gswchart982

This chart of the SOX shows a bearish rising-wedge formation (the blue lines) with negative divergence on the moving average convergence divergence (“MACD”) momentum indicator. As I showed you last week, this is a bearish pattern that most often breaks to the downside.

The chart closed Friday at the apex of the wedge. It’s likely to break this pattern one way or another this week. If the SOX breaks to the downside, we’ll likely see a swift and sharp decline to the first red support line at about 780. That would be a drop of more than 3% from Friday’s closing price.

A more significant decline could push the index down to 755 – a fall of more than 6%.

On the other hand, it is possible the SOX could break out to the upside of the wedge. That doesn’t happen often with this pattern, but traders should be prepared for it.

If the SOX pushes even higher from here, the S&P 500 is likely to play a game of “catch up.” That would ignite a strong stock market rally this month.

For now, I think the odds favor the SOX breaking down from this pattern. And that’s how I’m planning to trade it.

But if the SOX instead breaks out to the upside, traders should be quick to reverse course. After a six-week period of going nowhere, there’s a lot of energy stored up in the market for a big move.

Best regards and good trading,

Jeff Clark

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