Why Chip ETFs May Be Poised for a Comeback

Momentum investing could be ready for a rebound after one of its sharpest pullbacks on record, according to Morgan Stanley strategist Michael Wilson, per Bloomberg, as quoted on Yahoo Finance. While leadership is shifting toward companies with stable earnings and strong fundamentals, Wall Street believes the recent selloff in semiconductor stocks may have created an attractive entry point.

Semiconductor Selloff Creates Opportunity

The semiconductor industry remained one of the market's weakest areas in July, per the CNBC source.The VanEck Semiconductor ETF SMH remained down nearly 17% for July, putting the fund on track for its worst monthly performance since the 2008 financial crisis as investors reassessed AI-related valuations and the impact of higher interest rates (read: Top-Performing Leveraged ETFs of July).

Investors questioned whether the world's largest technology companies are spending too aggressively on AI-related capital expenditures. The pullback triggered one of the steepest momentum reversals in recent history, with a Goldman Sachs basket of momentum stocks falling about 35% from its June peak, per the same Bloomberg article.

However, the sharp decline has also pushed many semiconductor stocks to oversold levels, improving their risk-reward profile.

Inside the Technical Analysis

The 14-day Relative Strength Index (RSI) of the SMH ETF indicates that momentum has improved after a period of weakness. Earlier in July, the indicator flashed a bearish divergence, signaling fading upside momentum and preceding a pullback.

However, toward the end of July, two bullish divergence signals emerged as the RSI formed higher lows despite price weakness, suggesting that selling pressure was easing and buyers were regaining control.

The subsequent rebound pushed the RSI above the neutral 50 level to around 55.6, reflecting a moderately bullish momentum backdrop. While the indicator remains well below the overbought threshold of 70, the improving RSI suggests the recent recovery has room to extend, provided broader market conditions and earnings momentum remain supportive.

Image Source: Zacks Investment Research

AI Spending Remains Intact

Despite concerns over elevated AI spending, major technology companies continue to reaffirm their commitment to investing aggressively in AI infrastructure.

Strong quarterly results from hyperscalers have reinforced confidence that demand for AI chips, networking equipment and advanced computing infrastructure remains robust. It provides a favorable backdrop for semiconductor companies over the medium term.

Wall Street Expects the Sector to Stabilize

Wall Street strategists believe the semiconductor correction may be nearing its end. Goldman Sachs strategist Ben Snider noted that the recent consolidation in AI-related stocks is consistent with previous momentum cycles. He believes investor deleveraging has improved the outlook, provided earnings remain strong, per the same Bloomberg article.

Similarly, JPMorgan Chase strategist Mislav Matejka believes semiconductor stocks are approaching oversold levels while earnings momentum continues to improve, creating conditions for the sector to stabilize.

Quality Rotation Does Not Mean the End of AI

Although many analysts expect market leadership to broaden toward high-quality companies, that does not necessarily imply a prolonged downturn for semiconductor stocks.

Instead, the rotation suggests that while quality sectors may lead the next phase of the rally, chipmakers could recover alongside, benefiting from attractive valuations after the recent correction.

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This article originally published on Zacks Investment Research (zacks.com).

Zacks Investment Research