Semiconductor ETFs: Having Sight Beyond Sight; Look Out Below?

Below extract courtesy of today’s a.m. edition of macro-strategy commentary from Rareview Macro’s “Sight Beyond Sight”

1. Taiwan equities were cut to equal-weight from over-weight at Morgan Stanley (Jonathan Garner) on valuation concerns.
2. Morgan Stanley recently cut Asia’s semiconductor industry to equal-weight from over-weight.
3. Maybank, a local house, cut Taiwan Semiconductor (symbol: 2330 TT) to sell from hold. This is currently the only sell rating on TSMC.

Neil Azous, Rareview Macro LLC
Neil Azous, Rareview Macro LLC

If it were not for Russian equities falling on account of the new round of sanctions the Taiwan Taiex (symbol: TWSE) would be showing the largest negative risk-adjusted return in equities for the second day running. Taiwan Semiconductor closed down -4.6% last night. Taiwan Semiconductor holds a ~12% weight in the Taiex. This is a dramatic fall as it is not considered a high beta stock.

Compounding the matter further the Asian weakness followed on from Sandisk dropping by 10% after-hours due to a poor earnings release. We are not going to pretend that we know anything much about Sandisk, except that that it makes memory cards, but what we do know is that the professional community leaned very long into this earnings event. Furthermore, this follows the short-covering in Intel (symbol: INTC) that these same investors who are very overweight semiconductors used as a funding leg (i.e. short position) to pay for them. We still cannot believe Intel is/was the most heavily shorted name in the Dow Jones Index given its 35% run higher. That is a lot of PnL pain to endure, to the point where you have to truly believe your longs are going up even higher to make up for it.

The other issue is this profile:

1. The Market Vectors Semiconductor (symbol: SMH), the most widely traded semiconductor ETF, does not contain Sandisk (symbol: SNDK) despite it having a ~24 billion market capitalization. However, the ETF contains the Taiwan Semiconductor (symbol: TSM US) American Depository Receipt (ADR) and it makes up ~15% of SMH.

2. The Philadelphia Semiconductor Index (symbol: SOX), the main semiconductor benchmark, does not contain Taiwan Semiconductor (symbol: TSM US) but includes Sandisk (symbol: SNDK).

3. Intel (symbol: is the largest weight in both). For example, INTC is ~22% of SMH.

This means that these proxies/products are a lot less relevant for anyone who wants to monitor this trend, and useless as a hedge for semiconductor or technology related exposure to the Apple food chain. You either need to hedge with a single stock or sell down your long position to mitigate risk is the point.

There are two overall takeaways. Firstly, the shorts just got burnt hard in Intel and now their longs are at risk of a retracement lower following very strong pent-up demand in that space. Secondly, Taiwan has an issue all of a sudden. To what degree is yet to be determined and hard to handicap but the immediate debate has morphed into whether part of the long position in Taiwan (ETF: EWT) will be rotated into South Korea (ETF: EWY).

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