From Joseph Hargett: The market correction in early February set Wall Street on edge. Stocks were clearly overbought and overhyped, and investors rushed for the exits to preserve profits.
Even the famed FAANG stocks — Facebook, Apple, Amazon, Netflix and Alphabet’s Google — were hit hard in the rush to preserve investments.
Wall Street investors were worried that, without FAANG leadership, the market correction would continue unabated. But another sector emerged to help lead stocks higher once again: semiconductors.
Since February 9, the bottom of the correction, the PHLX Semiconductor Index (Nasdaq: SOX) has roared more than 18% higher. Riding strength from Nvidia, Intel and Micron Technology, the SOX even blew past its pre-correction highs and into all-time-high territory.
These gains haven’t come without reason, however. The main driver for semiconductor stocks is the considerable growth potential for the artificial intelligence market, which has invaded everything from self-driving cars to fast-food kiosks.
Furthermore, investors are keying off cyclical equipment upgrades at corporate accounts, which could be juiced by the Trump tax cuts.
All in all, everything looks rosy for the chips sector. There is one caveat, however, for investors in one extremely popular semiconductor name.
The hype backing this particular stock has driven shares to gains of more than 200% of its peers in the SOX since the market correction … and it could see short-term losses considerably greater than those seen in February.
The Miracle of Micron
Micron Technology Inc. (Nasdaq: MU) is currently the darling of the semiconductor sector.
In the past two years, Micron stock has rallied nearly 450%, driven by demand for DRAM and NAND flash memory chips. Micron is a leading manufacturer of such chips, which are used extensively in the mobile market.
That iPhone or PC you’re reading this on? One of its key memory components was likely made by Micron.
In the past, Micron caught flak from analysts and investors due to a glut of supply in the flash memory market. Oversupply and a dip in demand for mobile devices left Micron with little in the way of pricing power in the market. That situation has changed dramatically in the past year.
Micron now has its supply chain and inventory under control. Consumer demand for smartphones has recovered, and is expected to rise this year, in part due to the tax cuts.
Furthermore, Micron has developed leading-edge products, like solid-state hard disk drives and low power consumption flash memory chips. The company’s future looks promising.
Even the brokerage community is singing Micron’s praises.
Just last week, Evercore ISI lifted its price target on Micron stock to $80 from $60, claiming that the company’s proprietary technology would shield it from another round of pricing wars in the memory market.
Analysts at Nomura also issued a bullish research note, nearly doubling its price target to $100 from $55.
Overhyped, Overbought … a Dangerous Combination
One thing that investors don’t typically realize is that analysts are looking at a long-term time frame. Those price targets are set one, sometimes two years out.
Following the recent Micron hype, the shares have skyrocketed. MU stock is up a whopping 59% since February 9, more than doubling the gains of its peers in the semiconductor sector.
That’s wonderful if you were holding MU stock prior to the rally, or if you presciently bought the bottom. The problem now is that Micron stock is significantly overbought.
The stock’s 14-day Relative Strength Index is hovering just shy of 80, with 70 typically considered the upper limit by technical analysts. What this means in layman’s terms is that many investors are going to start looking for an exit to preserve their gains.
Another technical indicator is signaling that Micron stock could plunge by as much as 13% in the next couple of weeks. Specifically, MU shares have created what is known as a “bump and run” reversal pattern.
In short, a bump and run occurs when a stock that is already in a bull uptrend sees a significant bump in its price.
The trend line for the new “bump” rally is usually at an angle of between 30% and 45% sharper than the former bull rally. This new bump rally then stalls out, and sends the shares plummeting as the hype quickly evaporates and profit-taking leads to full on selling.
As you can see from the chart below, MU is currently near the top of this “bump and run” pattern:
The good news for Micron investors is that this is a short-term pattern. Support for MU should emerge in the $48 to $50 region, potentially cutting the “run” phase short. Micron’s longer-term uptrend should remain intact, allowing bulls who missed out on the initial rally to buy in at a 13% or greater discount.
That said, Micron will release its second-quarter earnings report on March 22. The proximity of this report adds volatility to MU stock.
In fact, weekly March 23 option implied volatility is pricing in a move of nearly 10% for Micron stock following the company’s earnings report.
Regardless of how well Micron performs in this trip to the earnings confessional, if the numbers don’t live up to the hype, the “run” phase of the “bump and run” pattern could send the stock down even further … especially if the shares don’t work off their overbought status before the report hits.
If you’re feeling adventurous, and have a high tolerance for risk, you could profit from Micron’s coming correction by purchasing an April $57.50 put. This Micron option was last going for about $3, or $300 per contract. That would put breakeven on the trade at $54.50 with a double, or 100% gain, on a trade below $51.50.
Remember, this is a highly speculative trading idea ahead of earnings. The risk is high, so buyer beware. Never risk any amount of money you aren’t willing to take a total loss on when it comes to options trading.
The iShares S&P NA Tec. Semi. Idx. Fd.ETF (SOXX) fell $2.27 (-1.18%) in premarket trading Monday. Year-to-date, SOXX has gained 13.67%, versus a 2.75% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of Banyan Hill.