SMH and TAN could continue following historical patterns
Broad market indexes have surged over the last few months, with semiconductors leading the charge. Since the end of March, the VanEck Semiconductor ETF (SMH) is up over 60%, making it the top performer of the 34 sector ETFs I track. The table below lists the 10 sectors furthest above their 200-day moving average. SMH easily outpaces all other sectors, sitting more than 50% above the moving average. The next most overextended sector by this metric is the Invesco Solar ETF (TAN).
This next table ranks ETFs by their distance from their 50-day moving average. The iShares Software ETF (IGV) is first on the table with SMH trailing behind.
This week, I’m looking at historical instances when the ETFs extended above these moving averages. Let’s carefully consider whether to grab onto the high-flying sector or look elsewhere for solid returns going forward.
Post-Extension Sector Performance
Using my list of 34 sector ETFs, I found times their price reached 50% above their 200-day moving average, like SMH recently did. There were 16 prior instances with a summary of coinciding forward returns in the first table below. The second table summarizes the returns if you purchased the S&P 500 ETF (SPY) instead.
The returns are interesting and mixed suggesting volatility going forward. The ETFs averaged a 1% gain over the next two weeks beating the SPY 63% of the time. Though over the next month they were down 0.6% on average and beat the SPY only 33% of the time. At that time, the ETFs seemed to take off again because they averaged about 15%, and 22% returns over three and six months, respectively. The one-year average return of 18% seems fair but ETF returns beat SPY just 33% of the time over the next year.
Instead of buying the ETFs, if you purchased the SPY at this time, your returns would have been excellent, averaging 9.1% over the next six months with 93% of the returns positive and 18% over the next year with all 12 returns positive. Four of the prior 16 instance occurred less than a year ago (that’s why there’s 12 one-year returns instead of 16). It could be simple randomness that the broad market tended to do well when a particular sector took off. Or maybe there’s something to a sector performing so well that it somehow urges the rest of the market to catch up.
The table below lists the individual ETFs, dates and forward returns after they reached 50% above their 200-day moving average (only one signal every six months). SMH first hit the level a little less than a month ago. Looking at the rest of the table, it’s dominated by commodities like gold, silver, metals, and oil. In fact, the only non-commodity ETFs are solar in 2013, retailers in early 2021, and regional banks in early 2021. The recent AI boom causing a surge in semiconductor stocks might be unique, making these generalizations less relevant
That being said, let’s look at how sector ETFs performed after they reached 25% above their 50-day moving average. This requires a surge in a shorter timeframe. We have over 30 signals using this method with SMH signaling in early May, and TAN signaling just last Friday. The returns below paint a more intuitive picture of how these signals tend to play out. The surge above their 50-day moving average tended to lead to short-term pullbacks but then strong returns from then on. The ETF lost 3% on average over the next month with just 31% of them beating the SPY. At six months, the average return of the ETFs beat the SPY (13% to 11.5%), and then one year after these signals, the ETFs average a return of more than 35% with 61% of them beating the broad market.
Based on the results above, I might keep an eye on SMH and TAN. If they pullback over the next month, they may be following the typical pattern after these signals and that could be a good time to buy.