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Watch This Chart to See What's Next

Posted July 25, 2022

Zach Scheidt

By Zach Scheidt

Watch This Chart to See What's Next

We're at an important crossroads for investors this week.

A summer rebound took a bit of the sting out of the current bear market. And the rally gives us some hope that we could be in a bottoming process.

But what can we really expect for the rest of the summer? Will this bear market rally lead to a brand new bull market or is this just another rebound to give us false hope?

There are a lot of variables to consider.

We're in the middle of earnings season, the Fed is about to announce another rate hike, second-quarter GDP estimates also come out this week, and there’s no shortage of geopolitical and economic concerns to keep track of.

But despite all of these crosscurrents, there's one chart I'm watching that will give us the best indication of what to expect this summer.

So today, we're going to take a look at that chart and I'll explain why it is so important.

The Most Important Indicator for Today's Market

Over the weekend, I posted this chart of the VanEck Semiconductor ETF (SMH) on my Twitter feed

I also included a thread explaining why it’s the most important indicator I'm watching this week. You can use the link above to read more.

chart

(By the way, I find Twitter to be a good place to post some of my day-to-day thoughts on what's happening in the market. So feel free to follow me there and see the thoughts I post throughout the week.)

This chart shows us how a basket of semiconductor (or computer chip) stocks are trading. And as you can see, this group of stocks has traded steadily lower this year.

Computer chips have become an incredibly important part of our global economy.

These days, it seems like you can't buy anything that doesn't need a computer chip (or ten) to operate. So if the economy is growing, demand for computer chips will expand.

Years ago, investors would watch transportation stocks for clues about what was happening next in our economy. 

If railroads, container ships, and planes were in high demand, it meant the economy was growing and people were buying things.

Today, computer chip stocks have become the new barometer for economic activity. And they tell us even more about how the economy is doing than transportation stocks did.

If consumers are buying, factories are humming along and expectations are strong, orders for new computer chips will come pouring in.

Professional investors watch these dynamics carefully and buy computer chip stocks when the environment is strong.

So if we see computer chip stocks trade higher, it's basically an all-clear sign for the rest of the market!

Challenging the Downtrend Line

Here at Rich Retirement Letter, we've been watching for this bear market rally. And hopefully, you've been able to book some healthy profits as stocks have rebounded.

But now that the market has moved higher for a few weeks, we need to manage our risk carefully.

If stocks turn back lower again, you don't want to be holding speculative names that could lose a lot of value. 

Instead, it's best to be invested in high-quality companies that generate reliable profits — and preferably pay a generous dividend.

It's also helpful to have some extra cash on the sidelines. This can help protect the value of your retirement savings and give you some "dry powder" to buy great stocks that may go on sale.

But before you fully put the defensive team back on the field, let's watch what the semiconductor index does this week.

In the chart above, I've drawn a trendline that simply shows the path that semiconductor stocks have taken over the last several months.

Active traders watch trendlines like this for clues about when to buy and when to sell. So while the lines aren't magic, they do give us an indication of what other investors may do.

If the semiconductor ETF trades higher over the next week, it will break above the bearish trendline. And that kind of break would be incredibly bullish.

This break could trigger a new wave of buy orders that could extend this bear market rally much higher.

On the other hand, if the semiconductor ETF turns lower this week, it will be a sign that the overall downtrend is still intact. And that could send active traders into a selling frenzy.

Since we're right in the middle of earnings season — with a lot of important tech names set to report this week — I expect plenty of action.

So if you're an active trader or just looking for some clues to how to invest your money in the second half of this year, keep a very close eye on the VanEck Semiconductor ETF.

And once again, if you want to see my thoughts as the situation continues, be sure to follow me on Twitter.

Here's to living a Rich Retirement,

Zach Scheidt

Zach Scheidt
Editor, Rich Retirement Letter
RichRetirementFeedback@StPaulResearch.com

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