This article is a part of InvestorPlace’s Best ETFs for 2018 contest. Dana Blankenhorn’s s pick for the contest is the VanEck Vectors Semiconductor ETF (NYSEARCA:SMH).
Despite an excellent showing in the first quarter, recent threats by the Donald Trump Administration to launch a trade war are worrying the shares of the VanEck Vectors Semiconductor ETF (NYSEARCA:SMH).
I picked this as my best ETF for 2018 and through the first quarter of the year it is up 7%. That’s easy to do when your holdings include Nvidia Corporation (NASDAQ:NVDA) and Lam Research Corporation (NASDAQ:LRCX).
The tech slam of March 27 hit the group hard, however, and no sector is as dependent on free trade. Semiconductors are mostly made in Asia with American intellectual property and equipment. Companies like Lam provide the equipment, companies like Nvidia provide the designs, and companies like Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM) provide the land and labor.
It would take years for this sector to adjust to tariffs, and America’s position in the industry would be at risk if a trade war broke out.
Beauty of an ETF
Remember, however, that in my original article about this ETF I called this a long-term call. The beauty of an ETF is that it’s aimed at sectors, not nations.
If Chinese companies come to dominate the semiconductor business because they control production, an ETF like this is designed to automatically rotate into those stocks. The managers aren’t picking stocks. They are picking an industry and letting the market pick stocks.
Thus, as a company like Qualcomm, Inc. (NASDAQ:QCOM) loses ground after its merger with Broadcom Ltd (NASDAQ:AVGO) is broken up by the government, its weighting in the ETF is reduced. SMH is tracking the MVIS US Listed Semiconductor 25 Index, so as the weights of stocks within the index rise and fall, the fund is matching the moves.
A stock picker would operate differently. Right now, I’d probably be grabbing Qualcomm because it’s cheap, and I might be dumping Nvidia because it’s dear. An ETF doesn’t operate that way. It merely follows the index, and the weighting of companies within the index, buying what’s rising and selling what’s falling.
This means the ETF is going to be burned by events like the Qualcomm merger failure, but if the whole chip sector is prospering, its investors are prospering, and for the first quarter of the year that’s what has been happening.
The question for this quarter is whether the Trump Administration is serious about a trade war with China, and how that might impact the semiconductor industry as a whole.
If it is serious, as I noted, there could be rough times ahead, at least for a while. Trade wars are bad for companies and other living things. Tariffs raise prices by raising costs and cut demand.
Much of how you should deal with the SMH ETF in the short term depends on your own investment time horizon. I’m 63. I can’t wait out a trade war. If you’re 36, you can, and you should. Demand for what chips do is going to continue to grow on a global scale, and the U.S. is not the only market. If we let the Chinese take the market by getting into a fight against factories they own, they’ll find other buyers.
But in the end, SMH should be fine.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.
