The chip sector has been on fire lately. The VanEck Vectors Semiconductor ETF (NYSEARCA:SMH) just set a new all-time high last week when it almost hit $121. This was the target of the technical breakout from $107 per share. So a dip here, if it comes, is part of normal price action as nothing goes up forever in a straight line. This morning, Western Digital (NASDAQ:WDC) is making sure the rally stalls as it’s falling on its earnings headline.
WDC stock is putting pressure on the whole sector. This comes after last week’s negative reaction to the Xilinx (NASDAQ:XLNX) earnings.
The main concern for the bulls is that last week’s highs may have marked the top for the sector for a while. I doubt it is the case as this will turn out to be a reset effort from the bulls.
Wall Street has a habit of overshooting in one direction then the other. In this case, the chip sector received too much love from investors so it was inevitable for the trend to reverse a bit to gather more steam. The important part is that this doesn’t turn into a full-blown correction.
So is this dip in WDC off its earnings a buying opportunity? Not yet.
Before you send me hate mail, this is not a condemnation of the company’s prospects but rather an evaluation of the short-term stock action. In fact, I don’t believe that the negative reaction today changes the thesis. I merely believe that there is no rush to buy the dip in WDC today.
Last night, Western Digital management reported earnings and they badly missed the mark. Investors hated what they saw, so they sold WDC stock down 6% on the headline. Management did not seem worried but that’s not what investors heard so they sell now and ask questions later.
The good news is that WDC stock just capped a 65% rally off the December bottom, so it has some room to give back without creating additional technical damage.
Fundamentally, Western Digital is not cheap as it sells at a price-to-earnings ratio of 18X. While this sounds low in absolute terms, it’s high relative to the sector. Micron (NASDAQ:MU) and Seagate (NASDAQ:STX) sell at P/E’s less than 5X and Applied Materials (NASDAQ:AMAT) at a P/E of 11X.
So while the drop in WDC will eventually turn out to be a buying opportunity, I’d rather avoid this falling knife now. The chip sector tends to trade in unison, yet WDC stock continues to lag.
For the past two years, while the SMH and stocks like MU, Intel (NASDAQ:INTC) and Nvidia (NASDAQ:NVDA) are up 40% to 70%, WDC is down almost 50% for the same period. So, clearly, to catch this falling knife, I’d rather do it by proxy. Meaning, I’d rather go long the SMH ETF or another stock like Advanced Micro Devices (NASDAQ:AMD).
Bottom Line on WDC Stock
There is no need to be a hero and try to catch WDC, which cannot get above $55 per share. This has been strong resistance ever since the October earnings, and this was a giant ledge that is not likely to be easy to recoup. Management will need to give investors a tangible reason to break through it.
Meanwhile, the first order of business for the WDC bulls is to hold the support.
The area around $45 per share has been a point of interest for over a year. This means that it will be where bulls and bears already agree on price so they will fight it out hard. This congestion in pricing will act as support on this dip. If the bears prevail then WDC could target $38 per share next. While this is not a forecast, it is a scenario that the bulls need to know exists.
But here is the best news of all. This same exact scenario happened three years ago when the stock fell from $110 per share and bottomed behind strong support from the $45 point of interest zone.
What followed was a massive rally back up to $100. While we cannot expect the exact scenario to happen this time, it does suggest that if you arealready long Western Digital stock, you should wait out the current battle.
As far as going long WDC to catch the rally, I bet that if WDC is spiking, then so is the whole sector. And if you ask me, there are simply better names to own.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on Twitter and Stocktwits.