Trading Nation

Obscure index could hold the key to the market's next move

Key Points
  • The Taiwan Plastics index could prove to be somewhat of a barometer of market health
  • Plastics and semiconductor stocks are often tightly correlated, though they have recently diverged
  • The index could signal problems short term for semi stocks, which have surged this year
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The obscure index that could determine where stocks are going next

Investors track plenty of different indicators to gauge market health — gross domestic product projections, garbage or how the bulls and the bears are feeling.

But it's an obscure and perhaps overlooked index that could point to where stocks go next.

The Taiwan Plastics index, comprised of 23 plastics manufacturer stocks, is tightly correlated to the Philadelphia Semiconductor Sector index, or the SOX; both indexes' components are heavily related to semiconductor manufacturing. Three stocks in particular weigh heavily on the Taiwanese index — Formosa Plastics, Nan Ya Plastics and Formosa Chemicals & Fibre.

"The thing is, there's a lot of plastics in the semiconductors, and whenever that moves, they tend to move in tandem. Every once in a while, you see a divergence take place, and usually the leading indicator is this Taiwanese plastics index," Matt Maley, equity strategist at Miller Tabak, commented. "It's not a real problem yet, but a divergence has been created."

For example, early last year, the plastics index began rallying while the semiconductor stocks declined. Shortly thereafter, the semiconductors bottomed and began a substantial rally that's continued to this day. Now, Maley sees a similar dynamic at work, but in the opposite direction.

The plastics index has begun to "roll over," he said, falling 6 percent from its 52-week high. Meanwhile, the semiconductor index is up 10 percent year to date. According to Maley's chart work, if history holds, the semi stocks could soon follow the plastics lower.

"There's reason to worry about the semiconductors over the short-intermediate term," for precisely this reason, Maley wrote to CNBC in an email Friday.

Plastics account for a sizable 8 to 9 percent of Taiwan Stock Exchange market capitalization, third in size after technology and financials, pointed out Leo Lee, analyst at Yuanta Research Taiwan.

"I think [plastics] can be representative of greater market health, but not as much as semi stocks do," Lee wrote to CNBC in a recent email.

Andrew Gillan, head of Asia ex-Japan equities at Henderson Global Investors, said the correlation may have been pronounced over 10 years ago, "but now technology and the Apple supply chain particularly play a much more important part in Taiwan's stock market."

Indeed, Apple could be a driver of many of the semiconductor companies which supply parts for the iPhone. Apple is the largest stock in the by market capitalization, which could further explain the correlation between the indexes.

To be sure, not all analysts and strategists track the index, but they didn't dispute its potential impact on the market.

Market watchers pay close attention to semiconductor stocks, as they are often viewed as a barometer for technology in general. Technology is the largest sector in the S&P 500.

"There is definitely a strong relationship between the semiconductors and the overall market, and if you look right now at the trends underlying the semiconductor index, you've seen rising earnings, and that … has really been the result of some tremendous sales, I mean the sales numbers in the semiconductors space has been really rock solid over the last year," Gina Sanchez, CEO of Chantico Global, said Friday on CNBC's "Trading Nation."