Chip stocks are wilting after a stunning rally, and it’s bad news for the tech sector

Semiconductor stocks are breaking down after posting their best year since the financial crisis, and this has negative implications for the broader technology sector.

The VanEck Vectors Semiconductor ETF (SMH) is barely positive since the start of 2018, just coming off two months of losses and mired in a relatively weak start to the year for tech stocks. The SMH surged 36 percent last year, its best year since 2009, with holdings like Nvidia and Micron soaring north of 80 percent in that time.

To be sure, the group rose modestly on the heels of Apple's strong quarterly earnings report Tuesday after the bell. The SMH rose nearly 1 percent and moved higher in Wednesday's premarket. These better-than-expected earnings should help the chip stocks, so this could be a nice catalyst. However, we have to wait to see how Apple shares trade throughout Wednesday. It was up more than 3.5 percent in Wednesday's premarket. If it holds up, this should bode well for the chips; if Apple fades, it will present problems for the chips.

The entire group has proved key leadership since the 2016 election, and the weakness lately is raising concern about the tech space. Of course, semiconductors are vital to the electronic devices that have become such an important part of our everyday lives, whether it be your desktop computer or cellphone; all of these devices are dependent on semiconductor technology. Without semiconductors, none of these devices would be possible … and our lives would be much different.

Consider the SMH relative to the broad S&P 500 technology index. The two traded tick-for-tick for many years leading up to the election. Since then, however, the chip stocks have outperformed for the most part. If the SMH rolls over and begins declining meaningfully, it should lead the broader group lower with it.

When examining the SMH on an absolute basis, one can see its 14 percent decline since March has taken it down to its 200-day moving average, and down near its February lows. Thus, any further decline would give the group a key "lower low."

The SMH did rally almost 150 percent over the two years prior to this current correction. Considering this, a 14 percent decline is not a major move. If the group can in fact bounce soon, this will show the recent pullback is a normal, healthy correction within a long-term bull market. But if it falls further from current levels, this would raise a warning flag on the semiconductors, and the broad tech sector, too.

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