US Semiconductor Index and ISM Manufacturing Historically Diverge: The Gap Will Eventually Close, Direction Is Key

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Analysis indicates that high oil prices are already hurting the economy, and stock investors have almost no choice but to chase bubbles in sectors such as semiconductors.

The Iran conflict is far from resolved, the Strait of Hormuz remains effectively blocked, and the prospects for negotiations look extremely challenging. This prolonged standoff is bad news for oil-import-dependent Europe, continuing to drag down the market performance of its energy-intensive cyclical stocks. In contrast, regions with a higher weighting of tech stocks are outperforming, benefiting from a renewed market enthusiasm for the AI theme.

Barclays strategist Emmanuel Cau’s team stated:

Renewed enthusiasm for AI demand has driven significant gains in storage and semiconductor stocks, which have contributed the vast majority of recent gains in US and Asian indices, while European stock markets—which have a lower proportion of tech stocks and are more sensitive to energy—have been left far behind.

Capital spending by AI and hyperscale cloud providers continues to boost profitability throughout the supply chain, although valuations and positioning have become less forgiving. This makes this week’s intensive earnings risk more pronounced — given the highly concentrated returns structure in the US and Asian markets, Microsoft, Meta, Alphabet, Amazon, and Apple will all release Q1 earnings reports and update capex plans, which is expected to provide further validation for this trading logic.

Although this apparently severely stretched rally has pushed the SOX index into bubble territory, investors are chasing the theme. The SOX index has reached its most overbought level in more than five years and has completely decoupled from the ISM Manufacturing Index — a divergence that historically tends to eventually converge in some way.

BofA strategist Michael Hartnett’s team stated:

The upward breakout for semiconductors implies that the US ISM will soar from its current level of 52.7 to above 60.

Nevertheless, they still advise investors to keep buying chip stocks in Q2 this year. The team points out that, due to the geopolitical need to monopolize chips, rare earths, minerals, and oil in the AI war, they believe the tech bubble has finally reignited, and the market is looking forward to the largest wave of IPOs in human history.

In addition, although consumer stocks remain sluggish, strategists say Wall Street is still expecting the return of a nominal economic boom narrative. They note that Trump may shift toward affordability issues to win midterm elections, suggesting buying cyclical consumer stocks. In addition, they also recommend buying Chinese stocks and commodities themes.

Meanwhile, oil prices continue to dominate market trends, especially in Europe. The 120-day correlation coefficient between the European Stoxx 600 Index and Brent crude has now reached its most negative level since data began in 1990, with a reading close to -55. For the S&P 500 and WTI crude, the corresponding value is -36, the lowest since 1994.

The European economy is already feeling real pressure. S&P Global’s preliminary April PMI released last week showed that the global economy is enduring a new round of price pressures for the second consecutive month. Eurozone private sector activity was further hurt and Asia’s resilience now looks shaky. In contrast, US business activity has picked up, boosted by the strongest manufacturing growth in nearly four years — war-related supply disruptions triggered a buying spree among companies for materials.

Chris Iggo, Chief Investment Officer at AXA IM Core and Chairman of the Investment Institute at BNP Paribas Asset Management, stated:

From an inflation expectations perspective, market pricing still suggests a mild inflation uptick soon, followed by inflation gradually reflecting the marginal diminishing effect of higher energy prices. However, whether the market has fully factored in the potential shock to economic activity, supply chain disruptions, and margin pressure is currently unclear. The bull market in tech stocks is currently shielding stock investors from these concerns.

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