The VanEck Vectors Semiconductor ETF (NYSEArca: SMH) is up nearly 8% year-to-date, but that fund and rival semiconductor exchange traded funds have recently faced headwinds. Over the past week, SMH is lower by more than 3% and some market observers believe more downside is in store for chip stocks.

There are some risks to consider with semiconductor stocks and ETFs. For example, President Donald Trump has pushed for restrictions on trade barriers with China, which might pose a threat to the sector. China is a key market for the global semiconductor industry, consuming more than $100 billion worth of semiconductors or roughly one-third of the world population.

“We think it’s going to be a messy September for trade talks, so that’s the number one warning sign. But then, if you look at the seasonal factors, there are all kinds of red flags,” including elevated inventory levels, Larry McDonald, editor of the Bear Traps Report, said in an interview with CNBC.

Declines Coming for ‘SMH’ ETF

McDonald warned that SMH could see significant downside before the end of this year.

SMH “here could be a 20 percent drop by year-end; I think it’s a screaming sell. The risk/reward to being short is very, very positive, and the risk/reward to being long, because of the macro factors, is very, very negative,” he told CNBC.

Traders looking to bet on downside for chip stocks can consider the ProShares UltraShort Semiconductors (NYSEArca: SSG), which takes the -2x or -200% daily performance of the Dow Jones U.S. Semiconductors Index, and the Direxion Daily Semiconductors Bear 3x Shares (NYSEArca: SOXS), which provides a -3x or -300% performance of the PHLX Semiconductor Select Index.

Investors could be paying up for future catalysts for semiconductor and broader technology names. If there is a silver lining for the rising valuations on chip stocks it is that some industry observers believe the group’s valuations should not be measured in the traditional sense because of the evolution of the semiconductor business.

For more information on the tech segment, visit our technology category.

Subscribe to our free daily newsletters!
Please enter your email address to subscribe to ETF Trends' newsletters featuring latest news and educational events.