By Jacob Sonenshine

Chip and software stocks have dropped to alarming levels.

The iShares Semiconductor Exchange-Traded Fund -- home to the likes of Nvidia, Broadcom, Advanced Micro Devices, Micron Technology, Qualcomm and Texas Instruments -- is down 13%, to $205 from $235.

And the iShares Expanded Tech-Software Sector Exchange-Traded Fund -- think Microsoft, Salesforce, Oracle, Palantir and Adobe -- is down 10% to $96 from $107.

For the chip names, the free-fall picked up this week when President Donald Trump put a March 4 start date for tariffs on imports from three countries: China, 10%, and Mexico and Canada, both 25%.

The new tariffs create a worry for tech: Moving chips into the U.S. will become more expensive, which probably will create a domino effect -- higher chip prices, then higher prices for smartphones and other electronics, and finally a drop in consumer demand.

Apple and other electronics companies, for example, could find themselves cutting their chip purchases. That spells a hit to earnings for chip makers.

That's why the semiconductor ETF is below a key "support" level, a price that buyers usually come in to support the stocks. For almost the past six months, these stocks enjoyed support between $211 and just above $220.

Trump's tariff news drove the stocks down, breaking below support to the current level. Buyers didn't rush in. On the contrary, a wave of selling took hold, which suggests to traders that something has changed -- and not for the better.

"Worrisome is the poor behavior in most Semis," wrote Frank Gretz, technical analyst at Wellington Shields.

The next support level is roughly the $200 range. Buyers have swooped in every time since January 2024. But there's no guarantee they'll save the day this time around.

Consider the fund's chart. The price looks like it has fallen off a cliff. It stabilized Friday, but still isn't close to reclaiming the key $211 level it marked before this selloff. All it would take for the fund to break below $200 would be cautionary commentary from management teams on the outlook for demand because of tariffs.

Then, the next stop would be $185, given support levels on the chart. That represents another 10% drop.

That is a very real possibility, given what these stocks may fundamentally be worth. A $185 price suggests 20 times aggregate earnings that analysts covering companies in the ETF expect to generate over the coming 12 months, down from 22 times today. There's precedent for a 20 times multiple, given that it traded below there in late 2023 after a drawdown.

Nvidia is the fund's second largest holding. If it keeps dropping, so could the ETF. Tariffs are potentially an issue for the company and Wall Streets needs evidence of improving gross profit margins.

Nvidia management mentioned as much this week, when it reported an earnings beat but projected a first-quarter drop in gross margins from 2024.

The outlook is for gross margins to tick up throughout the year, but the market needs to see hard evidence of the uptick, given that Nvidia's prices -- and in turn its margins -- are threatened by artificial-intelligence chips from new market rivals such as Advanced Micro Devices and Broadcom. If gross margins don't recover, analysts would reduce their earnings estimates, further pressuring the stock.

For software stocks, there's a similar worry about support levels, though less so -- and for slightly different reasons.

The fund is down 10% to $96 -- a red flag because it had held support between $97 and $100 all year. The break below puts $92 in play, the next support level. That is another 5% drop.

Tariffs aren't as much of a worry for the software sector simply because the companies don't import goods. Still, it is possible their corporate customers could eventually curb their tech budgets if tariffs hurt consumer demand hard.

So the worry for software companies is frankly because of their own success. They have had a great run the past few years and are one of the market's most expensive sectors by their price-to-earnings ratios.

The software fund trades at 33 times expected earnings for the coming 12 months, 12 points above the S&P 500's 21 times. If multiples across the board fall, chances are software multiples will drop, too.

Importantly, software stocks, in tandem with chip names, account for a huge portion of the S&P 500.

If you're a dip buyer, all this means proceed with caution. You'll probably need to be patient.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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February 28, 2025 13:39 ET (18:39 GMT)

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