Shares in chipmakers and the semiconductor sector have recently experienced a significant pullback. The VanEck Semiconductor ETF (NYSE: SMH), a leader with over 37% gains year-to-date, has entered correction territory, falling over 15% from its 52-week high. This decline has affected several top holdings, including AMD, down nearly 40%; AVGO, down over 18%; and the sector's giant, NVDA, down almost 20% from its 52-week high. 

As the sector corrects amidst a broader market rotation and reallocation of funds, the question arises: has the pullback been overdone, and does it now present a compelling buying opportunity?

Causes of the Pullback

The industry has faced pressure since reports of potential stricter trade restrictions to prevent China from acquiring advanced semiconductor technology. The potential use of the foreign direct product rule could restrict sales of foreign-made products incorporating American technology, affecting companies like ASML Holding (NASDAQ: ASML).

Additionally, former President Trump's comments about Taiwan's financial obligations for U.S. protection and his skepticism about the U.S. commitment to defend Taiwan have added to market uncertainty. Moreover, after the recent CPI data suggested higher odds of rate hikes as soon as September, a significant sector rotation occurred. Capital flowed from tech and semiconductor stocks into previously lagging sectors such as small-caps, healthcare, and biotechnology.

Is It a Buying Opportunity?

The SMH ETF has pulled back sharply to a significant potential support level of around $230. From a technical analysis perspective, this pullback, now over 15% from its 52-week high, may offer a great buying opportunity with a favorable risk-reward ratio. The ETF's holdings have an aggregate rating of Moderate Buy based on 485 analyst ratings covering 25 companies. The ETF has an aggregate price target of $292.65, indicating nearly 22% upside potential.

Notably, the just-beginning AI boom is a crucial driver for semiconductor growth. Semiconductors are integral to AI technology, and demand for AI will continue to drive growth in this sector. Recent earnings from Broadcom and Taiwan Semiconductor underscore this trend, with TSM reporting a 30% year-over-year net income increase primarily attributed to AI demand.

While short-term volatility may continue, especially with political uncertainties ahead, it doesn't diminish the semiconductor industry's long-term growth potential. 

Top Holdings Provide Key Clues

NVIDIA: Still Leading the Sector

As the top holding of the ETF, with nearly 20% weighting, NVIDIA (NASDAQ: NVDA) continues to lead the sector, especially in the AI chip and server markets. Recently, the company announced a new AI Foundry service, which will support Meta's Llama 3.1, enabling developers to build large language models using an open-source framework. This development highlights NVIDIA's dominant AI position and ability to drive growth through cutting-edge technology.

Taiwan Semiconductor Manufacturing: Impressive Earnings Despite a Dip

Taiwan Semiconductor Manufacturing (NYSE: TSM), the second-largest holding in the SMH ETF, has fallen over 16% from its 52-week highs. Despite the recent dip, the company reported impressive quarterly earnings on July 18th, 2024. TSM posted $1.48 earnings per share (EPS), surpassing analysts' estimates of $1.37 by $0.11. The company generated $20.82 billion in revenue for the quarter, exceeding the consensus estimate of $20.33 billion, and reported a 34.6% increase in revenue compared to the same quarter last year. This strong performance underscores the growing demand for semiconductors, driven by the booming AI industry.

Broadcom: Strong Growth Reflects Sector's Potential

Broadcom (NASDAQ: AVGO), the third-largest holding in the ETF, also delivered robust earnings. On June 12th, 2024, Broadcom reported $1.10 EPS for the quarter, beating the consensus estimate of $1.08 by $0.02. The company generated $12.49 billion in revenue, exceeding the consensus estimate of $12.06 billion, with a 43.0% increase in revenue compared to the same quarter last year. Broadcom's strong financial performance reflects the sector's growth potential and the company's ability to capitalize on increasing semiconductor demand.

Semiconductor Sector's Growth and Resilience

These top holdings demonstrate the semiconductor sector's resilience and growth potential, even amid short-term market volatility. The robust earnings and positive outlooks from NVIDIA, TSM, and Broadcom suggest that the sector is well-positioned to continue its upward trajectory, driven by strong demand for AI and advanced technologies.