By Johann M Cherian, Saqib Iqbal Ahmed and Lewis Krauskopf
July 17 (Reuters) – A brutal week for chip stocks — the same names that fueled this year’s blistering market rally — has left investors from Seoul to Silicon Valley asking whether the AI boom became over-leveraged and got ahead of itself.
Investors from Asia to Europe pulled back from AI-exposed stocks and so-called momentum names that had powered portfolio returns through much of this year.
The Philadelphia SE Semiconductor Index dropped 1.6% on Friday. For the week, it sank about 10%, its largest weekly fall in over a year. The index ended Friday down just over 20% from its late-June all-time high, a move that confirms it has been in a bear market.
“The pullback reflects profit-taking and rising scrutiny of AI capex sustainability,” said Toni Meadows, head of investment at BRI Wealth Management. “Valuations in semiconductor stocks had priced near-perfect demand, for what has been a cyclical area in the past, so was always going to leave stocks vulnerable at some point in what has been a rapid rise.”
The chip index remains up more than 60% for the year.
“I don’t think it has really anything to do about fundamentals as much as just repositioning of portfolios and just taking profits in stocks that have gone crazy,” said Chuck Carlson, chief executive officer at Horizon Investment Services in Hammond, Indiana.
CHINESE STARTUP TURNS FOCUS TO AI SPENDING
Analysts have highlighted several reasons for this month’s sharp reversal.
Chinese AI startup Moonshot unveiled a model that it said is the world’s largest open-weight AI system, rekindling investor scrutiny of the pace of potential returns from hefty AI investments by U.S. tech companies.
A Bloomberg report on Thursday suggested Alphabet’s Google is months behind schedule on the release of Gemini 3.5 Pro, its most powerful flagship AI model.
Traders have faced a volatile start to July: South Korea’s KOSPI showed it was in a bear market last week despite being up nearly 62% for the year, Japan’s Nikkei fell into correction territory on Friday, and Europe’s tech sector is among this week’s top losers after its biggest quarterly jump since 2001 in June.
After outperforming the benchmark S&P 500 by more than two to one this year, the S&P 500 Momentum Index, which tracks S&P 500 stocks with consistently strong performance, has pulled back 11% in July, compared to a less than 1% drop in the broader S&P 500.
Some semiconductor exchange-traded funds have recorded steeper drawdowns. The Direxion Daily Semiconductor Bull 3X ETF has slumped more than 50% from its late-June peak, although it remained up over 200% on the year.
LEVERAGE WORRIES
The sector weakness raised concerns about investors being overextended or highly leveraged.
Tony Pasquariello, head of hedge fund coverage at Goldman Sachs, said in a note to clients that leverage has built up across the marketplace, seen for example in a rise in retail margin, the assets under management of levered ETFs and the volume in short-dated options.
Large hedge funds that typically use leverage to take bigger swings at the markets to boost returns have in recent weeks reduced their exposure to top AI infrastructure players, according to executives at banks that cater to hedge funds.
“People got way overextended on these names,” said Walter Todd, chief investment officer at Greenwood Capital in South Carolina. “There are a lot of people under the impression over the last couple of months that these stocks only go up. And if they borrowed money to buy the positions, then they (could be) getting called out of them.”
Still, options traders seemed more focused on buying the dip and rotating into less crowded corners of the market than on retreating from stocks altogether.
“Investors have generally been rotating rather than broadly reducing risk,” Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group, said.
Some of the hottest chipmakers, including SK Hynix, Micron Technology, and SanDisk even drew some bullish options action around midday.
“This suggests that a short-term oversold bottom may be in,” said Brent Kochuba, founder of options analytic service SpotGamma.
HARD-HIT SHARES
On Friday, Nvidia shares finished 2.2% lower, while Intel dropped 2%, and Applied Materials fell 5.6%. Memory chip company Micron slipped 0.5% and SanDisk closed down 4%.
SpaceX dropped 5.4%, as a last-second abort of Starship’s 13th flight test piled more pressure after the stock slipped below the $135 initial public offering price this week.
SK Hynix’s U.S.-listed shares briefly dropped below their offering price before reversing losses to finish modestly higher.
The focus now shifts to earnings reports from two of Wall Street’s Magnificent Seven. Alphabet and Tesla are scheduled to report quarterly earnings next week, along with semiconductor company Intel.
(Reporting by Saqib Iqbal Ahmed, Anirban Sen and Lewis Krauskopf in New York, Johann M Cherian and Shashwat Chauhan in Bengaluru; Editing by Sriraj Kalluvila, Megan Davies, Rod Nickel)
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