Chip stock weakness raises worries about AI rally-strength, leveraged trades

A selloff of the biggest winners of the recent stock-market rally, such as high-flying chip stocks, is sparking fresh concerns about the sustainability of the AI-driven surge and whether investors have overextended themselves. Jitters in semiconductor stocks were felt from Seoul to Europe as investors 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 .SOX is down about 9% this week, on pace for its largest weekly fall in over a year. The index was down nearly 20% from its late June all-time high, a move that would indicate 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. Analysts have highlighted several reasons for this month's sharp reversal. Chinese AI startup Moonshot unveiled Kimi K3, a 2.8 trillion-parameter 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 report on Thursday suggested Alphabet's GOOGL.O 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 .SPX by more than two-to-one this year, the S&P 500 Momentum Index .SP500MUP, which tracks S&P 500 stocks with consistent strong performance, has pulled back 10% in July, compared to a 0.8% drop in the broader market. This happened despite strong forecasts from the world's largest chip manufacturer, Taiwan's TSMC 2330.TW and European semiconductor equipment maker ASML ASML.AS. Some semiconductor exchange-traded funds have recorded steeper drawdowns. The Direxion Daily Semiconductor Bull 3X ETF SOXL.P had slumped 57% from its late-June peak as of Friday morning, although it remained up over 200% on the year. 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." 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, noting that the activity was in line with trends seen over the past couple of weeks. On Friday, Nvidia NVDA.O shares were 1.6% lower, while Advanced Micro Devices AMD.O slid 3.2% and Applied Materials AMAT.O fell 4.8%. Memory chip darlings Micron MU.O and SanDisk SNDK.O erased early losses to trade slightly higher. SpaceX SPCX.O dropped 4.6%, as a last-second abort of Starship's 13th flight test piled more pressure after the stock slipped below the $135 IPO price this week. SK Hynix's U.S.-listed shares SKHY.O 000660.KS briefly dropped below their offering price, before reversing losses to trade 2% higher. The focus now shifts to earnings reports from two of Wall Street's Magnificent Seven. Alphabet GOOGL.O and Tesla TSLA.O are scheduled to announce quarterly earnings next week, along with semiconductor company Intel INTC.O.

Chip stock weakness raises worries about AI rally-strength, leveraged trades

Chip stocks sell off after a strong rally

AI spending and valuation doubts intensify

Leverage concerns rise as traders watch earnings

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