AI chip stocks enter bear market as leveraged trades unwind
A sudden 20% drop in semiconductor stocks from their June peak marks a bear market, driven by the forced unwinding of leveraged AI trades and rising doubts about tech capital expenditure returns.
The Philadelphia SE Semiconductor Index fell 1.6 per cent on Friday, capping a brutal 10 per cent weekly decline that pushes the benchmark more than 20 per cent below its late-June record. This technical threshold confirms a bear market for the chip sector, which had been the primary engine of global equity gains this year. Despite the severe drawdown, the index retains a year-to-date gain of over 60 per cent.
The velocity of the drop has exposed dangerous levels of leverage built up during the rally. Tony Pasquariello, head of hedge fund coverage at Goldman Sachs, warned clients that leverage has surged across the market, evident in rising retail margin debt, expanding levered ETF assets and heavy short-dated options volume. Large hedge funds have reportedly been reducing their exposure to top AI infrastructure names in recent weeks.
This deleveraging is inflicting concentrated pain on the most crowded trades. The Direxion Daily Semiconductor Bull 3X ETF has collapsed more than 50 per cent from its late-June high. "People got way overextended on these names," said Walter Todd, chief investment officer at Greenwood Capital. "And if they borrowed money to buy the positions, then they (could be) getting called out of them."
The fundamental triggers for the sell-off center on the economics of artificial intelligence. A new model from Chinese startup Moonshot, billed as the world's largest open-weight AI system, has intensified investor skepticism regarding the pace of returns on massive U.S. tech capital expenditure. A separate report indicated Alphabet is months behind schedule on its flagship Gemini 3.5 Pro model.
For many market professionals, the correction was inevitable given the rapid ascent of valuations. "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. Still, Toni Meadows, head of investment at BRI Wealth Management, pointed out that the pullback also reflects rising scrutiny of AI capex sustainability, noting that valuations had priced in near-perfect demand for a historically cyclical sector.
However, derivatives markets suggest the situation is a rotation out of crowded momentum plays rather than a wholesale liquidation. The S&P 500 Momentum Index has dropped 11 per cent this month, vastly underperforming the broader S&P 500's sub-1 per cent dip. "Investors have generally been rotating rather than broadly reducing risk," noted Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group.
Options traders actively bought the dip on Friday in names like SK Hynix, Micron Technology and SanDisk. "This suggests that a short-term oversold bottom may be in," said Brent Kochuba, founder of SpotGamma. Market attention will now pivot to next week's earnings releases from Alphabet, Tesla and Intel to determine if the AI growth narrative can survive the leverage purge.
