AI Chip Rally Takes Sharp Plunge as Valuations Come Under Intense Scrutiny

AI Chip Rally Takes Sharp Plunge as Valuations Come Under Intense Scrutiny​

The global frenzy surrounding artificial intelligence (AI) and semiconductor stocks faced a significant setback last week. A broad selloff led to widespread profit booking across numerous AI-linked equities that had driven substantial market gains throughout 2026. Investors are now reassessing the ambitious expectations associated with ongoing massive capital expenditure in the AI infrastructure space.

Semiconductor Sector Enters Bear Market Territory​

The Philadelphia Semiconductor Index (PHI) fell 1.6% on Friday, marking a steep decline and extending its weekly drop to around 10%. This descent represents one of the steepest weekly drops recorded in over a year. The PHI has now fallen more than 20% from its record high achieved at the close of June, officially breaching into bear market territory.

Despite this correction, the sector remains robust for the year, trading more than 60% higher overall. Market participants attribute the decline to a combination of necessary profit-taking and heightened investor caution following the rapid surge in semiconductor shares over recent months. Investors are closely scrutinizing whether current AI infrastructure spending pace justifies the elevated valuations across the industry.

Key Catalysts Spark Investor Caution Over AI Spending​

The weakness in the sector was fueled by several high-profile developments and competitive pressures. Chinese AI startup Moonshot announced what it described as the world's largest open-weight AI model, intensifying market questions regarding future returns on investment for major U.S. technology corporations.

Adding to investor concern, a report from Bloomberg indicated that Alphabet’s Google is facing delays in the anticipated launch of its flagship Gemini 3.5 Pro AI model. These developments have led analysts to scrutinize the sustainability and pace of massive AI-related capital expenditure across the industry.

Momentum Investing Faces Retrenchment Amid Leverage Warnings​

The correction was not isolated to U.S. markets; South Korea's KOSPI entered bear market territory last week, though it remains sharply higher for the year. Japan’s Nikkei also slipped into correction territory while European technology stocks came under pressure after posting their strongest quarterly performance since 2001 in June.

Momentum investing has also shown signs of fatigue. The S&P 500 Momentum Index, having significantly outperformed the broader S&P 500 this year, retreated about 11% in July and is significantly underperforming its benchmark index. Leveraged semiconductor products experienced even steeper declines; the Direxion Daily Semiconductor Bull 3X ETF has fallen more than 50% from its late-June peak, though it maintains gains exceeding 200% for the year.

Leverage Concerns Rise as Banks Note Large Fund Reductions​

The market correction has also revived concerns regarding financial leverage across various segments. Goldman Sachs noted rising leverage in multiple areas, including increased assets under management in leveraged exchange-traded funds and elevated short-dated options activity.

Executives at banks serving hedge funds confirmed that several large funds have recently reduced their exposure to leading AI infrastructure companies after having aggressively built positions earlier this year. Despite these negative signs, derivatives markets suggest that investors are rotating portfolios rather than abandoning the equities segment altogether. Options activity showed continued interest in buying semiconductor stocks following the correction, with names such as Micron Technology and SK Hynix attracting bullish options positioning on Friday.

Individual Stock Performance and Future Earnings Outlook​

Among individual stock performance, Nvidia fell 2.2% on Friday, while Intel declined 2%. Applied Materials slipped 5.6%, and SanDisk dropped 4%. Meanwhile, Micron slid 0.5% as part of the downturn. SpaceX shares also fell 5.4% after its Starship test flight was aborted last minute, putting additional pressure on the stock which recently traded below its initial public offering price.

U.S.-listed SK Hynix managed a recovery from early losses to close modestly higher after briefly trading below their offering price. Investor attention is now turning keenly toward the upcoming earnings season. Quarterly results expected soon from Alphabet, Tesla, and Intel will be closely watched by Reuters for fresh indications on AI spending plans and demand for semiconductor products, determining whether this correction is merely a pause or a broader reassessment of the AI investment theme.