The U.S. semiconductor sector is experiencing a significant correction after a surge driven by memory chip stocks.
The Philadelphia Semiconductor Index fell as much as 5.7% during Friday's session, and although it pared losses to close down 1.6%, the cumulative retreat from its late-June record high has reached 20%, officially entering a technical bear market.
This follows a remarkable 105% rally from its March low to the June peak, effectively doubling in just three months.
Several leading chip stocks have recently been in a sustained decline, with Micron Technology Inc (MU.US), Arm Holdings PLC (ARM.US), and Intel Corporation (INTC.US) each down more than 30% from their respective highs.
James Abate, Chief Fundamental Strategist at Horizon Investments, noted that while industry fundamentals remain solid, stock prices have risen much faster than the underlying improvement in fundamentals.
The semiconductor index's previous "parabolic" rise makes the current pullback unsurprising, according to Abate.
Simultaneously, concerns about the sustainability of the AI investment boom are resurfacing.
Investors are beginning to question whether hyperscale cloud providers like Microsoft Corporation (MSFT.US), Amazon.com Inc (AMZN.US), and Meta Platforms Inc (META.US) can continue their massive, multi-trillion dollar AI infrastructure capital expenditures in the future.
Additionally, persistently high valuations in the semiconductor sector are raising fears that stock prices have already priced in future growth expectations.
Muneeb Muzaffar, Senior Portfolio Manager at Bold Wealth Partners, stated that while industry fundamentals are still strong, market expectations have clearly gotten ahead of reality.
Current valuations reflect the most optimistic growth scenarios, prompting investors to reassess what chip company earnings are truly worth and whether previously inflated growth forecasts need to be revised.
The coming weeks present a critical test for the AI supply chain.
Alphabet Inc (GOOGL.US) will kick off the earnings season by reporting quarterly results after the market close on July 22, followed by Microsoft (MSFT.US), Amazon (AMZN.US), and Meta (META.US) the subsequent week.
Their AI capital expenditure plans and returns on investment will be a major focus for the market.
Muzaffar indicated that the market needs to see clearer returns on investment from the AI spending of hyperscale cloud companies.
As long as capital expenditures continue to be validated, these companies will keep investing, and chipmakers will continue to benefit.
However, the combination of high valuations, market sentiment, and fund flows is making the sector's short-term trajectory more complex.
Memory chip companies, one of the leading segments in the recent rally, have not been spared.
As the market grows concerned about when supply can catch up with rapidly growing AI demand and whether profit growth can be sustained, Micron Technology (MU.US) has fallen 30% from its peak, while Western Digital Corporation (WDC.US) and SanDisk Corporation (SNDK.US) have dropped over 35%.
South Korea's Samsung Electronics reported quarterly profit that surged 19-fold year-over-year earlier this month, but its stock still sold off as the results failed to meet even higher market expectations, following a roughly 150% year-to-date gain.
The world's leading contract chipmaker, Taiwan Semiconductor Manufacturing Company Ltd (TSM.US), has also faced profit-taking.
Despite raising its full-year capital expenditure and revenue forecasts this week, its stock has fallen for seven consecutive sessions, dropping 8.8% in total and marking its longest losing streak since July 2022.
For the full year, however, the semiconductor sector continues to significantly outperform the broader market.
Year-to-date, the Philadelphia Semiconductor Index is still up approximately 65%, far exceeding the S&P 500's gain of about 9%.
According to aggregated analyst price targets for the index's 30 components, the market still broadly expects the index to rise around 34% over the next 12 months.
Abate suggests investors should not overreact to the current pullback.
"Even though the index is down 20% from its high, it's only back to where it was in May. There's no need to overreact," he said.
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