U.S. chip stocks are just one step away from a bear market.

AI-driven chip trading is experiencing a rapid cooldown. The Philadelphia Semiconductor Index has fallen about 19% from its June highs, just shy of confirming a bear market. Funds are beginning to withdraw from highly valued chip and memory stocks, rotating instead into sectors such as finance, retail, and transportation that directly benefit from economic resilience.

In Thursday's US stock trading, the Philadelphia Semiconductor Index dropped 4.3%, with all 30 constituent stocks falling from their record highs set on June 22. According to Dow Jones market data, if the index further falls to a range 20% off its peak, it will confirm entry into a technical bear market. On Friday, the sell-off spread to Asian and European markets, with Japan's Nikkei 225 closing down 4%. TSMC, Kioxia, and European chip equipment maker ASML all came under pressure.

The reversal in AI trades is dragging global risk sentiment. The Philadelphia Semiconductor Index is down 8.5% this week, set for its worst weekly performance since last year’s "Tariff Day" shock. Nasdaq 100 futures fell 1.6%, S&P 500 futures dropped 0.9%. Concerns are rising simultaneously over the return on AI infrastructure investments, inflation risks, and the outlook for monetary policy.

Goldman Sachs trading directors describe the current AI market as an “elastic band” being stretched longer. As hyperscale cloud companies continue to ramp up capital spending, the key market question has shifted from “how big is the investment?” to “when and how will these investments translate into returns?” The upcoming tech giant earnings reports may become the first key milestone to validate this logic.

Chip Index Nears Bear Market, Profit-Taking Turns into Broad Cooldown

Chip stocks were among the most sought-after trades this spring. As investors once worried that the “Magnificent Seven” would bear most of the costs of AI data center construction, funds turned to chip manufacturing, memory, and semiconductor equipment firms, betting they would be direct beneficiaries of the capex cycle.

But this trade is quickly reversing. As of Thursday, the Philadelphia Semiconductor Index had dropped 19% from its historical high on June 22. The index fell 4.3% that day, just one step away from the 20% retracement threshold confirming a bear market.

Individual stock volatility is even greater. Marvell Technology has fallen nearly 40% since the semiconductor index peaked, though it is still up 121% for the year. This reflects that the current correction is mainly focused on AI winners with high prior gains, as investors reassess whether high growth expectations have already been fully—or excessively—priced in.

In Thursday’s US market, Sandisk, Western Digital, and Seagate all fell more than 9%, while Intel and Micron dropped about 6%. Friday saw the downturn continue in Asia: Japanese memory chip maker Kioxia plunged over 16% at one point, more than half off its June high. TSMC shares also dropped sharply.

Strong Earnings Continue, but Market Questions Growth Sustainability

The chip sector is not facing a short-term earnings collapse. FactSet data shows the S&P 500 constituent stocks are expected to see Q2 earnings grow 23.6% year-on-year, while the semiconductor and related equipment sector is expected to see earnings growth as high as 131%.

The question is whether strong current results are enough to support valuations that have already factored in years of expected growth. TradeStation Global Market Strategist David Russell noted that tech companies may deliver impressive results, but the market is now asking whether this growth can be sustained for one to three additional quarters.

TSMC's performance highlights this contradiction. Despite reporting record quarterly profits, its stock has notably weakened this week. The Financial Times reported TSMC was down more than 7% on Friday. Surpassing earnings expectations did not prevent share price declines, showing the market's focus has shifted to order sustainability, return on capex, and the slope of AI demand growth, rather than single-quarter profits.

Kevin Gordon, Head of Macro Research & Strategy at Schwab Center for Financial Research, believes the sharp correction in chip stocks may not represent a severe warning. Over the past decade, the Philadelphia Semiconductor Index has seen six declines over 20% and 31 adjustments of at least 10%, with volatility significantly higher than the S&P 500. Frequent corrections also mean this sector is highly sensitive to changes in valuation, inventory cycles, and capex expectations.

Funds Shift to Economic Sensitive Sectors, Market Breadth Expands

As chip stocks come under pressure, there is clear rotation within US equities. The financials sector on Thursday marked a second consecutive record closing high, driven by strong bank results. The Dow Jones Transportation Average is up more than 30% for the year, nearing all-time highs, and retail ETFs are also close to highs since early 2022.

David Royal, Chief Financial & Investment Officer at Thrivent, said, Broadening market participation is a healthy sign, and recent jobs and retail sales data show the economy remains resilient. Funds are flowing out of high-valuation tech sectors and into finance, consumer, and transportation, meaning investors are not fully exiting risk assets but re-allocating into those more sensitive to economic growth.

This rotation also erodes the relative strength chip stocks previously held. When the economic outlook remains stable, investors have more choices instead of continuing to pile into the highest-valued, most crowded AI infrastructure chain companies.

Goldman Sachs Warning: Tension Exists Between AI Capex and Monetization Returns

Mark Wilson, EMEA Head of Equity Hedge Funds at Goldman Sachs, and Rich Privorotsky, EMEA Head of Equity Flow Intermediation, believe the mismatch between AI infrastructure investment and commercialization returns is becoming the market’s core risk variable.

They note that hyperscale cloud firms like Microsoft, Amazon, Alphabet, and Meta are investing in AI infrastructure at rates outpacing their operating cash flow growth. But in the short term, there is still considerable uncertainty about how much revenue, profits, and cash return these investments will generate.

Privorotsky described the AI market as an “elastic band.” The key is not whether the market still believes in AI's long-term direction, but how long this stretch between valuation and capex can continue. Goldman also observes that as frontier models proliferate and inference costs drop, the AI value chain may change: the scarcity premium of hardware and computing power may decline, while platform companies controlling distribution channels and workflows may capture more value.

If any hyperscale cloud provider is first to cut capex, the market may quickly reassess demand expectations for the entire AI hardware chain, triggering broader knock-on effects.

Earnings Season Will Test If AI Trades Can Regain Support

The next market focus will shift to major tech company earnings and capex guidance. Alphabet and Tesla will report results on July 22; their statements on AI investment, data center construction, and commercialization progress may impact whether chip stocks can halt their declines.

In the short term, high earnings growth in chip stocks still provides some support for valuations, but the market is no longer satisfied with "high growth" alone. Investors need to see improvements in revenue, profit margin, and cash flow driven by AI investment, while confirming that hyperscale cloud providers’ capex is not slowing due to financing pressure, rising inflation, or disappointing returns.

Whether the Philadelphia Semiconductor Index officially enters a bear market may just be a technical boundary. For the market, the more important boundary is whether AI trades can shift from pricing in multi-year future growth to verifying real-world paths to returns.

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