The US semiconductor sector has begun July on a weak note, raising market concerns over the sustainability of the AI-driven rally. Analysts suggest that after significant gains this year, chip stocks now face multiple tests, including high valuations, uncertainty over the persistence of AI capital expenditure growth, and slowing profit expansion, which could lead to increased volatility in the sector moving forward.

Data shows the Philadelphia Semiconductor Index has declined more than 11% since hitting a record high in June, though it remains up approximately 83% year-to-date. Steve Sosnick, Chief Market Analyst at Interactive Brokers, noted that while the chip industry has achieved unprecedented profit growth in recent years, the market is increasingly focused on how long this growth can be sustained.

Investor Sentiment Shows Divergence in AI Enthusiasm

Fund flows also reflect significant volatility in investor mood. According to LSEG Lipper data, for the week ending June 24, US semiconductor-themed funds saw net outflows of approximately $11 billion, marking the largest weekly outflow for such funds this century. This followed net inflows of around $12 billion over the preceding two weeks.

Nevertheless, most institutions remain optimistic about the prospects for AI infrastructure investment. Bank of America projects that global capital expenditure on cloud computing and AI infrastructure could approach $1.5 trillion by 2027, representing year-on-year growth of 40% to 50%.

Brokers Maintain Bullish Stance, But Some Upside May Be Exhausted

Despite the recent sharp correction, several Wall Street firms have raised their price targets for chip companies, believing AI demand will continue to support industry profit growth. According to LSEG statistics, among S&P 500 semiconductor companies, Micron Technology Inc (NASDAQ: MU) still has the highest potential upside of over 60% relative to the consensus target price. Memory chip maker SanDisk (NASDAQ: SNDK) has a potential upside exceeding 30%, and the 12-month target price for NVIDIA Corp (NASDAQ: NVDA) is more than 40% above its current stock price.

The recent listing of South Korean memory chip giant SK Hynix (NASDAQ: SKHY) on the Nasdaq, following a $26.5 billion American Depositary Receipt (ADR) offering, saw its stock price rise over 10% on its debut, reflecting sustained market optimism about AI-related storage demand.

However, analysts point out that share prices for several major chip companies, including Advanced Micro Devices Inc (NASDAQ: AMD), Intel Corp (NASDAQ: INTC), and Marvell Technology Inc (NASDAQ: MRVL), are already close to consensus target prices, suggesting limited near-to-medium-term upside potential.

Alexander Lis, Chief Investment Officer at SD Ventures, stated that brokers' continual target price hikes largely reflect the sector's prior strong performance rather than necessarily indicating equivalent future upside potential.

Short Positions Hit Three-Year High as Earnings Face Crucial Test

Simultaneously, short sellers are re-engaging with the semiconductor sector. Data from analytics firm ORTEX shows short positions in major chip stocks have climbed to their highest level in nearly three years, with the average short interest for the industry nearly doubling over the past three years. Marvell Technology, Micron, and Qualcomm Inc (NASDAQ: QCOM) have seen the most pronounced increases.

Peter Hillerberg, Co-founder of ORTEX, indicated that the current market activity appears to be more about rebuilding hedging positions after the rally rather than a large-scale, unified bearish bet, thus not yet forming the extreme short positioning that could trigger a short squeeze.

Upcoming corporate earnings reports will be a key focus for the market. LSEG data forecasts that companies in the S&P 1500 Semiconductors & Equipment Index will see profits more than double this year, primarily driven by the performance of NVIDIA and Micron. However, industry profit growth is projected to slow to 46.1% by 2027.

Furthermore, macro factors such as the future path of Federal Reserve interest rates and developments in the Middle East could also influence market judgments on the sector's profit outlook.

Valuation Pressures Emerge as Industry Cycle Persists

Despite the substantial rally, valuations for some leading companies have actually receded. Data indicates NVIDIA's forward price-to-earnings ratio is currently around 19, a multi-year low. Micron's forward P/E ratio fell to as low as 5.4 in May, its lowest in nine years.

Chris Maxey, Chief Market Strategist at Wealthspire Advisors, explained that the decline in chip stock valuations over the past two years is primarily due to corporate profit growth outpacing share price appreciation, not falling stock prices.

However, for companies like Intel, AMD, and Marvell Technology, their forward P/E ratios remain significantly above long-term averages, implying the market holds high expectations for future profit growth. If earnings fail to materialize, investors may refocus on the semiconductor industry's pronounced cyclicality, particularly in the memory chip segment.

Marija Veitmane, Head of Equity Research at State Street Global Markets, stated that the cyclical nature of the semiconductor industry will not disappear; rather, future industry upcycles may simply become longer in duration.