The U.S. stock chip sector's surge hides risks; retail investors rushing in now raises concerns

Data shows that during the record-breaking rally of U.S. chip stocks in April, most retail investors chose to stay on the sidelines. Now, as the market becomes increasingly concerned that the rally may lack momentum, they are starting to flood in.

According to Morgan Stanley’s positioning data, last week retail investors’ buying intensity in technology stocks rose to its highest level in a year. Among them, storage chip companies benefiting from the AI boom were especially popular, with hardware stocks recording the second-highest ever capital inflow.

Over the past six weeks, the Philadelphia Semiconductor Index has gained 60%, with almost all valuation metrics appearing excessively expensive. For ordinary retail investors who only entered the sector in May, this means that if market momentum suddenly reverses, they are likely to face significant losses.

Dave Mazza, CEO of Roundhill Financial Inc., said, “This earnings season has proven that the logic of AI infrastructure trading still holds, with semiconductor and storage chip companies delivering impressive results. But market expectations for the future are already rising.”

“Retail investors re-entering the market isn’t necessarily a bearish signal, but they further fueled a rally that has already surged dramatically and is beginning to show parabolic growth.”

The return of retail funds also indicates a clear shift in market sentiment compared to early spring. At that time, concerns triggered by Middle East conflict risks pushed the S&P 500 close to a technical correction zone, prompting many retail investors to exit and watch on the sidelines.

Now, as U.S.-Iran negotiations continue to advance, retail investors are once again flocking into semiconductor and hardware stocks, including companies like SanDisk, Micron Technology, and Intel. The sector’s sharp rise has also driven the tech-heavy Nasdaq 100 Index to soar 25% in six weeks.

Chris Verrone, head of technical and macro strategy at Strategas Securities LLC, wrote in a report to clients, “The semiconductor sector has started to become increasingly crazy, in some cases even rivaling the extremes seen in 1999.”

“Parabolic rallies often develop their own vitality. We can’t accurately predict when the trend will reverse, but we must closely monitor positions and implement risk protections.”

In the broader S&P 500, the proportion of stocks trading above the 200-day moving average has fallen from 58% last week to 53%, which the Strategas research team views as a sign that a “melt-up” is forming.

Among the components of the Philadelphia Semiconductor Index, up to 97% of stocks are above their long-term moving averages.

Cameron Dawson, Chief Investment Officer at Newedge Wealth, said, “The semiconductor sector is undoubtedly severely overbought — this is the most extreme deviation from long-term trends since early 2000.”

Dawson pointed out that the key debate among investors now is whether this rally represents a long-term structural shift or just a new wave of gains in a highly cyclical industry.

Although the AI boom has led many to believe that chip manufacturers should enjoy permanently higher valuations due to sustained strong demand, Dawson still considers this industry fundamentally cyclical — just currently in the largest and longest supercycle in history.

“Since 2023, this supercycle has been seriously underestimated by the market. It has been very exciting during its duration, but ultimately demand growth will slow down. The question isn’t whether it will happen, but when.”

Currently, the Philadelphia Semiconductor Index is 57% above the 200-day moving average. John Kolovos, Chief Technical Strategist at Macro Risk Advisors, said that since 1990, this situation has only occurred twice — in 1995 and 2000.

Both times afterward, U.S. stocks declined, with the 2000 occurrence happening just before the dot-com bubble burst. Kolovos said this puts investors in a dilemma:

On one hand, risk appetite-driven rallies tend to last longer than expected, and prematurely exiting due to “overbought” conditions could mean missing out on huge gains;

On the other hand, those overly reliant on momentum leadership sectors may quickly lose control if the trend truly breaks.

However, some Wall Street figures believe it is still too early to bet on a top in chip stocks.

Alexander Altmann, Global Equity Strategist at Barclays, said he has been frequently asked by clients whether they should sell their chip stocks. In his view, the market has not yet shown enough signs of extreme euphoria, and this rally may not have truly reached its end.

He bluntly stated that shorting the VanEck Semiconductor ETF (SMH) at this stage would be like risking his career.

(Article source: Caixin)