The year’s hottest rally is losing steam. Investors are asking what comes next

By John Towfighi, CNN

New York (CNN) — The stocks that have fueled Wall Street’s powerful AI rally are suddenly under pressure as investors evaluate rising tensions in the Middle East, take profits after a historic run and reassess where to find value.

After months of hitting record highs, semiconductor chip stocks have dropped in recent weeks, weighing on the broader US stock market. The S&P 500 and Nasdaq Composite are down almost 2% and 5%, respectively, since their record highs on June 2.

The AI boom catapulted chipmakers into the spotlight: The semiconductor and semi equipment industry added nearly half of the S&P 500’s market value gains this year, according to Mike O’Rourke, chief market strategist at JonesTrading.

But the speed and size of the rally has fueled debate about its sustainability.

“The semiconductor rally was way over its skis,” said Jeff Buchbinder, chief equity strategist at LPL Financial. “Investors were as loaded up with tech stocks, particularly semis, as they ever get.”

Gains in shares of chipmakers helped global markets bounce back from a slump at the start of the US-Israeli war with Iran this year. But after posting their best quarter on record, chipmakers are wavering.

Chipmakers have stumbled as some investors are taking profits after strong rallies. Other investors are assessing Big Tech’s plans for spending on AI infrastructure and how that could impact chipmakers’ revenues.

Micron Technology, a chipmaker, has dropped more than 20% since hitting a record high on June 25. The PHLX semiconductor index is down 15% since hitting a record high in late June.

Chip volatility

Semiconductors, ranging from memory chips to graphics processing units, are critical for the AI boom. Intense demand for chips paired with constrained supply allowed companies to hike their prices and lock in profitable long-term agreements, boosting profits and outlooks for future revenue.

So, despite the recent volatility, chipmakers remain well ahead for the year. Micron is still up more than 200% this year, and the PHLX semiconductor index is still up 75% this year.

But as Wall Street gears up for another quarterly earnings season, the bar for earnings expectations continues to rise.

“Shares have been priced for super-strong earnings growth into the future and the worry is that AI infrastructure spend can’t keep driving memory prices higher forever,” Neil Wilson, strategist at Saxo Markets, said in a note.

The so-called hyperscalers, or the Big Tech companies like Microsoft, Meta and Google spending enormous amounts of cash to scale up data centers and AI infrastructure, will be under a microscope.

“The market is looking beyond the buildout phase now and increasing the scrutiny on hyperscalers and others who are investing heavily in AI to make sure that the payoff is going to come,” said Buchbinder at LPL Financial, “and that’s going to be a big focus of this upcoming earnings season.”

Spending on AI impacts the outlook for chipmakers. A slowdown in growth could spook some investors, since chipmakers rely on raising forecasts for revenue based on robust demand and a sustained AI buildout.

“You’ve seen almost staggering, unbelievable volatility in some of these chip stocks and memory stocks,” said Alonso Munoz, chief investment officer at Hamilton Capital Partners. “It makes us even more hesitant to dive in. I think we’d want to see what earnings look like in the next couple of weeks, and going into the back half of this year.”

Middle East risks linger

All told, the S&P 500 is up about 10% this year.

While chip stocks have stumbled, a rotation into other sectors has helped to buoy the market. Investors have moved into other sectors like financials and industrials, which pushed the Dow to close above 53,000 points for the first time ever earlier this week.

But the strength of the rotation also depends on the conflict in the Middle East remaining contained. The Dow on Wednesday had its worst day in almost a month after Washington and Tehran traded strikes.

Traders are watching developments in the Strait of Hormuz and their impact on oil prices and Treasury yields. The longer uncertainty lingers, the more risk there is for stocks at a moment when the market leaders, chipmakers, are wobbling.

The S&P 500 has not fallen more than 10% from its most recent peak since March and April 2025. Investors are on the lookout for any signs of cracks in the AI rally that could turn into larger spills.

“Another tough day for shares in the semiconductor sector highlights just how far the bar for a successful earnings announcement has been raised, and how reliant the overall tech equity boom remains on the fortunes of a handful of companies,” Jonas Goltermann, chief markets economist at Capital Economics, said in a Tuesday note.

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