Leveraged ETFs Triggering Stampede? Semiconductor Stocks Face 27-Year Worst Momentum Sell-Off; Analyst Warns Retail Investors May Be Washed Out

Semiconductor stocks faced a sharp correction in July, prompting market scrutiny over whether the sell-off originated from corporate fundamentals or from mechanical selling pressure driven by leveraged ETFs rebalancing daily.

Tyler Neville, a former buy-side derivatives trader and co-host of the podcast 'Forward Guidance,' pointed out that leveraged ETFs must passively sell holdings whenever the market declines to maintain their targeted leverage ratio. This mechanism could be a key driver behind the most intense momentum stock sell-off in 27 years.

According to Neville, the speed of this momentum stock correction has set a record as the fastest in the 27-year history of the Morgan Stanley Technology Momentum Index, with semiconductor stocks hit hardest. The downturn has already spread to global markets.

Japanese equities were also impacted: SoftBank Group (SFTBY-US) plunged over 11% on Friday in Tokyo trading, and Japanese semiconductor stocks followed Wall Street lower, signaling a rapid rise in market risk aversion.

Neville explained that leveraged ETFs must rebalance their positions daily, meaning they are forced to buy more when prices rise and keep selling when prices fall—regardless of changes in company fundamentals. This programmed trading could further amplify market volatility, creating a self-reinforcing downward spiral.

According to Citadel Securities, total assets under management in leveraged ETFs reached a record high of approximately $218 billion before this correction but have since shrunk to about $198 billion amid the market's sharp decline. Semiconductor-related leveraged ETFs have seen assets evaporate by around 20%, reflecting rapid capital flight from high-volatility tech sectors.

Neville bluntly stated, 'Retail investors will ultimately be washed out of the market,' noting that the very capital flows that previously pushed prices higher are now accelerating the downturn.

He further pointed out that implied volatility for many popular tech stocks is now approaching 120, suggesting daily price swings of around 7.6%. Such extreme volatility forces many funds to reduce holdings for risk management, creating fresh selling pressure.

Another study by Citadel Securities revealed that the gap between individual stock volatility and overall market index volatility has climbed to a historical high, indicating capital is highly concentrated in a few stocks and that structural market risks are rising.

Neville believes the real beneficiaries of this high-volatility environment are large market makers like Jane Street and Citadel Securities, which can continuously profit from market swings through delta-hedging strategies—while corporate fundamentals have become secondary in driving short-term stock prices.

Data shows semiconductor stocks are on track for their worst month relative to software stocks in history. The median decline among semiconductor ETF components in July has already exceeded 22%. Even AI chip leader NVIDIA (NVDA-US) has given back all its gains since July, reflecting broad-based selling pressure.

On the prediction market platform Kalshi, the probability of the S&P 500 falling to 6,300 or below this year has risen to 25.9%—about 15% below current levels—indicating rising market expectations of downside risk as momentum trades continue to unwind.

In contrast, prediction platform Polymarket holds a relatively optimistic view. The current market-implied probability of an AI bubble bursting before year-end is only 16%, down from nearly 30% in May, suggesting investors still maintain confidence in AI’s long-term prospects.

Neville stated that until individual stock volatility subsides, markets will likely remain dominated by capital flows and leveraged ETF trading mechanisms, with fundamentals unlikely to regain their central role in pricing in the short term. As earnings season unfolds, the market will closely watch the latest outlooks from tech giants to determine whether this correction can gradually return to being fundamentals-driven.