AI Frenzy Transforms Korean Stocks into Volatile Market
SINGAPORE – The South Korean stock market, historically a reliable barometer of global growth, has undergone a dramatic transformation, morphing into a highly volatile arena driven by billions of dollars in leveraged bets on artificial intelligence (AI) darlings. This shift, profoundly felt on dealing desks from Tokyo to New York, has not only disrupted investment portfolios but also significantly distorted investors' fundamental views on South Korea, a nation at the core of the global AI boom, according to July 17 reports.
In a striking indicator of this unprecedented volatility, more than half of all stock market circuit breakers on the benchmark KOSPI index in South Korean history have been triggered in just the past six months. These trading curbs activate when the index plunges by more than 8% for at least a minute, signaling severe market distress.
The Decoupling of a Once Predictable Market
By Decode Today News
"The index has decoupled from all of Korea's historical drivers," stated Alexander Redman, chief equity strategist at CLSA. He noted that Korea was once "an easy market for strategists, with long-term faithful relationships... to (help) pick entry and exit points." However, these established relationships have since fractured. Current price movements are primarily dictated by capital flows stemming from an explosion in single-stock leveraged funds, which, while promising amplified returns, have exacerbated market volatility.
The principal beneficiaries and targets of these leveraged funds are leading chipmakers Samsung Electronics and SK Hynix. These two technology giants, significant winners in the AI supercycle, now command over half of the KOSPI index's valuation, profoundly influencing its overall direction.
The market's current trajectory appears disconnected from traditional fundamentals. For instance, price-to-earnings (P/E) ratios at Samsung and SK Hynix have fallen to below 5, suggesting the market is not fully pricing the extent of future earnings potential. Furthermore, the market is no longer responding to usually reliable economic correlations. The KOSPI's volatility has surged, and its price movements, which historically tracked U.S. benchmarks, are now paradoxically influencing Wall Street. A rally that saw the index's market value double in six months has sharply reversed, losing 20% so far this month.
"In the past, if Korea drops 7% on the day, I would not be talking to you," Redman remarked, emphasizing the abnormality of the situation. "Now it's normal. But it makes institutional investors increasingly concerned."
Leveraged Bets Fueling the Frenzy
The current market rally in South Korea is built upon a substantial foundation of borrowed capital and highly concentrated bets funneled through leveraged single-stock exchange-traded funds (ETFs). South Korean retail investors held 34.37 trillion won (approximately $23 billion USD) in margin loans this week, slightly down from a record 38.6 trillion won in June, indicative of one of the strangest bear markets in recent memory.
A notable example is a Hong Kong-listed, twice-leveraged SK Hynix fund. Its assets have ballooned more than 20-fold since the beginning of the year, reaching $7.78 billion USD. This makes it the largest such fund globally, with rebalancing flows substantial enough to significantly tilt the broader market.
Florian Neto, head of investment for Asia at Amundi, highlighted the scale of this phenomenon. "Some of the single-name leveraged ETFs have four times the average volume of the underlying stock," he stated. Neto added, "When the assets under management are ballooning, we see the limits of the exercise of giving leverage on single names — this is sending some warning signals for us."
Regulatory Scrutiny and Market Interventions
South Korean regulators are navigating a delicate balance, aiming to curb excessive speculation without triggering a broader crackdown that could spook investors and exacerbate the very volatility they seek to control. In a recent move, South Korea sought to block new launches of single-stock leveraged funds. Furthermore, effective August 5, the minimum cash balance required to trade single-stock leveraged ETFs – including those listed abroad – will be tripled to 30 million won (approximately $20,300 USD).
Mike Sell, head of global emerging market equities for London-based asset manager Alquity, welcomed these measures. "The volatility in the Korean equity market has been insane recently," Sell commented. "So measures to restore a focus on fundamentals can only be welcomed... a return to rationality will be positive for long-term investors, in our view."
Understanding the Dynamics of AI Market Influence
The burgeoning AI industry has undeniably become a powerful force in global markets, attracting immense speculative capital and reshaping investment landscapes. The promise of advanced AI infrastructure, driven by demand for powerful chips and computing capabilities, has concentrated significant investor interest in specific technology firms. This intense focus, particularly on companies like SK Hynix and Samsung Electronics, has led to a feedback loop where soaring stock prices, fueled by leveraged bets, enable these companies to raise substantial capital, further bolstering their market position and investment yield prospects.
For instance, the insatiable investor appetite facilitated SK Hynix's record-breaking U.S. capital raise last week, securing $26.5 billion USD. This marks the largest U.S. capital raise by a foreign company on record, demonstrating how speculative capital is driving permanent changes in corporate finance and growth strategies.
"Speculative capital is actually making permanent changes to companies," affirmed Michael Green, chief strategist and portfolio manager for Simplify Asset Management. However, this dynamic also raises concerns about potential market bubbles and the long-term sustainability of such rapid growth.
Global Implications and Investor Vigilance
For global investors, especially those who, according to Bank of America's fund manager survey, consider an AI bubble to be the top tail risk facing markets, the developments in the Korean market hold significant weight. The extraordinary market valuation dynamics and the concentration of capital in a few key players serve as a potent case study for the broader implications of the AI supercycle.
"I actually think it's right for pretty much every investor around the world to be paying very close attention to what's happening in Korea," advised Damien Boey, portfolio strategist at Wilson Asset Management in Sydney. He cautioned against an overly simplistic view, stating, "The bull case is that earnings growth continues, the leverage wins out, and Korean equities fly. I don't think that the market action is telling you that the story is that simple." The ongoing situation in South Korea underscores the complex interplay between technological advancement, speculative investment, and regulatory challenges in today's interconnected global financial system.
