KOSPI enters bear market as retail leverage amplifies AI stock crash

South Korea's KOSPI dropped below 7,000 on Tuesday, marking a roughly 25% decline from its late June record close of 9,114.55 and officially entering bear market territory. The plunge follows a dramatic reversal in AI-linked semiconductor stocks. These companies had previously propelled the index to a 60% gain this year, making the KOSPI the world's best-performing major equity market and far outpacing the roughly 10% advance in MSCI's broad global index.

Monday's session illustrated the market's acute volatility. SK Hynix, which had tripled in value and recently completed a record $26.5 billion U.S. listing, fell 14% in Seoul. The decline triggered a more than 30% crash in a twice-leveraged exchange-traded fund tracking the stock in Hong Kong, dragging the broader KOSPI down 8% for the day.

The severity of the correction stems from a shifting ownership base. Foreign investors have withdrawn nearly $110 billion from South Korean equities this year, a record outflow driven by portfolio rebalancing after the market's soaring capitalisation. Domestic retail investors stepped in to absorb this selling, purchasing 42.4 trillion won in June alone and another 13.2 trillion won this month.

These individual buyers are carrying significant risk through borrowed money. Margin-funded investments in KOSPI shares reached 28 trillion won on July 14, just shy of the 29.8 trillion won record set on June 24. This heavy use of leverage has magnified losses during the selloff, highlighting the dangers of a market rally heavily dependent on retail margin accounts.

The underlying corporate earnings complicate the broader bearish sentiment. Rapidly rising profit expectations for Samsung Electronics and SK Hynix have actually caused their forward price-to-earnings ratios to fall, even as their share prices doubled this year. However, the broader market's valuations became increasingly disconnected from the domestic economy due to its heavy reliance on just a handful of chipmakers.

Authorities are now moving to address the structural instability. The Financial Supervisory Service said it is monitoring leveraged investment products, while the Bank of Korea is assessing whether single-stock exchange-traded funds are distorting markets. President Lee Jae Myung, who previously set a target of 5,000 points for the index, has maintained that equities remain attractively valued, though veteran investors are largely waiting for sentiment to cool before increasing exposure.