Do you remember past financial contagions? Those periods of time that tend to occur just when “things can’t get any better than this.” 1987, 2000, 2008, and 2022 are the U.S. versions of those.
And, with the summer froth having convinced the broad market that nothing can go wrong, my risk-manager brain goes into overdrive. Because when fundamentals leave the building, as they have recently, it allows a lot of bugs to creep in. Such as leverage-induced selloffs. Like that we just saw unfolding in South Korea.
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South Korea’s benchmark KOSPI index cratered 44% from its June peak — a collapse worse than the 2020 pandemic crash — before staging a record-breaking 18% single-day rebound on Friday. Is all well? Not likely.
The primary catalyst wasn’t just fear over AI capital expenditure or tech debt. It was a hyper-leveraged feedback loop that trapped over a million retail investors and forced the government to issue a public apology.
At the center of the storm sit two tech giants—Samsung Electronics and SK hynix, which account for over half of the KOSPI’s weighting. When single-stock leveraged ETFs launched in South Korea this past May, retail investors jumped in aggressively. By July, these leveraged products and their underlying stocks represented 70% of total daily trading volume on the local exchange.
As we see here, South Korea’s stock market is no stranger to volatility. This table shows the iShares MSCI South Korea ETF (EWY), the main tracker ETF for the country’s stock market. That beta of nearly 1.5 over the past five years implies that this market is 50% more volatile than the S&P 500 Index.
Recently, when AI sentiment cooled, the unwinding for the Kospi was mechanical and merciless. Of course it was! Because leverage is a double-edged sword: it amplifies daily upside, but aggressively compounds downside risk. Because leveraged ETFs must rebalance their exposure daily, a declining stock forces the ETF issuer to sell more shares into a falling market.
