South Korea's KOSPI Tumbles as AI-Fueled Rally Unravels

South Korea’s benchmark KOSPI index plunged on Wednesday, extending a steep sell-off as the market's recent artificial intelligence-fueled rally turned into a record-breaking rout. The index was last down 7%, hitting its lowest level since early April after chipmaker SK Hynix reported strong earnings that failed to meet investors' lofty expectations.

A Crowded Trade Unwinds

The sell-off is being driven by the rapid unwinding of what analysts describe as an overheated and crowded trade centered on AI-related equities. The trigger appeared to be SK Hynix's earnings, which, while strong, lacked new catalysts to justify the sector's high valuations. "SK Hynix delivered strong results, but in today’s AI market, strong is no longer enough," said Gary Tan, a portfolio manager at Allspring Global Investments, in a note cited by Reuters.

Analysts pointed to high levels of leverage as a key factor amplifying the decline. The unwinding is concentrated in stocks with the most leverage, particularly through single-stock leveraged ETFs that surged in popularity in May and June, according to Frank Benzimra, Head of Asia Equity Strategy at Societe Generale. Pierre Hoebrechts at East Eagle Asset Management called the situation "an accident waiting to happen," citing the staggering amount of money, local leverage, and concentrated exposure in names like SK Hynix and Samsung.

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Market Outlook and Volatility

Analysts expect volatility in AI-linked stocks to persist as the market resets expectations and leveraged positions are closed out. The sharp price action suggests that "leverage within Korean equity remains high and further unwind could be expected," noted Wee Khoon Chong, APAC Macro Strategist at BNY. He added that the movement may represent a rotation into other, less crowded sectors rather than outright panic.

The key question for investors is when the sell-off will stabilize. Some analysts believe the correction still has further to run. Hoebrechts suggested the rout will likely stop once most margin accounts have been liquidated, a point he believes may not be far off. For now, the high volatility is attracting interest from short-term traders, according to Fabien Yip, a market analyst at IG.