Kospi turns extremely 'frothy,' 'truly unnerving' as leveraged bets swing market: CLSA analyst

The Kospi's blistering rise has turned Korea into the world's best-performing equity market this year. But the rally has come with wild swings, with the benchmark index at times fluctuating by double digits in a single trading session, a volatility fueled by retail investors' growing appetite for leveraged bets.

Such a retail-driven market is “truly unnerving” and “very, very frothy,” according to Alexander Redman, chief equity strategist at CLSA.

“There’s been very few days of foreign net purchases since April, which tells that retailers are almost exclusively in the driving seat,” said Redman in an interview with the Korea JoongAng Daily in Yeouido, western Seoul, on June 23 — the same day when the Kospi plunged 10 percent.

“I would say foreign investors are a little bit alarmed by the fact that it is very concentrated within the retail space. You could get a misinterpretation of volatility. People think, you know, a down day is more structural, and therefore, that begins to feed on itself,” Redman added.

He recently cut his overweight position in Korean equities from 20 percent to 10 percent, even as he identified Korea as one of the biggest beneficiaries of the reopening of the Strait of Hormuz, given Korea’s heavy reliance on energy imports.

Volatility in the Kospi was amplified by the launch in May of single-stock leveraged exchange-traded funds (ETF) tied to Samsung Electronics and SK hynix, which were introduced as part of efforts to strengthen the won against the dollar.

Amid the heavy fluctuations, the circuit breaker — a mechanism that temporarily suspends trading in stocks and related derivatives to cushion the market from severe shocks during sharp declines — was triggered four times this year, bringing the total number of activations on record overall to 10. The sidecar mechanism, which is activated when Kospi 200 futures move 5 percent or more for at least one minute, was triggered for the 28th time this year, surpassing the 26 activations recorded during the 2008 global financial crisis in just six months.

Redman said a higher rate environment could also weigh on Korea’s reliance on cyclical businesses such as chips.

“One of the reasons for that is concerns about inflation driving rate increases in the developed world, and hence Korea and Asia Pacific, and what it would do to the yield curve.”

Redman argues that if the Federal Reserve raises interest rates as widely projected, it could lead to a bear flattening of the U.S. yield curve — a market condition in which short-term Treasury yields rise faster than long-term yields, often hurting cyclical businesses through higher borrowing costs, compressed profit margins and crush in consumer demand.

"That is not a pro-cyclical environment, and Korea is a quintessential cyclical play, not just in Asia Pacific but globally," he said. "If you get a bear flattening in the shape of the U.S. yield curve, that would typically drag down cyclicals with it, and that is one of the core reasons I'm more concerned now for Korean equities going forward."

The U.S. 10-year Treasury yield traded at 4.4 percent on Wednesday, compared to the two-year yield at 4.14 percent.

Redman also pointed to growing risks across the AI value chain as a potential headwind for the chip-driven Kospi.

While major chipmakers such as Samsung Electronics and SK hynix have orders that stretch well into 2027, and therefore their short-term business is relatively protected at this point, risks are emerging further down the AI value chain, he explained.

As AI labs such as Anthropic and OpenAI engage in a price war to capture market share, profitability could come under pressure. At the same time, hyperscalers are increasingly relying on debt and equity markets to finance massive capital spending plans. This raises the risk that investors may eventually balk at funding the AI buildout that has fueled the semiconductor earnings boom that has driven Korea's stock market rally, Redman said.

“We have to remember that ultimately something has to pay for those for that capex,” Redman said. The obvious sign that investors believe that the AI story is beginning to roll over is when the flows are recycled to a market like India, which has been at the other end of the spectrum with low AI exposure, he added.

“When you see the flows going towards India, then that is probably the most obvious sign that investors believe that the AI story is beginning to roll over,” Redman said, adding, “but we’re not there yet.”

BY JIN MIN-JI [[email protected]]