South Korea's Kospi index experienced a significant downturn, slumping more than 11% on Wednesday and a dramatic 43% from its June peak of 9,386 to 5,311.77. Deepak Shenoy, CEO of Capitalmind Mutual Fund, has sharply criticized the use of highly leveraged financial products, labeling 3x leveraged single-stock ETFs as 'pure gambling' and a primary driver of the recent market correction.
Leverage Blamed, Not Earnings
Shenoy emphasized that the market's decline was not primarily due to weak corporate earnings. In fact, major chipmakers like SK Hynix and Samsung Electronics, significant constituents of the Kospi, faced intense selling pressure despite reporting strong financial results. The issue, according to Shenoy, lies with excessive leverage taken by retail investors.
"3x levered single stock ETFs has to be the most clinically insane thing to do, just pure gambling. And then people borrowed money to buy these ETFs!" Shenoy stated, highlighting the risky behavior.
He further advised that investors chasing market momentum must recognize when that momentum is lost and be prepared to exit positions. While acknowledging the Kospi's substantial rise from 3,000 to nearly 10,000 before its current fall to 5,500, Shenoy stressed the importance of not overextending at market highs.
India's Market Contrasts
Drawing a comparison with the Indian market, Shenoy noted that domestic regulators have not permitted similarly aggressive leveraged products. However, he cautioned that margin trade funding (MTF) is growing in India, representing a form of hidden leverage. Despite this, India has not yet experienced a momentum-driven systemic issue of the scale seen in South Korea.
Good Earnings, Falling Stocks
The paradox of strong earnings coinciding with falling stock prices, particularly for memory sector giants like SK Hynix and Samsung, indicates a shift in market sentiment rather than deteriorating business fundamentals. Shenoy explained that these companies themselves are cash-rich, but the real concern lies with the debt and leverage assumed by investors betting on these stocks.
Looking ahead, Shenoy also warned that AI-linked investments, particularly those financed through leverage, could face significant pressure if there's a slowdown in AI spending or if increased competition drives down prices. He concluded that the "game is on" for these leveraged AI players.
The Kospi's Steep Decline
Despite being Asia's best-performing equity market earlier this year, the Kospi plunged into technical bear market territory, falling over 43% from its June peak. The selloff was exacerbated by SK Hynix's quarterly results, which, despite showing a sixfold jump in earnings (partly from a $44 billion asset value gain), failed to meet the elevated expectations fueled by the AI boom. SK Hynix shares dropped over 14%, while Samsung Electronics saw a 10% decline. Together, these two companies account for nearly half of the Kospi's weight and contributed approximately two-thirds of its gains earlier in the year.