South Korea Is Becoming Uninvestable, Too

South Korea is home to the world’s hottest and most volatile stock market this year. The Kospi’s near 40%tumble in just 27 trading days is comparable to China’s market crash in 2015. But with an easing of the global AI stock rout, it’s natural to askif the benchmark index is destined for a rebound.

Bulls might argue that unlike China a decade ago, Korea’s business fundamentals are sound. The two memory chipmakers Samsung Electronics Co. and SK Hynix Inc., which make up more than half of the index,are direct beneficiaries to the AI infrastructure boom. The Kospi is starting to look seductively cheap, trading at a decade-low of 5.5 times forward earnings.

I disagree with this simplistic argument. Before predicting a rebound,we should ask if the recent selloff and the government’s clumsy attempt to lift the Kospi have traumatized a new class of investors and stigmatized the market. In other words, it’s still possible to be a believer of the global AI-fueled industrial boom but stay far, far away from the Kospi.

For starters, volatility is a killer. Year-to-date, the Kospi has 33 days of at least 5% daily moves, versus four forthe Nikkei 225 and zero from the Hang Seng. This is a big problem for foreign institutional investors, who have been selling throughout 2026 to avoid excessive concentration. For traditional managers, risk-adjusted returns are as important as portfolio diversification —that meansthey are unlikely to increase their exposures if the Kospi continues to oscillate.

A majorforce behind this volatility is the outsizedinfluence of leveraged exchange-traded funds, turbocharged after the government approved the launch of single-stock products of this kind in late May. ETF providers need to mechanically rebalance their books every day, and their buy-high, sell-low actions amplify stock moves. At Kospi’s June peak, a 5% move in SK Hynix could trigger rebalancing flows that account for 40% of the stock’s average daily volume, according to Goldman Sachs Group Inc. estimates.

Acknowledging their detrimental impact on the Kospi, the government is planning to curb retail access to these instruments. But Seoul has fallen short of halting their operations altogether. As such, even though these ETFs have been shaken out during the July selloff, they loom large. Goldman concluded that leveraged products could still account for 17% of SK Hynix’s trading volume during days of extreme price moves. The Kospi will continue to whipsaw.

More alarming is what this policy mistake has done to retail investors, who drank President Lee Jae Myung’s stock-reform Kool-Aid after being wary of the notorious Korean discount for decades. Throughout this year, they bought the Kospi, filling the void left by foreign sellers.

Now they’re dealing with monumental losses. The most popular SK Hynix leveraged ETF has lost as much as 84% of its value from the June peak. Many couldn’t just ride out the storm —an estimated 360,000 brokerage accountswere forcibly liquidated, with 62% of them held by individuals under 35. It’s understandable that Koreans are angry. Seoul encouraged excessive risk-taking from inexperienced traders when the global AI trade was near its peak.

This rout might just reinforce Koreans’ long-held impression that their home market was a value trap. Unlike China,where tight capital control prevents locals from cross-border trading, Koreans are free to invest in whichever market they fancy. In the past, they preferred the Nasdaq. They might just pack up and never return to the Kospi.

Allowing single-stock leveraged ETFs is by no means Seoul’s only blunder. Earlier this year, the $1 trillion National Pension Service bent its own rules, lifting thedomestic equity target to avoid selling its Kospi holdings. But this maneuver defeats pension funds’ inherentcounterbalancing mechanism, which kicks in when theybuy during marketrouts and sell into rallies to lock in gains and cool down stockeuphoria. By failing to act within its pastguidelines,the NPS helped drive the Kospi into a frenzy.

In recent years, global asset managers have complained that China is uninvestable, mainly over two issues — the government’s policy failures and its disregard for investors. Unfortunately, similar concerns are surfacing over South Korea. Does Seoul know what it’s doing and are its first-time youngtraders well-protected? It’s time for the government to do some self-reflection.