The South Korean Composite Stock Price Index (KOSPI) closed at 8788.38 points on June 1, gaining 312.33 points, or 3.68%, setting a new record high. The market opened lower on June 2 but rallied in the afternoon session, with the KOSPI ultimately closing up 0.15% at 8801.49 points.
So far this year, the KOSPI has skyrocketed by 108.85%, completely overshadowing the performance of other major global stock indices. The sustainability of this rally, its underlying causes, and the associated risk level are now primary concerns for investors.
KOSPI's Stellar Performance and Its Narrow Base
In recent years, the KOSPI has delivered exceptionally strong performance, far surpassing the Nasdaq and other global indices. While the Federal Reserve's monetary policy shift and the AI investment boom have fueled gains in U.S. and European markets, and yen depreciation has boosted the appeal of Japanese stocks, these gains pale in comparison to the KOSPI's surge.
The KOSPI is weighted towards technology (48.2%), industrial (18.28%), and consumer cyclical (10.02%) sectors. However, a closer look reveals a severe divergence in performance among its components. On May 29, only about 373 of the 835 listed companies traded on the exchange had risen in price this year, despite the index's massive overall gain.
Three semiconductor stocks alone account for 42.94% of the KOSPI's weight and have contributed 74.06% of its year-to-date increase. The top ten weighted stocks, representing 54% of the index, have contributed 78.34% of its gains. This means the remaining 820+ stocks, constituting 46% of the index's weight, have contributed only about 30% to its rise. The rally has not broadly spread across sectors, which may limit the market's future performance.
Drivers and Sustainability of the Rally
Several short-term and long-term factors underpin the Korean market's explosive performance. First, the significant depreciation of the Korean won against major currencies has enhanced the relative value of domestic stocks compared to international peers. The USD/KRW exchange rate has risen above 1500, its highest level since March 2009.
Second, the AI investment boom, which requires vast amounts of memory chips, has been a windfall for companies like Samsung Electronics and SK Hynix. These firms possess the chip design and manufacturing capabilities critical for the AI era.
Third, the Middle East crisis has driven up global energy prices and inflation, increasing chip production costs. This has allowed Samsung and SK Hynix to raise prices, benefiting from the situation.
Finally, strong domestic buying from Korean funds and retail investors, driven by fear of missing out, has further fueled the rally in these key stocks.
Underlying Risks and Economic Disconnect
The stock market's performance starkly contrasts with the less impressive Korean economy, which faces challenges in traditional industries, weak personal consumption, and rising inflation pressure. The rally lacks strong macroeconomic support, making it highly dependent on the aforementioned positive factors, which could reverse.
The won cannot depreciate indefinitely, as it increases import costs for essential raw materials and intermediate goods. The AI investment cycle involves multiple layers; if returns from value-creation applications are low, it could impact investments in data centers, with power costs being a decisive factor. Many large data centers are already facing financial strain.
The Middle East situation remains unresolved, and market sentiment has swung wildly. A stabilization could lead to a reassessment of stock valuations, potentially bursting any irrational bubbles.
The extreme concentration risk is a major concern. Two companies, Samsung Electronics and SK Hynix, now constitute 42.94% of the KOSPI. This level of concentration is inherently dangerous, reminiscent of the dot-com bubble when a single stock dominated a major index.
Investors must not underestimate geopolitical risks. The U.S. government has pressured South Korea to increase investments, placing firms like Samsung and SK Hynix under greater scrutiny. The health of the U.S. economy and its financial markets will inevitably affect Korea. Recent downward revisions to U.S. GDP growth highlight potential vulnerabilities.
In the short term, key U.S. data releases—including the non-farm payrolls report, the CPI report, and the Federal Open Market Committee's interest rate decision—will significantly impact U.S. and, by extension, Korean stock markets.
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