South Korean stocks had the worst Q3 globally: a nearly 19% drop over three months, largely due to massive liquidations in AI memory trading.

South Korean stocks experienced a sharp correction in the third quarter, with the Kospi index falling 18.8% in the quarter, making it the worst-performing market among major global stock indices. In early July, core AI memory stocks such as Samsung Electronics and SK Hynix were subject to concentrated selling, and the liquidation of leveraged positions further amplified the decline.

On September 30, Kospi concluded its third-quarter trading. Despite a nearly 19% plunge in the quarter, the index is still up about 60% year-to-date. These substantial gains have led the market to reassess the valuation levels of South Korean chip stocks and the rationale behind AI trading.

Meanwhile, rising global bond yields further weighed on risk assets, and South Korea's domestic interest rate environment was also tight. According to the Financial Times, citing market participants, the concentrated sell-off in July has completed a round of valuation reassessment, but cyclical supply risks in the chip industry and the high-interest-rate environment may still limit the future performance of the South Korean stock market.

July saw a concentrated liquidation, causing a reversal in AI memory trading.

The sharp decline reportedly began with a concentrated sell-off in early July. Leopold Aschenbrenner's hedge fund, Situational Awareness, had previously established large leveraged positions in South Korean memory chip stocks, and the liquidation of these positions triggered a chain reaction in the market. At the same time, South Korean retail investors held a large number of leveraged ETFs for single stocks, which further accelerated deleveraging after the market turned downward.

Samsung Electronics and SK Hynix were previously key targets for investors betting on AI infrastructure development, accounting for approximately half of the total market capitalization of the South Korean stock market. Following the sell-off in July, the forward price-to-earnings ratios of the two companies have fallen to around 4 to 5 times, and the market is beginning to reassess the previously high valuations of chip stocks.

Prashant Bhayani, Chief Investment Officer for Asia at BNP Paribas Wealth Management, believes that the South Korean market is now more attractively valued after the July sell-off, but the likelihood of another significant valuation expansion is low. "A reasonable return may be possible in the near future, but can you really expect to see a 70% increase? Absolutely not," he said.

Joshua Crabb, head of Asia Pacific equities at Robeco, also believes that rising global bond yields will pose a headwind for the South Korean stock market. However, he points out that South Korean chip stocks are currently trading at low single-digit price-to-earnings ratios, so there is relatively limited room for further valuation compression.

However, a low price-to-earnings ratio does not mean that earnings risks have disappeared. A report released by S&P Global Market Intelligence in August warned of a "cyclical oversupply risk" in the chip industry, which could put pressure on companies' future earnings.

Despite high interest rates, the underlying demand logic for AI remains unchanged.

In addition to rising global interest rates, South Korea's domestic monetary policy is also putting pressure on the stock market. Jongmin Shim, head of research at CLSA Korea, said that rising bond yields will suppress stock market performance, and the Bank of Korea's interest rate hikes will further drag down market returns.

However, Shim remains optimistic about the sustainability of AI capital expenditures. He believes that although financing costs for hyperscale cloud computing companies have risen significantly and their reliance on debt financing is increasing, competition in the AI field continues to drive companies to invest. "AI companies have no choice but to continue investing—it's a battle for survival," he said.

From an industry fundamentals perspective, the AI logic behind South Korean chip stocks has not disappeared. Memory chips are a crucial component of AI infrastructure, with high-bandwidth memory (HBM) being a key product, especially for Nvidia's AI accelerators. Samsung Electronics and SK Hynix hold significant positions in this market. Continued growth in AI demand is also driving up the prices of traditional DRAM and NAND memory.

Bhayani views the South Korean stock market as a "proxy" for investors betting on massive investments in AI infrastructure. This highly concentrated trading structure amplifies both the rallies driven by AI and the pullbacks following reversals in sentiment.

Therefore, the plunge in the third quarter does not mean that the AI demand logic for South Korean chip stocks has reversed. A more direct change is that the previously highly crowded AI memory market experienced concentrated liquidation, leading to a valuation reassessment. Meanwhile, rising interest rates and chip supply risks further limit the market's room for further valuation expansion.

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