South Korean regulators accidentally triggered a 30% rally in small-cap stocks.
South Korean authorities' attempt to cool the overheated leveraged ETF market backfired: restrictions on leverage for major chips triggered an explosive surge in low-liquidity stocks. The KOSDAQ index has jumped 30% from its late-July lows, and this is far from the limit.
The country's financial regulators, trying to curb volatility, tightened requirements for leveraged ETFs focused on Samsung Electronics and SK Hynix shares. Retail investors were forced to increase cash collateral, but this did not stop the speculative frenzy. Instead of the expected cooling, private capital flooded en masse into small companies included in the KOSDAQ index, which has risen 30% since its July 30 low.
On Monday, the KOSDAQ index surged 6.8%, triggering an automatic trading halt on the Korea Exchange for the third time this month. This is a clear signal that the market is in a state of extreme instability.
The Regulation Paradox: Why Restrictions Amplified the Chaos
Analysts note that retail investors, who previously actively used leveraged ETFs to bet on semiconductor giants, are now shifting their activity to a more volatile segment. Park Wel, a global ETF expert at Shinhan Securities, emphasizes: "We are seeing growing inflows into KOSDAQ, especially today. Retail investors who love high volatility and moved into one-sided leveraged ETFs are likely to return to KOSDAQ."
Earlier, the KOSPI index plunged about 40% from its June peak to a low in late July. The sell-off was triggered by AI-based instruments, followed by forced liquidations and massive closures of margin positions worth billions of dollars. The leveraged ETF on SK Hynix fell 45% during this period. Regulators admitted: such products only amplified market fluctuations.
The authorities tightened deposit requirements but did not account for where speculative capital would flow next. Now the same audience that fueled the ETF boom on semiconductor manufacturers is driving up small-cap stocks. Regulators are again lagging behind the market.
Maximum Gap Between KOSDAQ and KOSPI Since 2000
Last week, the KOSDAQ index rose steadily while KOSPI lost ground. Currently, small caps are showing the largest performance gap with the benchmark index since the dot-com era. This is a historic moment that underscores the depth of structural changes in the market.
The sustainability of the KOSDAQ rally depends on whether the sell-off in Korean AI stocks has truly ended. If this is merely a repeat of the previous speculative cycle, exchange circuit breakers will continue to trigger, and the market will remain hostage to regulatory decisions.
My view: This situation is a classic example of how administrative measures without considering market behavioral factors lead to unpredictable consequences. Investors should be extremely cautious: the current KOSDAQ rally is speculative in nature, and at the slightest signal of new tightening, we could see an equally rapid correction. Diversification and risk hedging are now more important than ever.