The Leverage Frenzy of Borrowing to Invest in Stocks: Why Wall Street is Paying Attention to the Sharp Decline in the Korean Stock Market

[By Myungjeong Seon, Block Media] As leverage and short-term trading spread among individual investors and quant funds in the U.S. stock market, warnings have emerged that market volatility could structurally increase. In particular, Wall Street is focusing on the large-scale forced selling incident that occurred in the Korean stock market last month as a 'precedent' for risks that the U.S. market may face.

According to MarketWatch on the 30th (local time), market experts have raised concerns that both individual and institutional investors are actively engaging in investments using borrowed money, while the investment period is also shortening, leading to the possibility of rapid price corrections becoming more frequent than in the past.

Over the past decade, the number of individual investors trading stocks directly has significantly increased, while quant investment strategies have rapidly spread among institutions. Both types of investors are characterized by being more sensitive to short-term price movements than traditional fundamental investors.

The AI Boom and Leverage: Fast in Upturns, Faster in Downturns

The problem is that leverage amplifies not only market gains but also losses.

In the second quarter of this year, after the selling pressure triggered by the Iran war subsided, stocks related to semiconductors and artificial intelligence (AI) rose rapidly. However, in July, concerns about intensified competition with China caused investor sentiment to turn sharply. Stocks that had previously shown strength, including Micron and SanDisk, plummeted.

Philip Stral, Chief Investment Officer (CIO) at Morningstar Wealth, analyzed that the large inflow of funds into leveraged exchange-traded funds (ETFs) may have further accelerated the speed of stock price declines during this process.

Stral noted that while positions concentrated in AI semiconductors and memory stocks have eased compared to before, the overall level of leverage among individuals and hedge funds remains high. He explained that if investors simultaneously need to reduce their risk exposure, the market could again be exposed to significant volatility.

Leveraged ETFs are designed to track the daily returns of their underlying assets at two or three times the rate. While they can amplify profits in a rising market, losses can also accumulate rapidly if the market moves in the opposite direction. Especially when combined with margin trading, a vicious cycle can occur: price decline → margin call → forced selling → further decline.

Why Wall Street is Watching Korea: 1.2 Million Accounts Facing Margin Calls

The case that Wall Street is paying attention to is Korea. The Korean stock market, which had risen sharply this year, was quickly shaken last month as memory semiconductor stocks, including Samsung Electronics and SK Hynix, plummeted. During this process, it is reported that over 1.2 million trading accounts faced margin calls requiring additional collateral.

Korean authorities have since taken preventive measures, including restrictions on access to leveraged ETFs and strengthening cash margin requirements.

Joe Salucci, co-founder of Temis Trading, assessed that the Korean stock market illustrates what can happen when leveraged products and short-term investors combine. He stated that active short-term investors who can access derivative products like double-leveraged ETFs accelerate the uptrend, while latecomers rush to buy as prices rise.

When the market direction changes, the situation unfolds in the opposite way. Investors using credit cannot bear the losses and are forcibly liquidated, which in turn pulls prices down further.

"The Same Mechanism in the U.S.... Volatility Could Increase in the Next Correction"

The leverage investment frenzy is not unique to Korea. As the excitement around AI investments has surged this year, the assets under management of leveraged ETFs worldwide have rapidly increased. In the U.S., although leveraged products still represent a small share of the overall ETF market, they are considered a sector with active new product launches.

The market is also viewing the phenomenon of investors flocking to certain popular stocks as a risk factor. Michael Wilson, an investment strategist at Morgan Stanley, has warned that if investment positions become excessively concentrated in one direction, it could lead to market inefficiencies and price distortions. Owen Lamont, a portfolio manager at Acadian Asset Management, also assessed the excessive use of leverage by individual investors as a signal of market overheating.

It is still uncertain whether the U.S. stock market will experience a rapid liquidation of leverage similar to Korea. However, experts note that the operational mechanisms of the two markets are similar. In a rising market, leverage amplifies returns and attracts additional funds, but when the market turns downward, the same leverage becomes a trigger for forced selling.

Ultimately, the key for the future of the U.S. stock market will be how quickly high-leverage positions are unwound when popular stocks like AI and semiconductors undergo corrections. Wall Street warns that if investors simultaneously reduce their risk exposure while leverage levels are high, even small price shocks could amplify overall market volatility.