AI Boom Becomes a Double-Edged Sword! Taiwan and South Korea Tech Stocks Plunge as Emerging Markets Volatility Surpasses Pandemic Levels

Fueled by the artificial intelligence (AI) boom, South Korean and Taiwanese companies leading in high-bandwidth memory (HBM) and advanced memory technologies have seen dramatic stock gains, making emerging market equities a global focal point this year and gradually freeing them from their historical role of merely following U.S. markets.

Carlos von Hardenberg, fund manager at MCP Emerging Markets—co-founded in 2018 with emerging markets veteran Mark Mobius—said: "Previously, investors were only interested in the U.S. and the 'Magnificent Seven' because their performance was simply too good. But this year, the situation has completely reversed."

However, the AI rally has come at a steep cost. Since late June, tech stocks in emerging markets have experienced severe volatility, as if investors suddenly suffered from 'altitude sickness.'

South Korea's KOSPI index, driven by Samsung Electronics and SK Hynix, nearly doubled at one point. However, due to market skepticism and regulatory interventions, it plunged about 40% within just six weeks. Meanwhile, shares of Taiwan Semiconductor Manufacturing Company (TSM-US) also retreated nearly 14%.

This correction caused South Korea's market volatility to spike sharply. Even the MSCI Emerging Markets Index—which covers 24 countries, over 1,175 stocks, and represents approximately $1.8 trillion in market value—saw its volatility exceed levels recorded during the peak of the COVID-19 pandemic.

AI is making emerging markets increasingly resemble U.S. markets.

William Bratton, Head of Asia-Pacific Cash Equity Research at BNP Paribas, said many institutional investors now find South Korea's extreme volatility unbearable. "The institutional investors we've spoken to believe that even though fundamentals remain strong, the current level of volatility risk isn't worth taking."

MSCI continues to classify South Korea and Taiwan as emerging markets, primarily because foreign investors still face restrictions when trading local currencies in both regions.

Yet some market participants feel that while the AI boom has delivered the long-desired tech-led rally in emerging markets, it has become a case of 'be careful what you wish for.'

Currently, just nine companies account for over 40% of the weight in the MSCI Emerging Markets Index, including major tech firms from Taiwan and South Korea, as well as Chinese giants Alibaba (BABA-US) and Tencent (00700-HK). This concentration exceeds even that of the U.S. equity market.

Ashley Lester, MSCI's Head of Research, said: "Investors used to view emerging markets as a source of portfolio diversification. But now, with leaders in AI hardware rising to prominence, emerging markets no longer offer that diversification benefit. They are now at the very core of the AI frenzy."

Foreign capital flight from Asia hits largest scale in over a decade.

Ji Young Park, fund manager at Amundi—the largest asset manager in Europe—said she had already begun reducing certain positions before the market turbulence, but the scale of the correction still pressured her fund.

She revealed: "Over the past month, South Korea's stock market triggered circuit breakers about six or seven times—clearly showing the extent of volatility."

Park, who invests with a five-year time horizon, said she does not favor such highly volatile markets: "I just want to be able to sleep at night."

Dimitri Kallianiotis, Technology Portfolio Manager at Swiss private bank Union Bancaire Privée (UBP), acknowledged that some private banking clients have indeed been affected by market swings, but his advice remains: do not panic.

Data from London Stock Exchange Group (LSEG) shows that in the first half of this year, international capital exited Asian (excluding China) equity markets at the fastest pace since at least 2010. According to JPMorgan (JPM-US), South Korea and Taiwan were hit hardest, with capital outflows exceeding $100 billion and $44 billion respectively.

Since fund regulations often limit exposure to individual stocks, investors took profits after Samsung Electronics and SK Hynix surged approximately 500% and 1,100% over the past year.

Kallianiotis of UBP said: "Investors should accept volatility and avoid chasing the hottest stocks in the market. If you exit entirely during the most severe correction, you're likely to miss the subsequent rebound."