The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

By Robyn Mak

HONG KONG, May 27 (Reuters Breakingviews) - South Korea's markets are on fire. The benchmark KOSPI Index .KS11 rallied to a record high on Wednesday, thanks to the country's army of 14 million retail traders that have piled in even as foreign investors sell. But AI darlings Samsung Electronics 005930.KS and SK Hynix 000660.KS now account for nearly half of the index, leaving the market exposed to faltering AI demand and other risks. It's a potential tinderbox.

After a 1,000%-plus surge in its stock price over the past year, SK has just joined its memory-chip making rivals Samsung and U.S.-based Micron Technology MU.O in reaching a $1 trillion market capitalisation. Booming demand for high-end data storage silicon has tipped the notoriously cyclical industry into a severe shortage that analysts reckon will last for another year or two. That has been a boon for market leader SK: the company led by Kwak Noh-jung is on track to more than quadruple EBITDA to $174 billion this year, per Visible Alpha.

The stock frenzy is largely driven by South Korea's retail investors, whose numbers are equivalent to more than a quarter of the population. Since the start of the year, net outflows from foreign investors have amounted to $62 billion, though much of that was driven by portfolio weight adjustments rather than active selling, reckons Goldman Sachs Research strategist Alvin So. Domestic traders, encouraged by the government's generous tax breaks for those who sell overseas stocks and buy local ones, have more than replaced the exiting money.

Risks are building, though. The balance of margin loans outstanding has increased by nearly a third to over $20 billion since the start of the year, according to the Korea Financial Investment Association. While those absolute balances still look manageable, assets under management of leveraged exchange-traded funds have soared to $30 billion, per Goldman's So, equal to 1% of the market's free-float market capitalisation - significantly higher than in Taiwan, Japan, and Hong Kong. Moreover, investor bets look worryingly concentrated: more than a dozen single-stock leveraged ETFs linked to either Samsung's or SK's shares are set to debut this week and may attract as much as $3.5 billion of net inflows, Bloomberg reports.

All this points to more volatility. Over the longer term, however, South Korea's market will be at the mercy of the AI boom. The technology sector accounts for a whopping 73% of the country's forward aggregate earnings, estimate analysts at BNP Paribas, who conclude that non-tech stocks now look over-valued. Retail investors risk some nasty burns.

Follow Robyn Mak on X.

CONTEXT NEWS

South Korea's benchmark KOSPI stock index rose as much as 5% on May 27 and hit a record high of 8,450.26. The sharp gains triggered a "sidecar" curb that temporarily halted algorithmic trading.

Chipmaker SK Hynix's shares rose as much as 12%, taking the company's market value to a 1,624 trillion won ($1.08 trillion).