From "breaking the net" to the world's strongest, what makes the South Korean stock market so powerful?

Driven by the dual forces of the artificial intelligence boom and expectations of corporate governance reform, South Korea's Composite Stock Price Index (Kospi) has surged over 66% this year, becoming the best-performing major stock index globally, with its underlying drivers attracting the attention of investors worldwide.

So far this year, the Kospi index has outperformed the S&P 500 index by 49 percentage points, marking the largest gap in twenty years. For much of the past three years, the index's price-to-book ratio was below 1, indicating that most investors believed the value of its constituent stocks was even lower than the companies' own assets.

Now, with the return of foreign investment flows and the boost from AI to the country's largest companies (especially chip manufacturers), investors are reassessing this market. Albert Saporta, Group CEO of asset management company GAM, stated:

“This is a comprehensive re-rating of the Korean market. Before this rebound, the Korean market was very cheap.”

Analysts attribute this bull market to the combined effects of three pillars: bets on the future of artificial intelligence, sweeping corporate governance reforms, and the robust growth of manufacturers' exports in key supply chains.

AI-Driven Chip Boom

The rise of the Kospi index is largely due to the strong performance of its two major weighted stocks— Samsung Electronics and SK Hynix, which together account for nearly 30% of the index's weight. So far this year, Samsung's stock price has risen over 90%, while SK Hynix's stock price has tripled.

The direct catalyst for this boom is the AI-driven demand for semiconductors, particularly for its high-bandwidth memory (HBM) products. Joshua Crabb, head of Asia-Pacific equities at asset management firm Robeco, pointed out that the high valuations of U.S. tech giants have led investors to start thinking:

“If that valuation is correct, then which parts of the supply chain are relatively undervalued?”

The performance also confirms the market's optimistic sentiment. The world's largest memory chip manufacturer, Samsung Electronics, reported that its operating profit for the July to September quarter increased by over 30% year-on-year, reaching a three-year high. Meanwhile, SK Hynix is also expected to announce strong quarterly earnings this Wednesday. Additionally, it has been reported that both companies have reached an agreement with OpenAI this month to supply semiconductors for the latter's "Interstellar Gateway" data center project, valued at up to $500 billion.

Corporate Governance Reforms Attract Foreign Investment

The South Korean government's efforts to improve stock market valuations and the governance of family-owned business groups have successfully attracted the attention of foreign investors. Albert Saporta compared this initiative to Japan's corporate governance reforms a decade ago, noting that South Korea is “emulating Japan's approach from ten years ago and combining it with some tax reforms,” which is “exciting investors.” Specific reform measures are gradually being implemented. In July of this year, South Korea revised its Commercial Act to clarify the responsibilities of directors to shareholders. Currently, the government is preparing to cut dividend taxes, and the ruling party has submitted a bill that mandates companies to cancel their treasury shares.

Analysts believe that once these measures are implemented, they will serve as another catalyst for the Kospi index and help to end the long-standing issue of controlling shareholders "abusing" minority shareholders, which has been criticized by outsiders. Expectations for these measures have already driven up the stock prices of corporate groups and financial groups that hold large amounts of treasury shares.

Foreign Capital Inflow and Retail Investors' Caution

Changes in capital flows are the most direct reflection of market sentiment. After being net sellers of Korean stocks in the first half of this year, foreign investors have now turned into net buyers, purchasing stocks worth 20 trillion won (approximately 1.4 billion USD) this year.

Jongmin Shim, a Korean equity strategist at CLSA, stated that he expects the inflow of funds to continue, as the current net purchases by foreigners are still below the levels seen in mid-2024.

It is noteworthy that despite the strong market performance, retail investors in Korea, known for chasing momentum, have largely been absent from this record rebound this year. Jongmin Shim said:

“Net purchases are mainly coming from foreigners and domestic institutions. Once we see the Kospi index rise further, retail funds will return and further boost the market. Only then will I start to worry about the market.”

Rise of Key Supply Chain Manufacturers

In addition to technology stocks, the rise of the South Korean stock market this year has also been strongly supported by manufacturers operating in key sectors such as defense, shipbuilding, and batteries.

Since the Russia-Ukraine conflict, South Korea has become one of the top ten defense exporters in the world. With a manufacturing base that has a cost competitive advantage, investors expect South Korea to benefit from the rearmament trend among Western countries. The stock price of Hanwha Aerospace, South Korea's largest defense manufacturer, has soared by 296% this year. Meanwhile, as South Korea's largest shipbuilder, HD Hyundai Heavy Industries' stock price has also risen by 116%.

In the battery sector, driven by the demand for energy storage facilities from AI servers and growing optimism about electric vehicle sales prospects, the stock price of LG Energy Solution, the world's third-largest battery producer, has risen by over 40% this month. LG Energy Solution is making progress in the U.S. energy storage market as its Chinese competitors are impacted by U.S. trade policies.

Additionally, ahead of President Trump's planned meeting with his South Korean counterpart Lee Jae Myung on Wednesday, expectations for a trade agreement with the U.S. have also boosted investor sentiment