Beyond The AI Boom: Why South Korea And Taiwan Are Flashing Warning Signs

Not long ago, Taiwan and South Korea were among the biggest beneficiaries of the global artificial intelligence (AI) investment boom. Their stock markets surged to record highs as investors poured money into semiconductor companies at the centre of the AI revolution, propelling both markets to outperform most global peers.

But the same forces that fuelled the rally are now beginning to expose its vulnerabilities.

South Korea's benchmark KOSPI index has slipped into bear market territory after correcting more than 20% from its June peak, while Taiwan's stock market has witnessed sharp bouts of volatility as investors reassess the sustainability of AI-driven valuations ahead of Taiwan Semiconductor Manufacturing Company's (TSMC) earnings.

The developments have reignited a broader debate among investors: is Asia's AI boom becoming the next source of financial risk, or is the recent correction merely a healthy pause within a longer-term structural trend?

How AI Turned Taiwan And South Korea Into Market Leaders

The extraordinary rally in both markets has largely been driven by semiconductor companies.

In Taiwan, TSMC has emerged as the undisputed winner of the AI boom. The world's largest contract chipmaker now accounts for nearly 42% of Taiwan's benchmark index after its shares rallied sharply on surging demand for AI processors. The rally helped Taiwan overtake India earlier this year to become the world's fifth-largest stock market by market capitalisation.

South Korea witnessed a similar story.

Samsung Electronics and SK Hynix became major beneficiaries of booming demand for high-bandwidth memory chips used in AI servers. Together, the two companies now account for more than half of the KOSPI's market capitalisation, making the broader market increasingly dependent on their performance.

The concentration extends beyond individual markets.

According to DSP, nearly 72% of the MSCI Emerging Markets Index's gains this year have come from just three semiconductor companies — TSMC, Samsung Electronics and SK Hynix. Collectively, the three companies now account for almost 30% of the benchmark index and have contributed nearly 18 percentage points of its overall return.

Such concentration has prompted concerns that even a modest correction in semiconductor stocks could have an outsized impact on broader emerging-market indices.

South Korea's Debt Issue

South Korea's risks extend beyond stock valuations. Retail investors significantly increased leveraged exposure during the AI rally.

Outstanding leveraged positions reached a record 29.2 trillion won (around $19.7 billion) in early July after the launch of single-stock exchange-traded funds linked to Samsung Electronics and SK Hynix.

As share prices corrected, leveraged positions amplified volatility and triggered periods of sharp market declines.

Adding to investor concerns, foreign investors have withdrawn nearly $110 billion from Korean equities this year as many global funds reduced exposure following the market's rapid appreciation.

Meanwhile, the Bank of Korea raised interest rates for the first time in more than three years, increasing its benchmark policy rate to 2.75%.

The central bank cited inflation above its 2% target, rising household debt and financial stability concerns despite stronger-than-expected economic growth supported by semiconductor exports.

Higher interest rates increase borrowing costs precisely when leveraged investors face declining equity prices, creating additional pressure on financial markets.

Taiwan's Challenge Is Valuation Rather Than Debt

Taiwan's risks appear somewhat different. Unlike South Korea, the concern is less about excessive leverage and more about valuation concentration.

TSMC's extraordinary rally helped Taiwan overtake India to become the world's fifth-largest equity market by market capitalisation earlier this year.

However, such dominance has also made the market increasingly sensitive to any change in investor expectations.

The recent sharp decline in Taiwan's benchmark index ahead of TSMC's earnings reflected growing caution among investors who had accumulated significant gains during the AI rally.

Profit booking spread beyond semiconductor shares into several technology sectors before bargain hunting helped limit losses later in the trading session.

Investors are increasingly asking whether earnings growth can continue matching elevated expectations as AI-related capital expenditure reaches unprecedented levels.

Why Investors Are Becoming More Cautious

The recent correction reflects more than just profit booking. Several global strategists have warned that while AI remains a long-term structural opportunity, investor expectations may have run ahead of business fundamentals.

Macquarie recently argued that the AI investment cycle is unlikely to end through a dramatic collapse similar to the dot-com bubble. Instead, it expects the current boom to unwind through a series of "rolling bubbles", with different parts of the AI ecosystem experiencing periods of rapid appreciation followed by corrections.

Jefferies Global Head of Equity Strategy Chris Wood has expressed a different concern.

Rather than questioning AI demand itself, Wood argues that investors may eventually begin asking whether hyperscalers and AI companies can generate adequate returns on the unprecedented capital expenditure currently being deployed. He has warned that fears of "malinvestment" could eventually interrupt the AI trade if companies fail to justify their massive investments through future earnings.

These concerns have started reflecting in market behaviour.

Taiwan's stock market recently fell more than 660 points in intraday trade as investors turned cautious ahead of TSMC's earnings announcement, while South Korea's benchmark index entered a bear market after a sharp technology-led sell-off.

The corrections suggest investors are becoming increasingly sensitive to earnings expectations rather than simply rewarding AI-related exposure.

Saurabh Jain, Head of Fundamental Research at SMC Global Securities, said the risks differ across the two markets. "Taiwan's rally is mostly a valuation and concentration risk rather than a debt risk. TSMC continues to fund expansion through strong cash flows and maintains low leverage, but its weight in the benchmark index means the market has effectively become a concentrated bet on one company," he said.

"In South Korea, the risks are broader because AI-related optimism sits alongside already elevated household and corporate debt. That reduces the country's ability to absorb external shocks if the AI cycle weakens while broader financial conditions deteriorate."

Jain added that investors should closely monitor whether memory-chip supply begins exceeding demand, whether hyperscaler capital expenditure starts slowing and whether passive and leveraged investment flows begin reversing after amplifying the AI rally.

India Looks Different

Unlike Taiwan and South Korea, India's equity market is far more diversified across banking, financial services, manufacturing, pharmaceuticals, consumer companies and infrastructure.

India also lacks a dominant listed semiconductor manufacturer comparable to TSMC or SK Hynix, limiting its direct participation in the global AI hardware boom.

While this has prevented Indian equities from fully participating in the AI rally, analysts believe it has also reduced the market's dependence on a single investment theme.

Jain said this diversification represents one of India's structural strengths.

"What matters for India is whether companies possess genuine pricing power rather than simply benefiting from AI-related optimism. India's diversified market, rather than a one- or two-stock proxy like Taiwan or South Korea, is a structural advantage that investors should preserve," he said.

Ruchit Thakur, Market Analyst at VT Markets, echoed similar concerns.

"The AI boom has undoubtedly improved economic growth prospects and market sentiment across Asia, but it has also created pockets of financial risk. Rising household borrowing in South Korea and elevated valuations in Taiwan suggest optimism may be running ahead of underlying fundamentals," he said.

According to Thakur, investors should monitor profitability, credit growth, valuation multiples and margin debt rather than focusing solely on AI narratives.

"The long-term AI opportunity remains intact, but investors should avoid excessive leverage and speculative concentration. India's takeaway is to encourage AI innovation while ensuring that market gains remain supported by fundamentals rather than momentum alone," he added.

For investors, the recent volatility may serve as a reminder that transformative technologies often create extraordinary opportunities as well as periods of excessive optimism. While AI is expected to remain one of the defining investment themes of this decade, the experience of Taiwan and South Korea suggests that concentration, leverage and lofty expectations can quickly become vulnerabilities when sentiment begins to shift.