Interest rates are the gravity pulling every asset down

Every time share prices collapse, the same phrase makes the rounds among investors: "Be brave when others are fearful." But not every crash is a buying opportunity. Jumping in simply because prices have fallen far enough can leave investors nursing even deeper losses.

What matters is distinguishing between a temporary panic and a signal that the market's fundamental environment is changing. With high interest rates, a European fiscal crisis and China's advancing chipmakers all hitting at once, Korea's stock market is now asking investors to tell the difference between courage and recklessness.

In a column published in late July, I argued that investors were entering a stretch that called for courage. At the time, the Kospi had tumbled from the mid-8,000s to the low 5,000s over the course of that month. It subsequently recovered to the 7,000 level, but the move looked more like a directionless drift than a genuine rebound.

There were positive signals nonetheless. While the semiconductor sector — which had led the market — stalled, previously overlooked industries began to rise, building expectations for a sector rotation. But concerns over a French fiscal crisis and news of CXMT's push into the memory chip market have combined to send the Kospi back toward its July lows.

The greatest risk facing the market right now is interest rates. Rates act like gravity — they pull down the price of every asset. Since the US-Iran war, US Treasury yields have climbed sharply. The two-year yield approached 5%, while the 10-year and 30-year yields soared to around 5.2% and 5.6%, respectively — surpassing the levels seen during the global equity selloff of September and October 2023.

When rates rise, borrowing costs for companies increase and the present value of future earnings falls. That makes equities less attractive. When US Treasury yields spiked in September and October 2023, the S&P 500 fell 4.87% and 2.2% in those two months. Over the same period, the Kospi dropped 3.57% and 7.59%.

The Kosdaq suffered the most, tumbling 9.41% in September and 12.48% in October — a decline of more than 20% over just two months. Sectors that traded on growth blueprints rather than current earnings were hit hardest. The rate burden fell most heavily on growth stocks and small- and mid-cap markets, where profits are concentrated far in the future. Today's rate levels far exceed those of that period.

The bigger problem is that the recent rise in rates cannot be explained simply by war-driven oil price increases or inflation fears alone.

Expectations that AI will boost productivity and lift the US economy's long-term growth rate are also pushing up long-term yields. That cuts both ways: if AI investment slows or fails to deliver the anticipated results, growth expectations could collapse, dragging both rates and share prices down simultaneously.

US fiscal instability is another factor pushing yields higher. In August 2023, Fitch cut the US sovereign credit rating from AAA to AA+. Last May, Moody's followed, downgrading the US from Aaa to Aa1. Both agencies cited the country's massive national debt and deteriorating fiscal health.

On top of that, major US hyperscalers including Google are issuing long-term bonds to fund their AI investments. Some of these highly rated companies carry credit ratings above that of the US government yet offer higher yields than Treasuries — giving investors a growing incentive to choose their corporate bonds over US government debt. This disperses demand for Treasuries and adds upward pressure on yields.

On top of rising US rates, a French fiscal crisis has recently begun rattling global financial markets. France's 10-year government bond yield climbed from around 3.6% at the start of the year to nearly 4.96% — leaving France paying higher yields than Italy and Greece, both of which carry lower sovereign credit ratings.

Warnings have emerged that France's credit rating could be cut further if the government fails to meaningfully reduce its fiscal deficit. News that a major Japanese asset manager had sold all of its French government bonds and rotated into German and Japanese debt deepened investor anxiety.

France is the eurozone's second-largest economy after Germany, which means its fiscal troubles may not remain a single-country problem. If distrust of French government bonds spreads, it could destabilize bond yields across the eurozone and send shockwaves through global financial markets.

It calls to mind the European debt crisis of 2011. Back then, Greece's sovereign debt problems spread across the continent, triggering a sharp selloff in global equity markets. The United States had not fully recovered from the global financial crisis — unemployment stood at around 9%, and political gridlock over the national debt led to the country's first-ever sovereign credit downgrade.

A paradox emerged in financial markets at the time. Even as the US credit rating was cut, US Treasury prices surged. As the European crisis spread, investors sold risky assets and piled into the dollar and US Treasuries as a relative safe haven. Despite its own fiscal problems, the US remained the most trusted refuge for global capital.

It would be premature to assume the current situation will unfold exactly as it did in 2011. The US debt burden is larger now, and the inflation and rate environment is different. Still, investors should keep in mind that if global financial market stress deepens, demand for dollar assets and US Treasuries could rise again. That is reason enough to consider gradually increasing the share of dollar assets in a portfolio.

Turning to the domestic market, the competitive landscape in the semiconductor industry is also shifting. The main headwind rattling the share prices of Samsung Electronics and SK hynix is the advance of Chinese memory chipmaker CXMT, which recently announced plans to release server DRAM chips using next-generation technology before the end of this year.

The key point is that China is rapidly expanding its presence in the memory chip market — a pillar of Korea's industrial economy. CXMT's share of the global DRAM market already reached around 10% in the second quarter of this year. While assessments suggest the company still lags Korean firms in technology, if Chinese producers ramp up output and compete on price, it could hurt the profitability of both Samsung Electronics and SK hynix. Investors should be particularly alert to the possibility that Korea's long-held dominance in the memory chip market could come under threat.

A Chinese company announcing a technology development does not immediately mean Korean firms have lost their competitive edge — technology development and stable mass production are separate challenges. Even so, when news broke in July about China's progress in domestically produced semiconductor equipment, and again in September when reports emerged about CXMT's HBM production, Korean chipmakers' share prices fell sharply. Markets price in future threats before they arrive.

More important for assessing the semiconductor industry's future is the investment capacity of global AI companies. The engine driving the chip boom has been the massive capital expenditure on AI infrastructure by tech giants such as Google and Microsoft. But questions are growing about whether these companies are generating enough cash to match what they are pouring into investment.

The free cash flow of hyperscalers has in fact deteriorated recently, amplifying those concerns. Anthropic's third-quarter sales rose 46% from the previous quarter, but that pace was a slowdown compared with the second quarter, when sales more than doubled. Concerns about the financial health of CoreWeave, which has been carrying out large-scale AI infrastructure investment, are also mounting.

Ultimately, the question is whether AI companies can generate enough returns to recoup their enormous capital outlays. A genuine recovery in investor sentiment toward Korea's semiconductor industry will require confidence that these companies' cash generation improves and that capital expenditure continues.

The market's internal supply-and-demand dynamics are also unsettled. Customer deposits in brokerage accounts, which had once exceeded 130 trillion won ($96.8 billion), have fallen back to around 100 trillion won as money flows back to banks. Meanwhile, the balance of margin loans has grown from around 30 trillion won in early August to around 34 trillion won recently. Cash is leaving the market, yet the number of investors buying shares on borrowed money is rising.

Retail investors in particular appear reluctant to give up on Samsung Electronics and SK hynix. Since the Kospi hit its low in July, foreign and institutional investors have sold in large volumes, but retail investors' selling has been comparatively limited.

The danger arises if the market fails to rebound quickly. Investors who bought shares on margin could face forced liquidations when their collateral falls short, unleashing a wave of selling that pushes prices lower still — a vicious cycle. That is why a strategy of aggressively building up positions while waiting solely for a semiconductor rebound can be dangerous.

Stock markets have always cycled between fear and euphoria. Successful investing requires having cash available to deploy when fear peaks, and building up cash reserves when the market rises and risk is forgotten. In practice, however, investors tend to do the opposite — piling in aggressively when prices are rising in hopes of bigger gains, then finding they have no dry powder left when prices fall and genuine opportunities appear.

Maintaining a habit of keeping a certain level of cash on hand is therefore important. Using relatively stable assets such as short-term bond ETFs or bank deposits is one approach. This is not merely a defensive measure to avoid losses — it is preparation to seize opportunities when the market is gripped by fear.

One of the books I have returned to most often as an investor is "Mastering the Market Cycle" by Howard Marks, chairman of Oaktree Capital. Its central message is that understanding where the market currently stands in its cycle matters more than trying to predict the future precisely.

The market is clearly in a stretch that tests investors' nerve. But buying indiscriminately just because prices have fallen a long way is not courage. Investors must carefully weigh the risks — elevated interest rates, global financial market instability and shifting industrial competitiveness — and invest only within the bounds of what they can absorb. Finding opportunity amid fear is courage; ignoring risk while banking on a repeat of past gains is recklessness. What investors need right now is neither blind optimism nor excessive pessimism, but clear-eyed judgment and the readiness to act on it.