The sword of Damocles over the AI bull market: not just South Korea, but the leverage in U.S. stocks is equally alarming.

Original Author: Zhang Yaqi

Original Source: Wall Street News

Global stock markets have repeatedly hit new highs driven by the AI wave, but the fuel supporting this rally is becoming increasingly dangerous—from the US to South Korea, margin debt and leveraged ETF sizes have both reached historical limits, and the pro-cyclical nature of leverage itself is amplifying the tail risks of market volatility exponentially.

US margin debt surged 54% year-over-year in May to a record $1.4 trillion; simultaneously, the total assets of leveraged ETFs nearly doubled in less than 70 days, surpassing $220 billion around June 3 (FactSet data). The risks of this leverage frenzy have already surfaced first in the South Korean market: The Korea Composite Stock Price Index (KOSPI) triggered a circuit breaker after plunging 10% last week, followed by a rapid rebound, then another circuit breaker, with violent fluctuations dragging US AI-related stocks into a共振 weakening.

The alarm has subsequently sounded on Wall Street. Barclays analyst Alexander Altmann warned clients this week that leveraged funds have accumulated approximately $300 billion in derivatives linked to individual stocks and indices since the end of March. Once such a scale needs to be liquidated centrally in a short period, "the impact is chilling," and he characterized it as "unquestionably the largest non-discretionary source of risk in the market today." Morgan Stanley also warned on June 15 that the marginal buyers of US stocks are more dependent on leveraged financing than ever before, and this financing is becoming more expensive and scarcer. Charles Schwab, one of the largest US brokerages, tightened margin requirements this month and issued margin calls to clients exceeding the new thresholds.

All of this points to the same logic: When leverage-driven gains reach their limit, the backlash of deleveraging will amplify the declines by the same multiples.

US Stock Leverage: Scale and Intensity Both Hit Records

The enthusiasm of US investors for borrowing to buy stocks has reached unprecedented levels.

Data from the Financial Industry Regulatory Authority (Finra) shows that US margin debt rose 54% year-over-year in May to a record $1.4 trillion. Alongside this is the explosive expansion of the leveraged ETF market—such products typically track two or three times the daily return of underlying assets. According to FactSet data, between March 30 and June 3, total assets of leveraged ETFs surged from about $115 billion to $220 billion.

The most sought-after products are concentrated in technology and semiconductor stock indices, as well as single-stock leveraged funds for Tesla, Nvidia, and even SpaceX in recent times. The Direxion 3x Bull Semiconductor ETF, which tracks a semiconductor index, accumulated gains of approximately 700% between late March and late June—yet it plunged 31% on June 5 alone, amplifying the benchmark index's decline threefold proportionally.

From hedge funds to retail investors opening accounts on Robinhood, all types of investors are flooding in. Mark Hackett, chief market strategist at Nationwide Investment Management Group, expressed concern:

"I'm worried we're accumulating hidden leverage that is not fully understood. Some people have a lottery mentality, buying options on leveraged ETFs with borrowed money—that's already three to four layers of stacking."

Derivatives Mechanism: Pro-Cyclical Amplifier

The danger of leveraged ETFs lies not only in their own profit and loss amplification mechanism but also in their potential to distort the price movements of the underlying tracked assets—what market participants refer to as the "tail wagging the dog" effect.

Barclays estimates that to absorb continuously flowing new funds, leveraged funds have purchased approximately $300 billion in derivatives contracts linked to individual stocks and indices since the end of March. After market makers take on these contracts, to hedge their own exposure, they must buy corresponding spot stocks in the opposite direction, further boosting the gains of technology and semiconductor stocks this year.

The problem is that this mechanism works the same way when the direction reverses and has self-reinforcing characteristics. Once the underlying stocks decline, leveraged fund assets shrink, forcing position reductions, which in turn lower stock prices, triggering more redemptions and position reductions, forming a negative spiral.

Dave Nadig, research director at ETF.com, warned of this:

"Any market with known, price-insensitive buyers and sellers will create problems. I'm really concerned that more and more money is flowing into this system of leveraged single-stock products, because the more money that goes in, the stronger this pro-cyclical trading effect becomes."

South Korea's Warning: Extreme Concentration Plus High Leverage

The episode in the South Korean market this week is seen by market participants as a stress test that can be referenced.

According to a CICC research report, the KOSPI index has risen 87% year-to-date, leading the world, primarily driven by memory chip leaders such as Samsung Electronics and SK Hynix. However, the combination of highly concentrated holdings and extreme leverage has sharply increased market fragility: On Tuesday, due to concerns over memory chip expansion plans and the impact of news that South Korea is discussing taxing unrealized gains, the KOSPI plunged 10% in a single day and triggered a circuit breaker; it then rebounded strongly over the next two trading days, returning to 9,000 points, and triggered another circuit breaker on Friday.

CICC estimates that the current leverage multiple in the South Korean market ranges between 2x and 5x, with broad leverage scale reaching 271 trillion Korean won, an absolute level at historical highs—theoretically, a decline of 16% to 36% in the underlying assets could trigger margin calls. According to the Wall Street Journal, leveraged fund-related trades tracking Samsung and SK Hynix recently accounted for up to 50% of the average daily volume of these two stocks, significantly disrupting stock prices in both up and down directions.

Lee Chan-jin, head of South Korea's Financial Supervisory Service, said at a press conference last week that he regretted failing to block the issuance of leveraged single-stock funds: "These are high-risk products, and about 92% of holders are retail investors. Despite consumer warnings, trading enthusiasm has not cooled."

Rising Financing Costs: Borrowing to Buy Stocks Is Getting More Expensive

According to a previous article by Wall Street News, Morgan Stanley's analysis reveals the accumulation of pressure from another dimension.

The core metric measuring stock financing costs—the AXW futures (which track the spread between the implied financing rate of S&P 500 total return futures and the benchmark SOFR)—for the June-expiring one-month contract surged to +140 basis points last week. Even as the S&P 500 subsequently pulled back from its all-time high, this metric remained at extremely elevated levels, the highest since December 2020 (excluding year-end special periods).

Meanwhile, data from the Federal Reserve Bank of New York shows that as of the week ending June 3, 2026, US primary dealers held $223 billion in equity exposure through repo and other securities financing methods, a record high. Morgan Stanley's "stock financing dependency" metric—calculated as primary dealer stock repo size divided by S&P 500 free-float market cap—has surged nearly 50% over the past year, approaching the historical peak in mid-March this year, meaning that borrowing funds behind each dollar of market capitalization are becoming increasingly dense.

This financing demand is highly concentrated in a few sectors. Morgan Stanley's industry breadth data shows that over the past three months, only the information technology sector among the 11 GICS sectors has outperformed the S&P 500, with a gain of 24.2% and excess returns of 13.3%; in about 70% of trading days over the past year, the number of sectors outperforming the market did not exceed five. This means that the overall market's rise is actually supported by leveraged funds in a very small number of sectors. Once these funds begin to retreat, the impact on the overall market will be amplified simultaneously.

Once Deleveraging Starts, the Impact Will Be Multiplied Multiple Times

Morgan Stanley warns that the current situation constitutes a potential nonlinear risk: Rising financing costs prevent leveraged buyers from continuing to add positions, the disappearance of marginal buyers removes upward momentum, subsequent price declines trigger deleveraging, selling pressure is amplified by leverage, and ultimately the decline exceeds expectations. Historical data shows that inflection points in AXW futures often closely coincide with the S&P 500's cyclical peaks.

More troubling, Morgan Stanley's financial conditions index shows that from the outbreak of the Iran conflict to June 11, financial conditions have tightened by an equivalent of 31 basis points of rate hikes, driven mainly by rising 10-year Treasury yields and a stronger US dollar. However, because the stock market is still rising at the index level, most investors are unaware of this tightening—the stock market's rise itself has contributed approximately -21 basis points of easing to financial conditions, partly masking the pressure from other factors.

Morgan Stanley's base case predicts that the Fed will cut rates by 25 basis points each in March and June 2027, with the final policy rate target range falling between 3.00% and 3.25%. However, the bank warns that once deleveraging triggers a stock market decline, investors will be forced to reassess financial conditions, which will then lead to a repricing of the Fed's policy path, and the previously priced weight of tail risks from rate hikes will be the first to collapse.

Alexander Altmann wrote in a note to clients: "The technical forces that previously amplified upside momentum through leverage expansion may begin to cut in the opposite direction."