This correction was bound to happen. Such events are healthy in every market, but understanding the connection between crumbling AI stock prices and the recent margin unwind shows how bullish this is for long-term investors who can buy the dip.
Margin debt grew 53.7% year over year in May, reaching a record $1.42 trillion. It was also up by 8.5% month over month. All that margin meant that a small correction would inevitably turn into a big one — and it did.
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SK Hynix (NASDAQ: SKHY) is the poster child of this development. It dropped by more than 20% over the course of two days in July. But this dip has created a tremendous buying opportunity for long-term investors, especially when the margin unwind concludes.
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SK Hynix’s unique position
SK Hynix is a memory maker that has benefited tremendously from the AI infrastructure build-out, but it is also a South Korean company. Not only that, but it is that country’s most valuable company.
These are important details when assessing the current margin unwind. That’s because 12 million South Korean retail traders received margin calls over the past week. That was more than 3% of South Korea’s adult population.
That type of margin pressure can accelerate losses and margin calls for investors globally. Then, it creates a feedback loop that results in more margin calls and deeper corrections until the margin unwind is complete.
Since SK Hynix is its country’s most valuable company and a major part of the AI trade, it has outsized exposure to the margin unwind.
Leveraged ETFs have made the margin unwind even worse, with these types of ETFs debuting for SK Hynix earlier this year. These ETFs must maintain fixed ratios of their holdings, so whenever an underlying stock loses value, they are forced to unwind some of their positions. If too many traders pile into leveraged ETFs while having margin accounts, it can trigger even more margin calls.
South Korea’s Financial Supervisory Service Governor Lee Chan-jin called leveraged ETFs a “gambling operation” that has increased market volatility. “We are seeing a phenomenon in which ETFs themselves are driving market swings,” he said.
A closer look at fundamentals
The dramatic margin unwind in South Korea, fueled by margin loans and leveraged ETFs, has dragged SK Hynix well away from its all-time high. International investors have also been forced to sell some of their shares.
The smartest investors will attempt to ignore short-term stock price movements and focus on fundamentals. In that light, it’s easier to see SK Hynix as a compelling long-term opportunity rather than a stock that lost more than 20% of its value over just two days.
The company’s revenue almost tripled year over year in the company’s first quarter, and its 76.7% net profit margin shows that the memory-chip maker is having no problem retaining a large share of total sales. As the AI build-out continues to heat up, big tech will need more memory chips. SK Hynix has positioned itself well for a multiyear boom, even though its stock price’s recent action suggests otherwise.
SK Hynix only trades at a forward P/E ratio of 8 and a PEG ratio under 1. Both metrics suggest the stock is undervalued, especially given its impressive financial growth and long-term tailwinds.
Don’t time the margin unwind
Eventually, the margin unwind will conclude, and investors will return to focusing on fundamentals. Big tech players delivering strong earnings this month that further validate the AI trade may be the catalyst, but investors should not time the margin unwind and try to buy at the lowest possible point.
When large swings take place, they often go both ways. A stock that lost 20% of its value in two days due to a margin unwind can easily regain that ground within a few days. When investors start to feel better about market conditions, they will gradually pile into margin and leveraged ETFs again.
While leveraged products do increase volatility, investors who focus on fundamentals and have long-term time horizons are best positioned to capitalize on megatrends like memory chips.
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Marc Guberti has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
