The market’s big AI doubts are exposing the riskiest players

By Allison Morrow, John Towfighi, CNN

New York (CNN) — The meteoric rise and stunning near-collapse this week of a US hedge fund has sent shockwaves across global markets, becoming a kind of cautionary tale for the AI era.

On Thursday, the San Francisco fund Situational Awareness, founded by a former OpenAI researcher with no professional investing experience, was forced to sell the bulk of its public holdings to a bigger rival after its investments soured and it faced a raft of margin calls from lenders.

In a matter of days, the aggressively AI-concentrated fund went from being the envy of Wall Street — Situational was reportedly up more than 400% this year — to needing a bailout by a larger rival, a dramatic turn that’s deepening investors’ anxiety about the sustainability of the AI momentum trade and the risks of leaning on leverage.

But much of what ailed the firm is not unfamiliar to investors around the world, as they’ve sought to amplify their exposure to the parabolic gains in AI-related stocks. Situational borrowed heavily from lenders to buy tech stocks, a strategy that works well when the market is going up, and fails spectacularly when the mood sours.

When economists warn about the risks of too much concentration in the stock market, this situation is what they’re talking about: The financial world is deeply interconnected, for better or worse, making one relatively small hedge fund’s bad day a problem for everyone – from mom and pop investors to asset managers overseeing funds in millions of 401(k)s.

Market whiplash

AI-related market volatility has been especially pronounced in South Korea, which, like the US market, is heavily concentrated on tech and AI.

The top nine stocks in the S&P 500 – all tech – make up almost 40% of the index’s market value. In South Korea, things are even more tightly bound, with two chipmakers – SK Hynix and Samsung – making up half of the index’s value.

The Kospi surged as much as 116% from the start of the year to its peak on June 22. Since that record high, the index has dropped 28%.

The Korean selloff was the first sign of trouble for Situational Awareness, which invested heavily in memory chip makers SK Hynix.

But those peaks have sparked a trading frenzy that has attracted retail investors in South Korea, similar to the United States.

Those extraordinary moves in the Kospi have also laid bare just how widespread the use of leverage is in South Korea. The Kospi has tripped nine circuit breakers this year, sending South Korea’s market into a state of continued chaos, taking those retail investors with it.

When traders use leverage, they can have their accounts liquidated if losses get too steep. Margin calls in South Korea have become a regular occurrence. The South Korean finance ministry this week introduced new restrictions on single-stock leveraged ETFs, trying to cool a frenzy that has enveloped markets.

The volatility matters for US markets, too: The PHLX Semiconductor Index, a benchmark that tracks 30 chip stocks, surged almost 90% in the second quarter before tumbling more than 20% in July and entering a technical bear market.

Just a few weeks ago, Situational Awareness and its founder, Leopold Aschenbrenner, were riding high. The former OpenAI researcher’s core investing thesis centered on the belief that AI demand would continue to grow, requiring a massive buildout of data centers, chips and electricity infrastructure. Its holdings included memory chip makers SK Hynix and Sandisk and AI cloud provider Nebius — all of which suffered huge market losses in recent weeks.

As the value of Situational’s investments fell, the fund faced margin calls from lenders, forcing the firm to sell all of its public stock holdings. Citadel, a rival hedge fund, effectively bailed out Situational Awareness, which is reportedly left with its stakes in Anthropic and other private companies.

Aschenbrenner didn’t immediately respond to a request for comment.

Not necessarily a sign of collapse

Leverage in the stock market isn’t anything new. Prior bubbles and crashes were exacerbated by trading on the margin. But it’s not a sign that the AI bubble is popping. All told, the S&P 500 is less than 3% away from a record high.

As with any market frenzy, when volatility strikes, people with too much leverage in either direction get taken to task. That applies to regular everyday investors like mom-and-pop traders in South Korea, as well as investors handling professional money like Situational Awareness.

This could just be a shaky moment that the market recovers from. Risky bets just tend to get exposed in these moments.

The-CNN-Wire
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