The temporary announcement of martial law in South Korea caused market instability. Now, here's what's expected to happen with stocks.

• On Tuesday, South Korean President Yoon Suk Yeol unexpectedly declared martial law, but later reversed the decision.
• South Korea, a vital US ally and a crucial link in international supply chains, was thrust into the global spotlight due to political whiplash, causing financial markets to tremble.
• Natixis' senior economist, Trinh Nguyen, characterized Yoon's decision to declare martial law as a "very, very poor choice" that negatively impacts South Korea at a critical juncture.

The ongoing political drama in South Korea may worsen the already negative economic outlook for Asia's fourth-largest economy, according to analysts. However, some experts believe that a more severe crisis can be avoided, providing hope for a brighter future.

On Tuesday evening, South Korean President Yoon Suk Yeol declared an emergency period of martial law, stating it was necessary to safeguard the nation from North Korea's "communist threat" and to eliminate "opposing forces."

Hours after the shock declaration, which was perceived as a response to domestic pressures, Yoon reversed his decision. This change occurred after nearly 200 lawmakers entered the National Assembly and unanimously voted to block the move.

South Korea, a vital US ally and a crucial link in international supply chains, was thrust into the global spotlight due to political whiplash, causing financial markets to tremble.

On Yoon's initial martial law order, U.S.-listed Korean equities plummeted, while South Korea's won reached a new two-year low against the U.S. dollar. However, the currency has since regained most of its losses.

On Wednesday, Kim Byung-hwan, vice-minister of economy and finance, announced that the regulator was prepared to deploy 10 trillion won ($7.06 billion) to stabilize the stock market "at any time," according to South Korea's Yonhap News Agency.

On Wednesday, South Korea's Kospi index ended with a 1.44% decline, despite earlier losses of over 2% that day, as opposition lawmakers initiated impeachment proceedings against Yoon.

Strategists at Deutsche Bank stated in a research note published Wednesday that while the current situation in South Korea is calmer, its importance to the global supply chain makes it a story that should remain on our radar.

What next for Korean stocks?

On Wednesday, Jonathan Garner, the chief Asia and EM equity strategist at Morgan Stanley, revealed to CNBC's "Street Signs Asia" that the bank was underweight on Korean stocks.

Garner stated that our perspective on the Korean market is that it is not well positioned in a global economic slowdown, particularly as one of the most trade-exposed markets and geographies we cover, with all the tariff and non-tariff issues that are ongoing.

Additionally, a semiconductor cycle is emerging on the downside, and the global auto sector is severely impacted, with a significant presence in the Korean market.

"Next year, Korea's growth is predicted to fall below 2% by our economists, which is a significant decrease globally."

On Wednesday, Samsung, South Korea's largest company, experienced a 1% decline in shares, while LG Energy Solution and Hyundai Motor suffered losses of 2.8% and 2.4%, respectively.

TS Lombard's chief China economist and head of Asia research, Rory Green, stated in a research note published on Wednesday that it is likely that negative price action and volatility will persist in Korean assets and interconnected markets, particularly in Asian foreign exchange markets.

According to LSEG data, South Korea's won was last seen trading flat at 1,414.22 against the greenback on Tuesday, despite depreciating to 1,444.93, its weakest level since October 2022.

Natixis' senior economist, Trinh Nguyen, characterized Yoon's decision to declare martial law as a "terrible choice" that negatively impacts South Korea at a critical juncture.

Since 1979, martial law has not been implemented and is viewed negatively. Therefore, its reversal is positive. However, it has brought political uncertainty, particularly regarding the future of President Yoon, moving forward.

South Korea is facing a negative period, as the chip cycle is declining, and the October exports are shrinking. The Bank of Korea has had to lower interest rates, and domestic demand is weak.

Nguyen stated that a strong government is necessary to create a fiscally supportive budget that can address long-term challenges, including those from China and potential tariffs.

Investor sentiment could turn for the better

Not all individuals shared the same pessimistic outlook on the market consequences of South Korea's ongoing political crisis.

Capital Economics' head of markets for Asia Pacific, Thomas Mathews, stated in a research note published Wednesday that new reports suggest Yoon will likely be impeached or resign soon, which may aid investors in drawing a definitive conclusion about the affair.

The country's equities performed well during the most recent presidential impeachment in 2016/2017, as impeachments are not uncommon in Korea.

Capital Economics believes that there is some reason to be more optimistic about the chaos in South Korea, as long as a deeper crisis can be avoided.

Matthews stated that Korea's large tech companies are well-positioned to benefit from the current enthusiasm about AI and tech more broadly. If investor sentiment on the country turns for the better, it could do so quite sharply.

He remarked, "There's likely more water to flow under the bridge before we proceed."