After dropping 28% and still calling for 12,500, JPMorgan: South Korea de-leveraging is mostly complete, regulatory tightening limits rebound elasticity

TL;DR

• J.P. Morgan notes the KOSPI has fallen about 28% from its June high but maintains an overweight position on South Korea with a 12,500-point target.
• Leveraged ETF assets are estimated to have dropped from around $50 billion to $26 billion, and hedge funds are more than halfway through their deleveraging process.
• Selling pressure is concentrated in Samsung Electronics and SK Hynix; tighter regulation on single-stock leveraged products will still limit the potential for a rebound.

In a research report dated July 21, J.P. Morgan estimated that the KOSPI index has fallen approximately 28% from its peak on June 22, with significant deleveraging occurring in leveraged ETFs and hedge fund positions. Nevertheless, the bank maintains its overweight stance on the Korean market, keeping its 12-month KOSPI base target at 12,500 points.

The core thesis of this assessment isn't a simple bet on a rebound but rather an interpretation of the sharp decline in the Korean stock market as a leverage-driven stampede and concentrated portfolio adjustment. According to J.P. Morgan's metrics, the size of leveraged ETFs with Korean underlying assets has fallen from approximately $50 billion at the end of June to $26 billion currently, representing roughly 75% of the necessary deleveraging. Equity hedge funds have also completed more than half of their deleveraging process. Foreign outflows this year have exceeded $110 billion, with about 90% coming from the two major memory semiconductor stocks: Samsung Electronics and SK Hynix.

However, a reduction in positions does not equate to a return to calm. Volatility in the Korean stock market remains elevated, with the VKOSPI/VIX ratio near 5x, compared to a typical level around 1x. Tight swap capacity, stricter regulations on single-stock leveraged products, and whether AI demand can continue to support the memory and industrial supply chain remain the key conditions determining if this correction is truly nearing its end.

Deep Decline, but Selling Pressure Resembles a Position Squeeze

The decline in the Korean stock market has been severe. The KOSPI hit a record closing high of 9,114.55 points on June 22, but fell over 20% from that peak by early July. Based on the level around 6,516 points near July 21, the decline from the peak is approximately 28.5%.

The premise for J.P. Morgan maintaining its 12,500-point target is that this sell-off is not due to a sudden collapse in fundamentals, but rather an unwinding of previously overcrowded trades. The Korean market had rallied rapidly, driven by AI, the memory upcycle, and expectations for corporate governance reforms, with some funds amplifying exposure through leveraged ETFs, swaps, and long/short fund positions. When volatility increased, position closures and redemptions exacerbated the declines.

The nearly -26% four-week reversal in the price momentum factor points to the same issue: stocks that had the strongest gains and most crowded capital flows experienced the most significant pressure.

However, volatility itself has not yet normalized. The VKOSPI/VIX ratio near 5x indicates that volatility in the domestic Korean market is much higher than in the US market. While position pressure is decreasing, price swings could still amplify in the short term.

Leveraged ETFs Drop from $50 Billion to $26 Billion

The most visible unwinding has occurred in leveraged ETFs.

J.P. Morgan estimates that the asset size of leveraged ETFs with Korean underlying assets has fallen from approximately $50 billion at the end of June to $26 billion currently, achieving about 75% of the necessary deleveraging, approaching the bank's perceived more acceptable level of $18 billion.

This figure does not simply imply massive investor redemptions. Cumulative net inflows over the period remain positive, with the size decline mainly driven by the underlying market's downturn. In other words, net subscriptions haven't completely vanished, but falling prices have passively contracted leveraged exposure.

Leveraged ETF AUM fell from ~$50bn to $26bn, but cumulative fund flows remain positive.

This is also why J.P. Morgan believes substantial deleveraging progress has been made. If leveraged product sizes remained elevated, each market decline could trigger more forced selling. After the size halving, the same price fluctuations will have a diminished amplifying effect on subsequent selling pressure.

From a cross-market perspective, Korean retail margin financing itself is not extreme. The report notes that the Korean margin balance is approximately $21 billion, representing 0.5% of total market capitalization. Leveraged ETFs account for about $26 billion, or 0.7% of total market cap. In comparison, the US margin balance is about 1.9% of market cap, and leveraged ETFs about 0.3%. For China's A-shares, the margin balance ratio is about 2.8%, while leveraged ETF exposure is near zero.

Korea's margin balance of $21bn is 0.5% of market cap; leveraged ETFs at $26bn are 0.7%.

This comparison suggests the issue in the Korean market is not abnormally high margin balances, but rather a disproportionately high presence of leveraged ETFs. Retail investors remain a significant buyer in the Korean market; since June, several leveraged products have ranked among the top purchases of overseas stocks. Sentiment hasn't fully cooled, but the decline and anticipated regulations have first compressed leverage levels.

Hedge Fund Selling Pressure Has Eased, but Not Returned to Normal

The second line of unwinding comes from hedge funds.

J.P. Morgan's Prime book shows that equity hedge funds have completed over 50% of their deleveraging, with the long/short ratio falling from a peak of over 5.5x to below 4x. This indicates that funds which increased positions during Korea's rapid rally over the past year have trimmed a considerable portion of their exposure.

The index dropping about 28% suggests prices have adjusted, and the declining long/short ratio indicates that the fuel for "forced selling" is also diminishing. Should the long/short ratio continue to fall, the cascade selling pressure from overcrowded positions would be lower than the situation at the end of June.

However, being below 4x does not equate to complete normality. Deleveraging still has a way to go before reaching typical levels. Tight swap capacity and abnormal volatility have not fully dissipated. In a concentrated market like Korea, narrowing financing channels can amplify drawdowns in popular stocks, especially core holdings previously supported by the AI and memory chain.

The "75% unwound" metric also cannot be directly equated to a confirmed bottom. The market can pull back from its most crowded state, but as long as volatility remains high and financing tight, remaining positions could still amplify losses on certain trading days.

Foreign Selling Concentrated in Two Major Memory Stocks

The structure of foreign capital flows is more critical than the aggregate figure.

According to J.P. Morgan's July 21 report, net foreign outflows from the Korean stock market this year exceed $110 billion, of which approximately 90% stems from Samsung Electronics and SK Hynix. Public reports around late June cited a similar metric at about $95 billion, with the subsequent figure likely updated due to further market declines and foreign selling.

This type of concentrated outflow differs from a full-scale retreat from Korea. The weighting of these two major memory stocks in the MSCI EM Index has fallen from 9.5% and 8.3% at the end of June to 7.5% and 5.7%, respectively. As weights decrease, the forced selling pressure from funds constrained by mandates, benchmark weights, or concentration limits is somewhat alleviated.

Year-to-date foreign outflows exceed $110bn, ~90% from the two major memory stocks.

This is another key reason J.P. Morgan maintains its overweight stance on Korea. If foreign capital were selling Korean assets broadly, the problem would be closer to a systemic loss of confidence. If selling pressure is mainly concentrated in two overweighted memory stocks, the market's stress dynamics change as their weights decline and position constraints ease.

The risk is also concentrated here. The core support for the Korean market remains tied to AI capital expenditure, data center construction, and high-end memory demand. Should the market begin to question the sustainability of AI computing investment, or if technological expectations emerge that reduce the need for high-end memory, Samsung Electronics and SK Hynix would once again become amplifiers for foreign capital flows and index volatility.

Tightening of Single-Stock Leveraged Products Prevents Immediate Resurgence of Leverage

Korean regulators have started to cool down high-leverage trading.

The Financial Services Commission (FSC) confirmed in a July 16 announcement a suspension of new listings for single-stock leveraged, inverse, and covered call products. The minimum deposit requirement will be raised from KRW 10 million to KRW 30 million, scheduled for implementation on August 5. Starting August 19, only cash will count towards the initial margin. From November, the minimum trading unit for single-stock leveraged products listed in Korea is proposed to increase from 1 share to 20 shares.

These measures are not targeting all leveraged ETFs but are focused on single-stock leveraged products. Their impact is not to immediately bolster the index but to restrict the re-expansion of leveraged products. Even if retail sentiment remains strong, the space for capital to rapidly amplify exposure through small trades and non-cash margins will decrease.

This explains why J.P. Morgan, while bullish on Korea, still emphasizes the regulatory impact. If regulations only provide a temporary squeeze, leveraged capital might re-accumulate through other products or markets. If the new rules remain in effect, the volatility amplification mechanism in the Korean stock market will weaken.

AI Earnings Revisions are Still Upward, but Risks Also Lie in AI

Another reason for J.P. Morgan's optimism is that Korean earnings expectations are still being revised upwards.

The report shows that the EPS estimate for the Korean market in 2026 has been revised up by 143.4% over the past six months, with the tech sector up 215.5% and the industrial sector up 91.0%. Despite significant price pullbacks, analyst revisions for future earnings remain robust, particularly concentrated in AI-related tech and industrial chains.

Korea market 2026 EPS revised up 143.4% in six months; tech sector +215.5%; industrials +91.0%.

Factors supporting these revisions include hyperscale computing investment, data center construction, security and resilience spending, and the medium-to-long-term expectations from Korean corporate governance reforms. For the Korean market, memory, servers, industrial equipment, and related supply chains remain the most direct beneficiaries.

The risk comes from the same direction. The fundamental support for this rally in the Korean stock market is highly dependent on the AI cycle. If AI capital spending slows, or new technologies reduce demand for high-end memory and related hardware, earnings revisions could be subject to renewed scrutiny. The relative weakness in sectors like materials and consumer goods also indicates the Korean market is not experiencing synchronized improvement across all industries.

J.P. Morgan's 12,500-point target rests on a combination of conditions: continued deleveraging progress, AI demand not being disproven, and easing concentrated foreign selling pressure. What can be said currently is that the most crowded positions in the Korean market have significantly loosened. What cannot yet be said is that volatility has returned to normal, foreign capital has resumed sustained inflows, or that the earnings upgrades from the AI chain are fully locked in.