Morgan Stanley says after a 28% drop, still calls for 12,500 points: Korea's deleveraging is mostly complete, but tightened regulations limit rebound resilience

TL;DR

• JP Morgan states that the KOSPI has fallen about 28% from its June high, but maintains an overweight rating on South Korea and a target of 12,500 points.
• The size of leveraged ETFs is estimated to have decreased from approximately $50 billion to $26 billion, and hedge funds have also deleveraged by more than half.
• Selling pressure is concentrated in Samsung Electronics and SK Hynix, and tighter regulation of single-stock leveraged products will still limit the rebound's flexibility.

In a research report on July 21, JP Morgan estimated that the South Korean KOSPI index has fallen about 28% from its peak on June 22. While leveraged ETF and hedge fund positions have contracted significantly, the bank maintains its overweight rating on the South Korean market and keeps its 12-month KOSPI base target at 12,500 points.

The main thrust of this assessment is not simply a bet on a rebound, but rather an interpretation of the recent sharp decline in the South Korean stock market as a leveraged stampede and concentrated position adjustment. According to JP Morgan's calculation, the size of Korea-linked leveraged ETFs has decreased from about $50 billion at the end of June to the current $26 billion, completing about 75% of the deleveraging. The deleveraging progress for equity hedge funds is also more than halfway done. Net foreign outflows this year exceed $110 billion, with about 90% coming from the two major memory semiconductor stocks, Samsung Electronics and SK Hynix.

However, reduced positions do not mean the market has calmed down. Volatility in the South Korean stock market remains high, with the VKOSPI/VIX ratio close to 5 times, whereas the norm is around 1 time. Tight swap capacity, stricter regulation of single-stock leveraged products, and whether AI demand can continue to support the memory and industrial chains are the boundaries determining whether this adjustment is truly nearing its end.

The Decline Is Deep, but Selling Pressure Looks More Like a Position Stampede

The decline in the South Korean stock market this round has been severe enough. The KOSPI hit a record closing high of 9,114.55 points on June 22, and by early July it had already fallen over 20% from that peak. Calculated based on the level around 6,516 points on July 21, the drop from the peak is about 28.5%.

JP Morgan's premise for maintaining its 12,500-point target is that this decline is not due to a sudden collapse in fundamentals, but rather a concentrated exit from previously overcrowded trades. The South Korean market had been rapidly rising, driven by AI, the memory upcycle, and expectations for corporate governance reform. Some funds amplified their exposure through leveraged ETFs, swaps, and long/short fund positions. When volatility increased, liquidation and redemptions in turn exacerbated the decline.

The four-week drawdown of the price momentum factor, approaching -26%, points to the same issue: stocks that had seen the strongest gains and most crowded capital flows have faced the most significant pressure.

Nevertheless, volatility itself has not normalized. The VKOSPI/VIX ratio near 5 indicates that volatility in the domestic Korean market is far higher than in the U.S. market. While position pressure is decreasing, price shocks could still amplify in the short term.

Leveraged ETFs Decrease from $50 Billion to $26 Billion

The most prominent unwind has occurred in leveraged ETFs.

JP Morgan estimates that the assets under management (AUM) for Korea-linked leveraged ETFs have fallen from about $50 billion at the end of June to the current $26 billion, a deleveraging progress of about 75%, approaching what it considers a more acceptable level of $18 billion.

This figure cannot be simply interpreted as massive investor redemptions. Cumulative fund inflows over the period remain positive; the decline in size is primarily due to the drop in the underlying market. In other words, net purchases haven't completely disappeared, but the price decline has passively contracted the leveraged exposure.

Leveraged ETF AUM has decreased from around $50 billion to $26 billion, but cumulative fund flows remain positive.

This is also why JP Morgan believes substantive progress has been made in deleveraging. If leveraged product sizes had remained high, any market decline could trigger further forced selling. After the size halved, the amplifying effect of the same price volatility on subsequent selling pressure diminishes.

Horizontally, margin financing by Korean retail investors is not extreme. According to the report, Korea's margin balance is around $21 billion, accounting for 0.5% of total market capitalization. Leveraged ETFs are about $26 billion, representing 0.7%. In comparison, the U.S. margin balance is about 1.9% of market cap, and leveraged ETFs about 0.3%. China's A-share margin balance is about 2.8%, while leveraged ETFs account for nearly 0%.

Korea's margin balance of $21 billion accounts for 0.5% of market cap, while leveraged ETFs amount to $26 billion, or 0.7%.

This comparison shows that Korea's problem is not an abnormally high margin balance, but rather the relatively high presence of leveraged ETFs in the market. Retail investors remain a significant buyer in the Korean stock market. Since June, several leveraged products have ranked high in overseas stock purchases. Sentiment hasn't completely cooled; the decline and regulatory expectations have simply compressed the scale of leverage first.

Hedge Fund Selling Pressure Has Also Decreased, but Not Yet Normalized

The second line of deleveraging comes from hedge funds.

JP Morgan's Prime brokerage book shows that deleveraging progress for equity hedge funds has exceeded 50%, with the long/short ratio falling from a peak of over 5.5 times to below 4 times. This indicates that funds that increased positions during Korea's rapid rise over the past year have cut a significant portion of their exposure.

The index falling about 28% shows prices have adjusted, while the decline in the long/short ratio suggests that the fuel for 'forced selling' is also diminishing. If the long/short ratio continues to fall, the cascading selling pressure due to overfull positions will be lower than it was at the end of June.

However, being below 4 times does not mean it's completely normal. The deleveraging process is still some distance from equilibrium. Tight swap capacity and abnormal volatility haven't fully subsided either. In a highly concentrated market like Korea's, once financing channels narrow, drawdowns in popular stocks are amplified, especially for core holdings previously supported by the AI and memory chain.

Deleveraging by 75% also cannot directly be equated with confirming a bottom. A market can retreat from its most crowded state, but as long as volatility remains high and financing tight, the remaining positions could still amplify losses on certain trading days.

Foreign Selling Pressure Concentrated in Two Major Memory Stocks

The structure of foreign capital flows is more critical than the total amount.

According to JP Morgan's July 21 report, net foreign capital outflows from the South Korean stock market exceeded $110 billion year-to-date, with about 90% coming from Samsung Electronics and SK Hynix. In public reports, a similar metric was around $95 billion in late June, and the subsequent figure may have been updated to reflect further market declines and foreign selling.

This type of concentrated outflow is different from a full-scale withdrawal from Korea. The weights of the two major memory stocks in the MSCI EM Index have decreased from 9.5% and 8.3% at the end of June to 7.5% and 5.7%, respectively. With the weight reduction, the pressure on funds constrained by mandate scope, benchmark weights, or concentration limits to continue forced selling will ease somewhat.

Year-to-date foreign capital outflows exceed $110 billion, with about 90% coming from the two major memory stocks.

This is one of the key reasons JP Morgan maintains its overweight rating on Korea. If foreigners were selling Korean assets broadly, the issue would be closer to a systemic decline in confidence. If selling pressure is mainly concentrated in two overweighted memory stocks, the market's burden will differ as their weights fall and position limits ease.

The risk is also concentrated here. The core support for the Korean market remains tied to AI capital expenditure, data center construction, and demand for high-end memory. Once the market begins to question the sustainability of AI computing power investment, or expects technologies that reduce demand for high-end memory, Samsung Electronics and SK Hynix will again act as amplifiers for foreign capital flows and index volatility.

Single-Stock Leveraged Products Tightened, Leverage Unlikely to Resurge Quickly

South Korean regulators have begun to cool down high-leverage trading.

The Financial Services Commission confirmed in a July 16 announcement the suspension of new listings for single-stock leveraged, inverse, and covered call products. The minimum deposit requirement will be raised from 10 million won to 30 million won, expected to take effect on August 5. Starting August 19, only cash will be accepted for initial margin. From November, the minimum trading unit for listed single-stock leveraged products 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. The impact is not to immediately push up the index, but to limit the re-inflation of leveraged products. Even if retail sentiment remains strong, the space for funds to rapidly amplify exposure through small transactions and non-cash margin will decrease.

This explains why JP Morgan is both bullish on Korea and emphasizes the effects of regulation. If the regulations are only a short-term suppression, leveraged funds might rebuild exposure through other products or markets. If the new rules remain effective, the volatility amplification mechanism in the Korean stock market will weaken.

AI Earnings Upgrades Persist, but Risks Also Lie in AI

Another reason for JP Morgan's optimism is that earnings expectations for Korea are still being raised.

The report shows that the 2026 EPS for the Korean market 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 the sharp stock price correction, analysts' revisions for future earnings remain strong, particularly concentrated in the AI-related technology and industrial chains.

Korea's 2026 EPS revised up 143.4% in six months, tech sector up 215.5%, industrial sector up 91.0%.

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

The risk also 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 expenditure slows down, or new technologies reduce demand for high-end memory and related hardware, the earnings upgrades could face renewed scrutiny. The relative weakness of sectors like Materials and Consumer also indicates that the improvement in the Korean market is not industry-wide.

JP Morgan's 12,500-point target is contingent upon the combined conditions of continued deleveraging, AI demand not being disproved, and relief from concentrated foreign selling pressure. Currently, it can be said 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 consistently returned, or the earnings upgrades for the AI chain are fully locked in.