After a 28% drop, still calling for 12,500 points, JPMorgan: South Korea's deleveraging is more than halfway complete, regulatory tightening limits rebound elasticity.

TL;DR

JPMorgan states that KOSPI has fallen about 28% from the June peak, but continues to overweight South Korea and maintains a target of 12,500 points.
The scale of leveraged ETFs has been estimated to have dropped from about $50 billion to $26 billion, and hedge funds have also deleveraged more than half.
Sell pressure is concentrated on Samsung Electronics and SK Hynix, and regulatory tightening on single-stock leveraged products will still limit rebound elasticity.

In a research report dated July 21, JPMorgan estimated that the KOSPI index in South Korea has fallen about 28% from its peak on June 22, with significant reductions in positions in leveraged ETFs and hedge funds. However, the bank still maintains an overweight rating on the South Korean market, with a 12-month KOSPI benchmark target remaining at 12,500 points.

The main line of this judgment is not simply a bet on a rebound, but rather an explanation of the recent sharp decline in the South Korean stock market as a leveraged unwind and a concentrated position adjustment. According to JPMorgan's metrics, South Korean leveraged ETFs have decreased from about $50 billion at the end of June to the current $26 billion, completing about 75% of the deleveraging. The deleveraging progress of equity hedge funds has also exceeded half. Year-to-date, foreign capital outflows have surpassed $110 billion, with about 90% coming from the two major memory stocks: Samsung Electronics and SK Hynix.

However, a decrease in positions does not mean that the market has returned to calm. The volatility of the South Korean stock market remains high, with the VKOSPI to VIX ratio close to 5 times, while the normal level is around 1 time. Tight swap capacity, regulatory tightening on single-stock leveraged products, and whether AI demand can continue to support memory and industrial chains are still the boundaries for whether this round of adjustment can truly come to an end.

The decline is deep, but the sell pressure more resembles a position unwind

This round of declines in the South Korean stock market has been severe enough. KOSPI set a record closing high of 9114.55 points on June 22, and by early July had fallen over 20% from that peak. Calculating around 6516 points around July 21, the decline from the peak is about 28.5%.

The premise for JPMorgan maintaining the 12,500-point target is that this round of declines is not due to a sudden collapse of fundamentals, but rather that the previously overcrowded trades have been concentrated and squeezed out. The South Korean market had previously risen rapidly due to expectations surrounding AI, the memory upcycle, and corporate governance reforms, with some funds amplifying their exposure through leveraged ETFs, swaps, and long-short fund positions. After the increase in volatility, the closing of positions and redemptions further exacerbated the declines.

The price momentum factor has retreated nearly -26% over four weeks, also pointing to the same issue: stocks that had previously risen strongly and were crowded have displayed more evident pressure.

However, volatility itself has not normalized. The VKOSPI to VIX ratio is close to 5 times, indicating that local market volatility in South Korea is much higher than that in the United States. The pressure on positions is decreasing, but price fluctuations may still amplify in the short term.

Leveraged ETFs have fallen from $50 billion to $26 billion

The most striking deleveraging has occurred within leveraged ETFs.

JPMorgan estimates that the asset scale of South Korean leveraged ETFs has dropped from about $50 billion at the end of June to the current $26 billion, with a deleveraging progress of about 75%, approaching what they consider a more acceptable scale of $18 billion.

This number should not simply be understood as mass redemptions by investors. The total net inflow during the same period is still positive, and the scale decrease mainly comes from the drop in the underlying market. In other words, net subscriptions have not completely disappeared, but the price decline has already caused passive reductions in leveraged exposure.

The AUM of leveraged ETFs has dropped from about $50 billion to $26 billion, but cumulative fund flow remains positive.

This is also why JPMorgan believes that the deleveraging has made substantive progress. If the scale of leveraged products continues to remain high, each drop in the market could trigger more passive selling. After the scale is halved, the same price fluctuations will have a weakening effect on subsequent selling pressure.

Horizontally, the margin financing for retail investors in South Korea is not extreme. The metrics listed in the research report show that the margin balance in South Korea is about $21 billion, accounting for 0.5% of the total market capitalization. Leveraged ETFs at about $26 billion account for 0.7% of the total market capitalization. In comparison, the margin balance in the U.S. accounts for about 1.9% of market capitalization, and leveraged ETFs account for about 0.3%. Meanwhile, in China, the margin balance ratio is about 2.8%, and leveraged ETFs are nearly 0.

The margin balance of $21 billion in South Korea accounts for 0.5% of the market capitalization, while leveraged ETFs of $26 billion account for 0.7%.

This set of comparisons indicates that the problem in the South Korean market is not an abnormally high margin balance, but rather that the presence of leveraged ETFs in the market is relatively high. Retail investors remain an important buyer in the South Korean stock market; among overseas stock purchases since June, several leveraged products still rank highly. Sentiment has not completely cooled; rather, the decline and regulatory expectations have temporarily lowered leveraged scales.

Hedge fund selling pressure has also decreased, but has not returned to normal

The second clue for deleveraging comes from hedge funds.

JPMorgan's Prime book shows that the deleveraging progress of equity hedge funds has already exceeded 50%, with the long-short ratio decreasing from a peak of over 5.5 times to below 4 times. This indicates that a considerable portion of the exposure added by funds during the rapid rise in South Korea over the past year has been reduced.

A roughly 28% drop in the index indicates that prices have already adjusted, and a decrease in the long-short ratio further suggests that the fuel for "forced selling" is also diminishing. If the long-short ratio continues to decline, the subsequent chain selling pressure due to over-positions will be lower than the state at the end of June.

However, being below 4 times does not equate to complete normalcy. Deleveraging is still distant from normalization, and tight swap capacities and abnormal volatility have not fully dissipated. In concentrated markets like South Korea, once financing channels narrow, the pullbacks of popular stocks will be amplified, especially for core holdings previously supported by AI and memory chains.

"75% deleveraging" cannot be directly equated with confirming the bottom. The market can recede from the most crowded state, but as long as volatility remains high and financing is tight, the remaining positions may still amplify declines on certain trading days.

Foreign capital selling pressure is concentrated on two major memory stocks

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

According to JPMorgan's research report dated July 21, foreign capital has net flowed out of the South Korean stock market over $110 billion this year, with about 90% coming from Samsung Electronics and SK Hynix. Reports show that in late June, similar metrics were about $95 billion, and subsequent figures may have been updated with market declines and foreign capital selling.

This concentrated outflow is different from a comprehensive exit from South Korea. The weights of the two major memory stocks in the MSCI EM index have fallen from 9.5% and 8.3% at the end of June to 7.5% and 5.7%, respectively. After the decrease in weights, the selling pressure on funds affected by authorized ranges, benchmark weights, or concentration limits will ease.

Foreign capital has flowed out over $110 billion this year, with about 90% coming from the two major memory stocks.

This is also one of the important reasons JPMorgan continues to maintain an overweight rating on South Korea. If foreign capital were to sell off Korean assets broadly, the issue would be closer to a systemic confidence decline. If the selling pressure is mainly concentrated on two over-weighted memory stocks, as their weights decrease and position limits ease, the market's pressures will manifest differently.

The risks are also concentrated here. The core support of the South Korean market is still related to AI capital expenditures, data center construction, and high-end storage demand. If the market begins to question the sustainability of AI computing investments, or if new technologies lower the demand for high-end memory and related hardware, Samsung Electronics and SK Hynix will still become amplifiers of foreign capital flows and index volatility.

Regulatory tightening on single-stock leveraged products makes it difficult for leverage to recover immediately

The South Korean regulatory body has begun to cool down high-leverage trading.

On July 16, the Financial Services Commission of South Korea announced to confirm a suspension of the launch of single-stock leveraged, inverse, and covered call products. The minimum deposit requirement will increase from 10 million KRW to 30 million KRW, expected to be implemented on August 5. Starting August 19, the initial margin will only count cash. From November, the minimum trading unit for single-stock leveraged products listed in Korea is proposed to be raised from 1 share to 20 shares.

These measures are not aimed at all leveraged ETFs, but focus on single-stock leveraged products. The impact is not to immediately raise indices, but to limit the re-expansion of leveraged products. Even if retail sentiment remains strong, the space for capital to quickly amplify exposure through small trades and non-cash margins will decrease.

This explains why JPMorgan maintains a bullish view on Korea while still emphasizing regulatory effects. If regulation only suppresses in the short term, leveraged funds may accumulate again through other products or markets. If the new regulations continue to be effective, the volatility amplification mechanism of the South Korean stock market will weaken.

AI earnings forecasts are still being raised, but risks also lie in AI

Another reason JPMorgan remains optimistic is that profit expectations for South Korea are still being revised upwards.

The report shows that South Korea's market EPS for 2026 has been raised by 143.4% over the past six months, with the technology sector raised by 215.5% and the industrial sector raised by 91.0%. Even with significant price declines, analysts' revisions for future earnings remain strong, especially concentrated on AI-related technology and industrial chains.

The EPS for South Korea's market for 2026 has been raised by 143.4% in six months, with the technology sector up by 215.5% and the industrial sector up by 91.0%.

Factors supporting these upgrades include ultra-large-scale computing investments, data center construction, security and resilience expenditures, and medium to long-term expectations for corporate governance reforms in South Korea. For the South Korean market, memory, servers, industrial equipment, and related supply chains are still the most direct beneficiaries.

Risks also originate from the same direction. The fundamental support for the South Korean stock market in this round heavily relies on the AI cycle. If AI capital expenditures slow down, or if new technologies reduce demand for high-end memory and related hardware, profit upgrades may be re-evaluated. The relatively weak performance in sectors such as materials and consumption also indicates that the South Korean market is not improving uniformly across all industries.

JPMorgan's target of 12,500 points is based on a combination of continued deleveraging, the demand for AI not being invalidated, and easing foreign capital selling pressure. What can currently be said is that the most crowded positions in the South Korean market have clearly loosened. What cannot yet be said is that volatility has returned to normal, foreign capital has begun to flow back continuously, or that the profit upgrades from the AI chain have been completely locked in.

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