Written by: Rita
The South Korean KOSPI index has declined nearly 40% since its peak on June 22. The assets under management of leveraged ETFs have shrunk from $50 billion to $17 billion. The hedge fund long-short ratio has fallen from 5.7x to 3.2x. In a research report on July 29, J.P. Morgan noted that leveraged ETF liquidations have been completed and hedge fund deleveraging has surpassed 90%. While short-term price volatility may still persist, the market’s positioning structure has undergone a thorough clearance. J.P. Morgan’s assessment is based on three simultaneous conditions: absence of positioning pressure, sufficiently attractive valuations, and no deterioration in earnings fundamentals. Together, these factors indicate that the South Korean equity market has entered a valuation recovery window.
All three sources of leverage have been significantly reduced, and retail leverage risk remains manageable.
The primary driver of this South Korean stock market plunge is forced liquidation of leveraged positions, not a deterioration in fundamentals. J.P. Morgan has broken down the sources of leverage into three tiers and assessed the progress of deleveraging for each.
The first layer consists of leveraged ETFs. These products grew to $50 billion in size by the end of June, four times the relative market size in the U.S. Market declines triggered forced liquidations, further intensifying selling pressure. The size of this segment has since declined to $17 billion, with capital inflows largely stagnant. J.P. Morgan assesses that the deleveraging of leveraged ETFs has been completed.
The second layer consists of hedge funds. According to J.P. Morgan’s prime brokerage data, the hedge fund long-short ratio previously rose to 5.7x. As of July 27, this ratio declined to 3.2x. Combined with the price momentum factors observed on July 28 and 29, J.P. Morgan estimates that hedge fund deleveraging has exceeded 90%, nearing the upper end of the normal range for 2025.
The third layer is retail investor margin leverage. Margin trading comes with built-in margin buffers and broker discretion, so positions are not automatically liquidated during price declines. Korean retail investors still hold substantial unrealized stock gains, cash deposits, and overseas assets, giving them the capacity to meet margin calls. J.P. Morgan believes margin leverage has never been a primary source of risk. Current margin balances stand at approximately $20 billion, a share of market capitalization that has even decreased since the beginning of the year.
The liquidation progress from all three leverage sources is nearly complete or has been completed. The most intense passive selling is already behind us.
Foreign capital outflows are nearing an end, and valuations have fallen to crisis levels.
Continued foreign outflows are another weight on the Korean market, but they are in fact two sides of the same coin as leverage unwinding. Since the beginning of this year, foreign investors have net sold over $110 billion, with approximately 90% concentrated on the two leading memory chip giants. These same two companies are also the primary underlying assets of leveraged ETFs; the selling pressure from leverage liquidation has further intensified the passive reduction of foreign holdings, with both forces reinforcing each other and causing a rare speed of decline in the KOSPI.
Their weights in the MSCI Emerging Markets Index have decreased from 9.5% and 8.3% at the end of June to 6.5% and 4.5%, respectively. As these weights declined, the selling pressure on passive funds has significantly eased. After the completion of leveraged position liquidations, the primary driver of foreign capital outflows has also disappeared.
On a valuation basis, the KOSPI’s 12-month forward P/E ratio has fallen to 5x. Even accounting for the cyclical nature of the semiconductor industry, this level has entered a crisis-mode pricing range. The free cash flow yield is at a similar level. J.P. Morgan’s model suggests that current market prices imply memory prices will revert to pre-AI boom levels by early 2027. However, actual spot and contract prices continue to rise, with third-quarter contract prices increasing further quarter-over-quarter, albeit at a slower pace.
The price has already factored in a great deal of pessimistic expectations, and market concerns about the memory cycle have outpaced the facts.
After deleveraging, JPMorgan sees potential in four areas.
At the end of the report, J.P. Morgan listed sectors to watch after deleveraging is completed.
First, assets related to the wealth effect, including department stores, cosmetics, tourism, securities firms, and construction. These sectors directly benefit from the repair of South Korean residents' balance sheets and the rebound in consumer willingness to spend.
Second, biopharmaceuticals. This sector has significantly underperformed during this correction, but sentiment in the global healthcare industry is improving, leaving room for catch-up gains.
Third, preferred shares. The discount level of preferred shares is near its widest historical range, offering attractive yields and strong holding returns.
Fourth, bank stocks. J.P. Morgan believes banks are benefiting from three tailwinds: improving asset quality alongside revenue growth, support for net interest margins from the Bank of Korea’s interest rate hiking cycle, and increased market trading volumes contributing to brokerage income.
After deleveraging, cheap valuations and earnings resilience remain the market’s underlying foundation. Prices have dropped 40%, leverage has been reduced, yet memory prices continue to rise. J.P. Morgan’s assessment is straightforward: once positions are cleared, the market will recover on its own.
Disclaimer
This article is a compilation and interpretation by Chaoxiang Research of a third-party brokerage research report (J.P. Morgan, July 29, 2026), combined with publicly available market information. The ratings, price targets, earnings forecasts, and related judgments cited herein reflect the views of the brokerage’s analysts and represent the position of their respective institution only; they do not reflect the views of Chaoxiang Research nor constitute any investment advice.
The market carries risks; make decisions independently. This article should not be used as a basis for buying or selling any securities.