Written by: Rita

The KOSPI index in South Korea has fallen nearly 40% since its peak on June 22. The size of leveraged ETFs has shrunk from $50 billion to $17 billion. The long/short ratio of hedge funds has dropped from 5.7 times to 3.2 times. JPMorgan pointed out in a research report on July 29 that the liquidation of leveraged ETFs has been completed, and the deleveraging progress of hedge funds exceeds 90%. There may still be ripples from short-term price shocks, but the market position structure has already undergone a thorough liquidation. JPMorgan's judgment is based on three simultaneous conditions: the position pressure is gone, valuations are cheap enough, and the earnings fundamentals have not collapsed. With all three combined, the South Korean stock market enters a valuation recovery window.

All three sources of leverage have been significantly cleared, and retail leverage risks are controllable

The core driving force behind the recent plunge in the South Korean stock market is the forced liquidation of leveraged funds, not a deterioration in fundamentals. JPMorgan breaks down the sources of leverage into three levels and evaluates the clearing progress one by one.

The first level is leveraged ETFs. These products ballooned in size to $50 billion by the end of June, which is four times the size of the U.S. market. The market downturn triggered forced liquidations, further exacerbating the selling pressure. This portion has now fallen back to $17 billion, with capital inflows basically stagnant. JPMorgan judges that the deleveraging of leveraged ETFs has been completed.

The second level is hedge funds. Data from JPMorgan's prime brokerage shows that the long/short ratio of hedge funds once rose to 5.7 times. As of July 27, this ratio has dropped to 3.2 times. Combining the performance of price momentum factors on July 28 and 29, JPMorgan estimates that the deleveraging progress of hedge funds has exceeded 90%, nearing the upper edge of the normal range for 2025.

The third level is retail financing leverage. Margin financing and securities lending inherently provide a margin buffer and discretionary space for brokers, so they will not be automatically forced to liquidate during price declines. Retail investors in South Korea still hold a large amount of floating profits in stocks, cash deposits, and overseas assets, which enable them to cope with margin calls. JPMorgan believes that financing leverage has never been a primary source of risk. The current financing balance is about $20 billion, and its proportion relative to market capitalization has even decreased compared to the beginning of the year.

The clearing progress of the three sources of leverage is either nearing completion or has been completed. The most severe passive selling has already passed.

Foreign capital outflows are nearing the end, and valuations have fallen to crisis levels

Continuous outflows of foreign capital are another stone pressing down on the South Korean market, but they are essentially two sides of the same coin as the clearing of leverage. Since the beginning of this year, foreign capital has cumulatively net sold over $110 billion, with about 90% concentrated on those two storage chip giants. These two companies are also the main underlying assets of leveraged ETFs, and the selling caused by forced liquidations further exacerbated the passive reduction of foreign capital, with both forces mutually reinforcing each other, resulting in an unprecedented decline speed in the KOSPI's history.

Their weights in the MSCI Emerging Markets Index have fallen from 9.5% and 8.3% at the end of June to 6.5% and 4.5%, respectively. As the weights decrease, the selling pressure from passive funds has significantly eased. After the liquidation of leverage is completed, the largest driving force behind foreign capital outflows also disappears.

In terms of valuations, the KOSPI's 12-month forward price-to-earnings ratio has fallen to 5 times. Even considering the cyclical characteristics of the semiconductor industry, this level has entered the pricing range of a crisis mode. The free cash flow yield is also at a similar level. JPMorgan's model shows that the current market price implies that memory prices will return to levels before the AI boom in early 2027. However, actual spot and contract prices are still rising, and contract prices in the third quarter continue to rise quarter-on-quarter, albeit at a slower pace.

Prices have already factored in a large amount of pessimistic expectations, and market concerns about the memory cycle have outpaced reality.

After deleveraging is completed, JPMorgan is optimistic about four directions

In the final part of the report, JPMorgan lists sectors worth focusing on after the completion of deleveraging.

First is wealth effect-related targets, including department stores, cosmetics, travel, brokerage firms, and construction. These sectors directly benefit from the recovery of South Korean residents' balance sheets and the rebound in consumption willingness.

Second is biopharmaceuticals. This sector has significantly underperformed during this round of adjustments, but sentiment in the global healthcare industry is improving, providing room for a rebound.

Third is preferred stocks. The discount levels for preferred stocks are close to historically wide ranges, and the resulting high yields offer good holding returns.

Fourth is bank stocks. JPMorgan believes banks face threefold positives: asset quality is improving along with revenue growth, the South Korean central bank's interest rate hike cycle supports net interest margins, and increased market trading volume is contributing to brokerage business income.

After the clearing of leverage, cheap valuations and profit resilience are the market's fundamental colors. Prices have fallen 40%, leverage has come down, and memory prices are still rising. JPMorgan's judgment is quite straightforward: after positions are cleared, the market will find its way back on its own.

Disclaimer
This article is a compilation and interpretation of a third-party brokerage research report (JPMorgan, July 29, 2026) by Trend Research, combined with publicly available market information. The ratings, target prices, earnings forecasts, and related judgments quoted in the text are solely the views of the analysts at that brokerage and represent the position of their institution, not the views of Trend Research, and do not constitute any investment advice.
The market has risks, and decisions should be made independently. This article should not be used as the basis for buying or selling any securities.