Korean equity de-leveraging is more than halfway complete; J.P. Morgan maintains overweight Korea

Overview

This is a Korea equity strategy report focused on the de-leveraging process behind the recent sharp pullback in the Korean market. The report argues that the decline, initially triggered by fundamental concerns and sector rotation, was amplified by leveraged ETFs, hedge fund position unwinds, and foreign selling due to index weight constraints. Despite still-high short-term volatility, J.P. Morgan believes de-leveraging has progressed meaningfully and that the Korean market's medium- to long-term fundamentals remain sound.

Core views

The core view of the report is that the decline in the Korean market looks more like a self-correction of positioning and leverage than a reversal in the fundamental trend. Deleveraging by leveraged ETFs and hedge funds is normalizing, retail margin leverage is not high, and foreign selling pressure is easing as the weight of large memory stocks declines. On fundamentals, AI capital expenditure, data center economics, memory demand, industrial chain growth, the wealth effect in financials and consumer, and governance reform continue to support a positive trend in Korean equities over the coming years.

Analysis framework

The report uses a top-down equity strategy framework, breaking the Korean market pullback into six dimensions: leveraged ETFs, hedge funds/swap capacity, retail margin financing, foreign outflows, momentum factors, and fundamentals. It combines indicators such as KOSPI performance, VKOSPI/VIX, leveraged ETF AUM, JPM Primebook L/S ratio, margin balances, foreign flows, MSCI EM weights, and EPS revisions to assess the progress of de-leveraging.

Methodology notes

• Market strategyDecomposition of de-leveraging channels

  Break down market declines into channels such as leveraged ETFs, hedge funds, retail margin financing, and foreign outflows.

  This framework is used to determine whether the decline stems from deteriorating fundamentals or from technical clearing driven by crowded positioning and financing constraints.

• Risk and positioningPrimebook L/S ratio and momentum factor observation

  Use the long/short ratio and drawdowns in price momentum factors to observe hedge fund positioning crowding.

  The report notes that the JPM Primebook L/S ratio fell from above 5.5x to below 4x, while the price momentum factor saw an approximately 30% drawdown, indicating meaningful progress in deleveraging but not yet full normalization.

• Fundamental strategyAI cycle and earnings sustainability assessment

  Assess the sustainability of AI-related earnings based on model capability, financing availability, data center leasing returns, and memory supply-demand dynamics.

  The report believes that data center leasing economics at the hyperscaler level remain positive, so AI capital expenditure is likely to continue, supporting Korean memory and related industrial chains.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• KOSPI

  Core market index and strategy target

  Strengths

  Supported by AI capital expenditure, memory earnings, industrial chain growth, the wealth effect in financials and consumer, and governance reform.

  Weaknesses

  Has pulled back sharply from the June 22 peak, with unusually high volatility.

  Comparison

  The report says Korea is still one of the best-performing markets in the region in USD terms year to date.

  Risks

  Deleveraging is not complete, momentum factors may continue to draw down, and foreign selling pressure and AI demand expectations may fluctuate.

• Korea-related leveraged ETF

  Main channel amplifying market volatility and forced deleveraging

  Strengths

  Marginal risk has eased after the decline in size, and tighter regulation may limit future overexpansion.

  Weaknesses

  Previously, AUM was too large relative to market size, leading to passive reductions on down days and amplified volatility.

  Comparison

  The report says it was once about 4 times the U.S. relative to market size.

  Risks

  If the market continues to fall, it may still trigger further passive deleveraging and volatility shocks.

• Korean memory leaders / AI hardware chain

  Main area of concentration for KOSPI's recent rise and foreign outflows

  Strengths

  AI capital expenditure and data center economics continue to support memory demand and earnings sustainability.

  Weaknesses

  Excessive weight caused EM investors to hit position constraints, concentrating recent selling pressure.

  Comparison

  The weights of the two memory stocks in MSCI EM have fallen from end-June highs to about 7.5% and 5.7%.

  Risks

  Debates over AI monetization, concerns that technological progress could reduce memory demand, and continued release of concentrated holdings.

• KOSDAQ small caps

  Market where retail margin declines and margin pressure are more concentrated

  Strengths

  Systemic impact is relatively limited because the main pressure is not in KOSPI.

  Weaknesses

  Declines in margin balances and margin calls are more concentrated in small-cap KOSDAQ.

  Comparison

  Compared with KOSPI, KOSDAQ is more affected by fluctuations in retail margin financing.

  Risks

  If retail sentiment reverses, small caps may remain under pressure.

• Korea retail margin financing and margin

  Potential leverage channel, but the report views systemic risk as low

  Strengths

  Margin balances are only about 0.5% of market capitalization, and households still have buffers from stock gains, cash balances, income, and overseas assets.

  Weaknesses

  Balances have already fallen from high levels, and some small caps face margin pressure.

  Comparison

  Margin balances as a share of market capitalization are below those of the U.S. and China A-shares.

  Risks

  If stock prices continue to fall rapidly, margin pressure could spread further.

Key data

• KOSPI pullback from peakabout -28% to -29%The peak was on June 22, 2026, and the report believes the decline was amplified by deleveraging and volatility.
• Leveraged ETF AUMfell from about $50 billion to about $26 billionThe size of Korea-related leveraged ETFs has contracted significantly from its end-June peak.
• Progress of leveraged ETF deleveragingabout 75% completeThe report estimates it has fallen close to an acceptable level, with the target referenced at about $18 billion.
• Progress of equity hedge fund deleveragingmore than 50% completeBased on the assumption that the L/S ratio has fallen back near the upper end of the 2025 range.
• JPM Primebook L/S ratiofell from above 5.5x to below 4xThis shows that hedge fund exposure to Korean equities has contracted significantly, though it has not fully normalized.
• Retail margin balancefell from more than $25 billion to about $21 billionThis is only about 0.5% of total equity market capitalization, below the comparative levels of 1.9% in the U.S. and 2.8% in China A-shares.
• Foreign outflows from Koreamore than $110 billion year to dateThe report says about 90% came from two leading memory names, mainly due to EM investor weight constraints.
• KOSPI target12-month base target 12,500J.P. Morgan maintains an overweight allocation to Korea.

Impact & implications

For investors, the implication is that in the short term they still need to track whether volatility, leveraged ETF size, hedge fund positioning, and foreign outflows continue to normalize. But if fundamental resilience holds, the current pullback may represent more of a medium-term opportunity created by position clearing than a structural weakening of Korean equities. Korea's AI and memory chain remains a key support, though crowded trades and regulatory adjustments will affect the pace.

Risks

• Korean market volatility has not yet normalized, and VKOSPI remains elevated relative to VIX.
• Deleveraging by leveraged ETFs and hedge funds has not fully ended and may continue to amplify short-term declines.
• Monetization at the AI model layer could come under renewed doubt, affecting global AI hardware sentiment.
• Memory demand could be hit by concerns that technological and process breakthroughs may reduce unit demand.
• Selling pressure from foreign investors due to EM index weights and position constraints has eased but not fully disappeared.
• Swap capacity and financing cost constraints have not fully normalized.
• Seasonality in Korea's price momentum factor in the fourth quarter may be more challenging.

What to watch

• Whether Korea-related leveraged ETF AUM continues to decline from about $26 billion toward a more acceptable level.
• Whether the Korea equity L/S ratio in JPM Primebook normalizes further.
• Whether the VKOSPI/VIX ratio and single-stock futures open interest decline.
• Changes in the weights of the two memory leaders in MSCI EM and the pace of foreign outflows.
• Whether Korea sector EPS revisions remain strong.
• AI capital expenditure, data center leasing economics, and actual memory demand data.
• Whether Korea governance reform again becomes a driver of valuation upside within the year.