Sharp drop in Korean equities was driven by deleveraging rather than a collapse in fundamentals; J.P. Morgan maintains OW Korea

Overview

This is a J.P. Morgan update on Korean equity strategy, focused on the deleveraging mechanisms behind the recent sharp market pullback in Korea. The report argues that Korean fundamentals remain in relatively good shape, and that the recent decline has been amplified more by positioning and leverage channels: leveraged ETFs passively cutting exposure on down days, tightening global and local Korean swap financing capacity, crowded long unwinds by hedge funds, and forced foreign selling due to excessive weights in leading memory names. The authors believe these pressures are normalizing, and that the market can absorb position unwinds and continue its medium-term upward trend.

Core views

The report’s core views are: first, the direct pressure behind Korea’s market correction mainly comes from deleveraging and position unwinds rather than a broad deterioration in fundamentals; second, the deleveraging processes of leveraged ETFs and equity long/short funds are about 75% and more than 50% complete, respectively, and while volatility has not fully normalized, it has eased materially; third, retail margin financing and bank borrowing do not indicate systemic excessive leverage; fourth, foreign outflows are concentrated mainly in two leading memory names, and as their MSCI EM weights decline, forced selling pressure is weakening; fifth, AI capex, memory demand, industrial expansion, financial and consumer wealth effects, and corporate governance reform still support the fundamentals of Korean equities over the coming years.

Analysis framework

The report uses an equity macro and positioning analysis framework, breaking down the Korean market decline into six lines of inquiry: leveraged ETFs, swap financing capacity, hedge fund long/short exposure, retail margin, foreign flows, and fundamentals, and assesses whether pressures are normalizing using indicators such as market size, ETF AUM, financing balances, JPM Prime book long/short ratios, MSCI EM weights, and sector EPS revisions.

Methodology notes

• Market PositioningDeleveraging Channel Decomposition

  Break leverage pressure into futures/options, retail margin, swap capacity, leveraged ETFs, and hedge fund positioning.

  The report believes futures and options are mainly institutional markets with limited signs of speculative overheating; retail margin is relatively moderate; the main pressures come from leveraged ETFs, swap capacity, and equity long/short fund positioning.

• Fund FlowsAttribution of Foreign Outflows

  Decompose Korea’s year-to-date foreign outflows into leading memory-name weights and investment mandate constraints.

  The report notes that about 90% of the more than US$110 billion of foreign outflows year to date came from two memory stocks, because their weights in emerging-market portfolios became too high and triggered mandate constraints.

• FundamentalsAI Cycle and Earnings Revisions

  Assess the sustainability of Korean earnings through AI spending, data center economics, memory demand, and sector EPS revisions.

  The report believes hyperscaler data center leasing economics remain strong, AI-related capex should be sustained, and EPS revisions for Korean technology, industrials, and the overall market remain supportive.

Asset mapping & comparison

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

• KOSPI

  Core allocation asset

  Strengths

  Supported by AI spending, the memory cycle, industrial earnings, governance reform, and wealth effects; the report maintains a 12-month target of 12,500.

  Weaknesses

  Recently dragged down by deleveraging, rising volatility, and foreign outflows, with a sharp pullback from the peak.

  Comparison

  Despite the sharp correction, Korea is still one of the best-performing markets in the region year to date in USD terms.

  Risks

  If deleveraging is not fully over, AI demand expectations are revised down, or foreign selling pressure intensifies again, the index may remain under pressure.

• Korean Leveraged ETFs

  Volatility amplification channel

  Strengths

  Shrinking scale and tighter regulation help reduce future passive deleveraging pressure.

  Weaknesses

  Previously, AUM was too large relative to market size, causing passive selling on down days and pushing up volatility.

  Comparison

  Korea-related leveraged ETFs were once about 4x the size of those in the U.S. relative to market size.

  Risks

  If the market continues to fall, leveraged ETFs may still trigger additional deleveraging and volatility amplification.

• Korean Memory Stocks

  Key driver of the market and foreign fund flows

  Strengths

  The AI cycle, data center economics, and memory demand are still viewed by the report as fundamental support.

  Weaknesses

  Excessive weights triggered mandate constraints for emerging-market investors, making them the concentrated source of foreign outflows.

  Comparison

  About 90% of Korea’s year-to-date foreign outflows came from two leading memory names.

  Risks

  If technological breakthroughs materially weaken memory demand, or if weights and crowding become excessive again, these stocks may continue to amplify market volatility.

• Korean Retail Financing and Margin

  Secondary leverage channel

  Strengths

  Margin balances account for only about 0.5% of market cap, and Korean households still have buffers from stock gains, cash balances, income, and overseas assets.

  Weaknesses

  There has already been more margin decline and margin call pressure among KOSDAQ small-cap stocks.

  Comparison

  Korea’s margin as a share of market cap is below 1.9% in the U.S. and 2.8% in China A-shares.

  Risks

  If small-cap stocks continue to decline, localized margin call pressure may affect risk appetite.

Key data

• KOSPI Pullback-28% to -29%Decline since the peak on June 22, 2026.
• KOSPI 12-Month Target12,500J.P. Morgan maintains its base-case target.
• Leveraged ETF AUMDeclined from US$50 billion to US$26 billionThe size of Korea-related leveraged ETFs has contracted significantly from the late-June peak.
• Leveraged ETF Deleveraging ProgressAbout 75% completeThe report believes it has fallen back to near an acceptable level, around US$18 billion.
• Equity Hedge Fund Deleveraging ProgressMore than 50% completeAssuming the long/short ratio returns to the upper end of the 2025 range.
• JPM Prime Book Long/Short RatioDeclined from above 5.5x to below 4xReflects that equity long/short fund positioning has retreated from high levels.
• Korea Margin Financing BalanceDeclined from above US$25 billion to about US$21 billionMargin balances are about 0.5% of Korea equity market cap, below 1.9% in the U.S. and 2.8% in China A-shares.
• Foreign OutflowsMore than US$110 billion year to dateMay set an annual outflow record for Asian markets; about 90% came from two leading memory names.
• Leading Memory Names MSCI EM Weight ChangeDeclined from 9.5% and 8.3% to 7.5% and 5.7%Lower weights reduce passive selling pressure caused by mandate constraints.
• 2026 Market EPS Revisions1 month +7.8%, 3 months +35.5%, 6 months +143.4%The table shows Korean market earnings revisions remain strong.
• 2027 Technology EPS Revisions1 month +13.1%, 3 months +63.1%, 6 months +303.3%Technology remains one of the strongest directions for earnings upgrades.

Impact & implications

The report’s investment implication is constructive: in the short term, the market may still be disturbed by volatility, ETF rebalancing, hedge fund positioning, and foreign outflows, but the marginal pressure from deleveraging is declining; in the medium term, if AI capex and memory demand hold up, Korean equities should still be able to overcome position adjustments and resume an upward trend. For regional allocation, J.P. Morgan continues to recommend an overweight position in Korea.

Risks

• Volatility in the Korean market has not fully normalized, and the VKOSPI-to-VIX ratio remains well above normal levels.
• Deleveraging by leveraged ETFs and equity long/short funds has progressed but is still not fully complete.
• Constraints from swap capacity and financing costs remain, and full normalization will take more time.
• Crowding in memory stocks and emerging-market mandate constraints may continue to affect foreign fund flows.
• If the monetization ability of the AI model layer comes under renewed doubt and transmits to hyperscaler capex, it would weaken Korea technology fundamentals.
• If actual memory demand is hit by technological or process breakthroughs, Korea’s earnings upgrade trend may slow.
• External risks such as regulation and recession are not imminent at present, but remain medium-term tail risks.

What to watch

• Whether Korea-related leveraged ETF AUM continues to fall from US$26 billion toward more normal levels.
• Whether the Korea equity long/short ratio in the JPM Prime book moves further from below 4x back toward the 2025 range.
• Whether the VKOSPI-to-VIX ratio converges from nearly 5x toward a normal level of about 1x.
• Whether the MSCI EM weights of Korea’s two leading memory names continue to decline, and whether foreign outflows slow further.
• Whether EPS revisions in Korea’s technology, industrial, financial, and consumer sectors continue to trend upward.
• Whether AI data center leasing economics, model capabilities, funding availability, and capex plans remain positive.
• Whether the scale and trading activity of leveraged ETF products cool further after implementation of new Korean regulations targeting leveraged ETFs.