The Real Driver Behind Korea's Market Volatility

A recent report from J.P. Morgan pinpoints the primary cause of the sharp swings in South Korea's KOSPI index: forced deleveraging, predominantly within the leveraged Exchange-Traded Fund (ETF) sector. The analysis suggests that the concentrated liquidation of positions by these leveraged funds, rather than deteriorating corporate earnings or economic fundamentals, has been the key amplifier of market volatility.

Deleveraging Nears Its Final Stages

The institution estimates that approximately 75% of this deleveraging process, triggered by leveraged ETFs, is now complete. Assets in this segment have contracted significantly to around $26 billion. This explains the substantial pressure on stock prices even as underlying corporate fundamentals remain relatively sound.

J.P. Morgan expects that recent regulatory measures from Korean financial authorities—including raising margin requirements and halting new listings of single-stock leveraged ETFs—will be instrumental in driving the remaining deleveraging forward.

Shifting Market Structure and Foreign Flows

Hedge Funds Are Also Cutting Leverage

The report further notes that deleveraging is not limited to retail-focused ETFs; professional hedge funds are also rapidly reducing their leverage. Data indicates the gross exposure of hedge funds (long and short positions combined) relative to their net asset value has fallen from over 5.5x to below 4x, implying their deleveraging is also more than halfway done.

Foreign Selling Shows Concentrated Patterns

While foreign investors are projected to be net sellers of over $110 billion worth of Korean stocks this year, J.P. Morgan observes that about 90% of this selling is concentrated in memory semiconductor stocks. As the weight of these stocks in major indices declines, the overall market pressure from foreign outflows is gradually easing, indicating a shift from broad-based selling to sector-specific adjustments.

Four Pillars Supporting a Positive Long-Term View

Despite short-term deleveraging pains, J.P. Morgan maintains a constructive long-term outlook and an "Overweight" rating on Korean equities. This optimism rests on several key pillars:

  • Resilient Tech Investment Demand: Global investment in Artificial Intelligence (AI) and data centers remains robust, benefiting Korean tech firms in critical supply chains. A confirmed slowdown in long-term memory chip demand has yet to materialize.
  • Broad-Based Earnings Improvement: Beyond tech, corporate earnings are showing positive momentum in sectors like industrials, financials, and consumer staples, providing wider profit support.
  • Deepening Corporate Governance Reform: Ongoing improvements in the governance structures of Korean listed companies are enhancing shareholder returns and valuations, attracting long-term capital.
  • Deleveraging Nearing Completion: The most intense phase of forced selling is largely behind us, and its suppressive effect on the market should diminish.

Specific Index Targets

Based on this assessment, J.P. Morgan has set its 12-month base case target for the KOSPI at 12,500 points. In a bull scenario, the index could reach 15,000 points, while a bear case scenario sees support around 8,000 points.