Global investment bank (IB) JPMorgan pointed to deleveraging (reducing leverage) driven by leveraged exchange-traded funds (ETFs) as the reason behind the recent sharp drop in the KOSPI. It added that as the liquidation of leveraged ETFs has progressed substantially, foreign selling pressure is gradually easing, and it kept an "overweight" view on Korean stocks and its 12-month KOSPI target of 12,500.
On the 21st, JPMorgan said in its report "Trends in the deleveraging process of the Korean stock market" that "the corporate fundamentals of the Korean market remain solid, but intense deleveraging has led to the recent price decline."
The KOSPI has fallen about 28% from its high on June 19 to the day. On this, JPMorgan analyzed, "A correction that began with typical fundamental concerns and sector rotation was amplified through leveraged ETFs, and recently the unwinding of hedge fund positions overlapped, widening the losses."
JPMorgan explained, "As the domestic market rose steeply over the past year, leveraged money from individual investors, long-short hedge funds, and macro funds concentrated," adding, "With high volatility overlapping with foreign selling, the market's self-correcting mechanism kicked in."
JPMorgan assessed that deleveraging has now progressed to a considerable extent. JPMorgan said, "About 75% of the process of shrinking leveraged ETFs to $18 billion (about 26.5554 trillion won), which we view as an appropriate size, has been completed, and hedge fund deleveraging is estimated to be more than half finished."
In particular, it pointed to the domestic leveraged ETF market as a key factor that has recently amplified market volatility. JPMorgan explained, "The net assets of leveraged ETFs based on Korean assets increased to $50 billion (about 73.755 trillion won) at the end of June, reaching about four times the U.S. level relative to market size," adding, "In a down market, forced deleveraging repeated, pushing the Korea Volatility Index (VKOSPI) to about five times the U.S. Volatility Index (VIX)."
It added, "With the recent market correction, the size of leveraged ETFs based on Korean assets has decreased to about $26 billion (about 38.3526 trillion won)," and projected, "Further leverage reduction will continue as regulations tighten, including raising the basic margin requirement and halting new listings of single-stock leveraged ETFs."
It also predicted that foreign fund flows will gradually improve. JPMorgan analyzed, "Although foreign net selling of Korean stocks this year is expected to exceed $110 billion, about 90% occurred in memory semiconductor names," adding, "As the weight of memory stocks has recently decreased, foreign selling pressure is gradually easing."
It added, "As global investors increased investment in Korean stocks and concentrated on memory semiconductor names, brokers' capacity to supply swaps was constrained, but the recent market correction has eased much of that," and "Based on JPMorgan's prime book, the long-short ratio has also fallen from above 5.5 times to below 4 times now."
JPMorgan also maintained its mid- to long-term outlook for Korean stocks. JPMorgan said, "AI investment and data center investment remain solid, and a slowdown in memory demand has not yet been confirmed in the actual market," adding, "Improving results in industrials, financials, and consumer goods, and better corporate governance will also be positive for the market."
It added, "We maintain an 'overweight' view on Korean stocks and keep our 12-month KOSPI target at 12,500."
In its "Korean equity strategy" report released on the previous month, JPMorgan also presented a 12-month KOSPI target of 12,500. At the time, it offered 15,000 as a bull-case scenario and 8,000 as a bear-case scenario.