JPMorgan Research Report Analysis: After South Korea's KOSPI Plunged 40%, Deleveraging Basically Cleared, 5x P/E Ratio Enters Valuation Repair Window

Written by: Rita

The South Korea KOSPI Index has fallen nearly 40% from its high on June 22. Leveraged ETF assets shrank from $50 billion to $17 billion. Hedge fund long/short ratios dropped from 5.7x to 3.2x. In a research report on July 29, JPMorgan pointed out that leveraged ETF liquidation is complete, and hedge fund deleveraging progress exceeds 90%. Short-term price shocks may have lingering effects, but market position structure has undergone a thorough cleanup. JPMorgan's judgment is based on three conditions being met simultaneously: position pressure is gone, valuations are cheap enough, and earnings fundamentals haven't collapsed. With all three combined, the South Korean stock market has entered a valuation repair window.

All Three Leverage Sources Have Been Significantly Cleared, Retail Leverage Risk Controllable

The core driver of this round of South Korean stock market plunge was forced liquidation of leveraged funds, not fundamental deterioration. JPMorgan broke down leverage sources into three layers and evaluated the clearance progress one by one.

The first layer is leveraged ETFs. The scale of these products expanded to $50 billion at the end of June, representing 4 times the market volume relative to the US. Market declines triggered forced liquidation, further exacerbating selling pressure. Currently, this scale has fallen back to $17 billion, and capital inflows have basically stalled. JPMorgan judges that leveraged ETF deleveraging is complete.

The second layer is hedge funds. JPMorgan prime broker data shows that the hedge fund long/short ratio once rose to 5.7x. As of July 27, this ratio dropped to 3.2x. Combining the performance of price momentum factors on July 28 and 29, JPMorgan estimates hedge fund deleveraging progress has exceeded 90%, approaching the upper edge of the normal range for 2025.

The third layer is retail margin leverage. Margin trading and securities lending come with margin buffers and broker discretion, and will not be automatically forced liquidated when prices fall. South Korean retail investors still hold a large amount of unrealized stock gains, cash deposits, and overseas assets, and have the ability to cope with margin calls. JPMorgan believes financing leverage has never been a major source of risk. Currently, the margin balance is about $20 billion, and the proportion relative to market capitalization has even decreased compared to the beginning of the year.

The clearance progress of all three leverage sources is close to or complete. The most intense passive selling has passed.

Foreign Capital Outflow Nearing End, Valuations Have Fallen to Crisis Levels

Continuous foreign capital outflow is another weight pressing on the South Korean market, but it and leverage clearance are actually two sides of the same coin. Year-to-date, foreign capital cumulative net sales exceeded $110 billion, with about 90% concentrated on those two memory chip giants. These two are also the main underlying targets of leveraged ETFs. Selling brought by leveraged liquidation further exacerbated foreign capital's passive reduction, and the two forces reinforced each other, resulting in a rate of decline rare in KOSPI 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 weights decline, selling pressure from passive funds has significantly eased. After leveraged liquidation is complete, the biggest driver of foreign capital outflow also disappears.

At the valuation level, KOSPI's 12-month forward P/E ratio has fallen to 5x. Even considering the cyclical characteristics of the semiconductor industry, this level has entered the pricing range of crisis mode. Free cash flow yield is also at a similar level. JPMorgan's model shows that current market prices imply the assumption that memory prices will return to pre-AI explosion levels by early 2027. But actual spot and contract prices are still rising, and third-quarter contract prices continue to rise quarter-on-quarter, although the growth rate has slowed.

Prices have already priced in a large amount of pessimistic expectations, and market concerns about the memory cycle are ahead of the facts.

JPMorgan Bullish on Four Directions After Deleveraging Completes

JPMorgan listed sectors worth watching after deleveraging completes at the end of the report.

First are wealth effect-related targets, including department stores, cosmetics, tourism, brokerages, and construction. These sectors directly benefit from the repair of South Korean residents' balance sheets and the rebound of consumption willingness.

Second is biopharmaceuticals. This sector significantly underperformed in this round of adjustment, but global healthcare industry sentiment is improving, leaving room for catch-up gains.

Third is preferred shares. The preferred share discount level is close to the widest historical range, and the high yield resulting from this provides good holding returns.

Fourth is bank stocks. JPMorgan believes banks face triple benefits: asset quality improves along with income growth, the South Korean central bank interest rate hike cycle supports net interest margins, and increased market trading volume is contributing brokerage income.

After leverage clearance, cheap valuations and earnings resilience are the underlying tone of the market. Prices fell 40%, leverage came down, and memory prices are still rising. JPMorgan's judgment is direct: after positions are cleared, the market will find its way back on its own.

Disclaimer
This article is a compilation and interpretation by TechFlow Research of a third-party brokerage research report (JPMorgan, July 29, 2026), combined with the organization of public market information. Ratings, target prices, earnings forecasts, and related judgments cited in the text are the views of the brokerage analysts, represent only the position of their affiliated institution, do not represent the views of TechFlow Research, and do not constitute any investment advice.
The market has risks, decisions need to be independent. This article should not be used as a basis for buying or selling any securities.