South Korean Stocks Drop 40%: Is Deleveraging Over? JPMorgan Says Institutional Phase Near End, HSBC Warns Retail Risks Remain

Since its peak on June 22, the Korea Composite Stock Price Index (KOSPI) has fallen nearly 40%. This decline initially stemmed from concerns over fundamentals and capital rotation, but was later amplified by forced liquidations from leveraged ETFs. More recently, concentrated hedge fund rebalancing has subjected the market to intense structural shocks in a short period.

Against this backdrop, market attention has turned to whether this round of deleveraging is complete or if further unwinding remains.

JPMorgan: Institutional Deleveraging Nears Completion

In a report released Wednesday (29th), JPMorgan stated that various forms of leveraged capital in the Korean market have shown clear signs of cooling.

First, leveraged ETFs. The bank noted that the size of leveraged ETFs targeting Korean assets peaked at approximately $50 billion at the end of June—about four times higher than U.S. equivalents relative to market capitalization—and was a key amplifier of this market volatility.

However, as the market corrected, the size of these products has declined to about $17 billion, and recent capital inflows have clearly stalled. Therefore, JPMorgan believes deleveraging in leveraged ETFs has "largely concluded."

Regarding hedge funds, JPMorgan, using Prime Brokerage account data, pointed out that the long/short ratio in the Korean market has dropped from a peak of 5.7x to 3.2x on July 27. Combined with a sharp drop in price momentum factors from July 28 to 29, the bank judges that hedge fund deleveraging is about 90% complete and approaching historical high-end levels, indicating that major institutional investors have largely finished adjusting their positions.

On retail margin debt, JPMorgan is relatively optimistic. The report states that current margin balances are around $20 billion, and their share of total market value has actually declined this year, with no rapid increase observed.

Moreover, Korean retail investors still hold substantial unrealized gains, cash, and overseas assets, giving them the capacity to meet margin calls. Thus, JPMorgan considers retail leverage risk to be manageable.

On foreign investors, although they have sold over $110 billion worth of Korean stocks year-to-date, JPMorgan notes that about 90% of this selling was concentrated in just two memory chip giants. As both companies have seen reduced weights in the MSCI Emerging Markets Index, the selling pressure from passive funds has clearly diminished.

Based on these factors, JPMorgan believes the KOSPI's forward P/E has now dropped to around 5x, and free cash flow valuations are at "crisis levels." With improved positioning and valuation correction, the overall asset allocation appeal of Korean equities is beginning to emerge.

HSBC: Retail Margin Balances Still High, Deleveraging Far From Over

In contrast, HSBC takes a more conservative view of the market. HSBC believes the biggest risk remains with retail investors.

According to its data, as of July 27, retail margin balances in Korea were still around 32 trillion KRW (approximately $22 billion), down only about 15% from June's peak, remaining at elevated levels. Despite numerous forced liquidations in July, the amount liquidated represented only about 2% of total margin debt, indicating that actual deleveraging has been very limited.

Another focus for HSBC is single-stock leveraged ETFs. While the size of these products has now shrunk to about $10 billion—roughly one-third of peak levels—HSBC emphasizes that this reduction is primarily due to asset shrinkage from market losses, not from active investor redemptions.

The report notes that retail investors continue to buy single-stock leveraged ETFs and index-based leveraged products, so potential risks have not truly been resolved.

Thus, the key divergence between HSBC and JPMorgan lies in how they interpret the decline in ETF size.

JPMorgan sees it as a key signal that deleveraging is nearly complete; HSBC argues that if the shrinkage is due to price declines rather than capital outflows, investor leverage positions have not been genuinely digested, and the market still faces follow-on adjustment pressure.

Korean Regulators Act Early to Tighten Leverage Products

In response to the market's extreme volatility, the Financial Services Commission (FSC) of Korea has already implemented regulatory measures early.

Under the new rules, the minimum margin requirement for retail investors in single-stock leveraged ETFs will rise from 10 million KRW to 30 million KRW, and must be paid entirely in cash—no stock substitution allowed. Additionally, new listings of single-stock leveraged ETFs are suspended, and the minimum trading unit is planned to increase from 1 to 20 shares. These measures were brought forward and implemented on July 31.

HSBC stated that while these policies help reduce capital inflows into single-stock leveraged products, investors may shift to other leveraged instruments, so overall deleveraging is not yet complete.

Furthermore, the reduction of tax incentives for RIA accounts starting in August may further impact retail investment behavior.

AI and Memory Sector Remain Key Market Variables

Both reports also note that the recent correction in Korean equities is not solely due to funding factors—fundamental changes are also significant.

HSBC pointed out that SK Hynix (KR000660) has fallen 53% from its June peak, and Samsung Electronics (KR005930) has dropped 43%. The AI investment theme is evolving: memory manufacturers are signing long-term contracts, market expectations for continued price increases are turning cautious, the return on capital for hyperscale data centers' high capex remains unproven, and China's ChangXin Memory has completed a $9.8 billion fundraising, potentially increasing future supply pressure.

JPMorgan, through model estimates, stated that current market pricing already implies memory prices will return to pre-AI boom levels by early 2027. For every additional year high prices persist, theoretically, it could add about $150 billion in valuation for related companies.

Overall, both banks agree that Korean equities have undergone a significant correction, but they differ markedly on the progress of deleveraging.

JPMorgan believes institutional investor deleveraging is nearly complete and market valuations are now attractive. HSBC, however, argues that retail leverage remains high and ETF capital has not truly exited, meaning the market still needs time to complete the deleveraging process.