Has the 'shakeout' in South Korean stocks nearly ended? Multiple Wall Street investment banks: The market may have bottomed out

South Korea's stock market was likely one of the most watched markets globally in July, experiencing daily surges and plunges, with circuit breakers becoming almost routine.

Now that the KOSPI index has fallen nearly one-third from its all-time high and local investors are suffering, multiple Wall Street investment banks are regaining confidence in South Korea's market outlook. They argue that growth momentum—particularly among large domestic chipmakers like Samsung Electronics and SK Hynix—remains solid, while the intense deleveraging wave that previously battered the market may be nearing its end.

The 'Super AI Cycle' Story Isn't Over Yet

According to reports by Cailianshe, assets in leveraged exchange-traded funds (ETFs) targeting South Korean stocks such as Samsung Electronics and SK Hynix dropped sharply from $50 billion at the end of June to just $17 billion last week, according to JPMorgan analysis.

"This was a leverage event, not an earnings event," said Lawrence, Chief Investment Officer at Balfour Capital Group, which manages €400 million in assets. "Frankly, I'm bullish on Samsung. It was sold off only because it accounts for half the weight in the index, not because of any deterioration in its business fundamentals."

"The memory cycle and AI capital expenditure narrative remains intact, and the current sell-off is happening below fundamental value."

Indeed, capital flows clearly reflect shifting foreign investor sentiment: On Friday last week, as the South Korean market staged a record rebound, foreign investors reversed their year-long net selling streak and bought 7.2 trillion won (approximately $5 billion) worth of South Korean stocks—a volume more than double the previous single-day record.

Deleveraging Nearly Complete

Wall Street analysts note that the sharp decline in South Korean equities was also driven by the collapse of hedge fund Situational Awareness. However, this shock appears to have subsided, as most of the fund’s equity portfolio has been acquired by Citadel, led by Ken Griffin, known as the "king of hedge funds."

Data from research firm EPFR shows that over the past 18 months, global active emerging market funds steadily increased their average allocation to South Korea. But in June, amid heightened market volatility, this allocation ratio declined significantly.

Rajiv Batra, JPMorgan’s co-head of Asia and Global Emerging Markets Equity Strategy, stated, "We believe the unwinding of leveraged ETF positions in South Korea is largely complete, and hedge fund deleveraging has progressed about 90%, returning to acceptable levels."

In their report, they added: "If a sustainable bottom forms here, historical data provides support."

Typically, emerging markets deliver an average 12-month return of around 28% following a correction.

Leveraged Trading Was the Main Culprit

Throughout South Korea’s rapid rally and subsequent crash, leveraged trading remained at the epicenter—especially products like single-stock leveraged ETFs, which not only reshaped market dynamics but also dramatically amplified volatility.

Since South Korea introduced single-stock leveraged ETFs in May, the market peaked in June—after having more than doubled over the prior 12 months. Yet immediately after this surge came a cliff-like plunge.

"Pure long-only investors simply wouldn’t want to manage positions in stocks with such extreme volatility," said William Brattan, Head of Cash Equity Research for BNP Paribas in Asia-Pacific.

Citigroup’s trading strategy team estimated last week that South Korean retail investors suffered total losses of approximately $38.7 billion through leveraged ETFs.

Pierre Hoebrechts, Deputy Chief Investment Officer at Hong Kong-based East Eagle Asset Management, said: "The scale of capital flowing into SK Hynix and Samsung is staggering. With massive retail account openings, high domestic leverage, concentrated holdings, and large 2x leveraged overseas ETFs, it was a disaster waiting to happen."

Hoebrechts had maintained short positions betting on declines in both the KOSPI and Japan’s Nikkei 225 since late June but closed them last week, believing the market correction phase may be ending.

According to S3 Partners data, South Korea’s average short interest (value-weighted) stands at about 4.3%, down from a recent peak of 5.3%.

Still, risks remain. Last Friday, the KOSPI recorded a historic 17.9% single-day gain—an event as unsettling to many investors as the sharp drops seen last month. And on Monday this week, the index fell nearly 5% again.

Nevertheless, Larry Hatheway, Research Director at Franklin Templeton Institute, said while he remains cautious about entering a falling market, they "might be willing to reconsider some of these [South Korean] stocks."