Original author: Zhao Ying

Original source: Wall Street Insights

The Korean stock market is experiencing a rare financial structural tear: foreign capital is selling at a record high, but retail investors are taking over with the same amount of funds. The hedging of the two forces has jointly shaped the unique ecology of Asia's most volatile market against the background of rising fundamentals driven by the AI wave.

According to the Chase Trading Desk, the latest Korean stock strategy report released by J.P. Morgan on June 25 stated that foreign capital has had a net outflow of approximately US$95 billion from the Korean stock market this year, which is expected to easily break the annual foreign capital outflow record for any single market in Asia. At the same time, the cumulative net buying volume of retail investors (including local ETF purchases) during the year has reached approximately US$80 billion, becoming the main force supporting the market.

JPMorgan Chase maintains its bullish stance on the Korean stock market, raising the KOSPI benchmark/optimistic/pessimistic scenario targets for the next 12 months to 12,500/15,000/8,000 points respectively, and recommends investors to increase their positions and maintain maximum exposure during any correction.

The above-mentioned capital game pattern will not be reversed in the short term, but the rise in AI-driven fundamentals, the national wealth effect brought about by corporate profit growth, and the valuation repair potential of corporate governance reforms still constitute the core bullish logic of the Korean stock market. South Korea remains JPMorgan Chase's most preferred market in Asia.

Foreign capital is forced to sell: scale constraints trigger involuntary selling

The outflow of foreign capital from South Korea is characterized as "non-discretionary" rather than active short selling. The core reason is that the market value of the two memory chip giants, represented by Samsung Electronics and SK Hynix, has expanded dramatically and has reached the position limit of emerging market (EM) long-term funds. This scale constraint affects about 10% of foreign holdings in each of the two stocks, forcing fund managers to continue to reduce their positions as stock prices rise.

Data show that more than 90% of the total domestic and foreign capital outflows during the year came from the above two storage stocks. This structural feature means that as long as storage stocks continue to outperform regional benchmarks, the benchmark constraints of EM funds will not disappear and the pressure of foreign capital outflows will continue.

It is worth noting that although foreign capital continues to sell net, the proportion of foreign capital's holdings in Korean stocks has actually increased significantly compared with the beginning of the year - the reason is that the stock price increase far exceeds the scale of selling. Currently, the two major storage stocks together account for more than two-thirds of foreign capital's holdings in South Korea. In contrast, global funds (non-EM special funds) are significantly underweight South Korea. In customer surveys, many large real capital accounts reported insufficient exposure to South Korea and the need to cover positions.

Expansion of leveraged ETFs: structural increase in volatility

The abnormal surge in Korean market volatility is closely related to the explosive growth of domestic and overseas leveraged ETFs. The size of leveraged ETFs (AUM) targeting Korean assets has grown to $50 billion, with much of the increase coming from gains in the market itself.

This type of ETF mainly achieves exposure through stock index futures and some spot and options, driving open interest in single-stock futures to rise sharply. At the same time, demand for "crash protection" in ETFs has also pushed up implied volatility - the ratio of VKOSPI to VIX is currently close to 5x, compared with the historical norm of about 1x. The scale of Gamma imbalances related to leveraged ETFs currently exceeds US$1 billion, which has a significant amplifying effect on market fluctuations in both directions.

In addition, some brokers are also facing difficulties in managing concentrated exposures as Korean exchanges and clearing houses have raised capital requirements in response to higher trading volumes, resulting in higher financing costs for large-cap stocks. Given the wide popularity of such instruments at home and abroad, the scale of leveraged ETFs will not substantially shrink in the short term, and high volatility will become a normal feature of the Korean market structure.

Retail investors take orders: there is still room, leverage risk is controllable

In the context of continued outflows of foreign capital and institutional investors (pension funds) reducing their positions on highs on the grounds of rebalancing, retail investors have become the main buyers of the Korean stock market. Data shows that if NXT platform transactions and ETF purchases are included together, retail investors’ net purchases during the year will reach approximately US$80 billion.

There is still room for continued buying by retail investors for three reasons: first, although financing balances and leverage levels in option transactions have increased, they are still low relative to the overall market value and customer deposits; second, Korean retail investors have just begun to return overseas stock holdings to the local market, and there is a large room for return; third, as income growth and the stock wealth effect continue to ferment, residents' willingness to invest in stocks is expected to further increase, especially in the context of restrictions on real estate investment.

However, the proportion of retail investors in market transactions has fallen from the average of 65% in the past two months, and pension participation has increased. However, pension funds as a whole are still net sellers to maintain the target portfolio weight.

AI narrative disturbance: cyclical fluctuations do not change the upward trend

The fundamentals of the Korean market are highly bound to the AI cycle, and the AI cycle is still on a strong upward trajectory. Analysts maintain a constructive judgment that the storage cycle will "last longer at highs" and believe that the earnings of Korean technology stocks are more resilient to similar global stocks.

However, periodic disturbances in AI narrative are inevitable. JPMorgan Chase listed five major factors that have caused market fluctuations recently: First, there are signs of optimization and reduction of token consumption at the user level, triggering concerns about token pricing; Second, GLM 5.2 of China Smartphone AI has received positive market response, rekindling competition concerns; Third, the policy uncertainty caused by the latest export control policies; Fourth, continued stock and bond supply pressure; Fifth, the reopening of the Strait of Hormuz may alleviate pressure on related markets and sectors.

As long as the growth rate of hyperscale cloud computing capital expenditures continues to be higher than the growth rate of semiconductor equipment capital expenditures, the imbalance between supply and demand will continue, thus supporting the profit margins of memory chip manufacturers.

The AI benefits of Korean memory chip companies are large enough to have a substantial impact at the macro level. It is estimated that the direct taxes (including corporate income tax) paid by the two major storage companies to the government in the next three years may easily exceed US$350 billion, and the scale will be even larger if personal income tax on employee bonuses is included.

For reference, South Korea's current total foreign exchange reserves are approximately US$427 billion, and total government debt is approximately US$1 trillion. This wealth effect will provide the Korean government with ample resources for long-term physical and financial investment, social infrastructure construction, and strategic planning for the AI ​​era.