South Korea's financial regulators have inadvertently triggered a dramatic 30% surge in small-cap stocks through their well-intentioned crackdown on leveraged ETFs. The authorities implemented higher cash deposit requirements for single-stock leveraged ETFs beginning July 31, expecting to cool speculation in chip stocks tied to Samsung Electronics and SK Hynix. However, as BeInCrypto reports, retail money rotated en masse into Kosdaq small caps instead, with the Kosdaq index jumping 6.8% on Monday alone, triggering a Korea Exchange program trading halt for the third time this month. According to Shinhan Securities analyst Park Wooyeol, "We are seeing more money flow to Kosdaq, particularly today. Volatility-loving retail investors who have moved to the single-stock leveraged ETFs are expected to make a comeback to the Kosdaq."
South Korea's stock market turmoil appears to be subsiding after a historic selloff that saw the Kospi Index fall nearly 40% from its June high. According to Bloomberg, an index of volatility in Korean shares fell to a two-month low last week from a record high in June, with the volatility gauge declining from a record 96.9 in June to current levels. The stabilization follows forced liquidations that helped reduce outstanding margin debt and tighter rules on leveraged exchange-traded funds that cut trading in products tied to chip giants Samsung Electronics and SK Hynix. Global funds have sold more than $100 billion of shares this year, leaving emerging-market funds underweight on the country, though overseas money managers aren't rushing back in due to elevated volatility concerns. Morgan Stanley estimates the deleveraging process is more than half over, suggesting the most extreme phase of the market turmoil may be concluding.
The Korean market correction has resulted in significant retail investor deleveraging, with about 1 trillion won of retail accounts facing forced liquidation in June, and another 993 billion won in July according to the Korea Financial Investment Association. Outstanding margin loans used to finance stock purchases slid to 27.4 trillion won on August 4, the lowest level this year. The authorities responded with higher cash deposit requirements for single-stock leveraged ETFs beginning July 31, leading to drops in trading volumes and assets for funds tied to Samsung Electronics and SK Hynix. Despite the stabilization, global funds continue selling, offloading $6.2 billion in July and $4.3 billion so far in August after cashing out a record $30 billion in June. As Maxence Visseau of Arkevium Capital noted, "This looks like the beginning of a hand-off from domestic retail investors to foreign institutions."
According to a new Deutsche Bank Research report by Luke Templeman and Galina Pozdnyakova, the market may be underestimating systemic risks that don't appear in headline indices. The report highlights two apparently contained events that deserve closer attention: the $16 billion unwind of the Situational Awareness hedge fund after leveraged AI trades went wrong, and the extraordinary KOSPI fall of more than 20% in 48 hours before rebounding 25% and finishing the week close to unchanged. As reported by Deutsche Bank, these events demonstrate how leverage can transform ordinary corrections into forced, irreversible selling that destroys wealth even when indices recover.
Deutsche Bank warns that the next market accident may not begin with a traditional crisis like a bank failure or sovereign default, but with something that initially appears technical and contained. According to the report, this could include a hedge fund unwind, leveraged ETF reset, margin call in a peripheral market, or a company unable to refinance a division. As reported by Bloomberg, Morgan Stanley estimates the deleveraging process is more than half over, though overseas money managers remain cautious. Korean stocks trade at a record-low 5.1 times their 12-month forward earnings, but extreme volatility continues to make investors more cautious in the near term. Isaac Thong from Aberdeen Asian Income Fund stated, "We are getting constructive, but we're still not fully comfortable because volatility still remains high." Some analysts like Goldman Sachs maintain bullish views with a 12,000 Kospi target representing 90% upside, while others suggest taking a pause for another month.
