Morgan Stanley has upgraded its rating on South Korean equities to "Overweight," citing that the aggressive deleveraging process is nearing its end and that KOSPI valuations have fallen to historically extreme lows, presenting a more compelling entry opportunity for investors. According to the latest report on Asian emerging market equity strategy, the investment bank has set a 9,000-point target for the KOSPI index, implying approximately 36% upside from current levels.

The report highlights that the KOSPI's 12-month forward price-to-earnings (P/E) ratio has dropped to 5.7 times, below its previous historical trough. This valuation level, Morgan Stanley argues, already reflects the market's pessimistic outlook on the sustainability of memory-driven earnings in 2026. The bank views the 39% correction in the KOSPI as primarily technical in nature, rather than a deterioration of fundamentals. With hedge fund deleveraging approximately 75% complete and the assets under management (AUM) of leveraged ETFs linked to Samsung Electronics and SK hynix shrinking by about 70% from their peak, the market's positioning structure has significantly improved.

Morgan Stanley's Prime Brokerage data shows that the deleveraging process for Asian hedge funds is about 75% finished. The gross exposure of global hedge funds to South Korea has fallen from a peak of 3.8% to 2.7%, a 28% decline, while net exposure has dropped from 8.8% to 5.6%, a 36% decline. Concurrently, the AUM of leveraged ETFs linked to Samsung Electronics and SK hynix has plummeted from a peak of approximately $40 billion in June to around $11.8 billion, a drop of about 70%. The short gamma on these leveraged ETFs has also moderated from an extreme level of $867 million at the end of June to $288 million, a 67% decline. Morgan Stanley's Korea Capitulation Index has fallen to -2.53, its lowest level since 2008 (excluding the European debt crisis and the COVID-19 pandemic, when it hit -3.1). Historically, the report notes, the KOSPI tends to rebound by 10% to 30% within 30 trading days after realized volatility peaks. At the retail level, margin debt has fallen 14% from its late-June peak, representing about a 30% reversion to the post-2020 average, though absolute levels remain elevated. The report suggests that foreign capital inflows will be a key driver for further gains, but market volatility is expected to remain high in the near term.

The KOSPI's current 12-month forward P/E of 5.7 times places it at the 2nd percentile of its 10-year history, below its previous historical low. Excluding Samsung Electronics and SK hynix, the KOSPI's forward P/E is 10.8 times, down about 27% from its recent peak of 14.8 times. From an earnings growth perspective, the consensus is for MSCI Korea's earnings per share (EPS) to grow by 312% in 2026. More notably, the consensus forecast for the compound annual growth rate (CAGR) of EPS from 2027 to 2028 is still around 20%, higher than comparable forecasts for the United States and India. Morgan Stanley believes that at current valuation levels, the market has already priced in a significant downturn in memory earnings. Even if memory earnings consolidate over the next two years, the bank argues that South Korean stocks can still deliver excess returns relative to emerging markets.

Three Key Chip Catalysts

Morgan Stanley's Asia Technology Team Head, Shawn Kim, outlined three near-term catalysts for South Korean chip stocks in the report. The first is capital expenditure. The capital management moves of Samsung Electronics and SK hynix are seen as the most important near-term catalyst. The market is awaiting specific announcements regarding their "value-up" programs and capital returns, the timing of which is unclear, but the expectation itself constitutes a potential catalyst. The second is HBM4 pricing. Samsung Electronics recently indicated that HBM4 would account for about 60% of its total HBM sales by the end of next year. If HBM4 prices reach the market's expectation of over $3 per gigabit (Gb), it would be a positive catalyst for overall DRAM pricing in 2026-2027. The third is the iPhone 18 launch cycle. Mobile devices still account for 30%-40% of global DRAM demand and 25%-30% of NAND demand. According to feedback from Korean Apple supply chain members, such as LG Innotek, Apple is positive about the iPhone 18 cycle, expecting shipment growth of 5% to 10% year-on-year. The iPhone 18 is set to launch in September, with initial models being Pro series variants, including Pro, Pro Max, and a foldable device. Strong sales would positively impact Samsung Electronics and SK hynix.