Morgan Stanley has upgraded its rating on South Korean equities to overweight, indicating that the recent "leverage washout" has created a favorable buying opportunity for investors, particularly within the artificial intelligence trade and the broader industrial super-cycle.

The strategists, led by Daniel K Blake, stated in a note that following the significant unwinding of crowded trades and high leverage, the Kospi index is poised for a 36% increase, targeting a level of 9,000. The brokerage had previously held an equalweight rating on the country. The index experienced a sharp decline of up to 5.5% on Monday, following a record-breaking 18% surge in the prior session.

The analysts described the recent selloff as "mainly technical" and noted that the market has likely passed the midpoint of the unwinding process involving leveraged ETFs, hedge fund leverage, and retail margin positions.

The Kospi has fallen more than 30% from its June peak as traders rapidly exited the market, which had become a key bellwether in Asia for AI-driven demand. The selloff was worsened by a surge in single-stock leveraged ETFs and concentrated index weightings within the nation.

In response, South Korean regulators have stepped in to limit the use of these instruments. The government plans to restrict retail investor participation in leveraged products, including by capping such exposure as a set portion of overall portfolios.

Morgan Stanley, which forecasts a near-term trading range for the Kospi of 5,500 to 10,500, sees stocks like Samsung Electronics Co. and SK Hynix Inc. providing strong valuation support. The firm also expects tailwinds for stocks in sectors such as industrials, defence, and financials.

Additionally, Morgan Stanley upgraded its rating on Thai equities to overweight from equalweight, citing increasing opportunities in the Southeast Asian nation as it boosts foreign direct investment and competitiveness. The analysts noted that earnings are inflecting and valuations are cheap, while key stocks are set to benefit from AI capital expenditure and energy security themes.

Meanwhile, the bank cut its recommendation on Australia to underweight from equalweight, arguing that the market offers limited upside after several interest rate hikes and tax reforms that have reduced incentives for property investment. The firm saw potential upside in Australia due to its energy exposure amid the Iran conflict.