Morgan Stanley has upgraded its rating on South Korean stocks from equal-weight to overweight, stating that the recent "leverage clearing" has created a better entry point for investors looking to participate in artificial intelligence trades and industrial super-cycle themes.

Strategists including Daniel K Blake wrote in a report that with the significant unwinding of crowded trades and leveraged positions, the Kospi index still has 36% upside potential from current levels toward its 9,000-point target. The index fell as much as 5.5% on Monday, following a record 18% surge last Friday.

Analysts indicated that the recent sell-off was "largely technical in nature," adding that "the deleveraging process for leveraged ETFs, hedge fund leverage, and retail margin trading is more than halfway complete." The Kospi index has now declined more than 30% from its June peak.

As a bellwether for Asian AI demand, South Korean stocks have been rapidly sold off by investors, with the surge in individual stock leveraged ETFs and excessive concentration in index weights further exacerbating the downturn. Morgan Stanley expects the Kospi index to trade in a range of 5,500 to 10,500 points in the short term, and believes that Samsung Electronics and SK Hynix will provide valuation support for the market. Stocks in sectors such as industrials, defense, and financials are expected to benefit from positive catalysts.