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Posted by on Jul 13, 2018 in Korea Investment Management, Market Insight

Korea in Focus: A Monthly Recap & Outlook

Korea in Focus: A Monthly Recap & Outlook

By Korea Investment Management, portfolio manager of the AdvisorShares KIM Korea Equity ETF (Ticker: KOR)

In June, global stock markets performed poorly as concerns about a trade dispute between the US and China flared up again. After the US said it will impose a 25% tariff on up to 50 billion (bn) US dollars (USD) of Chinese imports, China fired back with a set of levies similar in scale. And with US President Donald Trump threatening China with an additional 10% tariff if the country proceeds to retaliate, fears escalated about a US-China trade war.

Unlike the June Federal Open Market Committee (FOMC) meeting that was more hawkish than the market anticipated, the European Central Bank (ECB) meeting outcome was viewed as accommodative, causing the euro (EUR) to plunge against the USD. And with the USD’s value rising on more investors seeking safe-haven assets, emerging countries suffered from faster capital outflows, leading to sluggish stock market performances. In particular, concerns that exports will be dented by the ongoing US-China trade dispute caused a significant slump across Korea, China and other emerging markets in Asia.

The domestic financial market was also on a wild ride. The (South Korean won) KRW/USD jumped from (won) W1,070 at early-June to W1,124. Such USD appreciation was triggered as 1) KRW upside momentum has dissipated since the US-North Korea summit, 2) preference picked up toward a safe-haven currency and 3) concerns mounted about slower domestic economic momentum due to dismal jobs market data and tepid exports growth.

The domestic market plummeted due to both external and internal noise. External factors include soured investor sentiment amid the reignited US-China trade spat and foreign capital outflow due to USD appreciation while internally, investors were on a selling spree to take profits from the potential beneficiaries of inter-Korean economic cooperation following the US-North Korea summit and domestic corporate earnings, including Samsung Electronics, were revised down in second quarter 2018 (2Q18).

In June, the Kospi retreated 4% and the Kosdaq fell 7%. By sector, the biggest gainers were telecom services (+6.2%), food & beverages (+4.3%), banks (+2.7%), textiles and apparel (+1.8%) and pharmaceuticals (+0.3%). In contrast, the biggest decliners were construction (-17.3%), non-ferrous metals (-16.9%), machinery (-10.9%), paper & wood (-10.3%), securities (-9.1%), transport & storage (-8.3%), electric & electronics (-7.2%) and transport equipment (-7.1%).

For the stock market to turn upward, the USD must lose ground and foreign buying resume. The key lies in the US-China trade war. The USD has been on a sharp rise but the upward pressure on the USD will likely ease if the trade row tones down. Risks related to monetary policies are mostly known to the public since the FOMC and ECB meetings in June while the economic and inflation gap between the US and the euro zone has stopped widening, which would help ease USD appreciation against the EUR.

The critical factor remains whether US-China trade hostilities will escalate. Even if the first battle in a trade war began on July 6 with the US and China imposing tariffs on one another for USD 34 billion (bn) worth of goods, the two countries would likely negotiate a deal to adjust the level of tariffs, in our view. The reason is an outright trade war would cause more bad than good for both. This is especially so for President Trump with the November mid-term elections ahead as the US unilaterally igniting a trade war could possibly fuel inflation and trigger opposition from US businesses.

If the extreme scenario for US-China trade tensions does not unfold, the Kospi is at a level that offers downside protection not only in terms of valuation but also as market sentiment has tilted toward “panic selling”. As the Kospi’s 12-month trailing 1x PB equals 2,300pt, the index currently sits in deep value territory.

Given that the index is unlikely to retreat further, stocks that tumbled too much are always those that deliver the best returns in times of post-dip rebounds. Among sectors that pulled back excessively relative to the market, those likely to deliver better 2Q18 earnings are construction, machinery, securities, insurance and retail.

The information, statements, views and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but not representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.