CONCLUSION: Despite what appears to be a buying opportunity in Korean equities ahead of what is likely to be a positive inflection in the country’s domestic fundamental story, it is our view that the prudent thing for investors to do at the current juncture is wait – specifically for quantitative confirmation and increased clarity from Chinese policymakers on how they plan to address their latest bout of economic deterioration in the immediate term (if at all).
Overnight, the South Korean Finance Ministry lowered its official 2012 growth estimate by -40bps to +3.3%; additionally, it reduced its 2012 inflation estimate to +2.8% from +3.2%. While we don’t assign much weight to the economic projections of governments or their affiliated institutions in our research process (look no further than the CBO or the Fed to see just how painfully wrong such forecasts can be), we are keen to note that revisions such as these are typically leading-to-concurrent indicators of policy shifts. On that front, the South Korean Finance Ministry also introduced a KRW8.5 trillion ($7.4B or 0.7% of GDP) stimulus package designed to assist small businesses and low-income earners.
As an aside, we continue to find favorable countries who’ve protected the USD-based returns of international investors by supporting strength (relative or absolute) in their currencies. South Korea has been one of Asia’s shining stars in this regard over the past month, outperforming other Asian currencies vs. the USD by +190bps (on a regional median basis) as the table below highlights.
On the fiscal policy front, South Korea can surely afford to loosen its purse strings a bit; it’s central government budget surplus is just shy of +2% of GDP (officially at +1.8% in 2011). Their fiscal prudence has also contributed quite nicely to their strong current account position of +2.7% of GDP (2011) – giving South Korea dual surpluses where they are most supportive (in the currency market). Additionally supportive is South Korea’s relatively pristine sovereign debt/GDP ratio of 33.2% – particularly in the current Global Macro environment where consensus is literally being forced to [finally] comprehend the statistical relationship between excessive sovereign debt (beyond the Rubicon of 90%) and economic performance.
On the monetary policy front, both 1YR OIS and NDF markets continue to take the Bank of Korea’s cues of stability quite literally (they’ve been on hold for just over 1YR now), which ultimately translates into relative hawkishness in an environment where most other emerging and developed market central banks have a clear easing bias.
Furthermore, a real benchmark policy interest rate of 0.75% is supportive of cross-border capital flows into the South Korean economy – as is the government’s recent decision to exempt foreign investors from paying taxes on their foreign currency deposits as well as lowering tax rates for domestic banks that attract incremental foreign currency deposits.
As always, capital chases yield. As such, we are fundamentally inclined to [virtually] invest our “capital” in the South Korean economy at the current juncture – particularly given the country’s favorable TREND-duration GROWTH/INFLATION/POLICY outlook. On this score, Philippines and Thailand are the only other countries in Asia that currently qualify as TREND-duration fundamental long ideas based on this proprietary screening process.
As you likely focused on in the prior sentence, we can’t stress enough how important it is to our research process to have unique processes by which we derive our fundamental and risk management conclusions. In South Korea’s case, the country’s benchmark KOSPI equity index is in a Bearish Formation, which means it is quantitatively broken across all three of our risk management durations (TRADE, TREND and TAIL). We are smart enough to know that we are not smarter than Mr. Market; as such we are keen to interpret the latest economic trends out of South Korea with a grain of salt, rather than through the purview of rose colored glasses in anticipation of a positive inflection.
As we look for explanations as to why South Korean equities remain broken, the intellectually lazy answer would be to point a [fat] finger at the European sovereign debt and banking crisis. For a more quantified explanation, we instead point to recently souring trends in the global information technology sector (23.7% of the KOSPI index) and in the Chinese economy (far and away South Korea’s largest export market at 24.4% of total shipments).
As we’ve pointed out in our recent research, growth expectations for each have come down in recent weeks, with the Technology Select Sector SPDR Fund or “XLK” (bearish TRADE and TREND) underperforming the S&P 500 by -134bps since the start of MAY and the Shanghai Composite Index (also bearish TRADE and TREND) underperforming the S&P 500 by -344bps over that same duration. In the interest of keeping this analysis tight, we won’t belabor this point further; for more details, refer to the following notes/conclusions:
- WHAT’S ASIA SIGNALING ABOUT TRENDS IN THE TECH SECTOR? (APR 30): The relevant growth data emanating from Asia suggests the tech sector is at risk of deteriorating operating metrics over the intermediate term.
- CHINA’S INCREMENTAL GROWTH SLOWDOWN CONFIRMED (MAY 29): While Deflating the Inflation remains a bullish catalyst for the Chinese economy, the lag between this event and the turn in both the reported growth data and growth expectations may have just increased. As such, we are of the view that waiting and watching for clarity is the best strategy in the immediate term for China.
- CHINA’S RATE CUT IS LIKELY A BAD SIGN OF WHAT LIES AHEAD (JUN 7): We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here.
All told, despite what appears to be a buying opportunity in Korean equities ahead of what is likely to be a positive inflection in the country’s domestic fundamental story, it is our view that the prudent thing for investors to do at the current juncture is wait – specifically for quantitative confirmation and increased clarity from Chinese policymakers on how they plan to address their latest bout of economic deterioration in the immediate term (if at all).