SHOULD YOU CHASE SOUTH KOREAN STOCKS UP HERE?

Takeaway: While the KOSPI has looked good on the long side for a TRADE, it’s important that investors do not overstay their respective welcomes here.

SUMMARY BULLETS:

  • Leading up to and through the recent 1-2 punch of monetary and fiscal stimulus, South Korea’s benchmark KOSPI Index has recaptured its immediate-term TRADE and intermediate-term TREND lines on our proprietary three-factor quantitative overlay. Now bullish TRADE & TREND and demonstrably underperforming global equities in the YTD (-0.9% vs. +12.3% for the MSCI World Index), the KOSPI looks like a tasty market to chase (it’s up +4.2% from its 4/18 YTD closing low).
  • At a bare minimum here, South Korea is no longer a short/underweight candidate across the Asian and/or EM equities space. What would reverse this conclusion, however, is the resumption of yen declines – arguably the single most important factor that has weighed on the KOSPI in the YTD. Over the past month or so, the trend of appreciation across both the dollar-yen rate and the US Dollar Index has been suspended. To the extent this immediate-term phenomenon reserves – as we think it should on strong US consumption growth that is underpinned by improvement in the domestic employment and housing picture, as well as a perpetually-widening divergence between Fed and BOJ monetary policy – the earnings outlook for KOSPI stocks will once again come under pressure as Japanese exporters take market share, at the margins.
  • All told, while the KOSPI (and emerging markets broadly; South Korea is the largest component of the EEM etf at 14.2%) has looked good on the long side for a TRADE, it’s important that investors do not overstay their respective welcomes here. While our TREND & TAIL duration calls on the USD (i.e. bullish) and JPY (i.e. bearish) have certainly cooled off quite a bit in recent weeks, we don’t anticipate yen strength and dollar weakness morphing into any kind of sustainable trend. In fact, both the DXY and USD/JPY cross remain bullish from an intermediate-term TREND perspective on our proprietary three-factor quantitative overlay.

SOUTH KOREA – BACK FROM THE DEAD

Overnight, the BOK cut its Benchmark 7-Day Repo Rate to 2.5% from 2.75% prior. The move was predicted by six of 20 economists surveyed by Bloomberg News, which was a reasonable position for consensus to take, given that BOK Governor Kim Choong Soo actually opposed a cut last month.

That being said, however, this fairly meaningful acceleration in the BOK’s easing bias is not completely out of the blue: CPI tied a for a 13-year low in APR at +1.2% YoY and Export growth continued at a paltry +0.4% YoY pace in the same month. Additionally, the swaps market started to price in some magnitude of rate cuts going back to mid-FEB.

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Make no mistake, this decision was particularly political: the KRW’s +30.2% increase vs. the JPY since the 9/27 initiation of our bearish bias on the yen is weighing on the new orders of South Korean exporters – particularly in the autos, electronics and capital goods sectors – aiding their Japanese rivals in the process; reference our 3/25 note titled, “IS THE KOSPI IS LOSING ITS LEADING INDICATOR STATUS?” for more details. In the accompanying statement, Kim indeed stated that “Japan’s aggressive monetary easing has big impact on South Korea” and added that “a big fall in yen is a concern and threatens market stability”.

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Finance Ministry Director General Choi Sang Mok aggressively welcomed the cut; recall that the Park Geun-hye administration had been applying pressure upon the BOK to ease monetary policy to support their fiscal stimulus efforts. Regarding those efforts, the government said yesterday it will add KRW11.1 trillion ($10.2 billion) of financial support this year for companies – particularly to export-oriented SMEs – to help them cope with the demonstrably weak yen. This is on top of the recently ratified KRW17.3 trillion ($15.9 billion) supplementary budget announced back on APR 16 (~1.4% of GDP).

Leading up to and through this 1-2 punch of monetary and fiscal stimulus, South Korea’s benchmark KOSPI Index has recaptured its immediate-term TRADE and intermediate-term TREND lines on our proprietary three-factor quantitative overlay. Now bullish TRADE & TREND and demonstrably underperforming global equities in the YTD (-0.9% vs. +12.3% for the MSCI World Index), the KOSPI looks like a tasty market to chase (it’s up +4.2% from its 4/18 YTD closing low).

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SHOULD YOU CHASE?

Starting with our proprietary Growth/Inflation/Policy modeling process, the South Korean economy looks set to enter Quad #2 and remain there for the foreseeable future (i.e. 2-3 quarters at best). This move to a steady state of Growth Accelerating as Inflation Accelerates is supported by the aforementioned stimulus measures, as well as an outlook for directional weakness in the YoY strength of the KRW – particularly relative external inflation pressures, which mostly emanate from the commodities market as well as from inflows of “hot money”. Regarding directional pressures on CPI, it’s not enough to simply have commodity inflation/deflation; the currency’s relative strength or weakness to the key markets within commodity complex is what matters most.

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While Quad #2 is neither overtly positive or negative for equities, we think that because CPI remains demonstrably below the BOK’s +2-4% target range, the market’s focus will likely be on the likely acceleration in Real GDP growth – a phenomenon that hasn’t occurred in South Korea since 3Q11!

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GLOBALLY-INTERCONNECTED RISKS REMAIN

At a bare minimum here, South Korea is no longer a short/underweight candidate across the Asian and/or EM equities space. What would reverse this conclusion, however, is the resumption of yen declines – arguably the single most important factor that has weighed on the KOSPI in the YTD. Over the past month or so, the trend of appreciation across both the dollar-yen rate and the US Dollar Index has been suspended. To the extent this immediate-term phenomenon reserves – as we think it should on strong US consumption growth that is underpinned by improvement in the domestic employment and housing picture, as well as a perpetually-widening divergence between Fed and BOJ monetary policy – the earnings outlook for KOSPI stocks will once again come under pressure as Japanese exporters take market share, at the margins.

All told, while the KOSPI (and emerging markets broadly; South Korea is the largest component of the EEM etf at 14.2%) has looked good on the long side for a TRADE, it’s important that investors do not overstay their respective welcomes here. While our TREND & TAIL duration calls on the USD (i.e. bullish) and JPY (i.e. bearish) have certainly cooled off quite a bit in recent weeks, we don’t anticipate yen strength and dollar weakness morphing into any kind of sustainable trend. In fact, both the DXY and USD/JPY cross remain bullish from an intermediate-term TREND perspective on our proprietary three-factor quantitative overlay.

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Alas, managing Duration Mismatch remains omnipotent to Global Macro investing.

Darius Dale

Senior Analyst