The latest indicators reflect a quickening pace in the Korean economy, which is headed for a healthy 4+% advance this year. Yet the Korea Composite Stock Price Index, KOSPI, declined 8.13% in the three months ending October 8th. The main US-listed Korean ETF, the iShares MSCI South Korea ETF, EWY, lost 13.6% on a total-return basis in that period. The difference between the two returns is due largely to the decline in the Korean won.
Divergences between short-term economic and equity-market performance are common. Economic statistics are backward-looking, while equity markets are forward-looking. Indeed, there are a number of downside risks ahead, as will be discussed below. In the case of South Korea there are structural reasons for the above divergence. The Korean stock market is heavily weighted towards information technology, which accounts for 33.8% of the index tracked by EWY, and communications accounts for another 10.92%. In line with the global downdraft in the technology sector following the first half’s boom, Korea’s hardware tech was hard hit in the third quarter, with foreign outflows heaviest for that sector. Recently it has been foreign institutional investors that have been selling Korean stocks, while domestic institutional investors have been purchasers.
It is also important to note that the Korean market has significant exposure to Samsung. The weight of Samsung Electronics in EWY is 22.9%, and that of Samsung LTD is a further 3.4%. Samsung reported record earnings in the third quarter and forecast increased momentum for its non-memory-chip businesses. But Samsung’s memory-chip business still is encountering headwinds, with falls in memory chip prices forecast to start around year end, a development that firms using these chips will welcome. It is notable that the company’s semiconductor operating profits are critical for Samsung’s total earnings. Samsung Electronics’ stock price, which tends to track developments in the memory chip market, peaked last January 11th and has trended downward since.
Samsung has reported supply disruptions affecting production, as well as rising costs for raw materials. These concerns have been common for firms in the tech sector. They are a major concern for Korea’s rechargeable battery market, which accounts for almost half of the globe’s production. Rechargeable battery production relies heavily on rare earths, for which China is the dominant supplier. This is just one example of the critical trade links between the South Korean and Chinese economies. China is Korea’s most important destination for its exports, accounting for 26%, and is also the most important source of its imports, accounting for 23.3%. These trade links are vulnerable to trade and political tensions as well as to strains in supply chains and unanticipated surges in demand.
Developments in South Korea’s battle with COVID have also affected its economy and stock market. The country, which had been relatively successful in dealing with the first wave of COVID and then was slow to progress with vaccinations, has experienced a recent rise in infections linked to the Chuseok holiday celebrating the fall harvest. Strict social distancing is in effect in the nation’s capital and surrounding areas. Fortunately, COVID hospitalizations and deaths remain low. It is good news that the government expects to fully vaccinate at least 70% of the population by the end of October and that restrictions can then begin to be eased. The pandemic looks likely not to be a significant restraint on the economy and the equity market in the coming months.
The prospects for the Korean economy in the fourth quarter and in 2022 appear positive. Foreign demand for Korean manufactured goods has strengthened, with total exports per day rising by 17.7% year-on-year in September. Also, investment is rising, and the government’s macroeconomic policy is expansionary. The Bank of Korea appears to share this view and to believe that the recovery is sound enough to permit a gradual course of normalization or tapering of its monetary accommodation. It has noted a concern about rising external price pressures.
More uncertain is the near-term outlook for Korean stocks. The third-quarter pullback in the KOSPI and the ETF EWY have made Korean stocks look relatively inexpensive. Goldman Sachs reports that consensus P/Es for Korea for 2021 and 2022 are relatively low, 10.8 and 9.7 respectively. There are significant uncertainties about the outlook for the technology sector, however. We are maintaining our current Korean positions in our International and Global Equity ETF portfolios and following developments closely.
William H. Witherell, Ph.D.
Chief Global Economist
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Sources: HIS Markit, OECD.org, Financial Times, Goldman Sachs, The Korea Herald, Barclays Research, Oxford Economics, The Economist
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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.
