Equities: Three Reasons To Expect Further Outperformance

BMI View: South Korean equities have done well versus the region in recent weeks, and we see scope for further outperformance (particularly against South East Asia) in the short-to-medium term. Macroeconomic stability, exposure to cyclical upturns in the US and eurozone, and fairly attractive valuations should all act as tailwinds for the market. In absolute terms too, the benchmark KOSPI could embark on a renewed leg higher should it manage to successfully consolidate above resistance-turned-support at 2,000.

South Korean equities have performed well in recent weeks. Since the start of July, the benchmark KOPSI index has notched up gains of 7.8% versus losses of 1.8% for the MSCI South East Asia Index. Going forward, we identify three reasons why we believe that Korean stocks can continue to outperform in the short-to-medium term.

No Repeat of 1997: One of our core views in the recent EM shake-out has been that Asia does not face another '1997 moment', as structural fundamentals such as current account positions, reserve coverage, and short-term debt paint a much healthier picture this time around. This is a particularly pertinent point for South Korea. As we wrote in last week's currency forecast, 'The huge current account deficits that were once the underbelly of the Korean economy have now become a thing of the past. Additionally… the country saw its external short-term borrowings hit a six-year low in Q213, accounting for less than 30% of the country's total external debt pile.' The market appears to agree with our view that South Korea's external health remains in decent shape. The country's 5-Year sovereign credit default swap (CDS) has hardly budged in recent weeks, standing at 74 basis points (bps). This stands in stark comparison to Malaysia, another investment grade credit, which saw spreads more than double at their August peak from the start of the year.

Korean Protection Has Hardly Moved
Asia - South Korea Versus Malaysia 5-Year CDS, bps

Equities: Three Reasons To Expect Further Outperformance

BMI View: South Korean equities have done well versus the region in recent weeks, and we see scope for further outperformance (particularly against South East Asia) in the short-to-medium term. Macroeconomic stability, exposure to cyclical upturns in the US and eurozone, and fairly attractive valuations should all act as tailwinds for the market. In absolute terms too, the benchmark KOSPI could embark on a renewed leg higher should it manage to successfully consolidate above resistance-turned-support at 2,000.

South Korean equities have performed well in recent weeks. Since the start of July, the benchmark KOPSI index has notched up gains of 7.8% versus losses of 1.8% for the MSCI South East Asia Index. Going forward, we identify three reasons why we believe that Korean stocks can continue to outperform in the short-to-medium term.

Korean Protection Has Hardly Moved
Asia - South Korea Versus Malaysia 5-Year CDS, bps

No Repeat of 1997: One of our core views in the recent EM shake-out has been that Asia does not face another '1997 moment', as structural fundamentals such as current account positions, reserve coverage, and short-term debt paint a much healthier picture this time around. This is a particularly pertinent point for South Korea. As we wrote in last week's currency forecast, 'The huge current account deficits that were once the underbelly of the Korean economy have now become a thing of the past. Additionally… the country saw its external short-term borrowings hit a six-year low in Q213, accounting for less than 30% of the country's total external debt pile.' The market appears to agree with our view that South Korea's external health remains in decent shape. The country's 5-Year sovereign credit default swap (CDS) has hardly budged in recent weeks, standing at 74 basis points (bps). This stands in stark comparison to Malaysia, another investment grade credit, which saw spreads more than double at their August peak from the start of the year.

An Improving Global Backdrop
US, Eurozone Purchasing Managers' Indices & Korean Exports To China

Exposure To Developed World Demand: South Korea's export machine means that its economic fortunes are inextricably linked to the ebbs and flows of global trade dynamics. With this in mind, recent cyclical improvements in developed world demand bode well for the country's exporters. As the accompanying chart shows, purchasing managers' indices in both US and Europe paint a largely positive picture, particularly in the US. The revenue structure of Korean companies very much reflects this exposure to developed world demand. By way of example, Samsung Electronics (which accounts for 17.6% of the KOSPI) derives roughly 45% of its revenue from US and Europe combined. Meanwhile, the recent bounce in Chinese demand - while likely to prove fleeting ultimately - looks well placed to be sustained through to year-end, which should also be earnings-positive for Korean companies.

Far From Expensive
Asia - MSCI Korea & Thailand, Price-To-Book Ratios

Valuations Remain Fairly Priced: In terms of valuations, Korean equities do not look particularly expensive to us despite the recent run-up. The price-to-book ratio for MSCI Korea stands at 1.26x - significantly below the 10-year average of 1.36x - suggesting decent scope for some multiple expansion in the coming weeks. Again, if we make a comparison to South East Asian markets, the MSCI Thailand is currently trading at 2.29x book value (versus a 10-year average of 2.09x), suggesting that Thai stocks remain richly priced despite growing macro risks.

KOSPI: All Eyes On 2,000

South Korea's benchmark KOSPI index is likely to feel the collective benefits of improved macroeconomic stability (both historically and measured against regional peers), exposure to cyclical upturns in the US and eurozone, and fairly attractive valuations. We expect the bourse to outperform in relative terms - particularly against equity markets in South East Asia, which despite their recent de-rating remain richly priced to us.

In Consolidation Mode
South Korea - Benchmark KOSPI Index

In absolute terms, we see potential for further upside in the KOSPI should the index manage to consolidate above resistance-turned-support at 2,000. In the event that this level gives way, we would expect long-term trendline support at 1,800 to hold firm, thereby providing an attractive re-entry point ( see chart).

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