Korean Stocks Promise Upside if External Factors Ease

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Although Friday is a day of reprieve for Asian markets, they remain near two-year lows. It looks likely that runs up like today — the Topix in Tokyo has added 1.9%, with similar gains across much the region — will be more than offset with subsequent lurches low.

South Korea is a case in point. Any crest has been undermined by a quick cave-in. So the Seoul stock market looks set to continue with the kind of intense volatility that has seen it double and then some from its COVID lows, up 130% from March 2020 to June 2021, and then fall 21.5% from that peak.

There are a lot of external factors, but domestic inflation and extremely overstretched levels of household debt are biting at home. Indeed, the market has priced in a recession, even though the outlook is pretty positive for key industries such as semiconductors, next-gen batteries, biosimilar drugs and alternative-energy vehicles.

“Simply put, demand will likely deteriorate first before supply starts to improve,” Nomura’s Korea strategy team, led by head of Korean equity research C.W. Chung, stated in an in-depth “anchor report” released today.

There may be value to be found, though, in a market that is trading at a price-to-book ratio that’s below 0.9. Companies have also been posting generally solid earnings. Investors should wait for signs of a rally, but it could be strong when it comes.

The chip-driven markets in South Korea and Taiwan have this year started to move in a similar pattern once again after showing shown unusual divergence in 2021. Sharing much of Nasdaq’s pain, the Kospi in Seoul is down 12.9% in 2022, while the Taiex in Taipei is off 13.3%.

Tech-driven names such as Samsung Electronics (LON:SMSN and 005930), SK Hynix (HXSCL and KR:000660) and Taiwan Semiconductor Manufacturing ( (TSM) and TW:2330) are hurt by higher interest rates in much the same way as their Nasdaq brethren. Their tech-sector customers rely on low borrowing rates to fund expansion, while many of their parts end up in consumer goods that buyers may opt to skip if their household costs such as mortgage and credit-card payments are rising.

Temporary supply chain disruptions haven’t helped. Those at least could ease if there’s some kind of resolution to the COVID outbreak in China and the war in Ukraine. But in both cases, Korean and Taiwanese companies are relying on external factors to resolve.

It’s also possible those factors don’t resolve and a global credit crunch occurs. Such conditions could prompt a global economic crisis, an outcome not yet priced into Seoul or Taipei stocks.

Nomura said it believes the risks are favorable, but predicts a wide range of trading for the Kospi in South Korea. Investment bank forecasts are tentative on the downside in particular, but Nomura sees a potential further 4.7% decline taking Seoul stocks to 0.8x book value, as well as a potential 19% rally to 1.0x book.

There’s an argument that South Korea will tackle inflation before the Fed. The Bank of Korea was the first Asian central bank to raise rates, back in August, and interest rates now stand at 1.5% in South Korea vs. 1% in the United States. Korean rates, which are already above pre-pandemic levels, are likely to reach 2.0% by the end of the year.

There’s new leadership at the central bank, where new Governor Rhee Chang-yong pledges to ease inflationary pressures by raising rates, and at the very top, where conservative President Yoon Seok-youl took up residence at the Blue House on May 10. He’ll be hampered by overseeing a National Assembly where 60% of the seats are in the hands of the opposition. Yoon’s most-noticeable contributions may come in international relations, where South Korea may look to join the Quad of Asia-Pacific democracies (United States, Japan, Australia and India) rather than on the home-economics front.

Those semiconductor stocks, in particular Samsung Electronics and SK Hynix, are likely to be undervalued given the importance and strong underpinning of their core industries. Investors looking to play emerging sectors may also want to consider battery maker LG Energy Solution (KR:373220), which counts General Motors (GM) and Tesla (TSLA) among its customers, and drugmaker Samsung Biologics (KR:207940), which should benefit from secular growth in their sectors.

Lastly, the Korean automakers would be the stocks likely to rebound if and when supply chain blockages ease. Hyundai Motor (HYMTF and KR:005380) and Kia Motor ( (KIMTF) and KR:000270) are seeing solid demand, with Hyundai reportedly looking to set up a new electric-vehicle factory in the United States, with Georgia the frontrunner right now.

It appears most of those picks are undervalued given the nature of their earnings and the state of their industries. Should the external pressures on Korean stocks abate, we could see them reclaim ground lost since the Kospi’s June peak.