Although Friday is a respite day for Asian markets, they remain close to two-year lows. It seems likely that increases like today – the Topix in Tokyo added 1.9%, with similar gains across much of the region – will be more than offset by subsequent declines.
South Korea is a good example. Any crest was undermined by rapid collapse. So the Seoul stock market looks set to continue with the kind of intense volatility that has seen it double, then some since its COVID lows, up 130% from March 2020 to June 2021, then drop 21.5% from this peak.
There are many external factors, but domestic inflation and extremely high levels of household debt are having negative effects on the country. Indeed, the market has priced in a recession, although the outlook is quite positive for key industries such as semiconductors, next-generation batteries, biosimilar drugs and alternative energy vehicles.
“Put simply, demand will likely deteriorate before supply starts to improve,” Nomura’s Korean strategy team, led by head of Korean equity research CW Chung, said in a ” in-depth anchor report published today.
However, there may be value to be found in a market that is trading at a price-to-book ratio below 0.9. Companies also posted generally strong earnings. Investors should wait for signs of a rally, but it could be strong when it does.
Chip-focused markets in South Korea and Taiwan have started following a similar pattern again this year after showing an unusual divergence in 2021. Sharing much of the Nasdaq’s pain, the Kospi in Seoul is down 12 .9% in 2022, while Taiex in Taipei is down 13.3%.
Tech-focused names such as Samsung Electronics (LON: SMSN and 005930), SK Hynix (HXSCL and KR: 000660) and Taiwan Semiconductor Manufacturing ((TSM) and TW: 2330) are hit by higher interest rates in the same way as their Nasdaq brethren. Their tech customers rely on low borrowing rates to fund their expansion, while many of their parts end up in consumer goods that buyers may choose to ignore if their household costs, such as mortgage payments and credit card payments, increase.
Temporary supply chain disruptions have not helped. These could at least subside if there is some sort of resolution to the COVID outbreak in China and the war in Ukraine. But in both cases, Korean and Taiwanese companies rely on external factors to solve.
It is also possible that these factors don’t resolution and a global credit crunch occurs. Such conditions could trigger a global economic crisis, an outcome that has yet to be priced into Seoul or Taipei’s actions.
Nomura said he thought the risks were favorable but expected a wide range of deals for the Kospi in South Korea. Investment bank forecasts are hesitant on the downside in particular, but Nomura sees a potential further decline of 4.7%, taking Seoul shares to 0.8x book value, as well as a potential rally of 19 % at 1.0 times book value.
There is an argument that South Korea will tackle inflation before the Fed. The Bank of Korea was the first Asian central bank to raise rates in August, and interest rates now stand at 1.5% in South Korea versus 1% in the United States. Korean rates, which are already above pre-pandemic levels, are expected 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 chairman Yoon Seok-youl has taken up residence at the Blue House on May 10. He will be hampered by the surveillance of a National Assembly where 60% of the seats are in the hands of the opposition. Yoon’s most notable contributions may come from international relations, where South Korea may seek to join the Quad of Asia-Pacific democracies (United States, Japan, Australia and India) rather than on the front of the domestical economy.
These semiconductor stocks, especially Samsung Electronics and SK Hynix, are likely to be undervalued given the size and strength of their core industries. Investors looking to play in emerging sectors can also consider battery maker LG Energy Solution (KR: 373220), which counts General Motors (GM) and Tesla (TSLA) among its clients, and drugmaker Samsung Biologics ( KR: 207940), which should benefit from the secular growth of their sectors.
Finally, Korean automakers would be the stocks likely to rebound if and when supply chain lockdowns ease. Hyundai Motor (HYMTF and KR:005380) and Kia Motor ((KIMTF) and KR:000270) are seeing solid demand, with Hyundai apparently looking to set up a new EV plant in the US, with Georgia currently leading the way. .
It seems that most of these picks are undervalued given the nature of their incomes and the state of their industries. Should the external pressures on Korean equities ease, we could see them regain the ground lost since the Kospi peak in June.