Kuroda’s bazooka crimps South Korean stocks

Kim Jong-eun’s nuclear weapons may be the focus of attention on the Korean peninsula, but the greater worry for its investors is Haruhiko Kuroda’s bazooka.

The Bank of Japan governor’s decision to go all out for growth may have been a boon for investors in the Nikkei, but it is having the opposite effect for many South Korean companies.

Tensions remain high on the divided peninsula, as Seoul awaits a possible North Korean missile launch that could come any day. Though hostile rhetoric – and even hostile actions – from Pyongyang have previously been a negative drag on both equities and the won, the impact has almost always been shortlived.

“We have learnt a lesson from North Korea’s past provocations. The stock market tends to fall sharply for a couple of days but it always rebounds,” says Chung In-ki at Truston asset management.

The Kospi is Asia’s worst performing index this year, buffeted by rising political tensions and a stumbling economy. On Thursday the Korean central bank cut its growth forecasts for 2013 to 2.6 per cent, but resisted calls for a rate cut. And now there is a new factor to consider – Japan’s monetary revolution.

Between the summer of 2008 and December 2012, the Japanese yen rose more than 50 per cent against the Korean won. That relative currency advantage helped Korean exporters, such as Samsung and Hyundai, which dominate the Korean index, to build market share across the globe.

But thanks to Japan’s Abenomics push, the yen has retreated by about 20 per cent in less than six months. As Japanese companies, long accustomed to battling high export costs, start to exploit the weaker yen, Korean rivals are expected to be the biggest losers.

“Foreign investors have been heavy sellers in Korea – not just because of the geopolitical situation but also concerns over Korean exporters,” says Chanik Park, head of Korea research at Barclays. “When you talk to investors they worry about [the impact] too much weakening of the Japanese currency will have on Korean exporters.”

The rally in Tokyo has also been a drag. Investors looking to increase exposure to Japan have looked to large, liquid markets to fund their trades. South Korea and Greater China have been the most affected.

So far this year the Kospi index has been Asia’s laggard. In US dollar terms it has fallen 8 per cent. During that time the MSCI Asia Pacific index, which includes Japan, is up 5 per cent. Over the past month alone, foreign investors sold a net $3.8bn of Korean shares.

But Korea’s one saving grace may well be all the bad news.

For investors looking to allocate funds to Asia outside Japan, the region offers a dilemma between price and momentum. Southeast Asian markets have soared in the past two years, leaving many at giddy multiples. The Philippines index, for example, now trades at more than 20 times earnings.

Chinese equities, after a brief, breathless rally, have stalled, with many analysts now expecting the market to remain range bound for the rest of the year. India has also failed to deliver, yet trades at relatively high valuations.

Korea, by contrast, looks cheap. Though the Kospi has long traded at the so-called “Korea discount” to the rest of the region, its current price to earnings ratio of about 8.7 times – compared with a historical average of 10 times – is starting to attract interest.

“Korea’s macroeconomic conditions seem challenging, [but] I think this is a good time for bargain-hunting, because hedge funds will start short covering”, says Kim Hak-joo at Woori asset management. “We are seeing some panic selling by foreign investors. But we know that we will have good returns if we buy stocks now.”

Herald van der Linde, head of Asia equity strategy at HSBC, says appearances can be deceptive, however. He believes that Korea’s apparent low valuation belies a long record of earnings downgrades and missed forecasts.

“Earnings expectations are too euphoric, [and] too optimistic in a world where growth is limited,” he says. “Yes it looks cheap, but on what earnings numbers? It’s not as cheap as you think.”

Others say that even if valuations look attractive, the market currently lacks an obvious catalyst for a turnround.

“From a valuation perspective it’s a market I’ll be watching out for very closely. But I don’t think we need to rush”, says Tai Hui, chief Asia strategist at JPMorgan Asset Management. “Until we see some signs of improvement in earnings, investors will stay relatively conservative.”

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