Korean Economy Showing Resilience to Currency Shock…

I noted in the last portfolio quarterly in mid-April that: ‘The KOSPI has weakened sharply in recent weeks, largely as a ‘zero sum’ portfolio bet versus Japan’s assumed competitive resurgence and steady earnings downgrades, although Pyongyang’s theatrics haven’t helped. Assuming that N. Korea’s tantrum doesn’t spin out of control, the consensus is almost certainly overestimating the loss of market share in consumer electronics in particular, given Japan’s loss of design and innovation leadership. A sustained rally is unlikely to start until the earnings downgrade cycle turns and we see a rate cut, but once conflict tail risks recede, building exposure in global leaders like Samsung should pay off in H2.’ That view stands and since then, Pyongyang has calmed its rhetoric and the JPY rally has stalled, helping stem the pace of outflows from Korean equities, which remain at a 6 year low valuation versus the MSCI AXJ index. As evidence of resilience to the currency shock, Korean manufacturing activity grew in April at the fastest pace in more than two years, boosted by an strong rise in new orders. The HSBC PMI hit a seasonally adjusted 52.6 in April, compared with 52 in March, the third month of growth and the highest since March 2011.

A $15bn stimulus package, unveiled by the government earlier this month, comes on the heels of measures to prop up the stagnant property market and $10bn of new financial support to help the country’s exporters. South Korean exports rose 0.4% y/y in April, but were down by 2.4% from March. However, there are some positive signals of stronger production and export growth in the coming month as investment in the technology sector is increasing to support growing demand for handheld devices. The domestic economy remains hamstrung by high household debt and a weak real estate market, and a BoK rate cut remains likely this quarter.

Global growth is for the third year in a row in a Q2 soft patch, and Korean stocks generally correlated with global leading indicators as  a high beta market.  However, the SEMI book-to-bill ratio, which tracks US demand for semiconductors relative to supply, is turning up, typically leading improved production and export growth in tech bellwethers Korea and Taiwan by about three months. Korea retains a strong comparative advantage over Japan in the production of smartphones, tablet devices and notebook computers, which are benefiting from a shift in technology consumption away from PCs and dedicated music players/cameras. Stronger sector tech sector investment in Q1 in Korea should ultimately flow through to better competitiveness while new product launches from Korea’s Samsung and LG will help to boost output.

Indeed, reports suggest some smartphone producers are struggling to keep up with demand, which has created shortages in key inputs such as memory chips. Korea’s investment over the past decade in China, which has overtaken the US as the world’s largest smartphone market, will be a key support. Overall, it remains likely that the heavy R&D and marketing investment over the past decade by leading Korean brands will make them far more resilient to recent currency moves than the consensus fears and the current panic out of Korean equities looks like a buying opportunity.