Emerging markets: Why Korea requires caution despite strong recent performance

Despite a period of strong performance, Pendal’s emerging markets team remains cautious on the outlook for Korea

• Korea experienced dramatic gains including strong performance among retail mid-caps
• But underlying economic indicators are weak, giving our team a cautious view
• Find out about Pendal Global Emerging Markets Opportunities fund

STOCK market volatility is driven by a complex mix of formal structures – such as investor mix, regulation and security availability – along with the behavioural tendencies of local and international investors.

These characteristics are often amplified in emerging markets, including Korean equities, which can be prone to big moves in price level in response to minimal fundamental news.

We feel the Korean financial landscape has several components that reinforce its position as an emerging market, despite undoubted technological prowess.

These include poor corporate governance, volatile politics (very much including last year’s attempt to impose martial law) and instruments and structures that amplify volatility such as use of complicated derivatives among retail investors.

(The latest trend is auto-callable ETFs – which hold structured products that provide income and principal return if the underlying asset meets certain conditions).

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Pendal Global Emerging Markets Opportunities Fund

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Bull market benefits Korea

We are now in a global environment that looks like a broad bull market in emerging market assets.

Historically in these environments, individual emerging markets often experience violent short-term, up-and-down moves as part of a trend of the broader asset class moving higher.

That’s definitely what it looks like in Korea.

The second quarter saw MSCI Korea rise 32.7% in USD terms, with the Korean Won’s 8.9% move up against the US Dollar contributing significantly.

At a stock level there were some exceptional moves, especially in some of the mid-cap names preferred by local retail investors.

Some names in sectors as diverse as shipbuilding and ecommerce rose more than 50 per cent in the quarter.

Of course, no investor will object to being caught in assets that are shooting higher – and Pendal’s top-down country process aims to consider liquidity and sentiment as part of our analysis and allocation process.

However, to be more than just a liquidity-momentum filter, we need to pay attention to the economic fundamentals and corporate earnings that underpin these stocks.

Caution at stock level

We need to think of equities as stakes in real businesses rather than just as tradeable securities.

And at this level Korea looks far more difficult.

The stronger Won is a drag on the exporters which are the backbone of the Korean economy.

Some major exporters in the semiconductor, automotive and steel sectors have seen their forecast earnings revised lower year to date.

First-quarter GDP growth was zero year-on-year, industrial production in the year to May grew only 0.2% and purchasing-manager surveys show an expectation of economic contraction.

Corporate governance and politics remain difficult despite the appointment of a new administration in June after peaceful elections.

Meanwhile the environment for global trade remains uncertain.

Emerging markets we like better

Our security selection within Korea has been strong, allowing us to hold some of the best-performing stocks in the market, and we remain alert to opportunities here.

Overall, though, we generally prefer markets with more sensitivity to the US dollar and less exposure to global trade.

It is markets such as Brazil, Mexico and South Africa where we see more opportunity for a stronger currency leading to faster, and further, interest rate cuts.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

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