After record run, Korean stocks look to Moon effect, earnings to build on gains

Defying a toxic mix of nuclear and political tensions, South Korean stocks - Asia's cheapest - have scored record-highs in the past week. Now, with the election of liberal moderate Moon Jae-in as the nation's president, bets are that Korean equities will run up further gains.
The benchmark KOSPI has jumped 13 percent this year, no mean feat considering a raft of risks, including months of leadership vacuum, North Korea's nuclear ambitions, China's boycott of South Korean goods and tourism, and US President Donald Trump's threat to potentially pull out of a free-trade agreement. South Korean stocks have enjoyed $6.93 billion of inflows this year up until May 10, second only to Taiwan, according to Thomson Reuters data. That compares with about $10.5 billion for the whole of 2016.
While strong earnings in the country's lynchpin technology sector, have helped to spark investor demand, funds are now counting on Moon's presidency to soothe some of the geopolitical tensions and provide a fresh catalyst for gains. Moon has promised to negotiate with both China, South Korea's biggest trading partner, and the US to ease tensions over the deployment of the US THAAD anti-missile system; push for reforms of the family-run conglomerates, known as chaebols; and introduce a fiscal stimulus package to breathe life into the anaemic economy.
"The election result is the spur to both hopes for reconciliation with China... and corporate reform of the chaebols," said Hugh Young, managing director of Aberdeen Asset Management Asia in Singapore. "So, provided the hope morphs into reality, the market can run further." A further important driver for the market will be an extended phase of earnings growth at South Korea's biggest companies, thanks to a revival in global trade and strong demand for hi-tech memory chips. Exports, for instance, surged for a sixth straight month in April, with growth hitting a six-year high.
Earnings estimates for South Korean companies for fiscal 2017 have risen 8.6 percent over the past eight weeks, the biggest upgrade among major Asian markets, according to Nomura. Investors are also downplaying the threat of US protectionism on South Korean exports.
Sean Taylor, Asia Pacific chief investment officer at Deutsche Asset Management, who remains overweight Korean stocks, expects Trump to renegotiate the free trade agreement between the two countries, rather than scrap it altogether.
Taylor sees limited impact on South Korean companies. "A lot of it is just Trump talking. We've seen that it's very hard for him to pass anything," he said. "The US really needs panels and DRAM and NAND (memory chips) and it doesn't have the volume itself." Another draw for investors in Korean stocks is their cheap valuations. When the KOSPI hit its previous record in April 2011, it was trading at 1.4 times forward book value. Although it has surpassed that high, its current price-to-book ratio is only 0.96.
South Korean stocks' valuation also contrasts with the most expensive markets, India and Philippines, at 2.6 and 2 times book value, respectively. Korea has historically traded at a discount to other Asian markets due to the dominance of chaebols, or family-run conglomerates, which have been stubbornly resistant to minority investors' calls for reforms. But some progress on changes makes this lower valuation more attractive now, particularly with Moon pledging to push for further reforms.
"The trends are definitely towards reform and change," said Mark Mobius, executive chairman of Templeton Emerging Markets Group. "I believe the chaebols in three years will move towards more and more professional management who heed the interests of all shareholders, not only the family who founded the company," he added. "Those families will gradually become passive shareholders with less and less direct managerial control."