Korean Stocks Teach Pessimists a Lesson

If any country seems like an unsettling place to invest judging by headline risk alone, it would be South Korea. 

The past year has brought recurring missile tests at its isolated northern neighbor while, at home, a corruption scandal engulfed the presidency and ensnared the country's largest conglomerates. The siting of a U.S. missile-defense system on Korean soil irked China, resulting in hefty retaliatory measuresagainst the nation's businesses including shutting down Lotte Group's discount stores and pulling popular television shows.

But what's happened in Korean equities is a good lesson for all investors: Opportunities may abound for those who can tune out the noise -- and the pessimists.

Foreign funds have injected more than $15 billion into South Korea's stock market over the last 12 months, more than in India or Taiwan. 

Free Flow

Foreign funds have sent more than $15 billion into South Korea's equity markets in the last year, more than Taiwan or India

Meanwhile, the Kospi Index is up 26 percent so far this year in dollar terms. That compares with an 8 percent rise in the S&P 500 in the U.S. and an 18 percent gain for Hong Kong's Hang Seng Index. Almost every week since April has brought Korea's benchmark to new all-time highs. 

There's evidence the winning streak can persist. For one, a new president can often prompt investors to price in campaign promises --whether the vows are kept or not.

U.S. stock markets soared since November on hopes Donald Trump's election would bring business-friendly measures such as lower taxes and infrastructure spending. Six months on, they've extended those gains even though the plans have yet to materialize.

Likewise, Korean investors have bought into the prospect that President Moon Jae-in, elected last month after his predecessor was impeached, can usher in shareholder-friendly reforms at the chaebol, the conglomerates that make up roughly half the Kospi by market capitalization. 

Moon's decision last week to pause the deployment of the controversial missile shield has also provided relief to investors who worried Chinese boycotts of companies including Lotte Shopping Co. and K-beauty shop Amorepacific Group would push away the country's consumers for good.

In a note last week, Morgan Stanley analysts outlined how the Kospi Index's price-to earnings ratio is still 25 percent lower than other emerging markets thanks to the "Korean Discount," a moniker for the record of poor corporate governance, depressed cash payouts, low returns on equity and geopolitical risk that's kept the nation's companies undervalued.

Discount Aisle

Shares in Korean companies trade at a discount compared to other countries

Morgan Stanley reckons that as that discount narrows, investors could push the gauge up as much as 35 percent by 2018.

That target might be too lofty. For one thing, it's still doubtful whether corporate governance reforms will unfold anytime soon, with a number of chaebol-related bills currently stalled. Moreover, the first left-leaning government in almost a decade has more pressing priorities -- like dealing with North Korea, coming up with a budget, and enacting promised labor and regulatory reforms.

YIELD DAY

But the direction is probably right. As long as investors are choosing optimism and betting on better days ahead, it doesn't really matter if the present feels somewhat bleak.