Why Korea Has Not Outperformed EM?
June 26, 2014
Year-to-date, the iShares MSCI South Korea ETF (EWY) lost 0.5% whereas the iShares MSCI Emerging Markets ETF (EEM) gained 4%. This is despite that the South Korean wongained 3.3% against the dollar, which should help the dollar-denominated ETF. The KOSPI Composite Index fell 1.5%.
Credit Suisse expects Korea to grow 3.5% this year, accelerating to 3.7% in 2015. In addition, as an open economy, with 47% export-to-GDP ratio, Korea is set to be among the first to benefit when the developed markets recover.
So why hasn’t Korea performed?
Credit Suisse gives six reasons. First, Korea’s stock market can’t perform until China, its largest export market, gets out of the slump:
Korea’s historical equity market performance is intrinsically linked with the relative fortunes of Greater China—with a 60-month correlation coefficient of 0.76 versus both China and Taiwan.
Second, Korea has seen a lot of downward earnings revisions lately:
The first quarter for Korean earnings revisions was particularly challenging—revisions breadth reached -19%, an ex-global financial crisis record low and at that point the lowest across emerging markets. A significant 4Q2013 earnings miss by Samsung Electronics (SSNGY) on account of a special Won800bn staff bonus and unanticipated heightened competition within the smartphone sector were primarily to blame. By June Korean earnings revisions had recovered somewhat to -11%, but remain the third weakest in emerging markets.
Samsung’s CFO yesterday said its second-quarter earnings will be “not that good.”
Third, declining margins and erosion in value creation continue to challenge Korea:
Korea has undergone a structural decay over the past decade in value creation (spread of return on equity over cost of equity calculated on a 12-month ex ante basis) similar to and yet deeper than that observed across the emerging market equities asset class overall—principally accounted for by declining profitability on falling margins owing to real wage growth outstripping productivity gains within a restrictive labour environment.
Fourth, the tragic boat accident:
Credit Suisse Korea Economist Christiaan Tuntono expects the tragic sinking of the MV Sewol to have a temporary negative impact on consumer spending. According to Governor Lee Ju-yeol, the Bank of Korea needs to closely assess the negative impact of the tragic incident, but he thinks that the effect is likely to last through 2Q.
Fifth, Yen weakness continue to overhang Korean equities.
Sixth, market uncertainties related to Samsung Group‘s restructuring plan, which my colleague Tiernan Ray covered in detail in this blog. Samsung Electronics by itself constitute over 20% of MSCI South Korea. This stock has dropped 3.8% this year and shaves close to 1 percentage point off MSCI South Korea’s gains.