Korea: Recent Tensions Represent a Buying Opportunity

Nov.29.10 | About: iShares MSCI (EWY)

By: Artin Memar

Sensationalism sells. There is no doubt about it. The 21st century media understands this and routinely exploits its ability to over-hype events, with the clear aim of attracting viewership through the creation of stories laden with shock-value. As of late, there has been a pronounced fixation on the increasingly sour relations between such countries as Iran and North Korea and the rest of the world. It can be argued, however, that the media’s incessant and exhaustive coverage of these issues has desensitized the masses to their true importance. It therefore came as somewhat of a shock when, on November 23, North Korea fired more than 200 artillery shells at the South Korean island of Yeonpyeong, killing at least two soldiers in the heaviest attack since the end of the Korean War in 1953.

The attack’s impact on the market was substantial, yet short-lived. A day after the firings, South Korea’s benchmark KOSPI index opened 2.33 percent lower, and the won opened at a two-month low. Typically, stocks in the KOSPI trade at an average 9.6 times estimates for the next year’s profit – the third-lowest valuation in Asia after Pakistan and Vietnam. Hence, it was traditionally low valuations, coupled with the shock of the attack, that presented a valuable opportunity for long-term investors to snatch bargains in a cheap market.

This opportunity was not unfamiliar to investors, as the market reaction to past North Korean animosity has been similar. After the sinking of the South Korean warship Cheonan in late March killed 46 sailors, the KOSPI faltered and has since climbed 13 percent. Similarly, in 2006, after North Korea’s first nuclear test, it took a mere five days for the KOSPI to recover losses. In fact, a prominent trend can be observed that has held true for all of the North’s hostility towards the South: defence and food makers outperform, as a result of foreign institutional investors hunting for bargains. To an extent, it is now widely understood that the market reaction to heightening geopolitical tensions in the area is fairly calm, as the negative market impact typically lasts only five to seven days.

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Staying true to historical trends, the impact of this latest disruption to the market reversed itself within two days of the attack. Losses were rapidly pared by what Seoul officials call the country’s “strong fundamentals, record foreign-exchange reserves, and trust of foreign investors.”

In fact, much of the KOPSI’s rebound can be attributed to the low valuations described earlier, which attracted foreign investors. And so in a span of 48 hours, an attack was endured, investment opportunities were created, the market rebounded, and – at least from an economic perspective – everything returned to its pre-attack state. While the media became flooded with stories of optimism at the speed of the recovery, some investors began to voice their growing concerns about the area’s volatility and the increasing risk of their investments in the country. In other words, many have begun questioning whether the market will continue to react in a similar fashion to future North Korean provocations.

While it is foolish to assert that absolutely every South Korean market disruption will correct itself in the manner demonstrated above, international credit rating agencies share the government’s view that, so long as the impacts are minor, market rebounds can continue to be expected. Moody’s Investors, Fitch Ratings, and Standard and Poor’s Rating Services agree that such attacks will not affect South Korea’s credit rating. For as long as the Republic of Korea-US military alliance remains robust and China maintains an interest in the area’s stability, the escalation of these reckless provocations to a war is unlikely. As such, there is no foreseeable near-term threat to Moody’s rating of South Korea’s foreign and local currency long-term debt of A1, the fifth-highest of 10 investment-grade levels with a “stable” outlook.

As a result of the country’s stable fundamentals, rapid development, and backing from major global powers, there is no reason to believe that the sequence of events described earlier will not hold true for future North Korean attacks on the South. Barring an instance of war, continued hostility is projected to result in further opportunities for foreign investors to get into the South Korean market. And while a solution to the geopolitical issues at the root of the animosity between the two countries may be far off, the short-term economic future of South Korea is likely secure and favourable.

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Disclosure: No positions