A positive macro picture for a land one is looking at investing in is a real prerequisite, and the purpose of this report is to assess if South Korea has a positive macro environment within which to invest.
One can summarize the national accounts in the following formulae:
Private Sector [P] = Government Sector [G] + External Sector [X]
GDP = Private Sector [P] + Government Sector [G] + External Sector [X]
These are accounting entities and are true by definition.
See the methodology section below for more detail on this formula.
The private sector is where the stock market is and we as investors want the stock market to go up. The stock market can only go up if the flows into it are positive. The private sector derives income from three sources:
Credit creation from banks - Banks lend more than is repaid in loans.
Externally from overseas commerce - Exports bring in more than imports cost.
Government spending - More is spent than taxed.
In an ideal scenario, the private sector would receive large, and growing income flows from all three sources, and at the very least, the overall impact should be a positive flow even if one or two of the three flows are negative.
The stock market in the private sector, as well as all other private financial assets, should rise if the overall income flow into the private sector is positive. Certainly, the stock market would be unlikely to rise if the income flows were negative. Even in a shrinking economy, some sectors can grow while the rest of the pie shrinks such as defensive sectors like consumer staples and utilities.
We will look at each inflow in turn and start with the private sector all the while updating our forecast result based on the latest data.
The chart below shows the level of private credit creation entering the private sector through commercial banks.
The picture overall is positive with loan generation exceeding debt retirement. 2017 is tracking to be the same as 2017 if not a little better adding some 1% to GDP.
The external sector captures trade and commerce with other countries and is best captured by the current account. The current account is exports minus imports, and it also captures capital flows in and out of the country from financial transactions and investments. A positive overall result is best.
This is the new data we have and can add into our sector flow model.
The chart below shows the current account balance. South Korea has a strong current account balance that adds 7% to GDP alone. 2017 so far looks to be weaker than for 2017.
This month the current account improved a little over last month but not over the same time last year and in general the current account is tracking to be less this year than last and the mode has been adjusted accordingly to calculate overall fiscal flows.
The government budget is shown in the chart below:
The government drained the private sector in 2016 by 0.8% of GDP and looks to be on target to do the same if not more in 2017.
In Korea, there is 3.6% general unemployment and 9.2% youth unemployment and an impressive capacity utilization rate of 113%. Before a government takes a surplus budget, it needs to ensure than idle resources such as the high level of unemployed youth that the private sector has no use for is put to work first.
Sectoral Analysis Methodology
British economist Wynne Godley developed this framework for the macroeconomic analysis of national economies.
Each nation state is comprised of three essential components:
The private sector
The government sector
The external sector
The private sector includes the people, business, and community, and most importantly for investors, the stock market. For the stock market to move upwards, this sector needs to be growing. This sector by itself is an engine for growth and innovation; however, it needs income from one or both of the other two sectors to grow.
The government through its Treasury also sets the prevailing interest rate and provides the medium of exchange. Too much is inflationary and too little is deflationary. It puts the oil in the economic engine and can put in as much as its target inflation rate allows. It is not financially constrained. For a sovereign government with a freely floating exchange rate, any financial constraint such as a matching bond issue is a self-imposed restriction. A debt ceiling is also a self-imposed restriction as is a fiscal brake.
The external sector is trade and commerce with other countries. This sector can provide income from a positive trade balance, or it can drain funds with a negative trade balance.
For the stock market in the private sector to prosper and keep moving upwards, income is required to flow in. Otherwise, the sector can only circulate existing funds or is losing funds and in decline.
The ideal situation is that the private sector has a net inflow of funds and is always growing, thus giving the stock market headroom within which to expand in value. For this to happen, one or both of the other sectors have to be adding funds to the circular flow of income.
Private Sector = Government Sector + External Sector
GDP = Private Sector + Government Sector + External Sector
These are accounting entities and correct by definition.
For the best investing outcome, one looks for countries with stock markets located in private sectors that are receiving positive income flows overall. Top marks come where private credit creation, the government sector, and external sector are all in plus and trending upwards.
Conclusion, Summary, And Recommendation
When we take our inputs and place them in our formula, we can calculate the following sectoral flow result based as a percentage of GDP.
Private Sector Credit Creation
(Source: Trading Economics and Author calculations based on same)
The South Korea macro fiscal flows are moderately strong at 6%. There is scope for financial assets such as stocks, bonds, and real estate to rise given that the private sector is receiving such an inflow of funds. On the downside, the flows are decelerating due to a weaker current account balance and a government taxing more than it is spending even though there is significant youth unemployment.
An investor wishing to have exposure to the Korean stock exchange and currency can do so via the following ETFs:
iShares MSCI South Korea Capped ETF
Deutsche X-trackers MSCI South Korea Hedged Equity ETF
AdvisorShares KIM Korea Equity ETF
Direxion Daily South Korea Bull 3X Shares ETF
First Trust South Korea AlphaDEX Fund
iShares Currency Hedged MSCI South Korea ETF
I first looked at South Korea in this article in April 2017 and recommended it as a buy due to the strong fiscal flows. If one had invested in South Korea following the article, one would have seen 13% capital growth return, and a tiny 0.95% dividend as the chart below shows. The Korean stock index has risen steadily since bottoming out in 2009, and one would have been well compensated over the period regarding income and growth.
The recent tension between North and South Korea gives an opportunity for the market to whipsaw due to market sentiment responding to the news of ever more and bigger nuclear weapon tests and missile launches.
The underlying market is strong and the market direction is upwards and dips caused by sentiment should be bought.
(Source: Seeking Alpha
The fiscal flows are now moderate, though, in decline. One can expect a weaker stock market performance going forward due to a weaker current account and the government spending less than it is taxing out. There is simply less wealth being generated to keep all asset prices moving up at the same velocity as before.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.