Mini liquidity rally
There is more room for an equity rise but be cautious about occasional pullbacks
By Kim Jae-kyoung
Is it just liquidity or fundamental change?
After a turbulent year in 2011, Korea’s stock market appears to be back on track for a rebound powered by a foreign investors’ buying spree. The benchmark index KOSPI closed at a yearly high of 2,025.32 Wednesday, up 10.9 percent or 199.58 points from last year’s close of 1,825.74.
What’s happening in the market has confused participants as most analysts and experts expected late last year that the domestic market would undergo a downward trend in the first half, citing worsening economic data and lingering debt woes in Europe.
Let’s rewind to December. At the end of last year, pessimism prevailed. The volatile won, rising inflation, a worsening current account balance and sovereign debt concerns in Europe made a perfect recipe for pessimism.
Fast forward to February. Now we have seen the equity market continue gaining ground, on the back of a massive inflow of foreign capital. Many believe that it was a short-term rally driven by ample liquidity but some have started thinking that it is the beginning of a cyclical upward move.
Market analysts, as well as individual investors, are not quite sure whether it’s still a bear market or a bull market. Now it’s time to ask big questions ― 1) Is it just liquidity or have fundamentals changed? and 2) Will this liquidity-driven rally continue, ushering us into a bull market?
“I think what is driving this rally is available liquidity and monetary expansion around the world. Also, the U.S. economy has been doing better,” Mauro F. Guillen, director at the Lauder Institute of Wharton School, told Business Focus.
“It is possible to see a bull market, but many uncertainties remain ― the euro and China’s growth. And the global economy (that is) still under financial stress,” he added.
Liquidity or fundamentals?
Market experts and analysts are split over what is driving the current market rally but most think that the recent gains have been supported by both liquidity and improvements in fundamentals.
In fact, central banks’ stimulation policies both in the U.S. and Europe are showing signs of making ways through real economies, which is increasing investors’ risk appetite and driving high-return seeking investors into emerging economies, including Korea.
Since the end of 2011, central banks have been easing liquidity access conditions. In December, the ECB lowered interest rates, while the U.S. Fed in January vowed to extend its commitment to keep near zero interest rates up to 2014. In February, the Bank of England expanded its quantitative easing (QE) program. A shift toward monetary easing is also the trend in many emerging countries and regions including China, Brazil and South East Asia.
“It was both liquidity and fundamentals. Central bank stimulating policies helped ease some global fears, very present in the third quarter of 2011,” said Edgardo Torija-Zane, a Natixis economist who oversees emerging Asia.
“Fundamentals are also improving. We think recessionary fears in Korea after the disappointing fourth quarter GDP numbers ― slowing manufacturing production and dropping consumer sentiment ― will progressively dissipate,” he added.
The economist at the French bank points out that Korea is also in the fortunate position that it exports to both the U.S. and China, two economies with reasonably strong GDP growth prospects in 2012.
The eurozone remains weak, but the leading economic indicators in the U.S., Japan and some emerging countries such as India are pointing to a global recovery. Many believe that the U.S. is undergoing a quite broad cyclical recovery.
Park Jin-hwan, head of the Wealth Management Consulting Division at Korea Investment & Securities, said that economic fundamentals have started being supportive of financial markets.
“A liquidity-driven rally has been leading to improvements in earnings. U.S. economic data are turning for the better, which many think is due to the effect of QE 2. If economic fundamentals strengthen, it will help sustain the current rally and result in a virtuous cycle between the market and the real economy,” he said.
Foreigners driving rallies
Whether this rally is being led by liquidity or fundamental changes, one thing obvious is that foreign investors are behind the rapid ascent. Just as they caused the local equity market to lose ground in 2011, they are playing a key role in driving up the value of local stocks.
“Some of the KOSPI’s 12 percent loss in 2011 was due to a flight from risk associated with events in the U.S. and Europe. Better U.S. data and positive developments in the eurozone, especially the liquidity provision by the ECB, have removed some of the fear factor and investors have responded accordingly,” ING Group senior economist Tim Condon said.
According to the Korea Exchange, as of Wednesday foreign investors have net-bought a total of 9.18 trillion won worth of local stocks since the beginning of 2012 ― 6.31 trillion won in January and 2.88 trillion won in February.
“The fundamentals were indicating 2,500 for KOSPI at least six months ago, but Europe's challenges sucked a lot of money back home, pulling down our market and creating a good buying opportunity for the brave and patient,” Market Force Company CEO James Rooney said.
“Now we are seeing some of that cash return to where it should have been all along.”
Will market rally continue?
Nobody really knows for certain where markets are heading, but things are in favour of optimism. With central banks continuing to push for growth, it is reasonable to expect further capital inflows and a further liquidity-driven rally.
In 2012, inflation will no longer be a key issue here as the headline inflation receded sharply to 3.4 percent in January year-on-year, falling below the central bank’s target range ― 2 to 4 percent, which is supporting monetary easing action.
Unless unexpected events take place in the course of recovery, the domestic stock market is highly likely to continue on an upward spiral, benefiting from lower interest rates and better prospects for the world economy.
“Liquidity rallies are now supported by economic fundamentals, with leading indicators showing improvements. Credit easing policies in the U.S. and China are easing investors’ concerns,” Kim In-eung, a senior private banker at Woori Bank, said.
“I think 2,050 will be the watershed as there are a large number of investors waiting to dispose of shares at that point. However, if markets break through that mark and sustain its upward momentum, I expect the KOSPI to rise up to 2,200,” he added.
Still, there are lingering risks that dampen this optimistic view. The mood on European growth has improved in recent weeks, but fiscal consolidation programs in several eurozone economies risk hurting economic growth in 2012.
Most worrying, perhaps, uncertainty concerning the solvency of countries such as Greece or Portugal could reignite liquidity issues, with the ECB showing little interest in intervening in any permanent or extensive manner. Fears over a “hard landing” in China also remain as a stumbling block.
Rooney, who serves as vice chairman of Seoul Financial Forum, said, “We still have upside to go from the 2,000 level of today. But around 2,250 to 2,500, you should expect it to get very choppy again. Big news positive or negative from overseas would again change that prognosis, but real good news is unlikely and there is still plenty of room for bad news, so there is plenty of room for a downside.”
Most experts suggest that individual investors diversify their assets to guard against a possible market crash caused by unexpected external shocks. However, when asked to pick one among stocks, bonds, deposits and real estate, they didn’t hesitate to choose the KOSPI.
“At this moment, financial assets, particularly stocks, are much more attractive than real estate. I think that the KOSPI will continue to walk sideways around 2,000 before rising up to 2,100 to 2,200,” Park of Korea Investment & Securities said.
“However, it would not be wise to make a lump-sum investment in individual stocks. It would be better to diversify your investment in different stocks or invest in mutual funds in monthly installments,” he added.
Edgardo echoed the view, saying, “The stock market will continue to show a liquidity-driven rally by foreign capital and look appropriate for risk-appetite investors. Many reasons will attract investors to the market. Korean companies look quite strong, with profits increasing; returns on equity are currently quite high.”
However, analysts warn that it is risky to be too bullish on local stocks. “We don’t see a significant under-pricing in the KOSPI. The price-earnings ratios ― taking expected profits ― are only a little bit above the average,” Edgardo said.
Guillen said, “Probably stock is the best choice. But no option, adjusted for risk, is ideal. That’s why it’s better to pay down debt, to deleverage.”