Peter S. Kim is a managing director at KB Securities.
Iran and the Korean stock market
Peter S. Kim
By Peter S. Kim
Since the COVID-19 pandemic, we have seen many forms of geopolitical risks rise, only for the stock market to shake them off and go for another rally. The Russia-Ukraine war and the Israel-Hamas conflict were all met with shrugs, likely spurring the U.S. Donald Trump administration to initiate a seemingly reckless and ill-informed attack on Iran. The Iran war comes at a time when the market was already bracing for a challenging year, with tariff tensions and growing concerns of an asset bubble.
Korean retail investors have been on a multiyear love affair with U.S. stocks, centered on the “Magnificent Seven,” of which they collectively own more than $150 billion in shares. However, the S&P index has underperformed Asian equities for more than 12 months, and signs of fatigue across equities are shaking the foundation of many investors' bullish thesis. Nearly two years ago, I called for global equities to see one of the most powerful asset bubbles on record. My positive thesis was based on a potent combination of an eagerly dovish monetary policy, unwavering fiscal spending and financial market deregulation. To cap it all off, artificial intelligence (AI) infrastructure spending has created a perfect alignment for the stock market. But over the past few months, all four catalysts have lost their luster.
Bullish equity investors over the past couple of years have leaned into the rationale that growing geopolitical risks will not escalate into a global crisis and, more importantly, that any instability will be met with an immediate response from central banks. When Trump’s tariff war did not lead to visible inflation as most had predicted, that seemed to be the fatal injection of ego that fed the Trump administration’s sense of invincibility.
The attacks on Iran, however, have shaken the bullish foundation of the financial markets, with Trump facing the first real challenge to his strongman policies in the form of global inflation, fundamentally damaging the “Fed put,” or the proactive prevention of major stock market declines by the Fed. Even the deregulation theme is losing its shine, as evidenced by the recent collapse in cryptocurrency prices. Finally, the surging gold price exemplifies growing concerns about the U.S.' global credibility and the status of the dollar as the unchallenged reserve currency.
I must make a couple of points regarding the Iran crisis and its impact on financial markets. First, despite what the Trump administration claims, Iran has the upper hand due to the disproportionate cost of a protracted war to the United States. Iran’s first and only strategy is to prolong the conflict and make this war as costly as possible for the U.S., both financially and politically. The longer the conflict goes on, the weaker the U.S. position becomes on both fronts. If Trump thought Iran was even remotely comparable to Venezuela, it would be one of the most miscalculated military decisions on record. As much as the Trump administration boasts of the size and power of the U.S. military, the proportional economic and political cost favors Iran as the U.S. midterm election cycle begins.
Despite recent declines, the Korean equity market maintains its outperformance compared to the rest of Asia despite consistent selling by international investors, who have shed more than 50 trillion won ($32.6 billion) already this year. The relative resilience is due to Korean retail investors shifting their focus from the U.S. to the Korean stock market behind President Lee Jae Myung's remarkably effective KOSPI 5,000 campaign. The Iran crisis coincides with KOSPI decoupling from the U.S. amid domestic retail fervor that comes around only once a decade. I have outlined the power of Korean “animal spirits,” which, once in motion, can defy all fundamental reasoning.
The bullish thesis on AI and the semiconductor industry has been the fundamental driver of the Korean stock market's year-to-date performance. The Iran war could undermine that thesis via inflation. Korean will soon welcome a new governor of the Bank of Korea next month. The new governor will immediately face concerns over weakening currency, a rising domestic property market and export uncertainty. Now, with the Iran crisis on course for an extended campaign, the central bank's previously dovish stance could be forced into the opposite direction with each week that oil prices remain elevated.
The global equity market has shown optimism by betting on a swift backtrack by the Trump administration on Iran, but long-term consequences will linger even if we see an agreement for a ceasefire. Korean equities are on relatively stronger footing, driven by strong retail sentiment and the semiconductor sector’s relatively low correlation with energy prices. However, I caution investors on the macro-sensitive sectors of KOSPI, which are vulnerable to energy prices and fading earnings momentum.
Peter S. Kim is managing director and global strategist at KB Financial Group. The views expressed here are his own.