Lazy investors cannot win forever

Rebalancing of KOSPI portfolio needed

A “lazy portfolio” is a strategy often cited when recommending investment in exchange-traded funds (ETF). For part-time investors (most individual, retail investors), it is hard to track the news flow or price movements in the market on a daily basis. So they can invest in ETFs for an extended period without too much cost and time commitment. In a broad sense, the idea behind a lazy portfolio is to “build it and forget it.”

Somewhat different, the same was true for Korea’s stock market recently. The KOSPI has gained 14.4 percent from its lowest point since the devastating earthquake and tsunami hit Japan in March. Despite the turmoil, investors who believe in the power of the market and liquidity enjoyed healthy returns. Leading stocks also remained unchanged throughout the rally, until early last week.

By sector, automobiles, chemicals and energy (solar and oil refining) constantly led the rally amid perceptions that they are unintended beneficiaries of the operation disruptions in Japan as a result of the disaster. Those who were “lazy” and stuck to their holdings made money whereas those who were diligent enough to frequently rebalance their portfolios went unrewarded.

Then, how long will the trend last? The U.S. dollar index, which measures the greenback’s value against a basket of six major currencies, fell to a fresh 52-week low after the U.S. Federal Reserve’s Open Market Committee (FOMC) meeting last April. Amid the weakening of the dollar, Asian currencies gained further strength and the VIX, a popular measure of the implied volatility of S&P500 index options, slid to a record low since July 2007. In these circumstances, it seems more likely the current best performers will continue to spearhead the rally and Korea’s stock market will tramp the brisk march northward, rather than sector-rotational trading prevailing.

But recently, noteworthy changes in the market drew my attention. First, the KOSPI’s trailing PE — the ratio of its stocks’ price to earnings of the past 12 months, as opposed to forward-based PE — is near its previous peak in November 2007. In a market with strong upward momentum like what is happening now, it is particularly hard to predict the ceiling of this liquidity-driven rally.

Valuation is less reliable than usual as earnings estimates are steadily adjusted upward. Despite the KOSPI’s record-setting ceiling rising past 2,200 points, the 12-month-forward PE stood at a mere 10.3x, just on par with the past average. I do not wish to stir any doubt about analysts’ earnings estimates but a devil’s advocate perspective can be handy.

This is where the trailing PE can step in. The KOSPI’s 12-month trailing PE and PB (price to book value of assets) are 16.7x and 1.66x, respectively, as of May 2 (DataStream) compared to 17.2x and 1.82x at its peak in November 2007. If we assume that the index can go as high as the previous peak, the multiples suggest that it has a potential to gain at least 2 percent (rise to 2,250) or as much as 10 percent (rise to 2,400) from the current level.

If the current upward momentum remains intact, it is possible that the KOSPI can reach the full-year targets within May. But the comparison of trailing multiples shows the KOSPI’s valuation is certainly entering an uncomfortable phase in the short-term. For investors, a steady rise throughout the year is a better picture than a single, short-term leap.

Second, the Nikkei 225 breached 10,000 points on May 2, a jump to the pre-disaster level. Market participants appear to think Corporate Japan is getting back on its feet although experts predict Toyota Motor won’t fully return to normal operations until November at the earliest. If such is the case, Korea’s beneficiary sectors such as automobiles, oil refining and chemicals may face headwinds down the road.

A lazy investor has so far prevailed. But this may no longer be the case, at least in the short-term.

Park So-yeon can be reached at sypark@truefriend.com