Contribution The season of flooding theme stocks

By Hwang Sei-woon

Competition for the 20th presidential election is heating up. The ruling party already selected its presidential candidate, and the opposition party is on its way to finalize its presidential candidate out of 4 contenders. Once the primary is over, head-to-head competition between the Democratic Party of Korea and the People Power Party for the presidential election will intensify until March 2022.

As the presidential election approaches, there is a place that appears to be as event-full as the political arena. That's the stock market. For up-coming election, it is very likely for the market to build up the longest list of what is called theme stocks. If the gap in the support rates between candidates is not large, more theme stocks will pour out and shake the stock market in even more furious manner.

In addition to this, the market is full of retail investors who are thirsting for high returns. A large number of new-coming retail investors have been active in the stock market since March 2020. These freshmen have a high level of expectation in stock returns as they have witnessed an unusual rate of return which was quite often as high as 100% in 2020.

In contrast, it seems difficult to achieve stock returns that can satisfy the high level of expectations this year. As a result, it will be quite challenging for retail investors to stay away from speculative temptations toward theme stocks. These are the reasons why there can be more theme stocks than ever until the big political event in March 2022.

Academic research showed that most of theme stocks failed to maintain their elevated prices and eventually went back to their price level before the bubble. Theme stocks rarely start with reasonable profit expectations. Although there is thin possibility of earning surge due to policy favors, the stock prices rise for reasons based on seemingly irrational points such as schools, hometowns, and last names related to the presidential candidates.

Evaluated from a long-term investment perspective, these speculative price movements only increase stock price volatility and do not reflect the intrinsic value of companies. They are nothing but price bubbles. However, retail investors who are heavily oriented on short-term trading focus more on whether stock prices are likely to rise tomorrow or within a week than on corporate fundamentals. This approach could end up with large scale investment losses.

Retail investors need to make their decisions based on a long-term perspective and set their target returns at feasible level. Reasonable target rates along with portfolio diversification strategies, which is one of the very basic investment principles, can lead up to successful investment results. It is well-known in baseball that swinging bats hard doesn't necessarily make more home-runs. The odds of a strikeout will only increase. It's worth remembering that sometimes you'll hit a home-run as you're constantly working towards singles and doubles.

The writer is a Senior Research Fellow at Korea Capital Market Institute.