End of COVID-19 bull market

By Peter S. Kim

More than 20 years ago, legendary investor Warren Buffet warned about investment bubbles by declaring, "Only when the tide goes out do you discover who's been swimming naked." Buffett's famous words seem pertinent with the fears of inflation shaking financial markets after two years of irreverent increases in asset prices.

The bull market that began from the pandemic outbreak's panic is now taking back much of the gains as stimulus responses are being undone to control roaring inflation. Adding to the investor nervousness are the rising geopolitical risks of the Russia-Ukraine war and U.S.-China tensions. Some brave investors may be tempted to buy into the market correction, but signs are that the risk factors are likely to get worse before getting better.

Over two years ago, retail investors led the spectacular COVID-19 bull market, encouraged by super-stimulus comprising quantitative easing, interest rate cuts and government spending. Now with COVID-19 restrictions easing and the world finding its way toward a new daily life, some stimulus policies are beginning to revert. Like a recovering patient coming out of a coma and undergoing a painful rehabilitation, the global economy is looking to figure out how to live without the same government aid.

The asset prices, including stock prices, pumped up by the extraordinary stimulus, will also have to find prices proportionate to the everyday world. Even with the recent market declines, symptoms of asset bubbles remain compared to the pre-COVID-19 era. Korean investors' most beloved stock, Tesla, has risen 450 percent over the past two years. The king of cryptocurrencies, Bitcoin, rose 415 percent during the same period. Korea's main bourse, the KOSPI, is 21 percent above the index level seen in 2019.

Since the subprime crisis and the subsequent ultra-easy monetary policies, investors and economists have heatedly debated the unintended consequences of quantitative easing (QE) and the zero interest rate policy (ZIRP). One of the key objectives of QE is to promote investors' appetite for risk, luring them to invest in higher-yielding investments. One beneficiary of that mission was the passive funds that got crazily popular with the bull market.

With the U.S. Federal Open Market Committee (FOMC) tightening in the coming months, the irreverent popularity of passive investing should be scrutinized. One of the most popular Exchange Traded Funds (ETFs) globally is ARK Innovation, created by Cathie Wood, who was most recently dubbed by some as today's Warren Buffet. To provide perspective on how much an asset can fall, ARK Innovation ETF has dropped 60 percent from its peak over the past 12 months.

This bull market is also known for being the "people's bull market" as retail investors have led the way rather than institutional investors, who used to be known as the "smart money." Retail investors' penchant for day trading via powerful mobile trading apps has tainted investing with a mixture of the cultures of gaming and gambling.

The U.S. central bank, the Federal Reserve, as the world's central bank leader, has forecast seven interest rate hikes this year. But with only a single rate hike so far, the road ahead could be long and winding for investors. With few generations of investors having experienced an inflationary environment, it would be fascinating to see how they respond to the prolonged period of price declines.

However, it would be rash to recommend that investors seek refuge in the safety of bank deposits. South Korea, in particular, is at the beginning of a low-growth era, which means the interest rate hike will be limited for a meaningful interest income for savers. Second, with the demographic cliff hitting South Korea, residential property is at the early stage of a long-term decline. Both factors will force Korean investors to continue to seek ways to earn investment returns, buoying financial asset prices over the long term.

With the U.S. Fed guiding an aggressive rate hike path approaching "normal" interest rate levels, we can envision the disciplinary role of higher interest rates to be an essential consideration once again. Since the pandemic's outbreak, the global equities market has seen a liquidity rally based on free money, where investors rewarded companies with aggressive growth business strategies and slim profits with dizzying valuations.

The ARK Innovation ETF is a fund glorifying such companies. On the other hand, companies with a strong balance sheet and prudent business plans, and mature, experienced management have been ignored by investors during the past two years. It is time for investors to construct portfolios with a good balance of innovative stocks with "boring" stocks.

For Korean investors, the retail investor fund flow wave has taken the market outside fundamental parameters, taking many stocks and sectors to huge premium valuations. Like ARK ETFs, Korea's growth sectors are represented by the basket of "BBIG" companies that include companies from the batteries, biotech, internet and gaming sectors.

Korean retail investors have enjoyed massive gains in the stocks from BBIG sectors over the past several years. With the market bracing for the volatility from liquidity tightening and exogenous shocks from a world increasingly divided, it is time for investors to revisit the long-forgotten discipline of value investing. For the first time in many years, boring investing could be the key to surviving the return to the normal world.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.