US appears to be winning new Cold War

The author is an analyst for NH Investment & Securities. He can be reached at bk@nhqv.com -- Ed.

In terms of policy effects, the US appears to be winning this new phase of the Cold War. Although Korea has chosen to support the US, it is still impacted by developments in both the US and China due to its diversified exports. Ultimately, for the Korean stock market, the key is export improvement and downward stabilization of the US dollar. Until such is confirmed, the Kospi is highly likely to remain box-ranged. In September, a series of issues—eg, supply-demand factors regarding the US government’s bond issuance, property crisis in China—are expected to peak. In line, we advise loading up on shares after September. 

I. Investment strategy (1): Korea’s exports are key to Kospi rally 

- We expect the Kospi to move between 2,400~2,750p in 2H23. The index is forecast to rise again after temporarily hitting a low point

- For a Kospi rally, the following needs to be confirmed: 1) export improvement; 2) downward stabilization of interest rates and the US dollar; and 3) orderly defaults of Chinese property firms and stabilization of the yuan

- We recommend loading up on stocks related to US momentum

II. Investment strategy (2): Is China in crisis? 

- Crisis scenario for China by phase:  1) defaults of property companies; 2) crisis spreading to the banking system (financial crisis); 3) foreign exchange crisis; 4) volatility expansion for the Chinese yuan; and 5) structural economic slowdown 

- ① Multiple Chinese property companies could default, but if such events prove to be a government-controlled restructuring of the Chinese property market, heightened market volatility should be short-lived 

- ② Financial crisis probability is low in China, given: 1) the government’s strong control over the economy; 2) reduced property exposure at banks; and 3) the sound fundamentals of major Chinese banks 

- ③ A foreign exchange crisis is also unlikely, given that China’s total foreign debt-to-GDP ratio is lower than Korea’s 

- ④ The dollar/yuan rate could rise to exceed its previous highs in the short term, but noting the government’s strong determination to elevate the yuan into a global key currency and measures in place for yuan defense, longer-term yuan depreciation is unlikely

- ⑤ In China, structural economic slowdown is likely. Having expanded on the back of explosive real estate market growth, the Chinese economy will need to de-leverage

III. Quant investment idea: Earnings momentum to differ by country 

- [US corporate earnings] US companies appear already immune to high interest rates. While the FF rate has increased, US companies’ net interest expense has dropped to the lowest level since 2007. Nearly half of S&P500 corporate bonds carry interest rates lower than the current levels and are set to expire after 2030

- US companies’ margins have not shrunk. It is positive that the PPI is declining faster than the CPI

- Earnings momentum should sustain, led by market leaders. Companies’ AI investment is to expand from data centers to the manufacturing arena. US corporate earnings are being driven by US government investment in boosting manufacturing capabilities. Also, no big adjustment is being witnessed recently in earnings estimates for companies with high exposure to the Chinese market

- [Korean corporate earnings] While the bottom was confirmed, there should be a lack of earnings momentum through the 3Q23 earnings season. The Kospi’s profit momentum should weaken on concerns over the semicon (delays in DRAM price growth), auto/parts (peak-out worries), and utility (possible additional hikes in electricity rates around the 2024 legislative election, and higher oil prices) sectors 

- [Quant investment idea] Higher discount rates should lead to stricter standards for corporate earnings and valuations. Interest is required in undervalued turnaround plays rather than lofty valuation plays. We draw attention to the sectors with strong top- and bottom-line growth prospects. Our preferences include the energy, machinery & electrical equipment, DFS, and shipbuilding sectors 

IV. Investment idea: Stocks capable of enduring discount burden

- If interest rates remain high, discount burden will likely limit the growth potential of high valuation stocks. In keeping, we believe that it is crucial to select stocks with both top- and bottom-line growth prospects 

- This year’s market leaders are semicon and rechargeable battery stocks. Among them, we like semicon plays that have rallied less but are expected to enjoy foreign capital inflows upon earnings turnarounds

- Out of healthcare, Internet, and IT stocks – growth stocks that have long been neglected, we prefer those with growth momentum. Such stocks include NAVER (Korean language-based generative AI) and Afreeca TV (Hangzhou Asian Games effects)

- Undervalued turnaround plays should come into the spotlight, including aerospace & DFS (China’s lifting of ban on group tours) and refining (refining margin improvement)