Invesco Perpetual’s Asian Equities Fund Manager William Lam on his reasons for cautious optimism towards the Korean market:
- Prospect of peace after inter-Korea summit, with potential for controlled opening up of North Korea’s economy
- International sanctions remain in place, progress likely to be slow with setbacks along the way
- Developments are positive, but do nothing to change the fundamental reasons we remain positive on South Korea
Last week’s inter-Korea summit has given markets a little boost, as Moon Jae-in and Kim Jong-un announced that they plan to sign a peace treaty in 2018 and formally bring about an end to military conflict. This is just a prelude to Donald Trump’s meeting with Kim, with denuclearisation likely to be his ultimate aim, but news reports suggest that Kim promised Moon he would abandon his nuclear programme and close the main test sites this month, inviting Korean and American media to witness the shutdown.
Denuclearisation would undoubtedly give holders of Korean equities a ‘peace dividend’ but the South Korean equity market’s excitement was more focused on Kim Jong-un’s interest in pursuing prosperity and economic development. Share prices of construction, cement, steel and rail companies all rallied strongly towards the end of last week.
The South Korean government has long been prepared for the opening up of North Korea’s economy, and even has a Ministry of Unification. Previous estimates put the cost of rebuilding the North’s economy at around 100% of its GDP. They have closely studied the case of Germany, although reunification remains politically unrealistic given Kim’s determination to hang on to power and likely opposition from China. The gap between the economies of North and South Korea is also far greater than in the case of Germany. However, it makes sense for South Korea – and China – to embark on development projects in North Korea, as a controlled opening up of its economy is a far more realistic aim than reunification.
The least appealing scenario for South Korea is the breakout of war. Regime collapse, either due to mass revolt or unforeseen circumstances such as assassination, would be also hugely destabilising for the region, as would sudden reunification, with millions of refugees likely to stream over the border into China and South Korea. Improving the economic prospects of North Koreans, who have suffered enormously over the years, both in terms of human rights and through numerous famines, would clearly be an improvement on current conditions, and would likely reduce the risks of other less appealing scenarios playing out. However, international sanctions against North Korea remain in place, and progress towards a peace deal and the opening up of the economy is likely to be slow with setbacks along the way.
Most importantly for us, while recent developments are positive, they are incidental, and do nothing to change the fundamental reasons why we remain optimistic in our outlook for South Korea, one of the cheapest markets in our region. The South Korea ‘discount’ is only partly attributable to geopolitical risk, with the country’s poor corporate governance largely accounting for the rest, as reflected in the its low dividend payout ratio. On this front we have seen important positive developments, led by the example of Samsung Electronics’ clear and transparent total shareholder return policy. We also see room for further improvement, with other companies following suit, thanks to pressure from the government, National Pension Service and institutional investors like ourselves. The South Korean government and its companies are also committed to R&D and innovation, with the potential for this to help them sustain strong earnings growth going forward.