One week / one topic: K-pop

What happened?

Since the June 3rd presidential elections, South Korean equities are up ~19% vs ~6% for global stocks.

Mind you, the background – and sentiment – with regards to South Korea and its equities had been quite negative for a long time, given structural challenges in the form of two belligerent neighbors, demographics despair and a recent attempt to impose martial law.

Top it all off with very high index concentration in a stock marred by long-term underperformance (Samsung Electronics), and it should be no surprise that South Korean equities had been trading at a discount for quite some time.

What’s even more interesting to me, is that these developments can be interpreted as:

1. A clear demonstration of how markets fail to instantaneously price all the available information, and

2. How much investors remain focused on short-term developments, as opposed to more structural considerations.

As to the first point, immediately after the election market commentators were already pointing out the following:

• The election of President Lee Jae Myung (seen as acting more “more like Bill Clinton than Bernie Sanders”) removed martial-law overhang and was expected to meaningfully reduce any political risk premium

• His pro-growth agenda – including a 1.5 %-of-GDP fiscal boost, plus a clear pro-industry stance (semis, biotech, defence, shipbuilding) – was welcome news to investors

• MSCI was seen as likely to place South Korea on its Developed Markets (DM)-upgrade watchlist, which would potentially bring an additional US$20-30 bn inflows in the first 12 months

• Valuations remained very cheap at ~1.0× P/B for a near-record 10-yr discount to global equities, with foreign ownership also at a decade-low.

With the benefit of hindsight, the trade was obvious (it never is in real time…!) – but what’s even more revealing to me is that the outperformance continued for several weeks.

Paul Samuelson’s dictum comes to mind – “Markets are micro efficient but macro inefficient” – as well tons of academic research about momentum everywhere. Food for thought!

As to the second point, short-termism remains the name of the game… with now even meme stocks making a comeback.

How can we apply these lessons when managing portfolios then?

Our observations

• Fundamentals: Many investors are experiencing strong cognitive dissonance: fundamentals say one thing, while price action say something completely different. Which game do you want to play?

• Price action: A couple well-followed X (Twitter) or Reddit accounts can conjure (or destroy) billions of dollars in market cap in the space of a few hours… This leads to a lot of frustration, yes – but also opportunities.

• Investor beliefs: Similarly to how social media and smartphones can lead to mass delusions, today more than ever investors can construct their own reality. Problem is, at some point the P&L should reassert itself.

So what?

While the commander-in-chief is busy arguing with Fed Chairman Powell in front of the cameras, The Apprentice-style, we seem to have fewer and fewer things we can count on.

If that is indeed the case, relying on price as the ultimate composite indicator seems therefore appropriate.

Looking then at the largest and most important moving part of the macro picture, what’s going on in terms of US rates expectations stands out.

In short – as per my colleague Robert Burrows’ recent, excellent blog post – “if the Fed is no longer fighting inflation, but instead grappling with the math of Treasury auctions, then it’s not just rates that need re-pricing, it’s the entire framework we’ve relied on to understand monetary policy for the last 40 years.”

In other words, expected interest rates – i.e. the price of money – could well be pointing towards an ongoing structural shift, likely to land us in very different territory vs what we have known for a long time. (Are we already there?)

If that is indeed the case, it seems to me that assigning slightly less weight than usual to structural concerns might be opportune in the current environment – albeit uncomfortable.

Which brings us back then to the cautionary tale of South Korean equities: yes, the future might look grim – but do you really want to stand in the way of these powerful short-term rallies?

Forewarned is forearmed, once again.

Mood music: HUNTR/X – Golden