– COVID-19 has smacked already weak South Korean stock market hard in recent weeks

– Pandemic panic clouds slow but steady improvements in S. Korean governance

– S. Korean ETFs can give good exposure to a potential virus snapback and more       

The equity world is stopped in its tracks by the surprisingly quick and dangerous spread of the coronavirus, or COVID-19. How worried should investors be? With some early evidence that the spread is potentially cresting in China, the epicenter, I think the market anxiety could be overdone. If so, it should fade as investors focus on fundamentals.

When Virus Fears Ease, Hard Hit Korean Stocks Look Cheap
Source: FS Insight, Bloomberg

One market that has suffered from COVID-19 fears and also has underperformed for a while is South Korea. As the virus fear subsides, I believe it could snap back 20%. Additionally, given its unusually low valuation and a number of other potential catalysts outlined below, there could be more than a snap back longer term.

The headlines are scary. Remember the global pandemic in “Dawn of the Planet of the Apes”? I’m not a Pollyanna and clearly, global gross domestic product growth will be dented in 1Q and maybe 2Q by COVID-19. However, the minute the market gets a whiff of containment, stocks are going to bounce, and perhaps sharply. 

How bad are things? If you are concerned that the outbreak will become a seriously world debilitating disease like the Spanish flu of 1918 (which took place before modern medicine and even the discovery of penicillin), you might as well stop here.  In that case, invest in cash or put your gold under your mattress.  But ask yourself if there is some reason a vaccine can’t be found?

Moreover, a former FDA commissioner, Scott Gottlieb, tweeted about Korea’s efforts: “Very detailed Covid19 reporting from South Korean health officials. They have tested, or awaiting results on, almost 20,000 individuals; demonstrating a significant diagnostic capability. They appear to have a current testing capacity of more than 3,000 cases/day.” Compare this to China’s obfuscation until things got out of hand.

It’s not that I don’t believe bad things can’t happen to good stock markets. The coronavirus spread is a bad, having infected more than 80,000 (vast majority in China) and killed more than 2,700 (again, vast majority in China.), according to CNN. Likely there will be more, unfortunately. It’s hard to step back and try to be rational when all others are losing their heads, but that is exactly what investors should do. 

The evidence still doesn’t point to a global pandemic that will be permanent or even long lasting. Bloomberg recently wrote (Feb. 25.) that China reported 508 new cases but only nine outside of the Hubei province of origin, suggesting containment is beginning to work. Yes, it is worsening elsewhere but it’s important to see that if China can slow the disease, then others will too, perhaps at even a faster rate in developed nations.

I think South Korea stocks were undervalued even before the virus began and now are even more so. It’s geographic (travel restrictions to China) as well economic relationship to China (the latter is biggest buyer of Korean goods) has made it the market’s whipping boy for COVID-19. 

After falling sharply in a matter of weeks, the South Korean stock market trades at a price/earnings ratio of about 10 times, a big discount to its long term 14-15 P/E, and to the SPX’s 18 P/E.  Indeed, the KOSPI index is at 2077, effectively where it was in 2011. That’s right: little change for nearly a decade. Since then the SPX is up almost 140%. In the 11 years previous, South Korea trounced the SPX 77% to a drop of 14%, respectively.

Other negatives include its fraught relationship with North Korea; trading tiffs with China and Japan; the chaebol conglomerate structure of its companies; and slowing GDP growth.  South Korean stocks lagged badly last year when Chinese and Japanese equities rebounded sharply. (Chaebols are huge conglomerates that make up about half the stock market capitalization. They are often controlled by one family and not particularly shareholder friendly.)

But there are good things going on in South Korea masked by these global issues. With valuations so cheap, governance is actually improving. Says Bernie Horn, president of Polaris Capital Management: More forward thinking large Korean government pension funds are pressuring the chaebols and other companies to unwind cross holdings, and improve governance and returns, so pension funds can meet their obligations.  That means higher dividends and payout ratios, and among global markets South Korea is also a relatively low beta market, he adds.  Polaris owns Korean stocks. South Korean companies have a long history of returns and relatively low levels of debt, Horn says.

When Virus Fears Ease, Hard Hit Korean Stocks Look Cheap
Source: FS Insight, Bloomberg

In short, I believe this could be a smart place (in addition to the U.S.) to invest for a snap back rally and a resumption of the bull market. One way to do so is through exchange traded funds and there are several for Korea: iShares MSCI South Korea Capped ETF (EWY); Korea KOSPI 200 ETF (HKOR); and Franklin FTSE South Korea ETF (FLKR); and First Trust South Korea AlphaDEX Fund (FKO).

There are stocks as well that Polaris owns, including the following names:  autoparts maker Hyundai Mobis (012330.KS); Kia Motors (OOO270.KS); Samsung Electronics (005930.KS), and telecom operator LG Uplus (032640.KS). Hyundai Mobis, where 80% of cash flow comes from high margin aftermarkets business, is stepping away from being a follower to a leader in developing new technologies and getting good traction. Kia, which missed the SUV boom in China, is a similar story and building quality cars at lower prices. Anyone who’s driven the Stinger can attest to that.

Samsung is Samsung, a dominate global provider of electronics—screens, TVs, phones, chips, you name it—on par with Apple (AAPL). Not many companies can compete with it, Horn adds. China, a potential competitor to Korean tech, is now less so going forward. LG Uplus is a leader in 5G rollout. The price war that has hurt seems to be abating.

In the end, either you believe the Dawn of the Planet of the Apes scenario or something less dire. I choose the latter.

Where I could be wrong: This isn’t our view, but the coronavirus could become a pandemic big enough to hurt global GDP growth for the long term. In that case, few stocks would likely be spared. 

Bottom Line: The Korean market is a major whipping boy for the coronavirus, but if, as we expect, the outbreak is contained, stocks will snap back.

Prior “Signals”

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