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Seoul questions recovery stamina

South Korea's recovery from the crisis of 2007-08 was impressive in its speed, but the country's Finance Ministry this month acknowledges that the economy still faces "downside risks" because of a possible slowdown in the economies of its principal trading partners. Consumer prices rose 2.6% in July over July 2009, within the government's target range, and industrial output was up 16.9% year-on-year, after a revised 21.7% increase in May, according to the national statistics office.

The country's principal leading index of economic indicators rose 7% in June over June 2009, following a revised 7.9% increase in May. "Despite such a continued fast recovery trend," the finance ministry said in its monthly report, "we need to strengthen our monitoring on external conditions and run our macroeconomic policy to achieve sustainable recovery."

The country's economy has recovered faster than analysts anticipated (see South Korea shows recovery skills, 11 September 2009; South Korea back on track, 10 March 2010), as a result both of improved domestic demand, robust corporate investment, and increased exports — up 29.6% in July from a year earlier, beating consensus expectations. Overall economic growth was up 7.2% year-on-year for the second quarter and 7.6% for the first half, with an anticipated rate of 6% for the whole of 2010, even taking into account a generalized slowdown expected throughout Asia and indeed globally.

The stock market in Seoul has been up thanks to the economic recovery and good corporate earnings. In the past two weeks, the Seoul exchange's benchmark KOSPI stock index has tentatively broken upwards through the upper bound of its year-long 1,524-1,752 trading range, which it had occupied since the third week of July 2009. However, it has weakening short-term technical indicators that caution the possibility of a pullback down close to 1,700. That is where the chart finds the lowest of the three trading-range maxima, and the results of a test at that level would be a significant medium-range indicator.

In particular, it would provide a first answer to the question whether the present advance a "throw-over" of limited technical significance or a real advance of sustained momentum. Also, the 50-day moving average is at 1,706 today and rising. (The 200-day moving average is down at 1,665.) At present the KOSPI is looking a bit overbought on only average volume, signifying an absence of real enthusiasm for the recent gains. Journalistic commentary has attributed this week's gains to the announcement by Yu Woo-ik, South Korea's ambassador to Beijing, that the country would probably begin negotiations with China on a free-trade agreement next year. China is Seoul's largest export market.

There is, however, a possible but unconfirmed medium-term support in the KOSPI around 1,770 that could give a first indication whether any oncoming weakness would even test those lower levels. If that level is respected, then it is possible that an extremely modest general uptrend would continue in the medium-term. In the short-term this would be indistinguishable from remaining within a slightly higher than previous trading range, and it would be a bit weak and subject to volatility that could overrun it to the downside.

Contrary to this cautious outlook is the opinion of Barclays Wealth chief investment officer Aaron Gurwitz, who correctly notes that Korean stocks "are undervalued compared with other markets" (at 9.9 times estimated earnings, the lowest in Asia after Pakistan, according to Bloomberg News) and believes that there is "substantial upside" for South Korean equities if there is no double-dip or period of "prolonged malaise" in the global economy. As noted above, however, this is not a small "if".

The South Korean currency, the won, is likely to continue its strength. "The won is gaining support from any positive data in the major economies," said Royal Bank of Canada's Hong Kong-based currency strategist Brian Jackson, as quoted by Bloomberg News. "Intervention is always a possibility if moves happen too quickly, but we expect the won will generally strengthen in the months ahead."

This view contradicts Credit Agricole's Mitul Kotecha, the banks head global foreign-currency strategist, who warned two weeks ago that the won could fall 4.7% against the US dollar by the end of September precisely because of oncoming export weakness, as the country's current-account surplus largely accounts for its strength. This surplus increased to $5.04 billion in June, the largest since June 2009 and up from a revised $3.82 billion in May.

The Credit Agricole research report also notes that the currency is highly dependent upon world market sentiment, as "investors' views on the Korean exports outlook and funding ability can be gauged by flows of portfolio capital to and from the country’s equity markets". The won's decline of 6.1% against the dollar since the beginning of May testifies to its vulnerability to risk aversion, driven by the European debt crisis.

According to the country's Financial Supervisory Service, foreign investors held 29.9% of total market capitalization among South Korea's listed shares as of the end of July, up 0.4% from June. South Korean brokerages, for their part, look to take measures to increase the nascent market for "wrap accounts" (which are fixed-fee individualized accounts for high-wealth individuals), in order to draw domestic investment capital back into the equities market.

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URL:  http://www.robertcutler.org/blog/2010/08/seoul_questions_recovery_stami.html
First published in Asia Times Online, 6 August 2010.

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