À̹ÌÁö È®´ë Usually this time of the year, Korean analysts are busy writing semi-annual forecast for 2H18. I am also one of those analysts racking my brain to understand the future of Kospi index. But before I build judgment and reasoning for the market, I have to look back where I - or we all - got wrong about 1H18.
Last year when most of the analysts wrote annual forecast for 2018 equity market, 10 out of 10 analysts predicted the bull run to continue throughout 1H18. But what actually happened was 9% decline in index versus its peak on January 19 2018. The reversal came after US Jan wage growth hit highest in 8 and a half years causing US 10yr TB yield to exceed 2.8%. Earlier-than-expected emergence of US inflation concerns snapped the winning streak. Experiencing more than 5% drop in index in just one day, market panicked over concern for the start of bear market. Afterwards, volatility range moved up, having level range up to 50p(historically high point since 2008 financial crisis). There was a rebound after the sudden drop but it wasn¡¯t strong enough to restore the Kospi to the level of 2017. With the market having reacted sensitively to short-term themes (eg, doubts over the global economic recovery, and heightening risk for EMs amidst dollar strengthening), investment visibility shortened.
That said, we still believe that an expansion phase is still underway for the global economy, and that the puzzle pieces that could click together and cause a bubble to burst have yet to be put in place. Moreover, we expect risk-on tendencies to strengthen entering summer, in line with the weakening of the dollar uptrend and stabilizing inflation. As such, we do not believe it is time to turn our back on the stock market. Let me delve deep into my logic by touching each and every doubt that investors cast after experiencing tremendous loss in 1H18
¨ç US economic expansion: overly prolonged?
The US economy has remained in an expansion phase for 106 months (since Jul 2009), marking the second longest expansion phase in its history. The majority of investors did not believe that the US economy would continue expanding for such a long time following the 2008 recession. Apparently, investors harbor anxiety that the much longer-than-expected expansion phase will soon come to an end. However, despite the prolonged economic expansion, real economic indicators have yet to signal an upcoming end to the expansion phase. At the moment, leading indicators (that move roughly six months ahead of the real economy) are climbing, whilst coincident indicators are turning to pick up. In particular, among key coincident indicators, the US¡¯s core durable goods orders and shipments (value terms) are expanding. Also, US corporate earnings are improving at a slow but steady pace. This implies that the current market landscape is yet to fit for bubble burst (previously right before the bubble burst, decoupling between share price and income existed). The financial markets are showing heightened sensitivity to CPI data, which could serve to validate the central bank¡¯s monetary tightening move. We expect US CPI and bond yields to peak in 3Q18, and then stabilize in 4Q18
¨è Are the US and EMs showing decoupling?
Decoupling between the US and EMs was most severe during the 1990s, when the US led a global economic boom. At that time, the US stock market enjoyed the dot.com boom and stable inflation (driven by the import of low-priced Chinese goods), giving rise to a bubble on an unprecedented scale. On the other hand, EMs struggled for a long time in the wake of the 1996~1998 Asian financial crisis (which followed excessive investment in the mid-1990s). As Trump endeavors to beef up the US¡¯s ¡®super-powerdom¡¯, bolstered Trump policies would certainly exacerbate concerns over decoupling between the US and Ems. Historically, dollar appreciation saps EM strength. Dollar recently regained strength by: 1) expectations that the ECB will extend its QE program; 2) concerns over the pace of FF rate hikes; 3) lingering geopolitical risks in the Middle East; and 4) Trump¡¯s trade protectionism. Over 2016~2017 (when EM currencies appreciated vs the dollar), EMs lowered key interest rates to stimulate their economies, even in the face of the US¡¯s rate hikes-a move that would stabilize their forex rates but weigh on their economies. The recent dollar appreciation has been mainly triggered by euro depreciation. As the EUR/US$ rate already reflects anticipation for the ECB¡¯s extended QE program, the actual announcement of QE extension is unlikely weaken the euro further. Accordingly, the current dollar appreciation will likely ease from 3Q18 allowing EMs to cut their base rate
¨é When will positive Trump policy effects resurface?
Trump¡¯s ¡®America First¡¯ policy has served as a double-edged sword for the stock market. While Trump¡¯s trade protectionism has stoked up fears among market participants, the administration¡¯s economic stimulus policies and deregulations have boosted the stock market. The positive Trump policy effects on the US stock market have been weakening, in line with the fading of Trump¡®s February tax cut effects. That said, once expectations for aggressive infrastructure investment revive in 4Q18, it should help bolster the market. Noting that both Democrats and Republicans agree on the need for greater infrastructure investment, Congress is unlikely to rush to pass infrastructure investment plans before the November elections, especially given that the fiscal deficit is estimated to rise 25% y-y in 2018 due to corporate tax cuts. The US Senate majority leader Mitch McConnell aims to unveil an infrastructure investment plan in November
¨ê What major events are in store for the stock market in 2H18?
Multiple MSCI rebalancing events are scheduled for 2H18. MSCI will add 235 Chinese A-shares to the MSCI EM index in a two-step process; MSCI will carry out the first inclusion process for 235 China A-shares at end-May (at 5% of their free float-adjusted market capitalization in the MSCI China Index), and the second step will follow at end-August. Meanwhile, at its annual market reclassification review in June, MSCI is might review the issue of additionally including 181 mid-cap Chinese stocks, and also the issue of adding Saudi Arabia and Argentina to the MSCI EM Index. All of these rebalancing events are likely to reduce Korea¡¯s weight in the MSCI EM Index
In conclusion, based on current economic situation and scheduled events in 2H18, we expect Kospi to attempt to break above its trading range in 4Q18 on softer dollar strengthening and higher expectations for US infrastructure investment. As we got wrong about inflation pressure looming over the market earlier than expected, we believe the rate hike pressure will ease out from 4Q18. Given that the Taylor¡¯s Rule-based prudent rate stands at 4.9%, gradual FF rate hikes are unlikely to weigh on the US economy
Historically, stock markets tend to perform sluggishly in summer, mainly due to tepid industrial activity and weak consumption. That said, the market¡¯s seasonality has weakened somewhat since 2008, due to aggressive global monetary expansion led by DMs. However, with tapering underway in major economies, we predict that stock market seasonality will re-strengthen. Noting this, we expect the market to react sensitively to negative news this summer.
¡¼The contributions from outside analysts are unrelated to the views of the publisher. They have been contributed in English and the wordings have been mildly edited.¡½ À̹ÌÁö È®´ë By NH I&S Strategy Department Analyst Julie Cho
[¨Ï Pulse by Maeil Business Newspaper & mk.co.kr, All rights reserved]