Korea has endured the hottest and longest summer in 111 years. The stock market as much as the Korean people have become listless. Concerns are lingering over passive fund outflows owing to the additional inclusion of China A shares in the MSCI EM Index in August; and additional US tariffs on US$200bn worth of Chinese imports; on top of US TB yield hikes from the expected expansion of the US’s fiscal deficit in 2019. The sprawling Turkish crisis is pressing weak sentiment towards overall emerging markets including Korea. Market has turned sensitive to all the negative noises responding with over-selling while being tepid towards any positive news.

We expect August market to be not much different since many issues still persist. We note that oil prices, the Fed’s monetary policy, and trade war issues hold the key to directing future stock market performance. We expect such uncertainty will limit the upper range of Kospi market throughout the third quarter.

Looking at YTD global share performance, the bottom-15 countries are: 1) oil importers; 2) countries with current account deficits; and 3) countries that have been hit hard by global trade conflicts. In addition to being an oil importer, Korea has also been negatively affected by global trade tensions. Given the need to deter new entrants from participating in the global oil market, and the US’s need to prevent its (oil-related) fiscal deficit from expanding further, the WTI is projected to range between US$60.0~75.0/bbl in 2H18, gradually stabilizing over time.

Oil producing countries seek to maintain stable fiscal revenue from the sale of crude oil. To that end, they employ policy measures aimed at bolstering both the upward and downward rigidity of oil prices. The US’s average daily crude oil output for 2018 stands at 10.49mn bbl, a figure that makes the US the second largest oil producer following Russia. A further surge in oil prices from the current level would likely attract new entrants (eg, US shale oil players) into the market, in turn triggering concerns over a potential supply glut. For the sake of a stable global oil market, oil producing countries (eg, the Middle East and Russia) do not want oil prices to soar from the current level

US wants oil prices to stabilize, in order to: 1) reduce trade deficit

President Trump has revealed his negative stance towards the recent surge in oil prices, urging OPEC members to up production. Reportedly, Trump asked Saudi Arabia on Jun 30 to raise its daily oil output by 2.0mn bbl. As an oil importer, the US relies on imported oil for around 30% of its oil consumption. Thus, a spike in oil prices should expand the US’s trade deficit (particularly in relation to oil). For this reason, the US wants to see oil prices stabilize

US wants oil prices to stabilize, in order to: 2) weaken taxpayers’ resistance to gas tax hikes

By utilizing a federal government subsidy of US$200bn as incentives for state and city governments, the Trump administration hopes to make US$1.5tn worth (in total) of infrastructure investment—the US$200bn federal government subsidy is to be allocated to the 2019 federal budget (with the relevant fiscal year to start from Oct 2018). The Trump administration also aims to finance its infrastructure investment by raising gas taxes. Following the mid-term election (slated for Nov 6), a bill on gas tax hikes will likely come under discussion. With a view to reducing taxpayers’ resistance to gas tax hikes, the Trump administration wants oil prices to stabilize

US wants oil prices to stabilize, in order to: 3) prevent higher inflation from negatively impacting consumption

From a long-term perspective, the misery index (ie, unemployment rate + rate of inflation – GDP growth) is to have an inverse correlation with share performance. The misery index has recently turned to rise, due to hikes in both the unemployment rate and inflation rate. Given that the US labor market is now near full employment, and the US’s GDP is unlikely to climb further, inflation should hold the key to the movement of the misery index

Among the sub-categories of US CPI, transportation has exhibited the fastest increase of late. The steep rise in transportation is attributable to: 1) low-base effect (avg monthly rise of 1.2% over May~Jul 2017); and 2) rising oil prices. In contrast, housing and F&B CPIs have remained stable

The US CPI’s strong uptrend continued in June, with the figure upping by 2.9% y-y. Worries continue that the ongoing steep inflation trend will lead to acceleration in the federal funds rate upcycle. However, we expect US inflationary pressure to ease gradually going forward, noting that low-base effect for oil price is expected to peak in 3Q18 and thereafter gradually weaken. Accordingly, market worries towards the pace of the Fed’s monetary tightening should also begin to dissipate from end-3Q18.

The PBOC’s RMB index has been moving in line with our estimated RMB index (calculated by using the same currency basket for the PBOC’s RMB index). This suggests that the recent weakening of the yuan currency has mainly stemmed from fluctuations of currencies belonging to the currency basket, rather than from artificial manipulation. Noting that the US dollar represents the biggest weighting in the RMB index currency basket, we believe that the recent dollar strengthening has had a major impact on the yuan depreciation. Based on the same logic, if the dollar weakens, the yuan will likely strengthen. Noting that the correlation between the dollar/the yuan and the dollar/the won has reached 1.0-level, we expect the strengthening in the yuan to be accompanied by appreciation of the won against the US dollar.

Consequently, US inflationary pressure should weaken into year end. Worries towards a steep oil price rise and the Fed’s accelerating rate upcycle should begin gradually easing from 4Q18. Also, US pressure on China is likely to fade from 4Q18, as US soybean exports to China concentrate in 1Q and 4Q.

The Kospi is trading at valuation levels seen during past economic slumps. We expect the market to undergo mild but extended corrections through 3Q18, hovering around the bottom of its trading range (2,200~ 2,400p). That said, the index is unlikely to fall much further through end-2018/early 2019.

【The 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.】



By NH I&S Strategy Department Analyst Julie Cho

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