What's wrong with the Korean stock market?

Peter S. Kim

As we approach the final days of 2024, the Korean stock market is about to end the year as one of the worst-performing markets in the world. Since the beginning of the year, much of the attention on Korean equities has been on the Corporate Value-up Program (CVP) and related market reform measures. The CVP is modeled after Japan's version, which helped the Nikkei 225 become one of the best-performing markets in the world.

However, Korea's two main bourses, KOSPI and Kosdaq, lag far behind the Japanese index and the rest of its Asian peers. KOSPI's decline is exacerbated by Korean retail selling, which intensified after the U.S. elections, and is visibly spooked by President-elect Donald Trump's threats to countries with a large trade surplus with the United States. Korea is one of the top countries with the highest trade deficits, making a tariff war a risk to monitor going into 2025.

Korean retail investors have been net sellers of KOSPI for the past couple of years after their wave of buying during the COVID-19 pandemic. One of the reasons for slumping local investor sentiment is the rate hikes by the central bank, the Bank of Korea (BOK). The BOK was one of the first central banks in the world to raise rates, not because Korea felt the inflation bite but because of the political sensitivity to rising property prices. Despite the dovish turn by the Federal Open Market Committee, the BOK lags in rate cuts due to these continuing concerns about property prices.

One of the follies of Korea's property market policy is that despite the country heading into a demographic abyss, central bank hawkishness remains. Korea's national property market policy and related central bank policy are formulated around the Gangnam area, a relatively small part of the nation. Understandably, national average property prices are showing signs of long-term decline in line with the shrinking population, making current monetary policy unnecessarily cautious in the eyes of many.

As for the overall domestic economy, it is barely treading water. Korea's current situation has some parallels to Japan's famous policy mistake during the 1980s when its central bank, the Bank of Japan, prematurely tightened its monetary policy for political reasons related to rising property prices. Even today, many believe that policy is one of the causes of Japan's "lost decades." Similarly, the political sensitivity over Gangnam apartments is raising the risk of policy being too hawkish for an economy struggling with slowing growth, a demographic cliff and weakening exports structurally and cyclically.

Another reason for the weak Korean market is the export side, which was already showing signs of a cyclical peak for Korea's key industries like semiconductors and automobiles. The upcoming cyclical phase of Korea's export industries is unique for many reasons. First, as we enter a deglobalized era, the divergence of export demand from export destination regions needs to be evaluated individually. In the past, global export demand moved in sync with the main areas of the U.S., European Union (EU) and China. This time, the U.S. remains reasonably solid, while the EU and China show signs of structural stagnation. The decoupling of the U.S. versus the rest of the world leads many analysts to talk of an impending downturn for Korean exporters led by semiconductors and autos. There are even fears of structural issues at Samsung Electronics due to Nvidia's decision to delay Samsung's artificial intelligence (AI) chip qualification. With SEC and SK Hynix taking up 23 percent of KOSPI, foreign selling on SEC alone has turned foreign investors into net sellers for the first time in several years.

Finally, Korean retail investors have been selling domestic stocks in favor of U.S. stocks since the pandemic. For decades, Korean retail investors have been famous for their obsession with growth themes and momentum trading. Famously called "stock immigration," the slowing economy at home and the increasing lack of growth themes in Korea are leading to a growing love affair with U.S. stocks. The U.S. stock market offers streams of globally famous brands and super-growth themes like AI (Nvidia) and electric vehicles (Tesla). Backed by the U.S. economy and facilitated by increasingly easy trading apps, retail investor flow into overseas funds, exchange-traded funds and single stocks have amounted to over $140 billion in just a few years, with $100 billion into U.S. equities alone. Their top holdings are Tesla ($17 billion), Nvidia ($14 billion), Apple ($4.6 billion) and Microsoft ($3.6 billion). It was recently revealed that Korean retail investors have also moved into cryptocurrencies, with purchases topping over $65 billion. If those funds were to flow into KOSPI, we would have a full-blown bull market at home.

The CVP was designed by the Korean government as one of the measures to reverse capital outflows. With less than 0.8 children per family, Korean households cannot rely on residential property for wealth creation. Domestic property has been Korea's most important driver of wealth for many decades. However, in the coming decades, the need for financial assets to replace residential property is one of the critical missions for the aging population and the Korean equities market.

Unlike the traditional Korean "hot money" that roamed the world for hot themes, like cryptocurrencies, Tesla and now Nvidia, the shift from residential property will involve long-term investors whose risk profile is very different. Risk-adjusted returns will increasingly matter for those individuals, which is why the CVP and dividends are important in educating the importance of stable returns for a population obsessed with trading for short-term gratification. Just like Japan's "Mrs. Watanabe" phenomenon, "Mrs. Kim" is likely to become a key investor whose investment preference could determine the path of the Korean equities market.

Peter S. Kim is managing director at KB Securities. The views expressed in this article is his own.