Go north in Asia: Korea & Taiwan

  • Written by 

    By Eddy Loh

  • 25/03/2014
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The export-oriented economies of South Korea and Taiwan are well positioned to benefit from the recovery in global growth, which would also lend support to their domestic consumption. We expect to see healthy returns for their respective equity markets, which are still trading at reasonable valuations. With the emerging world still under a cloud, these remain two of its more attractive equity markets.

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In 2013, North Asian equities outperformed their South Asian counterparts for the first time in five years (see Figure 1). The export-oriented markets of South Korea and Taiwan, in particular, are likely to gain more (than their regional peers) from the global growth recovery. Both countries are also more insulated from headwinds caused by the US Federal Reserve (Fed)’s tapering, given their relatively healthier current account surpluses (see Figure 2).

Riding the macro recovery in Korea

We expect South Korea to make a firm recovery in 2014, driven by resurgent global economic growth, stronger investment, recovering consumer confidence and a stabilising property market. The Korean economy is projected to grow 4.1% in 2014 (versus 2.8% in 2013) amid an improving global macro-environment and a turnaround in domestic consumption (see Figure 3).

Potential upside from domestic politics and retail investor flow in Taiwan

The recovery of the capital expenditure (capex) cycle is likely to be a key growth driver on the back of stronger external demand. With factory utilisation and shipments showing signs of bottoming, the capex cycle is anticipated to turn upwards. Korean corporations have also historically reduced capex during an election year and in the first year under a new government, before expanding in the subsequent year. President Park Geun-Hye has been in office since Feb 2013, meaning that companies may be more ready to invest now that the political outlook is clearer.

Along with improving external demand, a recovery in the domestic property sector should also contribute to stronger economic growth. Already, the local property market has started to show signs of strength (in terms of prices and transaction volumes) with the support of favourable policy measures from the government. The housing recovery would also have positive implications for domestic consumption as retail sales are expected to rise in tandem with the increase in (property) wealth.

Figure 1: Asian equities performance comparison and Figure 2: Current account matters

A key concern for Korean equities has been the strengthening Korean won (KRW), particularly relative to the weakening Japanese yen (JPY). Indeed, specific export-oriented sectors (e.g. auto) could face challenges in pricing and maintaining profitability if the KRW were to appreciate too much or too quickly.

We believe, however, that these concerns can be alleviated as long as global growth continues to tick up. Figure 4 data indicates a strong correlation between Korea’s export growth and volume demand in major economies. Analysis of key export companies by our investment banking colleagues also suggests that operating leverage (linked to volume growth) has a more significant impact on earnings than foreign-exchange movement. Hence, the anticipated turnaround in shipment growth could help mitigate the negative impact from KRW appreciation.

In addition, an appreciating won would make imports cheaper, supporting domestic consumption. Historical data over a 10-year period also shows that the KOSPI equity index records positive annual returns whenever the KRW appreciates against the JPY (see Figure 5). This data suggests that growth plays a more significant role than foreign-exchange movements in influencing market returns.

Korean earnings cycle bottoming out

An improving macro outlook should help lift corporate earnings and consequently equity market performance. Valuation wise, the risk/reward dynamic also remains favourable as the KOSPI is currently trading at one standard deviation below its historical average (see Figure 6).

Sector-wise, the Korean banks are expected to benefit from improving loan growth and interest margins due to a stronger economy. Recent issues surrounding credit card data leakage may have weakened investor sentiment, but the earnings impact may be far less limited. With the sector still trading, on average, below its book value, we see opportunities for banking stocks to re-rate higher on the economic up-cycle and property market recovery. Apart from the banks, consumer-related stocks – such as retail stores and cosmetics companies – will also benefit from stronger domestic spending.

As for the exporters, we see opportunities in the technology sector, which boasts a number of companies that lead the global market in terms of product innovation and market share. Conversely, we are more cautious on the auto sector, which may be more affected by the strengthening of KRW over JPY, as well as the shipbuilding/metal sectors, which are still facing oversupply issues.

Figure 3: Korea GDP projection and Figure 4: Korean exports correlated to global growth
Figure 5: KRW strength is not necessarily a bad thing and Figure 6: KOSPI and P/B valuation

Constructive on Taiwan

Last year, Taiwan equities outperformed most of their regional peers during what was a challenging year for many Asian markets. We expect the Taiwanese stock market to maintain its winning streak on the back of favourable global and domestic tailwinds and an undemanding valuation.

Korean equities to benefit from improving external demand and local property sector

Taiwan stands to benefit from stronger developed-market demand, robust domestic consumption and, over the longer term, closer economic ties with China. Given the supportive macroeconomic backdrop, our economists are projecting Taiwan’s GDP growth to accelerate to 3.5% in 2014 (see Figure 7).

Corporate earnings will continue to increase on stronger growth, particularly for the export-oriented technology companies. Domestically, we expect consumption to be buoyed by robust employment and the wealth effect created by healthy property prices. In addition, local politics could lend a hand with the Taipei mayoral elections occurring in Dec 2014. We expect related news flow in the run-up to the election to be supportive of the markets, although there are downside risks, including disappointing policy developments, surprise election results, or unexpected outbreaks of violence. Longer term, the further thawing of the cross-strait relationship with China could also lead to increased business, trade and tourism for Taiwan.

Figure 7: Taiwan GDP projection and Figure 8: TAIEX and P/B valuation

While some of the positives have been reflected in the steadily rising TAIEX equity index, the market is still trading reasonably around its historical average valuation (see Figure 8). We believe foreign institutional investors were the driving force of the TAIEX in 2013, but see potential upside from domestic retail investors going forward. Local investors have previously been disengaged from equities, channelling more funds into the domestic property market instead. Nevertheless, with increasing talk of measures to curb speculative activities in the property sector, coupled with a growing lack of supply, we may see more local investors returning to the stock market.

Favour Taiwan technology and financial sectors

We favour Taiwan technology stocks, which are generally inexpensively valued, while the healthy balance sheets evident across the industry should support dividend payouts. Specifically, semiconductor companies are likely to benefit from increased demand, driven by the adaptation of new technologies as well as increased corporate spending. Suppliers for smart phones and tablets will also gain from the launch of new products, particularly with the accelerated 4G-LTE network adoption in China.

On the domestic front, Taiwan’s financial sector outperformed local peers in 2013, driven by a re-rating of insurance stocks as well as constructive cross-strait deregulations, which are seen as a positive for the sector. While the financial stocks may not repeat their strong 2013 performance in 2014, we remain constructive on several fronts. The expected steepening of the yield curve would help to improve the investment spreads of Taiwan insurers and consequently their stock valuations. The banks are also expected to benefit from higher interest margins and, at the same time, gain from increased onshore and offshore Renminbi (CNY) business opportunities. China’s reform initiatives, in particular, would be supportive for Taiwan’s offshore bank business activities. The historically low loan-to-deposit ratio in Taiwan would also make its financial system less susceptible to US tapering and liquidity outflows.


While Asian economies as a whole should benefit from the uplift in global growth, we are more positive on Korea and Taiwan in view of the export-oriented nature of their economies. Their relatively healthy current account surpluses should also insulate them from any tapering-induced liquidity outflows. Recent concerns about the emerging markets may lead to some near-term volatility and indiscriminate selling, but we would view any pullback in Korea/Taiwan equities as a good entry opportunity. Ultimately, fundamentals should prevail.