EQUITY RESEARCH DWS MARKET EDGE MARKET STRATEGY D D W W S S M M A A R R K K E E T T E E D D G G E E Please carefully read important notices in the last pages of this report. Korea/Tactical Strategy CHEAP DOLLAR, MRS. WATANABE AND NEW CHINA T T r r a a c c i i n n g g b b a a c c k k t t o o t t h h e e o o r r i i g g i i n n o o f f t t h h i i n n g g s s Cost of Insuring Credit Derivatives and Normalized Equity Risk Premium in the US barely budged… 100 150 200 250 300 350 400 Mar-07 Apr-07 May-07 Jun-07 Jul-07 2 2.2 2.4 2.6 2.8 3 CDX Crossover (bp, LHS) Forward Equity Risk Premium implied by S&P 500 (%, RHS) Source: MarKit, DWS .....The market’s pattern of behavior had been irrationally singular up until the recent downturn in that it appeared to defy the accepted laws of the market. Undulation disappeared and unhinging between economic variables and financial asset prices became a regular feature. The majority of investors seemed to be attributing the market’s movements down to “Chinese growth factors” and the new world order brought on by them. Because the financial market lacks universal truth (as accepted by everyone), most people use inductive reasoning to formulate their investment forecasts, but we must be aware of the fact that most inductive reasoning is not based on exhaustive evidence. In fact, the logical certainty of a conclusion is entirely dependent on the correct interpretation and consistency of the evidence. Unfortunately, we all have the tendency to elevate our opinions to the level of infallible conclusions, as evidenced by the high level of conviction mostly among the individual investors that the market would continue its rise unhindered until the US subprime debacle recently came stomping on it in August. On the other hand, a deductive argument is always valid, even if the premise may not be true. The verity of the conclusion of a deductive argument, therefore, depends on only one thing: the verity of the premise. The conclusions are only as good as the premises. Said differently, the “only” weakness of a deductive argument is the truth value of its premises. Within this context of logic, the current downdraft was inevitable, and we have anticipated it for some time. We must realize that the US subprime crisis is merely a foretaste of what can happen in the aftermath of “Greenspan put” that had been “written” over years. This is to say that the US subprime crisis is not the cause of the market’s decline, but rather the end effect of artificial liquidity that had been created within it. It is, therefore, crucial at this juncture that we ask ourselves questions that are based on valid presuppositions, by which the conclusions ought to be determined. Only then will we be able to trace back to the very origin of things and from there, attempt to predict what will likely happen and why and how..... Tactical Strategy August 20, 2007 Alfred Park Head of Research +82-2-768-4143 [email protected][email protected]Focus List (May 10, 2007) √ SK Corp (003600.KS) √ NHN (035420.KS) √ Hite Brewery (000140.KS) √ Daelim Ind (000210.KS) √ SEC (005930.KS) Focus List (Aug 20, 2007) √ SK Corp (003600.KS) √ SK Energy (096770.KS) √ NHN (035420.KS) √ Hite Brewery (000140.KS) √ Daelim Ind (000210.KS) √ SEC (005930.KS) √ Samsung SDI (006430.KS*) √ KB (060000.KS*) * To be included if target price is hit
Transcript
EQUI
TY R
ESEA
RCH
DWS
MAR
KET
EDGE
M
ARKE
T ST
RATE
GY
DDWWSS MMAARRKKEETTEEDDGGEE
Please carefully read important notices in the last pages of this report.
Korea/Tactical Strategy
CHEAP DOLLAR, MRS. WATANABE AND NEW CHINA TTrraacciinngg bbaacckk ttoo tthhee oorriiggiinn ooff tthhiinnggss Cost of Insuring Credit Derivatives and Normalized Equity Risk Premium in the US barely budged…
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CDX Crossover (bp, LHS)
Forward Equity Risk Premiumimplied by S&P 500 (%, RHS)
Source: MarKit, DWS
.....The market’s pattern of behavior had been irrationally singular up until the recent downturn in that it appeared to defy the accepted laws of the market. Undulation disappeared and unhinging between economic variables and financial asset prices became a regular feature. The majority of investors seemed to be attributing the market’s movements down to “Chinese growth factors” and the new world order brought on by them.
Because the financial market lacks universal truth (as accepted by everyone), most people use inductive reasoning to formulate their investment forecasts, but we must be aware of the fact that most inductive reasoning is not based on exhaustive evidence. In fact, the logical certainty of a conclusion is entirely dependent on the correct interpretation and consistency of the evidence. Unfortunately, we all have the tendency to elevate our opinions to the level of infallible conclusions, as evidenced by the high level of conviction mostly among the individual investors that the market would continue its rise unhindered until the US subprime debacle recently came stomping on it in August.
On the other hand, a deductive argument is always valid, even if the premise may not be true. The verity of the conclusion of a deductive argument, therefore, depends on only one thing: the verity of the premise. The conclusions are only as good as the premises. Said differently, the “only” weakness of a deductive argument is the truth value of its premises.
Within this context of logic, the current downdraft was inevitable, and we have anticipated it for some time. We must realize that the US subprime crisis is merely a foretaste of what can happen in the aftermath of “Greenspan put” that had been “written” over years. This is to say that the US subprime crisis is not the cause of the market’s decline, but rather the end effect of artificial liquidity that had been created within it. It is, therefore, crucial at this juncture that we ask ourselves questions that are based on valid presuppositions, by which the conclusions ought to be determined. Only then will we be able to trace back to the very origin of things and from there, attempt to predict what will likely happen and why and how.....
Focus List (May 10, 2007) √ SK Corp (003600.KS) √ NHN (035420.KS) √ Hite Brewery (000140.KS) √ Daelim Ind (000210.KS) √ SEC (005930.KS) Focus List (Aug 20, 2007) √ SK Corp (003600.KS) √ SK Energy (096770.KS) √ NHN (035420.KS) √ Hite Brewery (000140.KS) √ Daelim Ind (000210.KS) √ SEC (005930.KS) √ Samsung SDI (006430.KS*) √ KB (060000.KS*) * To be included if target price is hit
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DWS Market Edge KOREA / TACTICAL STRATEGY
INTRODUCTION: SO WHAT SHOULD WE ASK? I’ve raised my champagne glass in triumph, and had my sleepless nights since I first began my career in 1990. But the market pattern in the first half of 2007 – while its direction was well anticipated - has been one of the harder ones to explain among a number of unusual situations that I’ve encountered in my 18 year-career.
The market’s pattern of behavior had been irrationally singular up until the recent downturn in that it appeared to defy the accepted laws of the market. Undulation disappeared and unhinging between economic variables and financial asset prices became a regular feature. The majority of investors seemed to be attributing the market’s upward movements down to “Chinese growth factors” and the new world order brought on by them.
Because the financial market lacks universal truth (as accepted by everyone), most people use inductive reasoning to formulate their investment forecasts, but we must be aware of the fact that most inductive reasoning is not based on exhaustive evidence. In fact, the logical certainty of a conclusion is entirely dependent on the correct interpretation and consistency of the evidence. Unfortunately, we all have the tendency to elevate our opinions to the level of infallible conclusions – a tendency that prompted the high level of conviction mostly among the individual investors that the market would continue its rise unhindered until the US subprime debacle recently came stomping on it in August.
On the other hand, a deductive argument is always valid, even if the premise may not be true. The verity of the conclusion of a deductive argument, therefore, depends on only one thing: the verity of the premise. The conclusions are only as good as the premises. Said differently, the “only” weakness of a deductive argument is the truth value of its premises.
Within this context of logic, the current downdraft was inevitable, and we have anticipated it for some time. We must realize that the US subprime crisis is merely a foretaste of what can happen in the aftermath of “Greenspan put” that had been “written” over years. This is to say that the US subprime crisis is not the cause of the market’s decline, but rather the end effect of artificial liquidity that had been created within it. It is, therefore, crucial at this juncture that we ask ourselves questions that are based on valid presuppositions, by which the conclusions ought to be determined. Only then will we be able to trace back to the very origin of things and from there, attempt to predict what will likely happen and why and how:
(1) Is global cash liquidity the result of the US monetary policy, in cooperation with the rest of the world (and its reverberating effect as many currencies are pegged to the US dollar) or (2) is it instead the result of a new world order with increased productivity worldwide and budding prosperity in emerging countries, most notably China?
The answer matters. Although the most appropriate answer is that there has been a combination of both, the direction in which the explanation leans will determine what strategy to adopt in response. If the answer leans in the first, the culprit is the “weak dollar” and the prudent strategy would be to scale back in equity positions of “China-related” exposure because the “China-premium” in market valuation may very well be a temporary element, created principally in reflex to artificial liquidity, which, therefore, may not be sustained. If, on the other hand, rising productivity and prosperity have brought on liquidity, then the boom can and will likely be sustained, justifying the China-led “new world order” that the world is and will be hung upon.
Subprime Crisis is an End Result, Not the Cause We suspect that current correction across the board in the world’s stock markets has been largely triggered by international hedge funds. Given the typical provisions of quarterly liquidity and the minimum notice period of 60 days, hedge funds will be likely hit by a wave of redemptions, potentially triggering forced selling. We still remember the 18 month-long streak of redemptions that led to fallout of many convertible arbitrage funds in 2004-2005.
The recent correction can be actually a constructive one because it seems as if hedge funds are preemptively selling “saleable” equities to be able to fund the upcoming redemptions, principally for the end of September. The Korean equities are one of the more liquid stocks in the emerging market complex and it would make a lot of common sense to sell shares that were overvalued anyway.
Despite the Fed’s rescue package on August 17, providing relief to stock markets across the Atlantics and Pacifics, the combination of hedge funds’ preemptive selling and unwinding of Yen-carry trading will continue to weight on Korean stocks across the board until the end of this quarter, and we need to see if liquidations will be balanced by new investments then.
We need to determine whether this is simply a correction in the long-term bull market or a beginning of trend reversal. As mentioned in my previous report, <L’Automate? – Should we re-define global liquidity or re-visit it?> (May 10, 2007), the speed at which global liquidity was expanding was simply too fast and the warning signs of liquidity contraction were abound in a number of distinct observations, i.e. decreased takedown of US treasuries by Asian central banks, the absence of credit dimension implied by debt markets and observed in equity markets, and the increasing “narrowing” of outperforming stocks. As a result, it was matter of when, not if, for the market’s exuberance to begin to ease.
1: Subprime Issuance in the US 2: Value of Household-Owned Real Estate
Source: FBR Investment Mgmt Source: Federal Reserve, DWS
However, looking at the related numbers subject to analysis, I can’t help, but think that the situation may not be as bad as it seems. Our estimate has it that the residential real estate market in the US is valued at USD17~18tril and this translates into LTV (loan-to-value) of 57% for the average lender. This is too high of a number for a lender/investor to be dismally discomfited.
The central point of the subprime crisis is that the related holdings are currently hard to be valued due to the dearth of bidders. The worst case scenario in which subprime mortgage-backed bonds could turn out to be worthless has not played out yet, and I don’t think it will.
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DWS Market Edge KOREA / TACTICAL STRATEGY
In fact, assuming subprime mortgage bonds issued since 2006 are problematic (from a financial investor’s perspective), investors are exposed to USD740bn (USD224bn since 2007). With the Fed’s rate cut on the card, a principal investor can actually cash out investors of problematic funds, instead of force-selling securities at fire-sale. In fact, this is precisely what some of the institutional managers did as of late. Further, given that “distressed securities” is one of the more popular strategies used by hedge funds, I wouldn’t be surprised to see active involvement of hedge funds if prices of structured products fall lower and hence, value restored.
While painful over the short-term, the current correction should not be mistaken as a prelude to an irreversible “disaster”. It is most likely the manifestation of “re-pricing” of securities worldwide whereas the risks that have been constantly ignored up until this point are now being revisited and accordingly priced in, with the subprime problem as the igniting catalyst.
Assuming that total losses from US mortgage debt would hit USD200bn, the losses will be a negligible 1.1% of the US stock market capitalization. While the losses will hit some investors and that there will be a short-term pain, this could actually help restore much needed “order” in financial markets, start creating profitable opportunities for merger arbitrage, and again boost M&A activities.
The subprime problem will be likely self-contained. The numbers suggest that it is not very realistic for it to turn into full-scale meltdown. The subprime crisis should be seen as the end result, as well as evidence, of the artificial liquidity expansion. This, in effect, answers to our key question in the introduction, albeit incomplete. It is imperative, in our opinion, to look at a bigger picture, to which the subprime crisis is merely a piece.
Liquidity Crunch from Credit Alarm Just a Possibility for Now Aside from the subprime mortgage problem, investment banks have another problem relating to corporate loans. It is widely known that private equity and hedge funds alike committed themselves to “subprime” companies with significant backup from investment banks. The recent crisis made it difficult for investment banks to sell their loan exposure into the market.
Principal investors, i.e. buyout groups and private equities, are in it for the long haul, and their investments need to be protected from the worst-case scenario, i.e. corporate default, over a long-term horizon of 5~10 years, during which they must execute their value transformation strategies so that the higher enterprise value be justified. Therefore, it would be painfully erroneous to mark the price of risk protection based on today’s reward/risk parameters perceived and implied by the markets.
Under normal circumstances, at a time like this, investors must focus more on a correlation crisis by and by, which will cause significant swings in the relative value of structured products backed by derivatives and eventually, of equity markets. This will result in a higher demand for protection, while the pool of participants willing to sell it shrinks. The “primary market” premium in the stock price of “old economy” companies, which had been built and granted on the basis of the relative value theory (companies that were actually acquired being the reference companies), can be knocked off once a slowdown in global M&A (or rather LBO?) activities is confirmed.
However, the cost of insuring the US investment-grade credit derivative index, CDX, widened only 74 bp since July, quite modest despite the subprime mortgage problem. The pattern has been similar with European companies. The iTraxx Crossover Index, which tracks 50 junk-rated European corporate names, widened 112 bp during the same period.
This supports our aforementioned opinion of the status regarding the US subprime crisis. It essentially means that the market approves two thing for now - which we agree on.
5
DWS Market Edge KOREA / TACTICAL STRATEGY
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First, price paid for by financial investors in primary market transactions was in a reasonable range from a long-term, normalized standpoint. And second, the central banks will continue to be there (to bail out the troubled) in the worst-case situation.
3: CDX Crossover 4: iTraxx Crossover
Source: MarKit Source: MarKit
5: Credit Debacles Has Yet to Spread into Liquidity… 6: Daily Change of Credit and Liquidity Premia
Source: Bloomberg, DWS Source: Bloomberg, DWS
The spike in high yield spread (as measured by S&P B-rating industrial corporate bond yield minus treasury yield) during July 26-30, while liquidity premia barely budged, was certainly a sinister symptom for emerging market equities, including Korean stocks. A reverse combination of falling credit premia and rising liquidity premia provides the condition for the risk curve to steepen (marked by rectangle in Chart 5). Incidentally, it did present the best buy opportunity to buy into risky assets (and Korean stocks) at the onset of February 2006, thanks to the Korean market’s backward-looking dynamics.
Reciprocally, Korean stocks are now vulnerable to a sizable correction. And it will be harbingered by credit and liquidity premia spiking in the opposite direction. As much as the market frets about the falling risk appetite (as indicated by rising high yield), it is the (diminishing) liquidity premia that we should stay attuned to. In conformity with observation in movements of CDX and iTraxx crossover, the diminishing liquidity premia have not surfaced yet.
6
DWS Market Edge KOREA / TACTICAL STRATEGY
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3 YR Avg: Industrial Production % less New Births YoY% (RHS)
Excess production tames inflation
Beware of Corollary of “Carry Trading” The diminishing liquidity premium – if it dips beyond certain point - will have a broad-based effect on the pricing of securities across the board, and could cause an unwinding of carry trading, the scope of which would be as hard to measure as the process that ferried carry trading to its current level.
Given that carry trading is a bet on the low volatility of carry trading currency, the risk of unwinding is on the rise, as spot volatility has started to edge up. Although the volatility still remains rather moderate to date, compared to 2004, the recent strength of the Yen since July appears to carry some weight and the support of 115 is presently being tested. We mentioned in our previous publication that, in order for the unwinding to spread into a broad-based sell-off of risky assets, the support of 115 would need to be broken. Trading at 114.5 at this moment I am writing this report, JPY/USD is at a very critical juncture, to which we will remain alert.
7: Industrial Production Growth Should Catch Up… 8: …Or Inflation Should Edge Up…
Source: Ministry of Economy, Trade and Industry - Japan Source: Ministry of Internal Affairs – Japan
Pressured by high import prices and falling production, inflation is likely edge up in Japan from a cyclical perspective. There is also a secular element of inflation, latent in the large number of upcoming retirees that will have money to spend.
However you look at it, the Dankai generation of baby boomers in Japan will have a profound impact on the world’s economy and its own, as 7 million people are slated to retire with an average nest egg of about 50 million yen over the next economic cycle or so. This has two implications: First, the labor force will drop by 10%; and second, these retirees, unlike their predecessors that placed the highest virtue in frugal lifestyle, will be inclined to spend big, as they have deeper pockets and higher living expectations.
We interpret it as the inevitable recipe for a sharp drop in government tax revenue and broad-based consumer inflation. The natural course for BOJ to follow is to raise interest rates. Regardless of what BOJ does at their next monetary policy meeting on August 22, there will be a series of rate hikes sooner or later, and eventually, higher JPY rates will punctuate JPY-based carry trading.
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DWS Market Edge KOREA / TACTICAL STRATEGY
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“WEAK DOLLAR” VS. “NEW WORLD ORDER” Evidence Abounds for “Weak Dollar” Thesis Before the subprime debacle struck financial markets, high commodity prices everywhere implied a “weak dollar.” Although we can argue that robust industrial demand in China and other emerging markets drive oil and steel prices, other assets, like gold, which have little to do with China’s industrial growth, are not so easily explained.
As seen in Chart 9, China’s hyper-growth became clearly pronounced from the end of 2002, preceded by GDP growth in excess of 8% for four consecutive quarters and followed by growth of 10.3% in the first quarter of 2003. Therefore it makes a common sense to set the starting point of data subject to analysis at the onset of 2003 whereby we are allowed to strip out the “China effects” on asset prices worldwide without erring on the precision dependence. Chart 10 supports the “weak dollar” thesis.
9: China’s GDP Growth 10: Prices of Crude Oil and Gold Since End-2002
Source: National Bureau of Statistics - China Source: Bloomberg
11: Per Capital Energy Consumption of the World and of China 12: Supply and Demand of Sources of Energy
Source: Energy Intelligence Group, DWS Source: Energy Intelligence Group, Bloomberg
Other factors lend weight to the “weak dollar” thesis. Unlike spiking oil prices that resulted directly from industrial demand growth during 2002~2005, persistently strong oil prices now appear to be the result of short oil supply since 2006, although energy consumption has in
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DWS Market Edge KOREA / TACTICAL STRATEGY
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Dubai (USD/bbl) Dubai at 2006 Dollar (USD/bbl)
fact slowed. What does this have to do with the weak dollar? For OPEC members, a weak dollar is a strong disincentive to produce more oil, because the real values of OPEC’s profits are falling. When adjusted for inflation and the weaker purchasing power of the dollar, OPEC oil prices have already fallen over the past year.
Under the Microscope: Oil Price and China’s Inflation So, the “weak dollar” gets a vote over the “new world order” on my scorecard. As a matter of fact, I subscribe to the fact that a weak dollar-induced oil price shock and subsequent economic slowdown may not be such a distant proposition. Unless the weakening dollar slows and oil-producing countries subsequently dig up more oil supply, the world economy could face severe inflationary pressure, in which case I would pencil in oil prices of USD80~100/bbl (with Dubai as the benchmark, currently at USD66.9/bbl) by the second half of 2008. In view of the dollar’s fall in value, the oil cartel’s refusal to increase production and compel a reduction in oil prices is more understandable when the lower value of OPEC’s spending power is taken into account.
After all, oil price was higher in real dollar terms in the past, meaning oil price is not quite as high as the current dollar price would suggest (Chart 13). As an oil price of USD80~100/bbl will manifest stress, we must weigh a possibility of the worst case scenario where higher oil prices coincide with a point in time in which China might have to start “exporting” inflation, thereby causing worldwide stagflation.
13: Real and Nominal Price of Oil (Based on World Basket) 14: China’s CPI on the Rise…
Source: Bloomberg, DWS Source: National Bureau of Statistics - China
15: …But PPI and Raw Material Price Remain Stable… 16: H-Shares Aren’t as Over-valued…
Source: National Bureau of Statistics - China Source: Bloomberg, DWS
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100%
110%
120%
130%
140%
150%
2003 2004 2005 2006 2007 2008 2009 2010 2011
0
2000
4000
6000
8000
10000
12000
14000
16000
Present Value of Ex-Post Fair Value of H-Shares (RHS)
Actual Value of H-Shares (RHS)
Actual/Fair (LHS)
9
DWS Market Edge KOREA / TACTICAL STRATEGY
China has been able to remain a low-cost provider of goods for rest of the world, thanks to low wages, and hence tamed inflation, despite its strong economic growth. The recent spike in headline CPI in China, however, has become public concern, and people have begun to discuss the possibility of China “exporting” inflation.
We do not believe that China will actually start to “export” inflation to its consumer markets yet for three reasons. First, PPI and raw material purchasing prices remain stable (Chart 15). Second, since the recent price hike is mainly food-driven (non-food inflation slowed to 0.9% in July), it can be immediately curbed with relative ease through administrative measures, i.e. food-price regulation. And lastly, despite its high growth, China still accounts for only 5.3% of global domestic product. This is to say that the impact of Chinese exports on global prices have been, while not negligible, fairly modest. Once again, far higher oil prices – both sweet and sour - would have to precede before Chinese “inflation” actually begins to affect the world economy on a broader basis.
As far as the stock market and property market boom, leading to a build-up of a long-term inflationary pressure in China, we find that the Chinese stock market is not as waywardly overvalued as some people have found it to be.
Let’s look at Chart 16. If we assume that China’s industrial demand will reach the level of Europe or Japan, at the current rate, the peak year of hyper-growth should arrive in 2011. Given that energy consumption growth and real economic growth are valid surrogates for the industrial demand growth and cost of capital respectively, I assumed that that China’s energy consumption growth rate will continue at 18% p.a. (a shade below the last cycle’s average of 19.4%) until 2011, and the real rate of growth will remain at 9.9% (the last cycle’s average). In retrospect, H-shares were steeply undervalued by 61% at the end of 2005, providing the basis for a steep re-rating in 2006 (up 94%). As of today, H-shares are overvalued, but only by 13%* (*we choose not to use Shanghai Composite for its arbitrariness. Overvaluation is currently measured at 58%). Given that the Chinese market is the darling of the investment world with strong growth visibility still intact, the current level of overvaluation is not unreasonable and could actually be acceptable.
Our assessment on this subject is that, while the aftermath of a weak dollar could continue to hurt the financial market sentiment, the possibility that it would actually spread into a wider economy, leading to global stagflation, is not very high at the moment.
10
DWS Market Edge KOREA / TACTICAL STRATEGY
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
-100%
-50%
0%
50%
100%
150%
200%US
EUROJAPAN
The Advent ofcheap dollar
Real Oil PriceYoY % (RHS)
Super-Easing
ORIGIN OF THE “WEAK DOLLAR” Monetary Policies: Key Factor According to our analysis, it was not the high levels of oil prices that slowed the economy and oil consumption in the past, but it was the very tight monetary policies worldwide accompanying oil price shocks that had these effects.
Let’s look at Chart 17. The most recent recession of the world economy took place in 2001. It was clearly preceded by concert monetary tightening in the US, Europe, and Japan and subsequently brought about downward pressure to oil prices, as shown in the first rectangular box. The recent tightening that commenced in June 2004 (shown in the last rectangular box) was mostly anchored by the US and wasn’t large enough to turn the ultra-weak dollar around, which was, in turn, the direct offspring of super-easing in 2001 (from Fed fund target rate of 6.5% to 1.75% in 2001 alone and eventually down to 1%) and thereafter. The chart clearly shows that the weakening dollar was imminent at the onset of 2002 (as validated by Chart 18). What then was the Fed’s objective?
17: Tightness of Monetary policies (by Slope of the Yield Curve Spread) 18: …Leading to a Weaker Dollar…
Source: Bloomberg, DWS Source: Bloomberg, DWS
We do not believe the Fed’s core intent was to slow down the economy, per se. The reason for the “controlled” tightening was two-fold: (1) to dampen the high growth of “non-earning” real estate prices; and (2) to create an interest rate buffer. The Fed stopped tightening since July 2006, at which point the US trade balance began to show improvement.
We have to keep in mind that it is, at least theoretically, in the US’s best interest to devalue the dollar so long as the trade balance improves and statistical data tracking inflation do not provide for a more comprehensive measurement because the US has an external competitiveness problem, i.e. balance of payment (which it cannot fix on its own), with foreign debt denominated in its own currency. From this perspective, although the Fed is walking on a very thin line, the risk of full-blown inflation and trade balance being too problematic does not look imminent yet. Given the time needed for monetary policy move to start kicking into the wider economy, the Fed’s “controlled” tightening has so far proved to be just about right, especially since it created enough of an interest rate buffer in the process.
The takeaway from this section of the study is that tightness of monetary policy was comparatively modest during 2004~2006, and the US economy (and rest of the world) is still not about to capitulate. So when will it become too much of a burden?
What Will the US’ Policymakers Do? I remain firm in my belief that the biggest risk lies in a possible oil supply disruption, partially accompanied by the weak dollar. As shown in chart 19, an oil price of USD90/bbl would put the US energy intensity (the ratio of energy consumption to GDP) at over 5%, which would easily surpass the level observed during the recession periods of 1990/91. Korea’s energy intensity would rise to nearly 9%, corresponding to the level during the same periods. As shown in chart 20, BRIC’s economies will be dealt an even bigger blow and economic development will be arrested. We do not believe that the aftermath of such a scenario could easily be offset by the increased efficiency that is arguably but largely accountable for the reference point shift in the world equity markets.
19. Dubai Crude Oil Price of USD90/bbl Will Manifest Stress… 20: Energy Consumption/GDP
Source: Bloomberg, DWS Source: Bloomberg, DWS
21: Long-Term Trend of Rig Count Still Downward… 22: …Though There May be a Momentary Pop in the Short-Term
According to the Financial Times on August 1, OPEC members stepped up their search for new oil and gas fields, and the number of oil rigs in operation, one of the best estimates of investment trends, increased at the highest rate in two decades, implying that the move could boost supplies in the future. While it is true that OPEC members are managing a record number of rigs since 1980, I believe this is largely a temporary means of making up for a lack of long-term investments in new production projects.
The world’s total rig count has actually fallen since 2006 (Chart 21), due to output drops in mature areas and long delays in new production projects. The long-term trend of investment is still downward, although there may be a momentary lull with increased spending in the Middle East and Asia (Chart 22).
12
DWS Market Edge KOREA / TACTICAL STRATEGY
Based on our findings and analysis, we believe that the US will likely continue to push for three major economic policies: revaluation of Chinese Yuan, broader free trade pacts with other countries, and more oil production by OPEC.
If there remains an economic accord and coordination between different economic blocs insofar as it helps the US’s trade balance improve (stabilizing the dollar) and induces oil supply to keep pace with demand, then the US economy could soft-land and global stocks could continue gliding for an extended period of time. On the other hand, if there are any disruptions in the aforementioned policy issues, the US will have to tighten again to fund its snowballing deficits. Despite tightening, the US dollar will fall further, long rates will soar, and the world economy will face very severe consequences.
The one good thing is that the Fed will then have created an even bigger interest rate buffer that it can stimulate the economy very quickly in the next recession as long as debt default volumes do not get out of hand. Based on the account of current developments, the situation does not seem as bleak as some claim. Not just yet.
13
DWS Market Edge KOREA / TACTICAL STRATEGY
0
2000
4000
6000
8000
10000
12000
1200~1300 1300~1400 1400~1500 Over 1500
KRWbn
THREATS TO NEW EQUITY CULTURE IN KOREA Liquidity Expansion into the Bottom of the 9th Inning, but “Profit-cycling” Well and Alive for Now Korean stocks have benefited – immensely – not only from both the weak dollar and new world order, but have also gotten as much of a boost, if not more, from the domestic liquidity expansion (which is, after all, circularly intertwined with the aforementioned phenomena).
In my previous report, <Comes 2007, Looms Sinister Twilight> (December 7, 2006), I estimated that the uppermost limit for the aggregate assets under management (“AUM”) for installment mutual funds would be about KRW33~38tril.
23: Have Individuals Been Too Confident Since May? 24: Distribution of Inflows Since 2006
Source: BoK, KAMA Source: KAMA, DWS
As of end-June, the aggregate AUM for installment mutual funds stands at KRW35tril, out of which, KRW26tril are in equity funds. Based on the record of monthly inflows by Korea Asset Management Association, we can estimate that retail investors invested in stocks mostly in the KOSPI range of 1300~1400. Inflows at these levels account for about 64% of total inflows since 2006, with a mean purchase price of KOSPI estimated at 1,390. This indicates that “profit-recycling” has successfully taken its course, and consequently, fundamental deterioration close to something of a disaster would be required to reverse the average Korean investor’s colors on the market.
With a floating gain of nearly 25%, individual investors have taken the recent correction in stride. There is the widespread belief that equity investing will not be defeated, much in the same way that real estate investment was once considered invincible. Although the incremental liquidity by way of the bank lending to households is visibly slowing down (chart 23), we believe that “profit-recycling” could help support the floor value of stocks for some time.
Moderate home purchase price inflation is definitely a boon for stock investing, especially if it occurs at a gradual, measured pace. It was, after all, the origin of the reference point shift in the domestic liquidity, external factors aside. A relatively stable *Chonse price (*a lump-sum deposit in place of rent, which is determined by a homeowner’s required rate of return) indicates that the slowdown in home price growth will be gradual rather than abrupt. This will compel individuals to stretch their time horizon for stock investing, as there will be a lack of alternative investments.
Based on our analysis, home purchase price growth will continue to slow down through the latter part of 2009 (Chart 25 and 26), which will likely perpetuate continued appetite for stock
-2000
-1000
0
1000
2000
3000
4000
5000
6000
7000
8000
Ap
r-0
5M
ay-0
5Ju
n-0
5Ju
l-05
Au
g-0
5Se
p-0
5O
ct-0
5N
ov-
05
Dec
-05
Jan
-06
Feb
-06
Mar
-06
Ap
r-0
6M
ay-0
6Ju
n-0
6Ju
l-06
Au
g-0
6Se
p-0
6O
ct-0
6N
ov-
06
Dec
-06
Jan
-07
Feb
-07
Mar
-07
Ap
r-0
7M
ay-0
7Ju
n-0
7
Monthly changes in Bank Loan to Household ex. Mortgage Loan
Equity Type Installment Funds Inflow
KRWbn
14
DWS Market Edge KOREA / TACTICAL STRATEGY
-10
-5
0
5
10
15
20
25
2000 2001 2002 2003 2004 2005 2006 2007
Chonse Price Growth Home Purchase Price Growth
%
-15%
-10%
-5%
0%
5%
10%
15%
20%
Jun
-02
Dec
-02
Jun
-03
Dec
-03
Jun
-04
Dec
-04
Jun
-05
Dec
-05
Jun
-06
Dec
-06
Jun
-07
Dec
-07
Jun
-08
Dec
-08
-15%
-10%
-5%
0%
5%
10%
15%
20%
YoY Growth of Number of Marriages(10 years and 10 months ago)
Home Purchase Price YoY Change
investing in the context of relative value, and thus sustain “profit recycling” even within a less-than-ideal situation, unless external factors, i.e. unwinding of carry trading or much higher oil price, hit the market sentiment harder than currently anticipated.
25: We Expect Moderation of Home Purchase Price Growth 26: Home Price Could Actually Fall in 2008…
Source: KB Source: KB, NSO, DWS
High Oil Price a Real Threat My survey of investors finds the majority reluctant to pencil in JPY/USD of 110 and an oil price of USD80~100/bbl yet. With Japan gripped by political uncertainty in the short-term, but subject to inflationary pressure in the long-term, the Japanese factor, i.e. unwinding of JPY carry trading, is a toss-up for now, and I will remain flexible while continuing to monitor further development. On the other hand, oil prices reaching USD80~100/bbl over the next 12 months seems more feasible.
In order for the Korean stock market to soft-land, companies must both: deliver earnings growth that matches or exceeds market consensus; and clearly show their willingness to increase dividends. However, with a slash in US earnings growth estimate from the mid-teens to just 5~7%, the current earnings growth rate for Korea seems rather high at 16~18%. A more reasonable number would be around 10~12%, based on a componential analysis of the geographic breakdown of Korea’s exports and the respective purchasing power of the destination countries.
Given that stock market is a forward-looking entity, oil (real) price demands more of my attention than, say, the US’ subprime problem. The economic coordination between the OPEC and G7 members does not carry a very good track record, which I believe is the most notable risk that the market may be overlooking at present. The Fed, ECB, and BOJ do not have as much of influence over oil price as they do over other policies and measures. Higher-oil price, if synchronous with the strong dollar, will be devastating to emerging economies.
The source of earnings shock will likely come from higher oil price, if any. Should oil price (Dubai) reaches USD80/bbl (currently USD66.9/bbl), the higher end of my earnings growth forecast of 12% would be reduced to 9~9.5%. Single-digit growth would compel investors to revisit companies’ earnings growth prospects and subsequently readjust their market exposure in line with it.
Higher oil prices would also strain consumer confidence as well. Energy, housing/dwelling, and education expenses are the three main determinants of consumer discretionary spending in Korea. Based on our empirical analysis, housing expenses have greater influence over a consumer’s “feel-good-factor” and thus affects final consumption more than energy costs. Since rent from primary residences only makes up about 10% of headline CPI, and private childcare/education fees hardly show up in an official CPI number, the official headline CPI does not, in my opinion, provide an accurate picture of living costs.
15
DWS Market Edge KOREA / TACTICAL STRATEGY
60%
65%
70%
75%
80%
85%
90%
95%
100%
19851986
19871988
19891990
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
2007
2007 Real Price of Oil (30%) and Housing Cost (70%):1990 Recession Price at 100
denote recession
If Dubai at USD80/bbl andChonse Price up 7% YoY
The outcome of the study demonstrated in chart 28 is based on the assumption that Chonse price (surrogate for housing costs) accounts for 70% and energy costs (with oil prices as a surrogate) for 30% (directly and indirectly) of final living costs - those costs which a consumer must incurs, in order to maintain his/her basic standard of living before any discretionary spending. As Chonse price is a lump-sum deposit in place of a tenant’s rent, it is equivalent to mortgage debt service expenses (excluding the utility for ownership premium) for a home owner.
The cost of living was at its highest level on a real term basis in the recession year of 1990. Using 1990 as a reference, I compared the inflation-adjusted cost of living each year to it. If Dubai crude oil price reaches USD80/bbl and Chonse price increases by 7%, the cost of living in 2007 will match that of 1990 on a real-term basis. Since Chonse price growth is currently clipping along at a robust 5~6% and is expected to remain stable for rest of the year, variability of the economic impact chiefly lies with oil price, with geopolitical and weather issues at risk.
There is an argument that since many people in Korea are “house rich, but cash poor,” any increases in housing costs will be detrimental, especially when the market for home sales is expected to remain flat, with the enactment of a new real estate tax bill in effect.
I, too, expect that - while the home sales market continues to stagnate - debt service costs will have risen by 20% or so, compared to 2006. But this is still short of reaching the critical point needed to reverse market sentiment. BOK is in no rush to raise interest rates further, households are still net cash, and there are few signs of de-leverage in Korea. Based on our estimate, the average interest rate charged on loans would have to go to, say, 12%, in order for the households’ excess monthly cash flow to be consumed.
Higher oil price aside, the liquidity situation in Korea appears to be on a rather solid ground, with few risks in the near future.
27: Comparison of Real Price of Oil and Housing (2007=100) 28: How Much of More Costs Will Manifest Stress?
Source: DWS Source: DWS
0%
20%
40%
60%
80%
100%
120%
140%
19851986
19871988
19891990
19911992
19931994
19951996
19971998
19992000
20012002
20032004
20052006
2007
2007 Real Price of Oil based at 100
2007 Real Price of Housing (Chonse) based at 100
16
DWS Market Edge KOREA / TACTICAL STRATEGY
0
1000
2000
3000
4000
5000
6000
7000
8000
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Korea PPP-adjusted Per Capital GDP Growth (1975~1988)
China PPP-adjusted Per Capital GDP Growth (1993~2006)
USD
0
100
200
300
400
500
600
700
800
1 2 3 4 5 6 7
KOSPI (1982~1988) H-Shares (2000~2006)
CHINA-LED “NEW WORLD ORDER” Prudence toward Chinese Factors Our analysis so far has been more inclined toward the thesis that the “weak-dollar” taking its root in US’ monetary policy was the greater determinants of the worldwide financial market boom.
That is because there is no conclusive evidence that China’s emergence in the global marketplace represents a secular force that will forever reshape the world economy. While China’s contributing factors – cheap labor and industrial development – have been very significant up to this point and merit intensive study, I feel that the “new world order” thesis is still inadequate and incomplete.
As previously mentioned, the US will likely continue to push for three major economic policies: revaluation of Chinese Yuan, broader free trade pacts with other countries, and more oil production from OPEC. The US cannot adjust its external balance on its own without precipitating global recession. Global macro economic cooperation will be needed, to which China must contribute through an expansion of domestic demand. However, China’s showing thus far, in my opinion, does not fully satisfy this proposition.
Although open to global economy, China still remains an autocracy. State-owned banks continue to dominate the economy, and credit goes preferentially to frequently moribund state-owned enterprises. Even though the Communist party has recognized the legitimacy of private property, the effectiveness of the guarantee is still questionable. Let’s not forget that “duty” and “right” are two different things. And as far as economic cooperation, it remains to be seen whether China has all the preconditions for developing and sustaining its domestic consumption without social unrest.
It is far from certain that China’s growth is anything more than a spurt of growth that generally occurs in the early stages of a life cycle. Korea’s economy, for example, expanded rapidly during the highly charismatic, autocratic regimes of Jung Hee Park and Doo Hwan Chun until 1988, when the Seoul Olympic Games were held. Of course, what ensued was the outbreak of the civil rights movement, during which the stock market ebbed away until it eventually hit a deep slump.
29: PPP-Adjusted Per Capita GDP Growth of Korea Then and China Now 30: Comparison of KOSPI Then and H-Shares Now
Source: DWS Source: DWS
17
DWS Market Edge KOREA / TACTICAL STRATEGY
Going back even further in history, the basis for the Age of Americas in the 19th century was not cheap labor, but the combination of higher wages, productivity growth, innovation, education, and capitalism. All of these were the direct results of free competition that placed business enterprises and their workers – small and big, natives and immigrants - on equal footing.
Not only that, American employers were more sophisticated capitalists who recognized that satisfied, productive workers were the greatest assets of all. This attitude toward labor played a vital role in attracting the most innovative and skilled Europeans to America, thereby expanding a high quality labor force, which sustained more industrial growth. Today’s emerging countries (China, India, and Russia) have a great shortage of talented workers in their labor pool.
The brief historical summary, while debatable, demonstrates a number of differences between the “new world order” then and now. Any future long-term bets on China are therefore reliant on further reforms and technological innovation. Although China’s economy has surged rapidly for the last 10 years, a presupposition of its continued contribution to rest of the world in a sustainable form is an entirely different matter. We need to stay tuned in this respect before jumping to conclusion.
18
DWS Market Edge KOREA / TACTICAL STRATEGY
60
80
100
120
140
160
180
200
220
240
260
280
300
320
340
8-D
ec-
06
23
-De
c-0
6
7-J
an-0
7
22
-Jan
-07
6-F
eb-0
7
21
-Feb
-07
8-M
ar-0
7
23
-Mar
-07
7-A
pr-
07
22
-Ap
r-0
7
7-M
ay-0
7
22
-May
-07
6-J
un
-07
21
-Ju
n-0
7
6-J
ul-0
7
21
-Ju
l-07
5-A
ug
-07
20
-Au
g-0
7
SK/SK Energy BlendedDoosan Heavy to Daelim IndMegastudy to SECNHNHiteKOSPI200Equal Weight Return of <DWS Focus List>
(%)
-5
0
5
10
15
20
25
30
35
40
8-D
ec-0
6
23
-Dec
-06
7-J
an
-07
22
-Ja
n-0
7
6-F
eb-0
7
21
-Feb
-07
8-M
ar-
07
23
-Ma
r-0
7
7-A
pr-
07
22
-Ap
r-0
7
7-M
ay-
07
22
-Ma
y-0
7
6-J
un
-07
21
-Ju
n-0
7
6-J
ul-0
7
21
-Ju
l-07
5-A
ug
-07
20
-Au
g-0
7
-10
0
10
20
30
40
50
60
Incremental Return since Portfolio Changes (%, LHS)(Theoretical) Return ex. Portfolio Change since May 10 (%, RHS)Cumulative Return of L/S Strategy: DWS Focus List - KOSPI200 (%, RHS)
SECTOR/BOTTOM-UP STRATEGY <DWS> Focus List: Source of Alpha
31: Performance of Members of <DWS> Focus List 32: Portfolio Changes Have Been Timely and Optimal
Source: DWS Source: DWS
As of August 20, <DWS Focus List> posted excess return of 48.1% over KOSPI200 since December 8, 2006. As per my previous <Market Edge> on May 10, Doosan Heavy (profit–take at/over W80,000) was replaced by Daelim Industrial Co, and Megastudy (profit-take at/over W180,000) was replaced by Samsung Electronics. As shown in chart 32, these “relative value” replacements worked out extremely well and added another 25.3 percentage points over the last 3 months since the changes. The portfolio’s sharp ratio stands at 2.59.
The undiversified <Focus List> will be designed to maintain a correlation coefficient of about 0.85~0.95 against KOSPI200 going forward, so that it has a predetermined range of monthly drawdown. Based on the stochastic density estimate, the portfolio currently has a monthly drawdown parameter of 4~8%, which I deem to be tolerable, if it gets caught in the wrong direction.
The portfolio has a very little bias toward Chinese growth factors, which is reflective of the investment thesis enumerated in this report and indeed the main reason for the extra returns over the last 3 months. SK Corp and SK Energy are two names that should have China-premium embedded in their share prices.
Aside from China-premium, SK Energy may not fit my overall macro factor strategy, giving much weight to higher oil price, but I believe it has a number of firm-specific factors that support a further re-rating, in addition to the inherently high energy intensity of Korea Inc. The company’s stock price might be pressed to correct over the short term, but should continue to thrive on long-term growth on a relative value basis versus the broad market.
Other companies (Daelim Industrial, SEC, NHN, and Hite) still offer a very attractive value on a relative value basis. NHN may be near the upper range of its central value, but there is still a strong momentum for the company’s earnings visibility. Given a little earnings-related risk, I plan to ride the horse as far as it will take me. We are adding KB (060000.KS) and Samsung SDI (006400.KS) on an equal-weight basis when their prices are right.
19
DWS Market Edge KOREA / TACTICAL STRATEGY
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
FQ
2 2
00
4
FQ
3 2
00
4
FQ
4 2
00
4
FQ
1 2
00
5
FQ
2 2
00
5
FQ
3 2
00
5
FQ
4 2
00
5
FQ
1 2
00
6
FQ
2 2
00
6
FQ
3 2
00
6
FQ
4 2
00
6
FQ
1 2
00
7
FQ
2 2
00
7
FQ
3 2
00
7
FQ
4 2
00
7
FQ
1 2
00
8
FQ
2 2
00
8
FQ
3 2
00
8
FQ
4 2
00
8
Estimate Reported
KRW
-40%
-20%
0%
20%
40%
60%
80%
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
-3
-2
-1
-
1
2
3
4
Korea Tech Outperformance over KOSPI (LHS)
Purchasing Power Proxy (%, RHS)
%
Technology Stocks: Relative Value and “Factor-exposure” Call We can decompose the long-term nominal interest rate into the sum of the real yield, expected inflation, inflation premia, risk premia and tax minus liquidity premia. The short-term rate can be decomposed into real yield, inflation premia, risk premia, and tax. As such, we can estimate a crude proxy figure for purchasing power, i.e. future inflation less current inflation, absent transitory external shocks to demand and supply.
It is only fair to assume that policymakers and corporate CEOs follow and monitor this type of a factor indicator. Policy measures and corporate actions duly taken will compel consumers to respond to certain stimuli in certain ways (whether consumers realize it or not). As shown in Chart 33, my purchasing power proxy (for the US) provides a “window” for the tech sector’s relative performance over the broad market in Korea.
33: Why It Makes Sense to Buy Into IT Shares Now… 34: Consensus EPS Estimate for Samsung Electronics
Source: Bloomberg, DWS Source: Bloomberg
The tech sector in Korea is mainly comprised of consumer electronic goods makers. Electronic goods are highly discretionary consumer goods - sales patterns are heavily dependent on prices. We believe that consumer electronic goods companies that have suffered from the loss of pricing power for years will slowly, but surely, regain their pricing power from 2009 and onward. Qualitatively, I believe that retirees in the US and Japan will begin buying household electronic goods, among which display devices and broad-band connectivity will be the most notable items. Demographics aside, I expect that the “on-shoring” of labor in the US will provide an additional catalyst for technology demand as well.
Some might say that it is still a year or two away. But we should not forget that the stock market is a forward-looking entity and that once the worst is over, stock prices of given companies will be responsive to a good newsflow while remaining immune to a bad one. While I don’t know the exact point in time in which the tech sector wll start recovering markedly and faring better against the broad market, I am convinced that any more downside in stock prices will be marginal, meaning I am willing to trade the cost of capital for holding stocks with low transaction and slippage costs available at currently falling prices. Given that SEC’s earnings are expected to improve in 2008, and its stocks are better protected from a de-levering downdraft, accumulation of shares of SEC (005930.KS) at and below KRW540,000 is a sensible move, while Samsung SDI (006400.KS) at and below KRW60,000 is a reasonable long-term buy too.
20
DWS Market Edge KOREA / TACTICAL STRATEGY
-2,000
-1,000
-
1,000
2,000
3,000
4,000
5,000F
Q1
20
04
FQ
2 2
00
4
FQ
3 2
00
4
FQ
4 2
00
4
FQ
1 2
00
5
FQ
2 2
00
5
FQ
3 2
00
5
FQ
4 2
00
5
FQ
1 2
00
6
FQ
2 2
00
6
FQ
3 2
00
6
FQ
4 2
00
6
FQ
1 2
00
7
FQ
2 2
00
7
FQ
3 2
00
7
FQ
4 2
00
7
FQ
1 2
00
8
FQ
2 2
00
8
FQ
3 2
00
8
FQ
4 2
00
8
Estimate Reported
KRW
Banking Stocks: Long-Term Relative Value Call Banking stocks in Korea have taken a big hit lately from the US subprime debacle. The KOSPI Banks index has underperformed KOSPI200 by about -13% in 2007 and was the third worst performing sector, bettering only Communication Services and Electricity and Gas. The index is trading at a very humble 8.2X the 2007 earnings estimate. I believe that values are being built into the current correction, and banking stocks are starting to become very attractive for long-term purchase.
The subprime debacle in the US, while having a psychological impact, is not causing a direct, material damage to Korean banks. Korean banking stocks are clearly uncorrelated with US banking stocks. KOSPI Banks index has a correlation of 0.032 with S&P500 Investment Banks index and -0.080 with S&P500 Diversified Banks index since 2006.
Some people have raised concern about a Korean version of the “subprime” crisis, citing the rapid growth of the mortgage market in Korea. However, based on our analysis, we have arrived at the conclusion that the mortgage market is in no way near its peak stage despite the speed of loan growth has indeed picked up in 2006, after slowdown in two preceding years.
35: Mortgages Loans Have Not Increased As Much Since 2002 36: Consensus EPS Estimate for KB
Source: BoK Source: Bloomberg
As of the end-May 2007, aggregate mortgage loans total about KRW220tril. Given that the average size of a mortgage loan in metropolitan areas is estimated at KRW125mil and average household income is about KRW3.4mil per month, an interest payment burden is only about 20% of monthly income.
The total value of residential properties in Korea, estimated at KRW1,550tril, easily covers the total amount of outstanding credits to households, mortgage loans included, currently at KRW590tril. Not only that, the average household is comfortably net cash unlike the average US household, which is in net debt. Based on our estimate, the average interest rate charged on loans would have to go to, say, 12% for the households’ excess monthly cash flow to be exhausted.
The mortgage market in Korea is structurally set on sound fundamentals and hence, intrinsically different from the US mortgage market. There aren’t really any types of subprime mortgages in Korea, which, in the case of ARM (adjustable-rate mortgages), are reset after the indicated amount of time, often from a very low teaser rate to much higher rate – with average increase of 35%. Further, the LTV (loan-to-value) ratio of mutual savings banks in Korea that lend subprime loans is about 55~60% compared to 85~90% for the US subprime mortgage lenders.
-2
-1
0
1
2
3
4
5
6
7
Jan
-01
Jul-0
1
Jan
-02
Jul-0
2
Jan
-03
Jul-0
3
Jan
-04
Jul-0
4
Jan
-05
Jul-0
5
Jan
-06
Jul-0
6
Jan
-07
Jul-0
7
0
1
2
3
4
5
6
7
Monthly Change in Mortgage Loan Balance (KRWtril, LHS)
3 Month CD Rate (%, RHS)
21
DWS Market Edge KOREA / TACTICAL STRATEGY
Mortgage loans proliferated during 2001~2002 in Korea. Outstanding balance on mortgage loans increased by KRW34tril and KRW46tril in 2001 and 2002, respectively, when the benchmark 3-month CD rate was in the range of 4.5~5%, not too far off the current level. There have not been many signs of financial stress in the balance sheet of the average household since then. The real estate market in Korea, with a few exceptions, appears to be erected with a deep root in solid fundamentals. The market for mortgage loans in Korea is still in its growth phase, and a Korean version of the subprime crisis is an unrealistic, distant proposition - against a very strong balance sheet of the average household - for now.
I recommend KB (060000.KS) as a long-term buy at or under KRW70,000.
22
IMPORTANT NOTICES Equity Research for International Investors (ERII)
As of August 21, 2007, Daewoo Securities Co., Ltd. issued equity-linked warrants with SK, Samsung Electronics, Samsung SDI, and Kookmin Bank as an underlying asset and has been acting as a liquidity provider for SK, Samsung Electronics, Samsung SDI, and Kookmin Bank, and other than this, Daewoo has no other special interests in the covered companies.
This report has not been distributed to any third party including institutional investors and other interest groups prior to the public release of this report.
Analyst of the subject company or member of the analyst's household does not have any financial interest in the securities of the subject company and the nature of the financial interest (including without limitation, whether it consists of any option, right, warrant, future, long or short position)
This report reflects the sole opinion of the analyst (Alfred Park) without any external influences by third parties
Daewoo Securities Co., Ltd. may have managed or co-managed a public offering of securities for the subject company, or received compensation for investment banking services from the subject company in the past 12 months.
This report has been provided by the ERII (Equity Research for International Investors) department of Daewoo Securities Co., Ltd. Daewoo Securities ERII is run independently of the research division of Daewoo Securities Co., Ltd. The stock ratings, target prices, estimates and overall viewpoints of ERII may differ from the research division of Daewoo Securities. This report must be viewed as Daewoo Securities ERII's independent opinion and must not be interpreted by any means as an official viewpoint of the research division of Daewoo Securities Co., Ltd. Daewoo Securities ERII was established to service international institutional investors although the reports are released publicly. Investors can access Daewoo Securities ERII's research through Firstcall, Daewoo research direct (www.bestez.com), Multex and Bloomberg (DWIR).
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