Investment Adventures in Emerging Markets

Update on Korea

North Korea engaged South Korea in an artillery duel near their borders on Tuesday, November 23, sparking off a fresh round of tensions on the Korean Peninsula. Regardless of the motivations behind North Korea’s latest transgression, this incident is more serious than its previous provocations because it was the first artillery attack on the South’s territory since the war in 1950 and because the attack included fatalities to South Korean civilians.

This incident will see deepening geo-political tensions between the North and South and is likely to be prolonged. However, the crisis is unlikely to escalate further as North Korea does not have the capability to implement and maintain a war without the support of its main ally, China. China is currently the primary supplier of fuel consumed in North Korea. The relationship between the pair has been difficult as China does not agree with North Korea’s provocative actions to date. Also, the South Korean government is trying to resolve the situation peacefully.  In South Korea, there are some people who favor a soft line with the North.  However, the recent event is probably going to weaken these views going forward thus enabling the South Korean government to take a much harder stance.

As for the impact on the stock market, past incidents that have resulted in stock market corrections were short-lived. Thus, we believe it should not be any different this time. However, on the currency front, the Korean Won (KRW) was weakened and the Credit Default Swap spread of South Korea expanded sharply. The Korea Composite Stock Price Index (KOSPI) fell by more than 2% at the opening on 24 November[1] but since has recovered and ended the day relatively unchanged. Year-to-date, the market is up 17% in US$ terms.[2] Assuming that the situation improves and does not escalate into a larger scale military confrontation, the financial market may stabilize quickly based on past experiences following the impact of North Korea’s actions.  For instance, the Korean market recovered shortly after North Korea’s nuclear tests of 2006 and 2009.

Investors are aware of the ever present geopolitical risk on the Korean Peninsula and this is reflected in the on-going valuation discount of the Korean market, as compared to the rest of emerging markets.  In the aftermath of this crisis, discounts on the Korean market could be even more significant than before in the short-term, but could restore to its normal level as the situation stabilizes.  The KOSPI began to recover just within one hour of trading and the KRW began to appreciate after weakening the night following the attacks.

Our investment philosophy has always been to focus on the long-term opportunities and prospects, looking beyond the short-term market distortions or ‘noise’. We remain positive on the outlook for South Korea as the country has continued its growth despite the geopolitical concerns.

[1] Source: KOSPI, as of November 24, 2010.

[2] Source: KOSPI, as of November 25, 2010.

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