Asian tigers: South Korea and Taiwan

Key takeaways:

• South Korea and Taiwan strongly outperformed most of their peers quarter-to-date.
• A strong US dollar and receding energy prices support solid macroeconomic fundamentals of export-oriented economies.
• Optimism is further spurred by what we consider attractive valuations, positive outlook for the chip and materials industries despite the current demand slump.
• Long-term supply-chain realignments could benefit both economies.

South Korean and Taiwan equities have been among the best performing globally thus far in the fourth quarter of 2022, and we believe for good reason. While their Asian Tiger peers Singapore and Hong Kong returned between 2% and 9% during the quarter, South Korea and Taiwan are up 17% and 12%, respectively.¹ Broad emerging markets have risen just under 5%.²

The primary factors driving the recent surge in relative performance appear to be:

• Investor bargain hunting
• Semiconductor chips and electric vehicles (EV) market optimism
• Strong fundamentals

How sustainable is this trend, and is the time ripe for investors to take a closer look? Let’s consider each element driving returns.

1. Bargain hunting

Both markets have recently seen some of their worst drawdowns in at least two decades. As of late November, the FTSE South Korea Capped Index is down 40% from its all-time-high (ATH), while Taiwan’s index has declined 28%. These returns are considerably less than during the Global Financial Crisis, but eclipse bear markets such as the bursting of the Chinese equity bubble in 2015-2016 and the 2018 US-China trade war. Additionally, for Taiwan, its return also surpasses the spring 2020 COVID-19 crash.

On its own, this development wouldn’t be sufficient reason for us to consider these markets attractively valued. However, even with the prospects of a possible global recession—which is not our base case—we believe comparatively low valuations can offer a buffer if earnings expectations are lowered. While multiples have already retreated from their highs, US markets are still trading at an estimated forward price-to-earnings ratio (P/E) of 18, while South Korea and Taiwan are at 10x and 11x. In our analysis, the discount is even more striking in price-to-book ratio (P/B) terms.³

In perhaps the most notable example of potential bargain hunting, Warren Buffett’s Berkshire Hathaway recently reported a new US$5 billion stake in Taiwan Semiconductor Manufacturing Co. (TSMC). The news came just weeks after the United States set new restrictions on sales of advanced semiconductors to China. The move is primarily intended to hamper Chinese technology capabilities, including military applications of artificial intelligence (AI), but it is also a further step in the “decoupling” of supply chains from China more broadly. The increasingly popular “China plus one” strategy could allow South Korea and Taiwan to pick up some business over the medium term. The recent passage of the US Inflation Reduction Act, which aims to generate investments in domestic manufacturing and encourage procurement of critical supplies from free-trade partners, may have a similar effect—provided Taiwanese and South Korean manufacturers manage to receive the extension on federal tax credits, for which they are lobbying.

Semiconductor chip manufacturing notoriously poses sky-high barriers to entry, driven by enormous capital requirements and technological know-how, maintaining the dominance of the industry’s few major players. TSMC has recently announced preliminary plans to produce advanced chips at its new factory in the western United States (Arizona), though the United States’ global chip manufacturing share remained a mere 12% as of last year (vs. close to 40% in 1990).⁴

2. Semiconductor and EV market optimism

Bargain hunting can benefit investors in the short term, but for medium- and longer-term outlooks, quality is worth assessing. South Korean and Taiwanese equity markets, both dominant in the information technology sector (namely semiconductors), are also heavily composed of materials and industrials holdings—with weightings currently ranging between 14% and 23%.⁵

Both markets host leading, highly profitable companies with wide moats and have built a robust ecosystem around them. Taiwanese companies, for example, command some 11% of the world’s liner fleet.⁶ Given that 80% to 90% of global trade is carried by sea, that is a crucial advantage in times of disrupted supply chains, especially for an export-heavy economy.

Semiconductors: There is some timid optimism that we are nearing the bottom of the chips cycle. After a near-unprecedented chip shortage during 2020 and 2021, this year has seen the squeeze turn into a glut. Over the summer, stockpiles soared and consequently some leading firms have cut planned capital expenditures by as much as 50% for 2023.⁷ At the same time, we are confident that capacity reductions today can morph into the price hikes of tomorrow—as has so often been the case in an industry known for its pronounced cyclicality. Generally speaking, we believe that if the semiconductor inventory cycle peaks around the turn of the year, the technology sector may have already reached its lows.

Industrials/Materials: With the world shifting more quickly toward EV, battery demand has soared in tandem. McKinsey forecasts the market for battery cells to grow, on average, by more than 20% per year until 2030.⁸ This bodes well for South Korea’s petrochemical heavyweights, one of which is spending billions to accelerate the sustainable expansion of its battery material production lines, including a recently announced plan to construct a manufacturing facility for EV components in the southern United States (Tennessee).

3. Strong fundamentals

Lastly, we note that both South Korea and Taiwan are in comparatively enviable positions when it comes to macroeconomic fundamentals. As export-oriented nations, they tend to benefit from weaker currencies. While the US dollar strength came to a sudden halt as of late, both the South Korean won (KRW) and Taiwan dollar (TWD) are still significantly cheaper compared to levels seen at the start of the year. Among the more negative effects of a weak currency in either market is the fact that energy imports become more expensive. But with energy commodities down almost a fifth from their June highs, some relief in budgets may appear.

With debt-to-gross domestic product (GDP) ratios of 30% in Taiwan and just under 50% in South Korea, both countries remain well positioned to withstand a global economic downturn in our view. While debt has grown, so have currency reserves that are hovering near all-time highs.

On an annual basis, South Korea’s economy is still growing at close to 3%, despite a weak third quarter with near zero growth. However, while forecasts for 2% growth next year may seem disappointing in an emerging market context, we believe South Korea should still outgrow most advanced economies. The country’s GDP-per-capita is more comparable to developed, not developing, markets.

The country can also benefit from a notably high rate of productivity that serves its “agritech” innovation well, considering still looming food security issues. South Korea has ranked highest in government research and development (R&D) funding for agricultural sciences among OECD nations.⁹ It also boasts impressive government blockchain initiatives, including plans for blockchain-powered networks to improve transparent food supply chains as well as another game-changer—new blockchain-based digital IDs to be implanted in smartphones and replace existing credentials. Such IDs could potentially transform business and government efficiencies and vastly benefit South Korea’s digital economic foundation and metaverse buildout.¹⁰

In conclusion, we think that despite the elevated risks—including geopolitical headwinds—of single-county allocations, overweighting Korean and Taiwanese equities today may benefit investor portfolios given what we believe to be moderate valuations that may be viewed as attractively priced. The Asia region’s standing as the global driver of middle-class growth should also continue to present long-term opportunities, particularly given the world’s imperative green energy transition and technological advancements.

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1. Source: Bloomberg, 2022.

2. Ibid.

3. Source: Bloomberg, 2022. The price-to-earnings ratio is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). The price-to-book (P/B) ratio measures the market’s valuation of a company relative to its book value; it’s used by value investors to identify potential investments.

4. Source: Semiconductor Industry Association, “2021 State of the U.S. Semiconductor Industry,” September 2021.

5. Source: FTSE Russell, November 22, 2022.

6. Source: Statista, “Leading ship operator’s share of the world liner fleet as of October, 2022,” 2022.

7. Source: Reuters, “In ‘unprecedented’ global chip slump, SK Hynix to halve investment as recession looms,” October 26, 2022.

8. https://www.mckinsey.com/industries/electric-power-and-natural-gas/our-insights/capturing-the-battery-value-chain-opportunity

9. Source: World Bank, “Digital Ag Series: Fostering Digital Agriculture Ecosystems and Smart Farming in Korea – Case of Smart Farm Innovation Valleys, World Bank Group,” 2021.

10. Source: Korea Post, “RDA shares ‘K-agricultural tech’ with developing countries,” 2022.