Index-Indicator Decoupling Affects Korean Stock Market

The time-honored principle of stock indices moving in tune with composite leading indicators is on shaky ground in Korea, with investors struggling to predict the direction of stock prices.

According to Mirae Asset Securities and the Bank of Korea yesterday, leading indicators meant to forecast economic trends over the next six to 12 months and stock prices, which reflect corporate business performance, moved in tandem in the past, but not so in recent months.

Leading economic indicators continued to recover from lows in November 2008, but edged down in December last year. They have since fallen 1.32 percentage points from December, clearly reflecting the decline in leading indicators.

The benchmark Korea Stock Price Index, which fell to as low as 1,550 in early February, has broken this year’s annual high.

Citing the financial crises in southern European nations and falling leading indicators as recently as early this year, pessimists had suggested that the KOSPI will fall to the 1,500 level. Yet more optimistic reports saying the index will break 2,000 have gained more ground lately.

Experts cite three major factors delinking leading economic indicators and the benchmark KOSPI index.

The biggest factor is foreign investors, who have purchased Korean stocks worth more than eight trillion won (7.17 billion U.S. dollars) since March. The brisk buying is in part due to expectations for the Korean stock market’s inclusion in Morgan Stanley Capital International’s advanced market indices and growing expectations for global recovery amid the continued rise of the Organization for Economic Cooperation and Development’s leading indicators.

The organization’s leading indicators bottomed out in February last year, later than Korean and Chinese indices did, and have since continued to recover.

Kim Seung-hyeon, head of research at Taurus Investment & Securities, said, “Considering the characteristics of the Korean stock market, which involves many exporters, the OECD’s leading indicators as well as leading economic indicators will play a key role in setting the direction of trends.”

“As the global economy continues its (recovery) stride, foreign investors are buying Korean stocks.”

Another reason for the bullish Korean stock market as cited by analysts is that leading economic indicators will only edge down due to recovery in corporate performance. Many companies posted record sales or profits in the first quarter, and analysts predict this trend will continue through the second and third quarters.

Cho Yong-joon, head of research at Shinyoung Securities in Seoul, said, “The trend of Korean stocks could remain flat rather than decline in a period of falling leading economic indicators.”

“Notably, if and when investment and employment recover and the momentum of the global economic recovery shifts from governments to the private sector, companies will post an even better performance.”

Finally, analysts also say the decline in leading indicators will slow the prediction of a delay in an interest rate hike, as countries will postpone exit strategies.

Other experts warn against excessively positive outlooks, however, saying forecasts for corporate performance are apt to be influenced by “positive bias.” If the Greek economic crisis and countries’ exit strategies resurface, they could wield significant influence, they say.

Cho Ik-jae, head of research at Hi Investment & Securities, said “Recovering global investment and employment have helped stave off deteriorating leading economic indicators in Korea, but over the long-term, the two are destined to move in tandem. Investors are advised to take a cautious approach in investment and should check corporate performance.”

artemes@donga.com