Oct 20, 2023 Equities

A Korean sneak preview

Can global central banks really engineer a smooth end after a turbulent pandemic ride? South Korea’s property markets may offer some fascinating glimpses at the future.

What next if and when global central banks finally stop raising, and perhaps even start cutting interest rates? One way to answer this is to look at South Korea, specifically its real estate market, which has had a bit of a head start. The country was among the first major economies to raise interest rates during the pandemic. In part, that reflected concerns not just about rising inflation, but also financial-stability risk posed by soaring asset values and high domestic household debt levels.[1] Since January 2023, the Bank of Korea has kept the base rate at 3.5%, with a potential rate cut expected in 2024. Amidst surging interest rates and weakening external demand, South Korea's economy has notably weakened since the start of 2023.

All of this has had predictable results for its currency, once the U.S. Federal Reserve (Fed) also started hiking rates. Following the rapid expansion of bond yield spreads between the U.S. and South Korea, the South Korean won (KRW) fell 21% against the U.S. dollar year-on-year by September 2023. Since then, the Korean won regained some ground, though still down by 12% compared to two years ago. As our Chart of the Week shows, high inflation, a weakening economy and turbulences in foreign exchange markets have also weighed on Korean equities, with the benchmark KOSPI index hovering at around 2,500 over the last 12 months, after plummeting from a record high of 3,300 in June 2021.

Won, not lost? South Korean equities and its currency against the U.S. dollar.

Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 10/18/23

With inflation moderating and labor market conditions remaining resilient, we believe there is now at least some reason for cautious optimism. One among several wild cards, we believe, are South Korean property markets. This is a niche topic, even for global investors in listed real estate. As in other areas, numerous legal and practical obstacles limit the choices for foreigners.[2]

“One consequence of low liquidity paired with rising interest rates has been that South Korean REITs have underperformed global peers with prices down 30% from the end of 2021,” explains Koichiro Obu, Head of Real Estate Research, Asia Pacific, at DWS. “This is somewhat curious when you consider that, Seoul’s vibrant office market has stood out amid widespread global woes. Average office vacancy rates were just 2.7% in the second quarter, the lowest level in the last 15 years.[3]

South Korea’s retail, and hotel sectors also show robust market momentum underpinned by solid fundamentals. Only the logistics sector, a star performer during the pandemic saw rising vacancy rates due to the incoming supply wave. This suggests we could potentially see commercial real estate capital values bottoming out in 2024.”

If so, it should provide a historically rare but perhaps early example of wider trends: central bankers proving they are able to engineer a smooth end to a turbulent ride. Of course, plenty could still go wrong along the way. “Trade activity has faced headwinds from weaker growth in China, the country's largest trade partner, and its semiconductor sector struggling from U.S. restrictions on China’s tech sector. It is too early to tell whether recent comparatively strong data out of China marks a turnaround”, argues Elke Speidel-Walz, Chief Economist Emerging Markets at DWS. Either way, we believe South Korea remains worth watching in coming months.  

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1. South Korea’s economy threatens to become like Japan’s (economist.com)

2. At least for now, such obstacles continue to relegate South Korean equities to emerging market status, to the chagrin of its government, not to mention many citizens. South Korea has had enough of being called an emerging market (economist.com); also see: Korea fails to land on MSCI's developed market index (joins.com)

3. Source: Avison Young and DWS Investment GmbH as of September 2023

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