[Lee Jong-woo's Economic Insights] Economic Recovery and COVID-19 Overcoming Boosts... May Become Ineffective Against Soaring Stock Prices

The Market's Power Turning Challenges Like Returning Foreigners and Vaccine Development into Opportunities
Driving KOSPI to an All-Time High
Rise Due to Supply and Demand, but Short-Lived Vitality
Before Singing the Hope Song of Economic Recovery Stocks, Need to Reexamine Interest Rate Hikes and More

The KOSPI has surpassed its all-time high. Despite burdens such as the third wave of the novel coronavirus infection (COVID-19), it could not suppress the surging market energy. The market says the U.S. presidential election was the decisive trigger for the stock price rise, but the election result was the worst among the various scenarios assumed in advance. Still, the stock price rose, showing the market's power turning bad news into good news.

The market identifies four reasons for the stock price increase. First, the trading participants changed. In November, foreigners recorded net purchases exceeding 7 trillion won. After showing signs of change in October, the scale of buying suddenly increased. From the perspective of the stock market, which had relied on individual investors as a single entity, this was a significant reinforcement. The fact that foreign buying was concentrated on stocks with a large influence on the KOSPI was also a factor driving up stock prices. Semiconductors are a representative example; as foreigners focused on buying Samsung Electronics, not only that stock but also related surrounding stocks with similarities followed suit.

Second is vaccine development. Starting with Pfizer, Moderna, the UK's AstraZeneca, and even Russian companies have introduced effective vaccines. Since they have applied for emergency use authorization from the U.S. Food and Drug Administration (FDA), vaccinations are expected to be carried out quickly. Vaccination means the de facto end of COVID-19. Before the COVID-19 outbreak, the smallpox vaccine was the fastest developed vaccine in history, taking four years from initial experiments to vaccination. This time, the development period is only one-fifth of that for the smallpox vaccine, so there is a possibility of side effects during the vaccination process due to the short development time. The issue is the severity of side effects. If not serious, it will not be a major problem. There is no alternative to suppress COVID-19 other than vaccines.

These two factors will lose their influence in the market over time. Being one-time events, they are not materials that can drive stock prices in the long term. Past cases show that foreigners have never sustained net purchases equivalent to 0.5% of market capitalization for more than three months. It should also be considered that the impact on the market decreases compared to the past when the same amount of money is invested at higher stock prices. Rises due to supply and demand have a short lifespan. Right after the foreign exchange crisis, when foreigners were actively buying Korean stocks, they purchased stocks equivalent to 3% of market capitalization over three months. Converted to current market capitalization, that corresponds to 60 trillion won. Stock prices rose nearly 20% while foreigners were buying, then returned to their original state after purchases ended. Vaccine development also does not have a lasting impact on the market. The success of vaccine development at the end of the year was already expected in July when phase 3 clinical trials began. Therefore, its influence will quickly fade, and additional effects are hard to expect.

The third is expectations for economic recovery. Liquidity and vaccine development are temporary factors, but economic recovery is an important factor that fundamentally changes the market. Both domestic and international economies entered a recovery phase from the second quarter low. Considering that in the past, once the economy changed direction, it continued to rise for at least one and a half years, expansion is likely to continue until next year. Various forecasting institutions expect our economy to grow in the 3% range and the world economy in the 5% range next year. Recovery is already within sight. The U.S. Institute for Supply Management (ISM) manufacturing index has risen to pre-COVID-19 peak levels. The new orders index is much higher than that. Employment has also improved. The U.S. unemployment rate dropped to 6.9%, and weekly new unemployment claims decreased to 700,000. South Korea's economy is also recovering rapidly, centered on exports.

The last is low interest rates. At the beginning of the COVID-19 outbreak, central banks in advanced countries focused on lowering interest rates and supplying ample liquidity. Thanks to that, interest rates remain very low, making it easy to borrow money for investment. When market interest rates drop from 4% to 1%, one can incur four times the debt while paying the same interest, creating a desire to borrow for investment. This principle is being applied to the stock market after COVID-19.

The problem is stock prices. Even if the economy recovers and interest rates are low, if stock prices are too high, the market cannot exert power. This is because high stock prices absorb good news such as expectations for economic recovery. The same applies to interest rates. If stock prices fall, no matter how low the interest rate is for borrowing funds, losses cannot be avoided.

The forecast that the economy would make a V-shaped rebound once the COVID-19 situation was under control was already made in March. Considering this, it seems appropriate to view that the third-quarter growth recovery and even the fourth-quarter outlook have already been reflected in stock prices. The problem is next year. The economy is expected to temporarily slow down in the first half due to the third wave of COVID-19. With vaccine development completed, it should also be considered that after the U.S.'s fifth economic stimulus package, no further stimulus measures may be introduced worldwide. This is because there is no reason to issue stimulus measures at the cost when COVID-19 is expected to disappear and the economy to normalize in the second half of next year. On the other hand, interest rates will bottom out and rise. The new U.S. administration will need to increase bond issuance to expand spending, which will be a factor for rising interest rates. Currently, the yield on the U.S. 10-year Treasury bond remains around 0.9%, but if bond issuance increases, this figure could rise to 1.3%. In this situation, the core structure of stock price rises?low interest rates and liquidity supply?will be shaken. For reference, a 1.3% yield on U.S. Treasury bonds is the lowest market interest rate level before the Federal Reserve (Fed) cut rates prior to the COVID-19 outbreak.

It is natural for investors to be excited as stock prices rise relentlessly. It is also common for optimistic forecasts to gain strength as stock prices rise. However, one should not be swept away blindly. Stock prices have risen more than 80% from the COVID-19 low in just eight months. Except for right after the foreign exchange crisis and the 9/11 terrorist attacks, stock prices have never risen this quickly. This means the burden on stock prices has increased accordingly. Just as low prices in March served as a driving force to overcome fears of COVID-19 and economic collapse, the good news of economic recovery and overcoming COVID-19 may not be effective due to high prices. In the financial market, unexpected outcomes often occur, as was the case right after COVID-19.

This content was produced with the assistance of AI translation services.