[The Editors' Verdict] Cloudy Stock Market Outlook, Numerous Risk Factors Remain

The stock market outlook this year seems more likely to be cloudy than clear. While some stocks in Europe and other regions that did not rise last year are increasing, the U.S., China, and South Korea are either declining or not showing strong momentum. Why is the market struggling like this? Let's examine it from the perspective of the fair stock price formula, which divides corporate earnings by ‘1 + discount rate.’

First, whether corporate earnings (the numerator) will be good or bad can be predicted through the growth rate, which can be considered a proxy indicator. According to the International Monetary Fund (IMF), the expected global growth rate this year is 4.6%, which is 1.3 percentage points lower than last year's 5.9%. Although this is better than the roughly 3% growth rate before 2019, the attractiveness of stocks in terms of corporate earnings is weaker than last year. For example, the U.S., which leads the global stock market, is expected to decline from 5.5% last year to 3.5%, China from 8.0% to 4.8%, and South Korea from 4.0% to 3.0%.

Second, the denominator ‘1 + discount rate’ represents the increase or decrease in liquidity in the financial market through changes in the discount rate. Therefore, when the discount rate, i.e., interest rates, rises, liquidity decreases, causing stock prices to fall; conversely, when the discount rate falls, liquidity increases, leading to stock price rises. The problem is that liquidity in the financial market, the denominator, is likely to shrink significantly this year due to rising interest rates. This is because of the Federal Reserve's (Fed) ongoing monetary tightening and interest rate hike statements, which have been intensifying since the end of last year. Initially, the Fed planned to end tapering around June this year and raise interest rates in the second half. However, in March, early tapering completion and three interest rate hikes (0.75%) within the year were discussed, and recently, there are even talks of monetary withdrawal measures in the financial market. At a time when corporate earnings are expected to slow, interest rate hikes and monetary withdrawal inevitably pose a considerable burden on the stock market.

The quality of the interest rate increase is also an issue. Interest rate hikes can be categorized as ‘good rate hikes,’ which occur naturally due to economic recovery leading to rising expected inflation and reflected in higher rates, and ‘bad rate hikes,’ where inflation or interest rate increases outpace economic recovery.

So, what is the quality of the U.S. interest rate hikes? Until October-November last year, the prevailing view was that U.S. inflation was a temporary phenomenon. However, with the consumer price index rising to 6.8% in November and 7.0% in December?the highest in 40 years?the mood is changing. In fact, due to aging and the spread of COVID-19, labor supply is rapidly decreasing, causing wage increases and the pass-through of labor costs to consumers, which experts assess as a structural phenomenon. If the high inflation persists for a considerable period, corporate earnings will weaken further due to increased corporate financing costs from sustained interest rate hikes, and liquidity will decrease further. The key to future stock price judgments is whether inflation will continue or stabilize, and the situation is far from easy.

If the U.S. raises interest rates, countries with a high proportion of foreign investors in their stock markets, like South Korea (34%), must also watch exchange rates as a risk factor. A stronger dollar and weaker won due to U.S. rate hikes could reduce foreign investment in Korean stocks because of potential foreign exchange losses. China, which has a close economic relationship with South Korea, also presents several risk factors to monitor this year. Although the Chinese government announced economic stimulus policies, the expected growth rate is around 5%, much lower than usual. Additionally, the real estate issues triggered by the Evergrande Group default are likely to prolong, and rising prices of raw materials and energy are constraining sensitive private investment, revealing further problems.

Jeong Yushin, Dean of the Graduate School of Technology Management, Sogang University

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