[Financial Planning for the 100-Year Life] Increase Bond and Stock Allocation, Watch Real Estate Carefully

Bond Bubble Bursts and KOSPI Undervalued
Housing Prices Still Overvalued by 30-40%

[Asia Economy] Bubbles in the bond and stock markets are largely being resolved. However, the housing market bubble appears to be in the early stages of deflation.

In overcoming the 2008 global financial crisis and the 2020 COVID-19 crisis, the Bank of Korea significantly lowered interest rates and greatly increased the money supply. As a result, a bubble first emerged in the bond market. The yield on Korea's 10-year government bonds hit an all-time low of 1.26% in March 2020. From 2000 to 2021, the average 10-year government bond yield was 3.9%, which was lower than the nominal GDP growth rate of 5.7%. According to my estimates, Korea's current potential nominal growth rate is about 3%. However, in October last year, the yield surged to 4.63% before falling to 3.49% in November. This reflects the process of government bond yields moving toward an appropriate level.

Bubbles are also deflating in the stock market. The economic variable most correlated with the KOSPI is the average daily export amount. Statistical analysis since 2005 shows a very high correlation coefficient of 0.86 between these two variables. In April last year, the KOSPI overvalued the average daily export amount by 41%. However, after surpassing 3300, the KOSPI recently fell to 2155, entering an undervalued range. As of September last year, the KOSPI undervalued the average daily export amount by 22%. Even considering liquidity, the KOSPI has fallen below an appropriate level.

Broad money supply (M2) is one of the representative indicators of liquidity. From January 2005 to June 2022, the proportion of the KOSPI market capitalization relative to M2 averaged 58%. In June last year, this proportion rose to 68%. However, in September this year, it was 46%, which is 22% lower than the historical average.

According to the monthly housing price trends published by KB Kookmin Bank, apartment prices in all cities rose 75% from the low point in March 2009 to June 2022. However, starting from Daegu in June 2022, the downward trend in apartment prices has spread to Gangnam, Seoul. The issue lies in the duration and magnitude of the decline. Indicators used to assess the housing price bubble include consumer prices, income, and monthly rent indices. From March 2009 to June 2022, overall city housing prices rose 60%, and apartment prices rose 75%. Considering that consumer prices rose 29% during the same period, it is clear that housing prices increased at a much faster pace than inflation.

Next, the indicator used to judge whether housing prices are overvalued is the ‘PIR’ (Price to Income Ratio = Housing Price / Household Income). At the end of 2021, the nationwide PIR was 7.6, which was 39.3% higher than the 2008?2021 average of 5.5. The situation is particularly severe in Seoul. For median-income households in Seoul in 2021, the PIR was 19.0. Although the Seoul PIR decreased to 17.7 in June 2022, it remains 46.3% higher than the 2008?2021 average of 12.0.

Finally, the indicator used to assess the housing price bubble is the ‘PRR’ (Price to Rent Ratio = Housing Price / Housing Rent), which shows how much housing prices have risen relative to monthly rent. In June 2022, the nationwide PRR was 131, exceeding the long-term average (1986?2021) of 100 by 31%. Apartment prices, in particular, were overvalued by 59% compared to the long-term average.

Evaluating consumer prices, income, and housing rent, housing prices are overvalued by about 30?40%. This suggests that housing prices may decline. This trend in asset prices has important implications for household asset allocation. First, the proportion of bonds and stocks, where bubbles have been deflated, should be increased. There is no need to rush to expand the real estate proportion.

Kim Young-ik, Adjunct Professor, Graduate School of Economics, Sogang University

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