Hi Investment & Securities "2023 Year Starts Strong Then Slows... January Rebound Continues"

Stock Market Driven by China's COVID-19 Policy Lift and US Tightening End Expectations
"KOSPI Upper Range Expected at 2600"

[Image source=Yonhap News]

[Asia Economy Reporter Hwang Yoon-joo] Hi Investment & Securities forecasted the stock market this year as 'rising early and falling later.' Lee Woong-chan, a researcher at Hi Investment & Securities, stated in his recent report titled '2023 is Rising Early and Falling Later (2): Six Questions on the Rising Early and Falling Later Outlook' that the Korean stock market, which rebounded in January, still has room to rise. Since the domestic stock market's rise is driven by China's lifting of COVID-19 restrictions and expectations of the end of U.S. interest rate hikes, he expects stocks related to China's economic momentum and large semiconductor companies to increase. He also recommended paying attention to value stocks. Below is the full content of the report.

1. Why did stock prices rise from the beginning of the year?

The researcher identified two main factors driving the domestic stock market's rise: ▲China's lifting of COVID-19 restrictions ▲the end of U.S. interest rate hikes. China's COVID-19 restrictions, which were expected to be lifted gradually, proceeded faster than anticipated after Xi Jinping's third term began.

At the end of last year, despite price stability, the Federal Reserve continued its rate hike stance citing the employment market. However, this year, calling it a year of disinflation, the Fed signaled a slowdown, stating that if prices stabilize, the February rate hike would be limited to 25 basis points (1bp=0.01 percentage points). Since the Fed is now prioritizing prices over employment again, it is believed that the Fed's decision-making has already been somewhat settled.

With policy changes from the Fed and China, global financial markets changed direction. The U.S. dollar peaked (peaked strong dollar then declined), and long-term interest rates stabilized downward. Stock markets outside the U.S. showed strength. Additionally, Europe's warm weather and the Bank of Japan's monetary policy changes led to the strengthening of the euro and yen. Structural inflation factors such as U.S. reshoring, labor shortages, and the new Cold War between the U.S., China, and Europe remain. However, the first half of this year is a period when cyclical economic factors outweigh structural ones. Prices have peaked, and the base effect will continue until the third quarter.

China and Europe's economies have begun to rebound. Although the U.S. economy's weakness raises concerns about a recession, stabilizing prices and easing Fed tensions could be positive for the stock market. Thus, stock prices rose from the beginning of the year because it was reasonable for them to do so.

2. Is the January rebound the end of the rise?

Since the market has reached a technical resistance level, it might take a breather. Some markets, such as European stock markets, have already rebounded significantly, reaching levels before the tightening at the end of 2021, so their upside potential is expected to be limited. Time is needed to digest January's sharp rise.

However, the KOSPI index fell sharply to pre-COVID levels and has only slightly rebounded. The large drop, still negative sentiment, cautious betting, and positions concentrated in defensive stocks suggest that there is still room for the stock market to rise.

The global financial market will gradually shift its focus from China's reopening to the easing effects of global liquidity. While U.S. interest rate hikes are nearing their end, the Bank of Korea has already stopped raising rates. Other countries like Europe and Australia are also expected to halt rate hikes. The Financial Conditions Index, which indicates liquidity conditions, has been easing since the end of last year, and global credit spreads, which surged last year, have stabilized downward worldwide. Now, there are no Korea Electric Power Corporation bonds with yields above 4%.

Since the Fed must actually stop raising rates, Fed officials may become more sensitive to stock market rises and may make more hawkish statements. The market may experience one or two shocks, and first-quarter earnings announcements could be problematic. However, maintaining a rate hike stance during an economic downturn and price stabilization phase is difficult.

Liquidity is easing, year-over-year inflation indicators are falling, China's and Europe's economies are good, and although the U.S. economy is weak, with rate hikes stopping and the stock market rebounding, the speed of decline will be limited. As the U.S. economy remains ambiguous, confirming economic momentum outside the U.S. will likely lead to some talking about a goldilocks scenario in the second quarter.

3. How high can the goldilocks in Q2 rise?

After the February Federal Open Market Committee (FOMC) meeting and the earnings season, the stock market is expected to seek further gains. Inflation is expected to decrease, and China's economy is anticipated to recover. Additional positive events that could be imagined include China's announcement of easing policies, a reduction in geopolitical risks between Russia and China, and confirmation of the U.S. economic bottom.

China's economy is expected to show improvement in indicators after March and into the second quarter. Attention is focused on potential policy changes at the March Two Sessions, real estate easing policies, and possible reserve requirement ratio cuts.

The U.S. economic decline, which started in real estate, is now seeing interest rates stabilize, so it remains to be seen whether the decline will stop starting from real estate. The 30-year mortgage rate has already fallen significantly from its peak, and the National Association of Home Builders (NAHB) leading index has begun to rebound.

How far can the domestic stock market rise? Technically, a strong resistance level is seen around 2500?2550 points. Valuation-wise, it is difficult to discuss appropriate levels due to a large expected earnings decline this year. Instead, trust in next year's earnings will be more important. If semiconductor earnings recovery can be trusted, applying a P/E ratio of 10 to next year's earnings yields about 2650 points, roughly similar to the technical resistance level.

However, the index is not expected to show an ultra-strong rally. The upper bound of the stock market is suggested to be around 2600 points. It is anticipated that a surprisingly strong market may appear in the first half, but if consensus turns optimistic entering the second half, the market may not be as strong thereafter.

4. What will rise? Which sectors and styles will rise?

China's economic momentum will be the first beneficiary. Chinese consumer goods have already risen once, and the upward trend is spreading to IT hardware and materials. Our sector analysts have recommended stocks such as Hyosung TNC, Samsung Electro-Mechanics, and POSCO Holdings as beneficiaries of China's economic recovery.

In the global stock market, defensive stocks outperformed throughout 2022, and in the domestic market, Chinese-related stocks have suffered for years. Since the end of last year, a rebound phase has appeared. Chinese economic-related stocks are showing strength in anticipation of the March Two Sessions and economic improvement, and market interest is expected to expand to oversold growth stocks and small- and mid-cap thematic stocks. Global interest rates have peaked, credit spreads have stabilized downward, and cryptocurrency assets like Bitcoin have begun to rebound, but growth stocks have yet to show a clear rebound in the stock market.

Improved liquidity conditions will manifest as a rebound in oversold growth stocks, Chat GPT-related stocks, and small- and mid-cap growth and thematic stocks such as metaverse, robotics, and content. Although the financial market currently lacks confidence in global economic improvement, after the second quarter, with China's full economic recovery and the halt of rate hikes limiting the U.S. economic decline, attempts to price in stock market recovery are expected. Subsequently, anticipating next year's semiconductor industry improvement, rebounds in large semiconductor stocks like SK Hynix may follow.

5. When will the rise stop?

Will it turn bearish in the second half? If global interest rate hikes stop and global economic recovery appears, and if the U.S. economy also stops declining, optimism about the economy may emerge. However, if the U.S. economy improves again, there are concerns.

This rally is due to the weak dollar, so if China's economic momentum fades in the second half and the U.S. economy bottoms out, the weak dollar may turn strong. China's reopening will eventually return as inflation to the global economy. Copper prices have already rebounded once, and oil prices have started to rise. This will become an inflation factor for developed countries over time.

Price stability throughout the first half may prove to be just a base effect by the third quarter. Structural factors such as reshoring and the new Cold War remain, and foreign direct investment (FDI) into the U.S. continues. Although U.S. consumer spending may be weak, manufacturing investment will continue. Labor shortages are difficult to resolve with monetary tightening alone. Without expansionary fiscal policy, expecting spontaneous demand recovery is difficult, and debt ceiling negotiations in the U.S. are expected to be difficult.

If price declines and interest rate stabilization are not confirmed, the growth stock rebound may end after one round. After the 2000 Nasdaq bubble burst, growth and value styles briefly lost direction, but with China's rise and interest rate increases, the stock market favored value stocks. For growth stocks to trend upward, a downward stabilization of interest rates must be confirmed, which seems difficult without price stability.

6. What factors could change the outlook for the second half?

The stock market is unlikely to fall sharply or rise further in the second half. However, if the following factors change, the outlook could differ. For the market to rise further in the second half, structural inflationary pressures must decrease.

Recently, long-term inflation expectations have fallen back to the low 2% range. Despite short-term Consumer Price Index (CPI) fluctuations, the biggest upside risk is that long-term inflation settles back at 2%.

Since Xi Jinping's third term, relations between the U.S. and China have somewhat improved, and easing tensions between the two countries is also considered an upside risk.

If the stock market rises significantly in the first half, expectations for the second half should be lowered. However, if the economic downturn deepens or credit risks emerge amid no recovery and high interest rate burdens, a larger-than-expected decline may occur. Interest rate inversions have often been resolved by cutting benchmark rates following adverse situations, a historical pattern that cannot be ignored.

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