Making Money off Mayhem


What good are investment ideas if they aren’t actionable?

Marcus Noland (PIIE)



Using the stock market to assess the zeitgeist is inadvisable, but the blog queue is bare…so here goes.

This train of thought was stimulated by a recent report by Nam Gilnam of the Korea Capital Market Institute titled “Politically-themed Stocks: Characteristics and Investment Risks.” In this paper, Dr. Nam identifies 60 “politically-themed” stocks, generally those allegedly linked to a presidential candidate via kinship, school ties, or regional ties. Those stocks do in fact exhibit unusually high volatility in the run-up to the election. On the day following the election, stocks associated with the winner on average exhibit an abnormal return of approximately 5 percent, while those associated with the second-place candidate exhibit an abnormal fall of about 6 percent. However, there is reversion and within five trading days, returns on the two sets of stocks have converged. This suggests that betting investing on political connections is a risky strategy, and in any event, one that you will probably need to wait five years to implement. Sorry for the stale advice.

Another domestically themed approach would be to look at cabinet appointments. When Kent Boydston passed along a newspaper article indicating that Jang Ha-sung was going to the Blue House, and his colleague from People’s Solidarity for Participatory Democracy, Kim Sang-jo, was going to be running competition policy, my reaction was “short the KOSPI!” And, as the first differenced data below shows, the market went negative on Moon’s election. To be clear, that is a market reaction, not normative, assessment—I have long been a fan of the work of the PSPD, but I think that it is fair to say that President Moon’s appointments suggest that the next few years may be hard sledding for the chaebol.

What about the external sector? Torsten Sløk over at Deutsche Bank Securities puts some numbers on rising tensions on the Korean peninsula, taking North Korean missile launches as a rough proxy of risk.

That said, the graph above suggests that the market greeted the launch of the apparently successful test launch of the new Hwasong-12 medium-range missile with a yawn.

Depending on which opposing tendency prevails, unification, or at least engagement-oriented, stocks could be a play.

Sløk’s colleague Sameer Goel reports that at a recent DB conference in Singapore when participants were polled as to whether they expected military action between North Korea and the US in the next 12 months, 69% said “No.” Goel writes, “Asked in a different session about assigning probabilities, a combined 64% of the audience put between only 0-25% chance to the likelihood of military action. Note though that a similar question last year had a cumulative 89% putting between 0-25% probability on conflict in the Korean Peninsula within the next 10 years.” So while most analysts do not expect military action, the share that do is growing. The price of South Korean credit default swaps has risen a bit this spring as the North has ramped up the invective and threatened nuclear war.

This sets up an interesting conundrum: on the one hand President Moon has laid out a vision of Sunshine 3.0 while on the other hand observers see the risk of military action increasing. Depending on which opposing tendency prevails, unification, or at least engagement-oriented, stocks could be a play. 

A couple of years ago I wrote a post titled “Unification for Fun and Profit!” profiling two new Korean mutual funds, the Shinyoung Marathon Unification Korea Stock Fund and the HI Korea Unification Renaissance Stock Fund. (AXA subsequently launched a unification fund as well.)  My treatment was mocking, and given the impenetrable mumbo-jumbo being used to flog these funds, deservedly so.

So how have they done? Not so well, as one might expect, given the trajectory of inter-Korean relations in recent years. Shinyoung, the largest of the funds, has a bit over $60 million of assets, weighted toward big firms like Samsung and POSCO that would benefit from infrastructure investment. The HI fund holds more tech.

Given the top-heavy nature of the Korean market, a fund like the Shinyoung Marathon Unification Korea Stock Fund looks suspiciously like a KOSPI index fund. (And a slightly underperforming one at that.) I suppose if President Moon adopts a more forward engagement policy as promised, there is some money to be made. As I argued in that earlier post, it is all scenario-specific, but the potentially divergent fortunes of the traded v. non-traded sectors, mergers and acquisitions, and opportunities for investment in natural resources would be themes I would be tracking in constructing my unification or engagement portfolio.

Unless of course there is a shooting war, at which point credit default swaps will be about the least of our worries.

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