Korea Strategy:What BREXIT means for the KOSPI?

Obviously, the volatility of capital markets would remain high for thetime being: There are a number of legal and other obstacles remaining untilthe UK completely exit EU. More importantly, we think BREXIT might openthe door for other EU economies to consider a similar path to the UK. As aresult, BREXIT is not a removal of uncertainties but a trigger for biggeruncertainties. Hence, the volatility of capital markets including FX marketswould remain high and risk appetite of the markets would meaningfullydecrease, which should not be positive for the KOSPI, in general.

We maintain our relatively cautious view on the KOSPI: In our latestreport (See Korea strategy – Back to basics, 24 May 2016), we turnedrelatively sceptical on the outlook of the KOSPI and recommended investorsto be selective as we think there has been no major improvements in globalsupply-demand. Given unexpected negative event (BREXIT), we maintain ourrelatively cautious view for the market.

However, do not make a mistake via just looking at each company’sexposure to Europe: A traditional way to judge impacts on companies’fundamentals or valuations is looking at companies’ revenue exposure to theregion. However, this is not as simple as it was. Given expected shrinkage ofglobal risk appetite, we believe KRW would be weakening further against bothUSD and JPY. Hence, without significant disruptions in end-demand, someexporters (auto/auto parts and IT companies) should benefit from weakcurrency. Hence, we maintain our bullish calls on SEC, SK Hynix, and AutoParts. Also, while we are not very bullish on Auto Makers, weak KRW couldimprove investor sentiment on their competitiveness in global markets.

Also, we maintain our bullish view on non-life insurers, internet/media,and some consumer names: We believe positive underwriting cycle for nonlifersis underestimated by the market and impacts from BREXIT should beminimal (although investment yield could be under pressure for longer periodthan originally expected). In addition, we do not expect any visible impacts oninternet/media sector, which we believe will deliver strong earnings in thefuture. In addition, our top-picks in consumer sectors include KT&G, LoenEntertainment, Hanssem, and LG H&H.

If uncertainties stay longer, we cannot rule out the possibility of furtherrate cut from the BOK: Viktor Shvets, Macquarie’s head of Asia strategy,believes that central banks would have no choice but to embark on a moreaggressive stance (See Brexit et al, 24 June 2016). Although the BOK alreadycut its overnight call rate target to 1.25% in June and we do not expectadditional rate cut in 2016, we cannot rule out the possibility of additional ratecuts if uncertainties of global macro outlook stays long. If happens, it shouldbe negative for banks and life insurers, while credit card companies couldbenefit from longer than expected low interest rate environment.

Despite expected weak KRW, we remain bearish on shipbuilders andconstructors: These exporters could benefit from potential weak KRW.

However, as we expect global risk appetite to meaningfully decrease, possibledifficulties in financing for projects could significantly affect their financialstabilities, which are already very weak.