I work on the VIEQX international equity index which I helped design and which I help maintain. As of the last rebalance in January of this year, the Korean peninsula was still considered to be greatly at risk and headlines were almost uniformly negative. But we were not. In fact, we moved exposure to South Korea to the highest permissible weighting under the rules of the index. Why?
Here's what I wrote about that in early March:
Scores: Highly resilient. Valuation is very attractive and policy changes are better than average.
Notes: South Korea has demonstrated remarkable resilience through a recent period of domestic and international political instability. Resignation of Prime Minister and tensions with North Korea did not produce long-term negative market effects. This is partially due to the media tendency to overstate the severity of crises, but also due to South Korea’s reasonably strong rule of law and economic freedom, particularly in the realm of free trade. Debt to GDP is also low, at 38.6%."
At the time, the South Korean KOSPI index was at low valuation, largely because of the negative press about it. The following image is from a larger Country Score Card which looks at 40 highly liquid investible countries around the world.
For reference, here is the scale we use for color-coding.
‘Resiliency’ refers to a general Country Resiliency Index which was created (with some input from me) to identify a nation’s resistance to catastrophic losses during rough patches in global markets. ‘Short-term Opportunities’ is a valuation composite and ‘Long Term Opportunities’ refers to policy shifts in trade, labor market flexibility and entrepreneurial climate. The nation is extremely healthy in terms of national debt, savings rate and currency reserves (the sort of thing which triggered no end of troubles during the ‘Asian Contagion’ for those who lacked it). Business freedom is quite good too. Valuations were attractive at the beginning of the year, and there was a shift towards optimism among analysts’ forecasts which had not been matched by market participants.
SoKo was all green, but especially green in resiliency and valuation. In short, it was a nation the stock market of which was driven down in value well below its historic valuation levels, despite being highly resilient. This made it a good buy, and likely to perform well. And perform well it has. As of this writing, the KOSPI has returned 4.8% in the last 3 months, while the Dow Jones has only returned 2.27%.
The South Korean KOSPI is below in brown, against the US Dow in orange.
The lesson is this: Headlines are designed to capture your attention. Fear captures your attention probably better than anything else. Therefore, headlines tend to stoke fear. I had no more inside knowledge than anyone else did about the Korean geopolitical situation. But I did know from historical data that most headline-grabbing crises do not turn into wars, and that markets tend to overreact to international relations crises in the short run. The smart long-term move is to buy resilient countries when they are on sale. But understand this: they are on sale for a reason. When you find a nation's markets at low valuation, there will always be a fear factor pushing down, which means that in order to implement the principle of inherent value, you have to be willing to go against the emotion of the crowd. You have to buy what people are afraid of (even if it is following good principles) and sell what people are in love with (even if it is violating sound principles). Principles are most important when they are least comfortable.