Korea's stock market is a bubble

Now that Korea’s is cancelling its short-selling ban on 3 May 2021, I thought I should go through the evidence of whether Korea’s stock market is a bubble or not. Here are some numbers to put it all into perspective.

Anecdotal evidence

From CLSA:s Head of Korea Research:

“If we were given a task to create a giant stock market rally, what would we do? We would cut rates as low as possible and money supply as high as possible but just enough to maintain confidence in the currency, run a fiscal deficit and give out cash to people, restrict money flow into property and other assets through regulations, dis-incentivize business investment through new anti-business rules, keep people bored and from consuming and ban short- That is essentially what has happened in the real world.”

CLSA:s banking analyst wrote:

“Mr and Mrs Kims have ploughed $100bn into the local equity market since the beginning of 2020. Moreover, it is the first time in history, where we have seen tangible evidence of money from property markets move into equity.“

Reuters had an article on a Korean 12-year old boy becoming a retail trading icon:

Korea’s chief policy secretary Kim Sang-jo said:

“It’s true that signs of an unstable bubble have been seen in the stock market under the current excessive liquidity situation”

Choi Kwangwook, the chief investment officer of J&J Investments in Seoul commented:

“This current euphoria reminds me of of 1999, when the Kosdaq rallied even though the economy was still recovering from the 1998 Asian economic crisis”

A group of women in the port city of Pohang said the following, as quoted by Nikkei:

"Trading is simple and easy… You can search for brokerage houses on the internet, like Kiwoom, and open your account there."

Yoon Ji-ho, head of E-Best Research Institute said:

“The market we see now is unprecedented because it is being pushed up continuously by individual investors.”

At the beginning of the year, South Korean retail investors owned more than US$10 billion of Tesla stock, roughly 1.3% of shares outstanding - a 73x increase since the end of 2019.

Roughly three million Koreans started trading stocks last year, increasing the number of retail investors from six million to nine.

Trading volumes have tripled

The number of shares traded in KOSPI has now reached and exceeded the previous record set in 2002. The number of shares traded has gone up 3x since pre-pandemic levels.

The numbers are similar for KOSDAQ: 3x higher trading volumes than before the pandemic.

The daily average trading value has also shot up significantly:

Retail participation has gone through the roof

In late 2020, retail investors represented almost 90% of all trading volume, up from roughly 50% in March 2020.

Retail investors are buying while professional investors and foreigners are selling:

Daily net purchase value by retail investors really spiked in 2020, reaching levels that far exceeded the previous high in 2011:

The total value of Korean retail brokerage deposits has gone from below KRW 30 trillion in early 2020 to KRW 70 trillion today. The trend shift occurred in the early stages of the pandemic.

Fund flows suggest a surge in speculative activity

The value traded in major Korean ETFs also reached record highs in 2021:

Fund flows statistics from Korea Financial Investment Association also suggest significant inflows from early 2020 onwards:

Search query data suggest retail investor interest

Naver search query statistics for “stock prices” (주가) has been elevated since early 2020:

Google search query data also suggest an increase in search activity for stock-related topics. Here the same keyword “stock prices” (주가) - aimed at capturing the number of times individuals are checking the prices of stocks they own:

Record IPO activity expected in 2021

IPO activity tends to peak around speculative bubbles. Companies and insiders try to take advantage of high prices to offload shares.

Anecdotal evidence suggests very high IPO activity, especially in software & EVs:

According to this article from Reuters quoting certain analysts, the 2021 IPO market could reach roughly 4x the level achieved in 2020.

Valuations are touching record highs

KOSPI’s P/E ratio of 28x is at the top of its trading range, as is KOSPI’s P/B ratio. Note that KOSPI’s 5-year median ROE is only 6%, implying a P/E ratio of 21x against a very low return on capital.

KOSDAQ’s P/S ratio is now 1.64x, which represents a record high compared to its 20-year trading range. The same is true for KOSDAQ’s current P/B of 2.5x.

The Seven Princesses are still showing strength

Speculative activity has mostly been concentrated in a number of stocks within the EV, software or biotech industries. Local brokers jokingly called a few of them “the Seven Princesses”. An index of these seven stocks peaked in early 2021 but are still trading at a relatively high level.

Short-selling ban to be lifted on 3 May 2021

A 6-month short-selling ban was imposed in March 2020 as a temporary measure to stabilise the market. The short-selling ban was then delayed another 6 months. On 3 February 2021, the Financial Services Commission (FSC) said that it would delay the short-selling ban until (and including) 2 May 2021.

Retail investors are going to be able to sell short individual stocks. FSC is going to enable retail investors to borrow KRW 2.4 trillion from 28 brokerages to make sure that they are on an even playing field vs investment professionals when the ban is lifted. The Korea Financial Investment Association will be educating retail investors on the risks and they will only be able to engage in short-selling after taking part in mock trials with the Korea Exchange.

There are precedents: Korea resumed short-selling on 1 June 2009 after a ban was imposed in October 2008. Nothing really happened when the ban was lifted.

The situation was different back then, however. Speculative activity is much higher today. Valuation levels are at the top of their historical ranges.

Value investors will not be keen to step and buy the Seven Princesses even at 30% lower levels. Short-sellers are likely to target biotech stocks, just like they have in the past.

It’s hard to time the exact peak of a bubble. But it always ends badly.

I’d be very cautious investing in Korean stocks at this point.

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