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The year 2022 was one where investors faced a multitude of hazards like the Russian invasion of Ukraine, China's reversal of its market reforms and the disorderly global recovery from COVID-19. But most notable was soaring inflation not seen since the 1970s.
After decades of fighting deflation, inflation has come back with a vengeance forcing unprecedented hikes in interest rates from central banks. The pains from the deleveraging have been particularly acute for Korean investors' favorite growth stocks like Tesla, Amazon and Netflix. Another casualty was the spectacular crash of cryptocurrencies, which continues to hound investors after creating a cult-like following.
After such a challenging year, investors are understandably looking for signs of the market bottom for the coming year. I identify three key factors to watch: deglobalization, China and the Russia-Ukraine war.
The current version of inflation has a mix of the supply and demand sides of the equation. For the past 15 years, economists warned of global deflationary risks from demographic decline, technology and globalization. Unfortunately, COVID-19 has derailed the globalization movement from the deflation equation. Even before the pandemic, early signs of global trade fracturing were visible from Brexit and President Trump's presidency. The swift action from the Federal Open Market Committee (FOMC) since the beginning of last year now risks an overly hawkish path that could lead to a global recession.
The common theme throughout last year has been the increasing public and political backlash as the untouchable aura of capitalism has come under the greatest scrutiny since the 1970s. The globalization trend that served the world so well over the past decades is fracturing under the weight of deglobalization, U.S.-China tensions and the Russia-Ukraine war. The harmonious global community held together by the globalized ecosystem is coming apart, and inflation is one of the unintended consequences.
On the positive side, China is signaling its intention to relax its harsh COVID lockdown measures after almost three years of its "zero-COVID" policies. Under such a scenario, South Korea would be one beneficiary as its immediate neighbor and major trade partner. However, investors expecting a repeat of the trade boom many years ago will have to accept that times have changed permanently for Korea's China-focused industries. For many years, Korean management blamed the Terminal High Altitude Area Defense (THAAD) system for Korean products' struggles on the mainland. However, it is now apparent that the combination of Beijing's efforts for "self-sufficiency" and improving local products have made Korea Inc.'s struggles a canary in the coal mine for other global brands.
Over the past five years, South Korea's biggest and best brands saw their China businesses struggle, notably Samsung handsets, whose market share went from 20 percent to less than 1 percent in China. Hyundai Motor's market share has similarly crashed during the same period. Notably, the sales declines are not purely due to government sanctions, as fast-improving Chinese products are equally responsible.
Before the THAAD issue, Korean companies in China were led by cosmetics and duty-free sales as the Chinese swarmed both shops in the mainland and Korea for the massively popular mid-end cosmetics products popularized by the Korean entertainment industry, which comprises its dramas and K-pop bands.
The impending stimulus from China will not have the same effect on Korean exporters like the past. Korea Inc.'s past industries popular in China such as cosmetics, duty-free, cars and IT are manufacturing goods that China has now quickly replaced. With China on a path to accelerated self-sufficiency, investors should not expect that policy to change with their stimulus policy. Instead, I believe that the Korean industries that should now be directed at the China market should be "soft industries" comprising online game developers, entertainment and tourism.
If China has the greatest impact on global inflation for manufactured goods, then the Russia-Ukraine War is having a similar impact on food and European economies' energy prices. The invasion of Ukraine could not have come at a worse time as the world just started to normalize and inflation started to take hold. For many decades, global food prices have seen food price declines with the modernization of the agricultural sector and global trade. The Russia-Ukraine conflict added fuel to the inflation fire by weaponizing its energy supply to the rest of the world, providing further chaos for a nervous world already seeing interest rate hike pressures.
But regardless of China's reopening or the endgame for the Russia-Ukraine conflict, investors have to accept that the inflation genie is now out of the bottle. Key policymakers are fully aware of the risks of the premature easing of monetary and fiscal policies, which could create a stagflation scenario.
The looming recession for this year could be a necessary medicine required to tackle inflation. The recovery for the global economy and, therefore, the stock market will find it difficult to see the V-shaped recovery typical of the financial market in the past. I recommend investors keep strict discipline by investing in quality stocks with sound financials and a proven management track record and brace for a necessary period of a sobering reality check.
Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.