Bears Having a Field Day as 'Korean Discount' Extends Through Political Upheaval

It sounded like a joke to many South Koreans when they first heard that their president had declared martial law. There had been no recent escalation with their nuclear-armed neighbors to the north. No straying of a South Korean destroyer into territorial waters claimed by China, as there was in 2018. No social or economic crisis. And the only chaos in the streets was prompted by the declaration of martial law itself.

But it wasn’t a joke. Embattled president Yoon Suk-yeol shocked his citizens by announcing that, as of 11 p.m. on a chilly Tuesday night, all political activities were banned, and the military would be in charge. Yoon justified his declaration, the full text of which you can find here, as necessary to “protect liberal democracy,” “protect the safety of the people,” and ward off “anti-state forces” intent on toppling the government.

It seems ludicrous to claim you’re protecting democracy by seizing power as a dictator. All media and publications were to fall under martial-law control. The unpopular Yoon, faced with a string of scandals involving his ministers and his wife that had driven his approval rating as low as 19% of the public, hoped to negate all activities of South Korea’s parliament, the National Assembly, which is majority controlled by his opposition, and rule by decree. None of those pesky politicians blocking his policies, investigating corruption or impeaching his appointees.

Martial law lasted less than six hours before Yoon was forced to lift his declaration by 4:30 a.m. local time on Wednesday. Despite soldiers attempting to block their entry, enough politicians made it into the National Assembly to vote down Yoon’s move. Opposition politicians have pledged to impeach Yoon for treason, and his defense minister has already resigned.

It’s all pretty chaotic, and took virtually everyone by surprise. Even the leader of the main opposition party thought he was watching a deepfake at first.

So, what’s the takeaway for a U.S. investor? Korean assets of all sorts sold off, of course, then stabilized. Where do we go from here?

First of all, there’s for years been a “Korea discount” priced into the Seoul market. Academic research demonstrates that Korean companies see their shares trade at a price-earnings ratio that’s 30% lower than international peers. Regulators and the stock exchange have recently worked hard to remove it via their voluntary “Corporate Value-up Programme” of shareholder-friendly corporate-governance reforms.

All that work has been undone and the discount now appears fully justified to remain. Investors have priced in poor corporate governance at the country’s chaebol conglomerates, which have all too often run for the benefit of the members of the founding family first and foremost. The controlling family offered themselves spinoffs in sweetheart deals and consolidations that somehow always concentrating power in their hands. Customers and employees came next, with shareholders a distant priority.

Prior to this whole military-law debacle, the greatest recent scandal has surrounded Samsung SSNLF. That chaebol’s executive chairman, Jay Y. Lee, was charged in the influence-peddling scandal that brought down impeached former president Park Geun-hye — South Korea’s first female leader, and also the daughter of assassinated dictator Park Chung-hee. Current president Yoon, by the way, pardoned Lee.

These close ties between business and government are no coincidence. Similar to Japan, a post-war South Korea was on its knees and saw companies work hand in hand with the government to restore the economy. This produced superb results, the “Japanese economic miracle” led by Tokyo, and in Seoul the “Miracle on the Han River.” Named for the river flowing through the capital, that saw South Korea leapfrog from one of Asia’s least-developed nations into a full-fledged, roaring Asian economy.

Korea is now the world’s 12^th-largest economy, slightly bigger than Mexico. In terms of market categorization, it fluctuates between “developed” and “emerging” status. Index provider FTSE, for instance, reclassified South Korea as a developed market back in 2009. But MSCI opted yet again to maintain its status as emerging, at its review this June.

This whole episode undermines claims that the Seoul market should be mainstream. Investors will already have been concerned with the red tape and difficulties trading stocks in South Korea, where regulators, for instance, suddenly banned short selling last November. The “temporary” ban, with the potential threat of life in prison for violators, was due to end in June but is now extended through March 2025.

Yet it had appeared that South Korea was progressing, both politically and in terms of market reforms. You may recall Kim Dae-jung winning the Nobel Peace Prize back in 2000 for his “Sunshine Policy” that led to a warming of relations with North Korea. But the North has retreated once again, back to blasting missile tests into the East Sea, and now Yoon’s move calls to mind South Korea’s darkest days.

Now, a tiny bite of history. I promise it's tiny!

South Korea has been a thriving democracy this century. But Yoon’s attempt to short circuit the system called to mind the dark days of the military dictatorships that fell into place in the wake of the 1950 to 1953 Korean War.

The country fell under the iron fist of military officers, with army second-in-command Park Chung-hee seizing power in the country’s first coup in 1961. After Park’s assassination by the Korean central-intelligence chief in 1979, counterintelligence general Chun Doo-hwan followed suit and rolled tanks and troops through Seoul. Both dictators at times declared martial law. In fact, Yoon’s announcement is the 16^th time it’s been declared since South Korea came into being in 1948.

Just like Chun’s 1980 coup, the justification is a made-up threat from North Korea. More often than not, military rule was used as a means of suppression, and for unpopular leaders to stay in power. Yoon, a conservative politician, reminded older citizens of a period of oppression, with soldiers and military vehicles once again in the streets.

Thank goodness there’s been no repeat of the crackdown in 1980, when at least 200 demonstrators against the military law were killed in the southwestern city of Gwangju. It was public protests once again in 1987 that brought Chun’s downfall, followed by the first democratically installed leader the following year.

This time, it was the alacrity with which politicians moved to vote Yoon’s declaration down that led to the quick failure of this would-be political coup. They were, in the world of social media, also aided by public protestors marching on the legislature to register their displeasure, and resist the troops. Yoon has effectively committed political suicide, political analysts say.

For now, Defense Minister Kim Yong-hyun has stepped down, with local media reporting that he suggested martial law to the president. A former student from the same high school as Yoon, Kim joined the presidential campaign in 2022 but only stepped into the cabinet post in September.

Although martial law appeared to come out of the blue, some politicians had warned of that potential in the summer, as Yoon assembled a “Chungam faction” of close allies. Yoon, who took power in May 2022, had often praised Korea’s earlier dictators. He had also named Lee Sang-min named interior minister, like Yoon and Kim also a former pupil of Chungam High School. By law in Korea, either the defense or interior minister can “propose” martial law to the president at times of national emergency. Oh and the special-forces chief who directed 300 troops to the National Assembly? Another Chungam grad.

Of course, there was no emergency this time — other than an emergency bid to keep Yoon’s presidency alive. Now he faces sure consequences, for what appears a premeditated move to seize power in an unconstitutional way.

It’s a measure of the quick response that the Seoul stock market closed only slightly down on Wednesday. The finance ministry said on Thursday that it is activating the equivalent of $28.4 billion in a market-stabilization fund, while the central Bank of Korea says it will purchase government bonds and expand operations as necessary to maintain market order.

The benchmark Kospi fell 1.4% yesterday and another 0.9% today. The political and economic uncertainty leaves the Seoul market down as a whole for the year, though, off 8.5% when most Asian markets have moved well ahead. Taiwan, a chip-heavy market like Korea, is up 30.3%, the best showing across the region in 2024.

The Korean won has suffered, too, falling to two-year lows amid the tumult. It’s down 9.5% against the U.S. dollar year to date. Bears are having a field day, noting that the “Korea discount” is justified. It ensures, for instance, that the Kospi trades at a price-to-book ratio below one, compared with 3.5 for the MSCI World.

There are plenty of reasons beyond politics as to why Korean assets have not performed. The Korean economy is flirting with recession, shrinking 0.2% in Q2 quarter on quarter, and only eking out 0.1% growth in Q3, we hear on Thursday. The full-year forecast from S&P Global of 2.0% growth next year is the lowest in Asia, outside Japan.

The voluntary corporate value-up scheme has underwhelmed investors so far, with not enough corporate buy-in or fundamental change. International institutions have been withdrawing allocations, with other Asian markets looking more attractive. There’s also tariff and trade risk for an export-heavy economy. Many Korean companies have close ties to China, which is also floundering economically. There’s the constant risk of a deterioration in the status-quo standoff against the North, with the two Koreas still technically at war.

Most of all, it is corporate reform that will be needed to improve valuations. Korea must shake off that old, clubby way of arranging corporate and political power in back rooms. Sunshine and reform must return.

This political crisis appears to have passed. But the Korea discount, we’re now reminded, will endure. 

At the time of publication, McMillan had no positions in any securities mentioned.