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Will South Korean Equities Take Off After A Japanese Rally?

Summary Over the decades, the South Korean economy has become heavily dependent on exports. In recent years, strong won have not facilitated growth of South Korea’s GDP and the profitability of local companies. Korean equities trade at very low multiples that limit the downside risk. The introduction of any monetary stimuli could potentially kick off an equity rally. In that case, DBKO could be a winning security. Unlike Japanese stocks, the South Korean equity market has not performed well in recent years. While the most popular Japanese index, Nikkei 225, has appreciated more than 110% since the start of Abenomics in late 2012, South Korean KOSPI has gained almost nothing during the same period. Even though Japan and South Korea have much in common, they are very different in many aspects as well. For example, both countries are known for exporting high-tech products and high-quality vehicles. The South Korean economy is, however, much more reliant on exports, as demonstrated by the graph below. Data Source: The World Bank Strong won and stagnating profitability The reason behind the recent lackluster South Korean equity market returns lies in weak corporate profitability caused primarily by strengthening won. While earnings of companies listed on the First Section of the Tokyo Stock Exchange rose by 97.9% from 11/30/12 (the beginning of Abenomics) to 4/1/2015, earnings of companies included in the MSCI Korea decreased by 2.6% over the same period. It is not a big surprise that earnings of companies such as Samsung ( OTC:SSNLF ), LG Display (NYSE: LPL ), Hyundai ( OTC:HYMPY ) and Kia Motors ( OTC:KIMTF ) were significantly hindered by strong domestic currency as more than half of their revenue comes from outside of the country. Cheap valuation Based on PE multiples, South Korean equities remain incredibly cheap in global comparison. Over the above-stated period, PE of MSCI Korea has expanded from only 10.0x to 10.3x as price and earnings remained almost unchanged. To gain a better insight, PE of TOPIX has decreased from 15.0x to 14.9x thanks to strong corporate profitability due to weakening yen. Moreover, some sectors of Korea Exchange trade at extremely low multiples. This is specifically the case with autos, semiconductors, banks and IT, which last month traded with PE of 6.13x, 8.84x, 8.16x and 10.54x respectively. Some sectors like autos and banks traded even below their book value, with PBV ratios of 0.90 and 0.56 respectively. Will BOK follow in BOJ’s footsteps and introduce monetary stimulus? Without a doubt, the relative strength of South Korean won has been distinctively magnified by foreign quantitative easing programs. South Korea has suffered a great loss of its product competitiveness on overseas markets in particular against Japan. Because both countries compete in very similar markets, the BOJ’s aggressive quantitative easing program has been fatal to South Korean exports. Despite the BOK cutting interest rates to record low levels, the question remains: What will the central bank do after it runs out of its conventional monetary policy measures? We can only speculate for now, but I don’t believe that South Korea would abandon the global currency war if it realizes how important exports are for its economy. President Park stated recently at the National Assembly: We are standing at a crossroads, facing our last golden opportunity; which road we take will determine whether our economy takes off or stagnates. Now is the time for the National Assembly, the Administration, businesses and the people to come together as one and make dedicated efforts to resuscitate the economy. Graph: JPY/KRW since the start of Abenomics (click to enlarge) Source: Yahoo Finance Conclusion The launch of any quantitative easing from the side of BOK would be a bold turning point not only for South Korean won, but also for profitability of South Korean companies as more than half of their revenue comes from abroad. Therefore, subscribing to commentaries of BOK’s board members and closely monitoring the JPY/KRW currency pair can become a potentially rewarding activity. The largest and most liquid South Korea ETF is the iShares MSCI South Korea Capped ETF (NYSEARCA: EWY ), which seeks to replicate the MSCI Korea index. However, this is not a FX-hedged fund and its capital returns in case of introduction of any monetary stimulus would be diminished by currency losses for investors denominated in U.S. Hence, I would consider buying the other two funds – the Deutsche X-trackers MSCI South Korea Hedged Equity ETF (NYSEARCA: DBKO ) and the WisdomTree Korea Hedged Equity ETF (NASDAQ: DXKW ). They both have the same expense ratio of 0.58% and around the same percentage share of assets within its top ten holdings. The key difference between these two funds is in their holdings. Whereas DXKW consists of shares of only 47 firms, DBKO is diversified across 107 companies with significant exposure to Samsung Electronics, which accounts for a fifth of the fund’s assets. Top 10 Equity Holdings as of 17-Jun-2015 Name & Ticker Weight (%) Samsung Electronics Co Ltd 20.77 Sk Hynix Inc ( OTC:HXSCF ) 4.13 Hyundai Motor Co 3.25 Naver Corp ( OTC:NHNCF ) 2.82 Shinhan Financial Group Ltd (NYSE: SHG ) 2.75 Posco (NYSE: PKX ) 2.33 KB Financial Group Inc (NYSE: KB ) 2.31 Hyundai Mobis Co Ltd 2.25 LG Chem Ltd ( OTC:LGCLF ) ( OTC:LGCEY ) 2.13 Amorepacific Corp ( OTC:AMPCF ) 2.10 Data Source: Deutsche Asset & Wealth Management I believe that significant exposure to Samsung Electronics may pay off, as it is one of the most valuable brands in the world with a proven track record of sales CAGR 20.8% from 1989 to 2013 as well as above average earnings growth potential, currently trading at 9.4x PE. Therefore, I believe that DBKO is the single best security to own for eventual South Korean economy revival. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DBKO over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Momentum In High Yield Has Shifted: Buy Some Protection

Summary Since bottoming on May 27, junk bond yields have begun steadily rising again. Corporate profits indicate that yields will continue to rise. With default risk increasing, buy credit protection for high upside. Starting around the latter half of 2014, one of the major changes to take hold in the market (besides the rise of the dollar index and collapse in oil prices) has been with bond yields. Junk bond yields have been rising substantially and quickly over the past few months. Much of the change has been due to oil prices, but another cause has been the weakening of corporate profits starting in 2014. With the trend continuing strong through the first half of 2015, there is still time to buy protection against rising yields. As profits fall and oil prices stay low, rising default rates are likely in the future. In fact, default rates in junk bonds have risen to their highest level in 6 years. This article will examine the current state of the junk bond market, the sustainability of current trends, and also recommend a way to play the rising yields and default risks using a credit default swap ETF. Current State of Bond Yields (click to enlarge) Since the European Debt Crisis, which peaked in 2012, junk bond yields had been steadily falling outside of a small blip in 2014. Starting around the end of 2014, however, the increase in yields began in earnest and is now accelerating to the quickest pace since 2011. Yields are spiking, and while this is still far from what is seen during a credit crisis, the warning signs are there. Junk bond yields are now more than 20% higher than they were just a year ago, and there is no sign of an impending correction. On the contrary, the fundamentals seem to be pointing toward a further rise in junk bond yields. Explaining Recent Price Action (click to enlarge) Much of the current trend in junk bond yields can be explained by referring back to oil prices. As oil prices started to fall in 2014, yields immediately began to rise in response. When the oil price bottomed at the start of 2015, yields steadied a bit, though the trend toward rising yields remained. There was hope that oil prices would continue to rebound in the second quarter of the year, but those hopes have been dashed as oil has stood its ground around $60 a barrel. At this point, yields have responded by rising even more and accelerating. While oil explains much of this phenomenon, the increase in yields cannot be blamed totally on the black liquid. (click to enlarge) Another major trend that came about starting in 2014 has been falling corporate profits. These numbers have been showing consistent deterioration since then, and while the Q1 2015 numbers give a sign of possible hope, the historical record does not look good. The last time that corporate profits fell this much, bond yields soared in response after about a year and a half. If that sets any precedent, then bond yields are again about to soar either at the end of this quarter or in the next, especially if corporate profits are weak yet again. Given the past, now is absolutely the time to buy protection against rising yields and bond defaults. The ProShares CDS Short North American HY Credit ETF (BATS: WYDE ) may be the perfect way to play the current situation. As the ETF is short high yield credit, it profits when default rates rise, as the ETF owns a broad basket of high yield credit default swaps. While offering protection against default risk, WYDE has also shown itself to protect against time decay. Since its inception in August of 2014, WYDE has lost less than 5% of its value. CDS protection does have a cost over time, and given that it has lost so little over the time, WYDE is a safe way to play the high yield bond market with little time decay. Summary and Action to Take Junk bonds are a risky proposition right now. Oil prices look to have stalled and a quick recovery to previous levels looks a long way off. In addition, corporate profits have been weak and have been deteriorating at a pace not seen since the onset of the financial crisis. Now is the perfect time to buy protection against a spike in junk bond yields by buying credit default swaps. For the small retail investor, CDS exposure is difficult, and thus gaining exposure via the WYDE ETF may be the perfect way to do so. Disclosure: I am/we are long WYDE. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Concerned About Rising Interest Rates? Consider These 4 Alternative Investments

Summary Certain types of alternative investments are well suited to help prepare portfolios for rising interest rates in the future, while also potentially adding value in the present. We highlight senior loan, unconstrained bond, market neutral and global macro strategies. Looking past traditional stocks and bonds may help prepare portfolios for a future rise in rates By Walter Davis, Alternatives Investment Strategist As I travel across the country meeting with financial advisors and their clients, a common concern I hear voiced is “how can I position my portfolio for when the inevitable happens and interest rates start to rise?” In response, I state that certain types of alternative investments are well suited to help prepare portfolios for rising interest rates in the future, while also potentially adding value in the present. Specifically, I highlight four different types of alternatives for clients to consider: Senior loans (also known as bank loans, senior secured loans and/or leveraged loans) – Senior loans are loans made by banks to non-investment grade companies, commonly in relation to leveraged buyouts, mergers and acquisitions. The loans are called “senior” because they are contractually senior to other debt and equity, and are typically secured by collateral. Given that the loans are made to non-investment grade companies, the yield associated with them tends to be higher than on investment grade corporate bonds. 1 For example, as of the end of May, senior loans were yielding 5.51% versus a yield of 2.99% on investment grade corporate bonds. 2 Another key aspect of senior loans is that the interest rate paid is a floating rate that resets every 30 to 90 days. 3 This means that in a rising interest rate environment, as long as the rate rises above a predetermined minimum level, the investor will receive increased payments from the borrower. Therefore, senior loans may potentially outperform other types of bonds in rising rate environments due to their floating rates. Unconstrained bond funds – Unconstrained bond funds are funds in which the portfolio manager is given the flexibility to invest globally across all sectors of the fixed income markets. The manager also may use derivatives, leverage and shorting when implementing his or her strategy. Given the tools made available to the manager, unconstrained bond funds tend to have an absolute return orientation, meaning that they may seek to generate a positive return in any market environment. In a rising interest environment, an unconstrained bond fund has the ability to take advantage of rising rates by utilizing a number of derivative strategies. One such strategy would be to short Treasury bond futures. Treasury bond futures mimic the returns of Treasuries, which are negatively impacted by rising rates. Therefore, by shorting Treasury futures you would gain when interest rates rise. Furthermore, such funds have the ability to avoid regions and sectors that they do not find attractive while focusing on the regions and sectors they believe offer the best potential for success. In general, investors should expect unconstrained bond funds to potentially outperform traditional bond funds in down bond markets, and to possibly underperform traditional bond funds in rising bond markets. Market neutral funds – Market neutral funds seek to generate positive returns regardless of market environment by trading related stocks on a long and short basis. Such funds are designed to cushion a portfolio against broad market swings. Although market neutral funds invest in equities, many of these funds are designed to generate returns that are bond like, both in terms of the level of return and the volatility associated with the return. That said, investors considering market neutral funds should be aware that such funds, unlike traditional bond funds, do not generate current yield, and that they can experience more severe declines than traditional bond funds. Global macro funds – Global macro funds are funds that invest across the global markets in equities, fixed income, currencies and commodities on a long and short basis. As a result, these funds tend to be very opportunistic in their investment approach. When interest rates begin to rise, the fallout is likely to be felt across the global markets. Given the markets traded and their opportunistic nature, global macro funds have the potential to thrive in a rising interest rate environment. Read more about alternative investing from Walter Davis. References This is due to the increased credit risk associated with non-investment grade companies relative to investment grade companies. Bloomberg L.P. as of May 31, 2015. Corporate bonds are represented by a subset of the Barclays US Aggregate Bond Index, and senior loans are represented by the S&P/LSTA Leveraged Loan Index. Senior loans are usually priced relative to three-month LIBOR, with the lender receiving a fixed spread above the LIBOR rate. Therefore as LIBOR rises, the amount paid by the borrower increases. Importantly, most loans have a provision that establishes a minimum, or floor, for LIBOR. Typically the floor rate is around 1.00%. This helps protect the lender should LIBOR fall below 1.00%. Currently, the three-month LIBOR rate is approximately 0.28%. Due to the floor, LIBOR would need to rise above the 1.00% floor before the investor would receive the benefit of rising interest rates. Important information The Barclays US Aggregate Bond Index is an unmanaged index considered representative of the US investment-grade, fixed-rate bond market. The S&P/LSTA Leveraged Loan Index is a weekly total return index that tracks the current outstanding balance and spread over Libor for fully funded term loans. An investment cannot be made in an index. Past performance cannot guarantee future results. Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate. You can lose money. Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Most senior loans are made to corporations with below investment-grade credit ratings and are subject to significant credit, valuation and liquidity risk. The value of the collateral securing a loan may not be sufficient to cover the amount owed, may be found invalid or may be used to pay other outstanding obligations of the borrower under applicable law. There is also the risk that the collateral may be difficult to liquidate, or that a majority of the collateral may be illiquid. Short sales may cause an investor to repurchase a security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, exposure to potential loss is unlimited. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Before investing, carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the products, visit invesco.com/fundprospectus for a prospectus/summary prospectus. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2015 Invesco Ltd. All rights reserved. Concerned About Rising Interest Rates? Consider These Four Alternative Investments by Invesco Blog