[Good Morning Stock Market] "Domestic and Global Markets, Inflation and Interest Rate Rise VS Fundamental Drivers"

[Image source=Yonhap News]

[Asia Economy Reporter Eunmo Koo] As expectations for growth relative to inflation weaken, it is analyzed that the overheating and valuation burdens in the global asset market are leading to increased volatility. In particular, the short-term volatility expansion of the KOSPI, which has shown relatively strong performance compared to global stock markets since the fourth quarter of last year and whose overheating and valuation burdens have grown to extreme levels, is considered inevitable. On the other hand, if fundamental momentum that outweighs inflation and interest rate increases flows in, it is expected that the global stock market and the KOSPI can resume their upward trends.

◆Kyungmin Lee, Researcher at Daishin Securities=The biggest topics in the global asset market at the beginning of the year are inflation and interest rates. In addition, the tapering issue of the U.S. Federal Reserve (Fed) has intensified volatility in the global financial market, especially in risky assets. This is because the overheating and valuation thresholds that investors can tolerate have been exceeded.

In fact, the rise in inflation indicators and the U.S. 10-year Treasury yield persisted throughout the second half of last year. The increase since the beginning of the year (22 basis points) is also similar to the rise in the fourth quarter of last year. In the fourth quarter, investors interpreted the rise in inflation and interest rates as a relief from deflation concerns, which became a driving force for risky assets. By the same logic, the recent rise in interest rates could be seen as reflecting expectations for economic recovery. However, the market's reaction is the opposite. Despite Federal Reserve Chair Jerome Powell's remarks last week alleviating concerns about tightening and tapering, and President Joe Biden’s announcement of a large-scale additional economic stimulus package ($1.9 trillion), the global financial market showed an uneasy trend. What would have been reassuring and welcomed in the past was instead perceived as a factor driving interest rate increases, becoming a variable that expanded volatility in the global asset market.

The problem lies in the perception of the economy. In the second half of last year, the sharp global economic recovery, combined with the success and rollout of COVID-19 vaccines, additional stimulus policies, and liquidity supply expectations, allowed the rise in interest rates to be interpreted in line with economic recovery. However, recently, major economic indicators have shown clear weakness, including a reversal in China’s PMI decline, a shock in U.S. employment data, and retail sales falling short of expectations. Expectations for COVID-19 vaccine rollout have also been diluted by the continuously record-breaking global COVID-19 case and death numbers.

In fact, recent global GDP growth forecasts for the first quarter of 2021 have been rapidly revised downward. The Eurozone’s forecast dropped from -1.9% at the end of last year to -3.05%, and the Asia region’s forecast fell from 11.98% to 11.64%. The U.S., which had shown differentiated upward momentum, also saw its first-quarter GDP growth forecast reverse downward in the second week of January (from -0.6% to -0.7%). As a result, the G10 region’s first-quarter 2021 GDP growth forecast turned negative, from 0.26% to -0.15%. This is judged to be a turning point where growth expectations shifted to disappointment.

It is concluded that weakening expectations for growth relative to inflation have led to overheating and valuation burdens in the global asset market, resulting in increased volatility. In particular, the short-term volatility expansion of the KOSPI, which has shown relative strength compared to global stock markets since the fourth quarter and whose overheating and valuation burdens have grown to extreme levels, is inevitable. On the other hand, if fundamental momentum that outweighs inflation and interest rate increases flows in, the global stock market and the KOSPI will resume their upward trends. In this regard, attention is focused on the second quarter. The GDP growth rates for the U.S. and Europe in the second quarter are expected to reach 10.2% and 13.8%, respectively. This is why the recent volatility expansion in risky assets is expected to be short-lived and why a stronger-than-expected resilient rise in the global stock market and the KOSPI is anticipated after the second quarter. Short-term volatility expansion is an opportunity to increase exposure.

◆Jaeman Lee, Researcher at Hana Financial Investment=The stock market prefers inflation over deflation. However, it is quite sensitive to level changes that occur during the rise in market interest rates. The KOSPI experienced corrections during the U.S. 10-year Treasury yield surpassing 5% in 2006, 3% in 2011, 2013, and 2018, and 2% in 2015 and 2016. Currently, the U.S. 10-year Treasury yield has exceeded 1%. The stock market has entered a process of adapting to this new interest rate level, which is expected to lead to index corrections.

Since the beginning of the year, the U.S. stock market has shown relative strength in the Russell 2000 index based on rising market interest rates and expected inflation. While the tech sector, a growth sector, has underperformed within the S&P 500 index, it has shown relative strength within the Russell 2000 index. Among the Russell 2000 sectors, inflation-related sectors such as energy have the highest stock returns. This phenomenon is also observed in the S&P 500 index. This has strategic implications. In the short term, interest in existing growth stocks (or leading stocks: tech hardware, automobiles, chemicals) is likely to spread to small and mid-cap stocks. Companies with upwardly revised 2021 sales estimates, relatively high return on equity (ROE) compared to peers, and relatively low price-to-book ratios (PBR) may stand out. From a medium-term perspective, if the rise in market interest rates continues, corporate value attention may shift from intangible assets to tangible assets for revaluation.