Geopolitical Developments: South Korea’s Importance To Markets Goes Beyond K-Pop Stimulation

The global growth scare occasioned by the downturn in copper and US small stocks helped shift sentiment to the negative side yesterday, but this likely subsides as the markets work through quadruple witching of derivatives today. The volatility risk premium points to a higher market over the next few days (though volume may be light since the VRP could easily reverse and catch investors offside), while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought several positive factors for US stocks. The action in EM currencies indicates the $US is somewhat weak. The US yield curve is falling and in the current context that is bullish. Expect the S&P 500 to rise modestly over the next few days.

The risk of a deep slowdown in global growth clearly affects high valuation American stocks but also has geopolitical implications that could tip power back to the Trump wing of the GOP, a development that would most likely bring back market volatility that upends the neat and tidy uptrend in the S&P 500 since the Biden inauguration. One of the key geopolitical fronts is the Korean peninsula, which hosts the one global risk that can’t be gauged with any precision, namely the erraticism of nuclear-powered Kim Jong Un. Biden has effectively been silent on North Korea, reverting back to the pre-Trump policy of managing KJU by showing the stability and benefits of global engagement, while humoring him to keep him from getting paranoid. This could change not because of anything Biden does, but the upcoming March 2022 election in South Korea.

The election pits the centrist-liberal Democratic Party against a newly resurgent conservative big tent party known as People Power. Should the right wing triumph, it could easily send KJU into paranoia, and China might not be inclined to step in and force him to calm down. Key to the election is the relative unimportance of geopolitics to the SK voter, compared with domestic economic and cultural issues, particularly real estate, the labor market and the ability of SK to adapt its exporting prowess to current economic and commercial trends. SK has a history of valiant student protests and thus the views of its young demographic are important, and here the Democratic Party has been largely unable to alter the status quo of a have and have-not economy. Young South Koreans either participate in wealth and stature accumulation and secure jobs or are outside the arena, competing in a global economy with all the insecurities this implies. As the this note from the think tank Center For American Progress (CFAP) notes “Very few people dissatisfied with the Moon administration attribute that dissatisfaction to foreign policy. In a survey conducted at the end of November 2021, real estate policy was the most-raised source of dissatisfaction with the Moon administration, and a desire for change in government was the most-raised reason for supporting Yoon.”

Biden can do little to shape the SK election, but any aggressive action by China could easily rattle SK voters and push them to the right wing. CFAP further notes “The Biden and Moon administrations do not see eye to eye on the best way to manage China’s growing economic, military, and diplomatic power. This gap is becoming increasingly apparent as the United States engages its allies and partners to address the challenges posed by Beijing’s agenda and the Moon administration strategically avoids taking sides…The Moon administration has been circumspect in how it participates in these efforts. It is not a member of the Quad, and the May 2021 U.S.-South Korea leaders’ joint statement did not directly refer to China.8 This was in sharp contrast with the April 2021 U.S.-Japan joint leaders’ statement, which announced that U.S. President Joe Biden and Japanese Prime Minister Yoshihide Suga shared concerns over Chinese activities that are inconsistent with the international rules-based order.”

The reason Moon doesn’t take sides is China’s economic power, as 25 percent of SK’s export revenue and 21 percent of its imports by value came from China in 2019, per CFAP. But this could backfire as CFAP notes “The South Korean population’s views of China are becoming increasingly negative. In spring 2015, 37 percent of the South Korean population held a “somewhat” or “very” unfavorable view of China; by summer 2020, this figure had risen to 75 percent—comparable to the United States.35 Lee Jun-seok, the head of the conservative opposition People Power Party (PPP), said that South Korea needs to “fight against the enemies of democracy” and push back against Chinese “cruelty.”

Key to watch is the South Korean Won, which reflects both the state of global trade but also SK’s political stability. Should the Won weaken further, the prospect for a liberal world order and the health of the financial markets would both be downgraded.

My current market positions include a large cash position, and the following holdings: Activision (ATVI), Amgen (AMGN), American Express (AXP), Johnson & Johnson (JNJ), 3M (MMM), Titan Machinery (TITN) and a small net long position in the S&P 500 (the levered inverse ETF SPXU and levered ETF UPRO).