A Korean Soap Opera Comes to an End

Move aside, France-you aren't the only country with a new president! Last Tuesday, South Korean voters chose Moon Jae-in of the center-left Democratic Party (Minjoo Party) to replace the recently ousted Park Geun-hye. As observers speculate on the implications, from domestic issues like chaebol reform to renewing relations with its neighbors to the north, the immediate impact for markets is falling uncertainty. This is the latest example in a fully global trend.

Moon's win caps a turbulent stretch in Korean politics. A shocking^[i]influence peddling scandal involving one of Park's personal associates and a Rasputin-like figure led to the now-former president's impeachment last December-which Korea's Constitutional Court upheld in March. Three candidates emerged to replace Park: Moon, software entrepreneur Ahn Cheol-soo of the centrist People's Party and Hong Jun-pyo of Park's conservative Liberty Korea Party. However, ideology wasn't the dominant issue this election. Rather, many pundits saw this race as an indictment of the status quo, exemplified by Park and the corrupt political culture she represented. Polls had Moon as the favorite since early April, so his winning with 41% of the vote wasn't shocking. Hong did surprise though, finishing second at 24%, while Ahn-who enjoyed some brief bursts of popularity-fell to third at 21%. With Moon now in power and promising big changes, what can investors expect?

While Moon made standard campaign pledges-e.g., creating new jobs-gridlock will make it difficult for him to make any big, sweeping changes. For one, Moon won the lowest share of the vote of any Korean president since 1987, indicating the election was more anti status-quo than pro-Moon-perhaps limiting his mandate and political capital. More importantly, the Democratic Party holds only 120 of 300 seats (40%) in the National Assembly. Even with total support from the People's Party, a center-left coalition would only manage about 53%: short of the 60% super-majority required to pass any non-budget bills. The opposition could block legislation, promoting gridlock.

While we have frequently highlighted some of gridlock's underappreciated positives,^[ii] this could also hamper chaebol reform plans, which many foreign observers are hopeful for. Chaebol are the huge, family-run mega conglomerates that dominate Korea's political and economic realms-think of them as corporate feudal empires. These vested interests, which are generally governed opaquely and unaccountable to outside shareholders, are at the heart of the corruption culture prevalent in Korea. The government (Park included) has made numerous attempts to reform the chaebol to help free up the economy and allow greater market influence and competition, but those efforts have largely failed.

Today, pundits are more optimistic about reform prospects. Public opinion seems in favor of it, and some major chaebol heads have even been arrested for corruption and are awaiting trial-perhaps a sign the appetite for change is real. However, the chaebol still wield significant power in Korean politics, and considering they account for nearly 60% of South Korean GDP, it will be a tall order to implement significant change-even if the president had a broad mandate.

That said, chaebol reform would be a long-term benefit if it comes to pass. In the here and now, the removal of political uncertainty has benefited South Korean markets. When the scandal first broke, Korean stocks fell -8.5% in a month,^[iii] likely driven by the surprise hit to sentiment. However, year to date, Korean stocks are up 24.7%, outpacing the MSCI Emerging Markets' 16.6% return.^[iv] While hope for chaebol reform may be driving some of those returns, Korean stocks have been rallying ever since bottoming in November, when Park's days in office looked numbered. (Exhibit 1)

Exhibit 1: Korean Stocks Rise During Park Impeachment

Source: FactSet, as of 4/21/2017. MSCI Korea Index with net dividends from 9/30/2016 - 3/31/2017.

The low coincided with opposition leaders agreeing to pursue the formal impeachment process, evidence of forward-looking markets pricing in what was likely to come. After each subsequent step-the motion passing, the trial beginning and the Constitutional Court finally affirming the impeachment-Korean stocks kept climbing.

Falling uncertainty is a powerful force, and Korea hasn't been alone in experiencing it recently. In Brazil, markets rallied well before President Dilma Rousseff was impeached last September, indicating investors thought anyone would be an improvement over her. This has also been the case following different European elections this year, too (e.g., the Netherlands and France). Once markets and investors see the likely outcome-whatever it may be-they can start pricing it in and getting on with life.

With Moon now in the Blue House,^[v] one new uncertainty is South Korea's approach to North Korea. Moon has expressed desire to reopen talks with North Korea and restart the "Sunshine Policy"-an effort to engage with Pyongyang on economic and political issues-in contrast to the conservatives' hardline approach. However, the Sunshine Policy has been dormant since 2008, and it could set up some contentious points with the US. Considering North Korea's recent saber-rattling and ongoing hot war against fish, some analysts have questioned the potential broader geopolitical fallout. However, Korean tensions aren't new. They may grab headlines from time to time-as they have over the past few years-but hot rhetoric and potential regional strife lack the power to derail a global bull market or expansion. Unless the situation mushrooms into a broader global conflict, don't let the noise and speculation spook you out of your investment plan. Besides, if tensions now were really different than they've been for decades, Korean stocks probably wouldn't be rising.^[vi]

Korea's presidential election is a prime example of the power of falling uncertainty. We expect this phenomenon to continue this year-specifically in Europe-and it's a reason for global investors to be bullish this year.