[viewpoint]Recent Momentum Is Expected to Ebb

Last week, the Korea Composite Stock Price Index moved up 4 percent, ending at 624.1 points. The rally was fueled by three main factors: anticipation of increased market liquidity after the U.S. Federal Reserve Board lowered interest rates by a steep half-percentage point for the fifth time this year to boost the shaky U.S. economy; a strong rally in the U.S. Nasdaq; and high expectations for Korea's economic recovery.

The Fed's surprise rate cut manifests its firm resolve to jump-start a stalling U.S. economy by spurring investments and improving business conditions. The cut also may have led investors to believe that both the U.S. and the Korean equity markets have bottomed out.

But we see no clear signs that the Korean economy is recovering. Exports are still sluggish, with negative growth for the last two months. We expect this trend to continue through the second quarter, as imports by manufacturers to produce exports have fallen sharply. In April, imports of raw materials fell 20 percent and imports of capital goods 23 percent. Imports of consumer goods are still growing, but at a slower pace.

The earnings power of Korean corporations remains weak, though the consensus is that earnings will pick up if the business cycle turns around by the fourth quarter, which is widely expected. But we believe that it would be premature to expect a full recovery without seeing a strong rebound in exports, which are still the engine that drives Korea's economic growth, and significant improvements in corporate earnings.

Despite improved liquidity in the stock market, its upside potential should still be limited by fundamental constraints like the gloomy export prospects and slowdowns in corporate earnings. About a month ago was a very good time for foreign investors to buy key large-capitalized blue chips. The Kospi was in the 500-520 range, and the blue chips were being traded at record low price-earnings ratios. But things have changed. The Kospi has surged more than 20 percent, and the share prices of major blue chips, like POSCO, have risen 30 percent to 50 percent. Consequently, we expect the prices of key blue chip stocks to subside and approach more realistic values.

This week, we expect the U.S. stock markets to continue to move the Kospi. In addition, we see the Dow Jones average of industrial stocks and the shares on the U.S. Nasdaq undergoing a correction period after their strong showings last week. Indeed, considering the still feeble U.S. macroeconomy, a sustained rally on the U.S. stock markets seems unlikely. As a result, the Kospi is expected to become more volatile this week, compared with last week, and end up losing any momentum for a further rally. Many investors, looking to take profits, will be watching for a reverse in the market, making for more selling pressure. We advise investors to remain cautious for a while.

The writer is a senior analyst at Meritz Securities CO., LTD.

by Kim Sang-chul