KOSPI Falls as Much as During Financial Crises... Rose in All 9 Similar Past Episodes

The index rose in seven cases even as earnings forecasts were lowered

"Semiconductor fundamentals remain solid... extremely undervalued"

A sharp drop in semiconductor stocks is unlikely to trigger a credit crunch

Over the past 20 years, the KOSPI has risen without exception whenever its forward price-to-earnings ratio (PER) entered an extremely undervalued range. Even when operating profit estimates were being revised downward, the unwinding of undervaluation helped drive a rebound in the index. With the KOSPI's forward PER now at a record low, analysts say valuation normalization could provide downside support even if earnings expectations are lowered further.

According to Daishin Securities on October 27, an analysis of nine periods since 2006 in which the 12-month forward PER fell to the bottom 25% of its range up to that point and subsequently recovered found that the KOSPI rose in every case. In particular, in the seven periods other than the two in which earnings increased (November 2009 and April 2017), the forward PER rose by 8% to 43% and drove a rebound in the index while forward earnings per share (EPS) was cut by 1% to 28%.

The market is now pricing in both past experience and concerns about declining semiconductor earnings. Consensus estimates for 22 target years typically start 22% above final figures, based on the median, 15 months before those figures are finalized. At present, using the median PER of about 10 over the past 20 years, stock prices reflect a 75% decline in semiconductor earnings. This is a steeper drop than in 2019, when realized earnings were 60% below the previous year's consensus, the largest such gap on record. As a result, despite earnings forecasts being at an all-time high, the KOSPI's forward PER has fallen to its lowest level since 2006. This is seen as reflecting a combination of doubts about the profitability of industries serving the artificial intelligence (AI) sector, the sustainability of investment, and access to financing.

The pace of the KOSPI's recent decline is comparable to that seen during major economic crises. According to Eugene Investment & Securities, the KOSPI plunged 21% in the seven trading days since the start of this month. Since the 1980s, it has fallen more over the same period on only three occasions: during the 1997 Asian financial crisis (25%), the 2008 global financial crisis (31%), and the 2020 COVID-19 pandemic (25%). This has led to assessments that the market has fallen excessively, unless the decline reflects a systemic crisis involving the collapse of the real economy.

In fact, despite the sharp fall in stock prices, earnings outlooks for global semiconductor companies remain positive. According to Hana Securities, estimates for global semiconductor earnings have been raised for five consecutive weeks, even as the Philadelphia Semiconductor Index plunged 14% over one month. The dollar TED spread, which indicates whether the financial system is facing a liquidity crisis, has also remained stable at around -0.05. Analysts therefore say the likelihood that this sell-off will develop into a credit crunch is extremely low.

Daishin Securities said its analysis of 64-month periods that began with low PERs found that high-quality stocks with both strong financial health and profitability had an 86% probability of delivering gains when held for 12 months. Even in the bottom 10% of adverse scenarios, returns were limited to a loss of 0.5%, indicating far greater defensive stability than value or growth stocks. By sector, the IT sector's forward PER had fallen to 0.29 times its median for the previous five years, making its valuation discount the steepest of all sectors.

Experts said the recent stock market decline reflects a valuation adjustment driven by excessive fear, rather than a financial system crisis, and that attention should be paid to the normalization of the extreme gap between stock prices and earnings. "With the market already factoring in a cyclical discount, valuations are expected to recover in stages as earnings are confirmed," said Kwon Sunho, a researcher at Daishin Securities. "IT remains the most undervalued sector and should continue to be the core focus. But with confidence in earnings low, investors should also include high-quality stocks as a core holding for the year, since their losses would be limited even if the recovery takes a different path."

"Semiconductor stocks have plunged, but there is virtually no stress in the dollar funding markets, indicating a valuation adjustment in equities rather than systemic risk," said Lee Kyungsoo, a researcher at Hana Securities. "The gap between prices and earnings estimates has widened for five consecutive weeks to an extreme level, making the timing of mean reversion the key point."

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