EWY - EWY: Layers Of Concern

2023-06-25 23:19:49 ET

Summary

• EWY is a value-weighted Korean ETF that is heavily exposed to semiconductors.
• In addition to fundamental risks in those markets, there are also mounting geopolitical risks that concern Korea as a central player.
• While priced in accordance with a previous semiconductor glut, it's possible geopolitics isn't being considered.

The iShares MSCI South Korea ETF ( EWY ) is an exposure to Korean stocks, where on a value-weighted basis a lot of the exposure is to Samsung Electronics ( SSNLF ) at a 23% allocation. Other semiconductor companies feature heavily too, and ultimately EWY's fortunes are heavily determined by the situation in the semiconductor markets. While markets may be pricing in a semiconductor glut similar to what was seen some years before COVID-19 and after Trump was first elected, they may not be pricing in the political issues that are brewing as Korea must balance its interests between the US and China, both important partners. Things could go wrong on the political front and affect major holdings.

Considering the Issue

As a foreign-weighted ETF EWY has a decently high expense ratio at 0.58%. Besides that, EWY is exposed to semiconductors due to lopsided holdings in chip manufacturers including Samsung but also SK Hynix. With various salvos of economic warfare being fired off in China's direction over chip technology, the US is consolidating its allies into a united front against China. Japan has limited some export of machinery to China related to the CHIPS act, while Korea must walk a tight rope as it balances the fact that its major industry depends on China as a trading partner but also depends on the US for chip technology .

China is aware of this, and is beginning to flex its diplomatic power in South Korea with its representatives making highly provocative remarks, and drawing a line in the sand around the issue of Taiwan and other key geopolitical objectives for China .

Furthermore, with China banning Micron ( MU ) imports after the G7 nations agreed to look to de-risk their supply chains from China, there is a credible threat that other economic-nationalistic policies may be put into place by China that could put pressure on South Korean exports and companies. Not all is well on the geopolitical front.

Furthermore, semiconductors, previously in shortage, are now in a glut with inventory levels too high. De-stocking is hitting the industry , as will a likely consumer slowdown already seen in Chinese markets, where both home-grown informal Chinese consumer campaigns to boycott Korean companies but also general economic difficulties in China around the end of COVID-zero have reduced revenues meaningfully from this market. What's more is that most semiconductors anyway face secular price decreases, and this could become a problem if manufacturers cannot continue to scale in a way that is largely enabled by globalised trade, which is increasingly threatened.

Bottom Line

If we have a look at the performance of EWY we can get a better picture of how markets are appraising the situation.

Prices of the ETF are similar to where the price was at when there was the semiconductor glut sometime after Trump was elected and before it was resolved in 2019. With similar glut risks now and a clear downturn in the cycle for semiconductor, markets seem to be appraising that on a historical price basis. However, a further discount might be warranted due to geopolitical risks, which could indeed mount as China seems undeterred by recent economic strife and economic blows already sustained by a certain degree of decoupling.

While the PE of the ETF is less than 10x, we think this only prices in the long-in-the-tooth cycle and not geopolitical concerns. We'd be a bit careful, especially due to the inherent operating leverage in semiconductor companies.

For further details see: