South Korea ETF Looks Like a Sell

In today's Wall Street Journal, Henny Sender describes an ugly situation in South Korea as labor battles corporate Korea in THE OUTLOOK: South Korea Experiences Growing Pains As Its Workers Strike for Bigger Slice of Prosperity.

Summertime means its strike season in South Korea. Some of the biggest names in the Korean economy such as steelmaker Posco (PKX), automaker Hyundai and even a local unit of General Motors (GM) have been hit by workers demanding higher compensation among other things.

"With so much production capacity idled by strikes, Korean auto exports dropped 32% last month, according to data from J.P. Morgan Securities. Hyundai, where 44,000 production workers were on strike, estimates its losses from the walkout at more than $1 billion, which will hurt the company's third-quarter results."

The reality for South Korea's workers is that they and their country have benefited more than most economists ever imagined from globalization. South Korea has a population of only 48 million but ranks as the world's 10th largest economy, just behind China and ahead of Brazil. However, Korea is now struggling with higher commodity prices, falling productivity, and a strengthening currency. As a result, more investment by Korean manufacturing firms is taking place overseas and especially in places like China, India, and the U.S. With firms shifting investment and thus having a lower dependency on their home country, workers will have even less leverage. Sun Bae Kim, managing director in charge of economic research at Goldman Sachs Group in Hong Kong comments:

"The manufacturing contraction at home is the price that they pay for globalization."

Comment: The investment implication here seems to be obvious: sell iShares MSCI South Korea Index (EWY), especially in the near-term. The labor situation only exacerbates the problems South Korean firms curently face. Also note Korea's economy is dominated by conglomerates and so too is EWY. Leading consumer electronics firms such as Samsung and LG Electronics are also feeling the pinch of a strong won (the local South Korean currency) and must deal with ever-falling LCD panel prices and higher inventories as global competition intensifies. It is worth mentioning that a stronger South Korean won could limit the downside of EWY but it also hurts it when its components report earnings.

Lastly, I believe the success story of South Korea's economy prevails but its conglomerates face one of those "inflection points" Andrew Grove warned of, and so far based on the shift in investment and the continued profitability of conglomerates, the results are positive. If EWY were to sell-off, then I think it would be a worthy consideration of a nice bounce back up and present nice upside in '07, noting that Korean firms will benefit with future Bank of Japan rate hikes easing the currency disadvantage.