Citi Bets Big on This Asian Market Laggard
South Korean stocks have been one of the laggards in Asia this year, down 2 percent, while its peers like Japan's Nikkei has surged over 26 percent.
Despite this poor performance, which comes on the back of two dismal years during which the benchmark Kospi tanked some 10 percent each year, Citi is betting on this index to deliver big gains in 2013.
The bank forecasts the index to hit 2,300 this year - an upside of more than 15 percent from current levels. In fact, South Korea is Citi's second most overweight market in the Asia-Pacific region after Hong Kong.
Improvement in the economy and better corporate earnings growth in the second half of the year together with lessening impact from a depreciating yen and low valuations are all going to be positive for South Korean equities, according to Michael Chung, managing director & head of Korea research at Citi.
"GDP [gross domestic product] growth will increase to 3.9 percent on the year in the second half of 2013 versus 1.7 percent in the first half, based on our economists' forecasts," Chung said in a note. "We estimate earnings of our Korea universe [companies] to improve 50 percent year on year in the second quarter and 122 percent in fourth quarter."
Asia's fourth largest economy grew at its fastest pace in two years in the first quarter at 0.9 percent from the previous quarter. But, on a yearly basis growth of 1.5 percent remained the same as in the fourth quarter of last year, which was a three-year low, Reuters reported.
But Chung said GDP growth will pick up later in the year on a recovery in government spending, which will bode well for equities. Citi is overweight on the construction, technology and auto sectors.
South Korean President Park Geun-hye's new government introduced a $15.5 billion extra budget and stimulus package in April to jump start the economy that grew at rates of 4 percent or higher before the global financial crisis in 2008.
The depreciating Japanese yen has also hit Korean exports, but Chung expects the yen to appreciate in the second half which will be positive for exporters.
"We believe this is already reflected in the market. With rising bond yields, Japanese yen depreciation has decelerated recently," Chung said.
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The Japanese yen-Korean won currency pair has depreciated more than 8 percent so far this year, making Korean exports more expensive relative to its rival.
Exports in South Korea, home to some of the world's biggest manufacturers of cars, ships and smartphones, grew at a four-month high of 3.2 percent in May despite pressures from a weakening yen.
— By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu